The Debt Multiplier

31 Pages Posted: 20 Dec 2018 Last revised: 29 Oct 2020

See all articles by Alice Albonico

Alice Albonico

Università degli Studi di Milano-Bicocca - Department of Economics, Management and Statistics (DEMS); Università degli Studi di Milano-Bicocca - Center for European Studies (CefES)

Guido Ascari

University of Pavia

Alessandro Gobbi

University of Milan

Date Written: December 20, 2018

Abstract

This paper studies the debt multiplier, that is the effects of a temporary and pure change in government debt on economic activity. Contrary to an infinitely-lived representative agent model, in an overlapping generations (OLG) framework output increases even after a temporary increase in debt due to a lump-sum tax reduction that is totally reversed in the future. When nominal interest rates are positive, the debt multiplier is generally quite small. However, the debt multiplier is much larger when the nominal interest rate is at the zero lower bound. Hence, the call for fiscal consolidation in recession times seems ill-advised. Moreover, the steady state level of debt matters in an OLG framework. Multipliers tend to increase with the level of debt in steady state. A rise in the steady state debt-to-GDP level increases the steady state real interest rate and thus it provides an alternative route to increase the room for manoeuvre for monetary policy facing deflationary shocks.

Keywords: Fiscal Policy, Public Debt, Multiplier, Overlapping Generations

JEL Classification: E52, E62, H63

Suggested Citation

Albonico, Alice and Ascari, Guido and Gobbi, Alessandro, The Debt Multiplier (December 20, 2018). University of Milan Bicocca Department of Economics, Management and Statistics Working Paper No. 396, Available at SSRN: https://ssrn.com/abstract=3304494 or http://dx.doi.org/10.2139/ssrn.3304494

Alice Albonico (Contact Author)

Università degli Studi di Milano-Bicocca - Department of Economics, Management and Statistics (DEMS) ( email )

Piazza dell'Ateneo Nuovo, 1
Milano, 20126
Italy

Università degli Studi di Milano-Bicocca - Center for European Studies (CefES)

U6 Building
Viale Piero e Alberto Pirelli, 22
Milano, 20126
Italy

Guido Ascari

University of Pavia ( email )

27100 Pavia
Italy
+39 0382 506211 (Phone)
+39 304226 (Fax)

Alessandro Gobbi

University of Milan ( email )

Via Festa del Perdono, 7
Milan, 20122
Italy

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