Public Debt and Aggregate Stability with Endogenous Growth and a State-Dependent Consumption Tax

Abstract

We analyze how different budgetary rules affect the stability of an economy in a basic endogenous growth model with public debt and a state-dependent consumption tax rate. We show that a discretionary policy implies that the government violates its inter-temporal budget constraint along a balanced growth path, whereas a balanced budget rule guarantees that the economy is stable. A rule based debt policy gives rise to stability if the reaction of the primary surplus to higher public debt is sufficiently large. Further, in case of a strongly regressive consumption tax rate over a certain range, multiple balanced growth paths may emerge. The main results can be generalized to hold for any endogenous growth model with infinitely lived households.

Keywords: Budget rules, public debt, inter-temporal budget constraint, stability, endogenous growth

JEL Classification: C62, H63, O41