A Brief Survey of the Literature

Abstract

A good deal of analysis has been performed on the sustainability and optimality of public debt. First of all regard a closed economy where the government fixes the deficit ratio (or, for that matter, the deficit per head). Diamond (1965) builds an overlapping generations model of a growing economy. The government makes public transfers. Specifically it fixes the deficit per head. Diamond postulates the existence and stability of a long-run equilibrium. He reaches the conclusion that budget deficits crowd out private investment. Phelps and Shell (1969) investigate a Solow model of a growing economy. Once again the government makes transfers and fixes the deficit per head. The authors demonstrate that there are two long-run equilibria, one of them being stable, the other unstable. Barro (1974) studies an overlapping generations model of a stationary economy, emphasizing the bequest motive. The government makes transfers and fixes the deficit per head. As a consequence, a steady state does indeed exist. He shows that, under these circumstances, budget deficits do not crowd out private investment (Ricardian equivalence). Carlberg (1984, 1985, 1988) starts from a Solow model of a growing economy, allowing for public consumption and public investment. The government fixes the deficit ratio. In this situation there is a unique long-run equilibrium. What is more, there exists an optimal deficit ratio. Further he probes into an overlapping generations model of a growing economy where the government makes transfers. The government fixes the deficit ratio. In this case there are two long-run equilibria. In addition the optimal deficit ratio is ascertained. Ihori (1988) constructs an infinite horizon model of a growing economy with public consumption as well as public investment. Assuming a constant saving ratio, he deduces the optimal deficit ratio. The monograph by Grill (1989), though written independently, is much in the same spirit as the paper by Ihori. Michaelis (1989) examines an overlapping generations model of a growing economy. The government either consumes or invests. It fixes the deficit ratio. Within this setting there are two steady states. And there exists an optimal deficit ratio. Beyond that he introduces the bequest motive and determines once more the optimal deficit ratio. Under these conditions, surprisingly, Ricardian equivalence does no longer hold.