Sustainable Government Debt in a Two-Country Overlapping Generations’ Model

Abstract

Several years before the outburst of the present economic crisis, maximum sustainable government debt in closed economies has become a matter of theoretical concern (Chalk, Journal of Monetary Economics, 2000; Rankin and Roffia, The Manchester School, 2003). The closed-economy framework precludes, however, the analysis of sustainable government debt in large open, interdependent economies. At the present stage of international integration, dramatically rising government deficits in large open OECD countries make it imperative to explore limits for national government debt levels which, if slightly changed, would lead to a sudden collapse of the world economy. To the best of these authors knowledge, limits for government debt in neoclassical open-economy growth models have not been investigated at all. Hence, there are the following research questions to be answered: (1) Do maximum sustainable government debt levels always exist and what happens if these limits are reached? (2) How are national maximum government debt levels related, positively or negatively? (3) Which structural parameters determine national government debt limits? Methodologically, we extend Rankin and Roffia’s closed economy overlapping generations’ model towards a two-good, two-country setting which portrays a world economy consisting of two sets of countries characterized by opposite net foreign asset positions. Both countries are interconnected through free trade in produced commodities and in bonds emitted by national governments. Within this model setting, interconnectedness and determining factors of maximal national Int Adv Econ Res (2010) 16:124–125 DOI 10.1007/s11294-009-9236-5