How Do Governments Set Public Deficits? A Note on Persistent Deficit, Growth, and Indeterminacy

Abstract

In a recent paper Minea and Villieu (2012) present an endogenous growth model with productive public spending and government debt and assert that their model can generate multiple balanced growth paths. We show that their result is non-generic and point out where the error in their analysis is. In addition, we demonstrate that their deficit rule is a restrictive special case of a more general rule that has been frequently analyzed in economics, empirically and theoretically. This general rule gives rise to a richer dynamics in the sense that two saddle point stable balanced growth paths can ocur. In particular, the inter-temporal elasticity of substitution of consumption and the way how governments set the primary surplus are decisive as concerns the emergence of multiple balanced growth paths.