On (Non-)Neutrality of Public Debt in Growing Economies

Abstract

In this paper we analyze effects of public debt on the long-run allocation of resources in a basic endogenous growth model with infinitely lived households. The government levies an income tax and issues government bonds to finance unproductive public spending. We demonstrate that in the case of flexible wages and elastic labour supply the balanced growth rate is the higher the smaller the ratio of public debt to GDP for a given income tax rate. When wages are rigid public debt is neutral in the sense that it does not affect the allocation of resources along the balanced growth path.

Keywords: Public debt, inter-temporal budget constraint, wage flexibility

JEL Classification: E62, H61, O41