Abstract
Empirical evidence shows an inverted U-shaped relationship between public debt-to-GDP ratio and economic growth for many advanced economies. Using a simple endogenous growth model with public debt under the Golden Rule of Public Finance (GRPF), which allows the government to issue bonds only to finance public investment, this paper explains the relationship. Although Greiner [1] explains it in the similar model, he introduces a more restrictive assumption than GRPF that the amount of public investment must be always equal to that of newly issued bonds, i.e., public investment must be financed only by newly issued bonds. This paper shows that the assumption is not needed. In other words, the inverted U-shaped relationship emerges in a more realistic case when public investment is partly financed by other sources than government bonds such as taxes.
Highlights
For many advanced economies such as the United States, Japan, and European countries, the accumulated public debt has been one of the biggest concerns
Proposition 2 Under the Golden Rule of Public Finance the relationship between debt-GDP ratio and the long-run growth is inverted U-shaped regardless of the share of public investment financed by government bonds
From Subsection 3.3, which shows debt-GDP ratio increases with tax rate, we derive the relationship between debt-GDP ratio and growth is inverted U-shaped
Summary
For many advanced economies such as the United States, Japan, and European countries, the accumulated public debt has been one of the biggest concerns. Checherita-Westphal et al [11] investigate an endogenous growth model with public debt and productive public capital under GRPF to derive the growth maximizing debt-GDP ratio in the long-run. They extend the theoretical analysis and give the robust estimates of the growth-maximizing debt-to-GDP ratios for the OECD, EU and euro area countries. We reexamine the conditions under which an inverted U-shaped relationship between debt-GDP ratio and economic growth emerges in an endogenous growth model.
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