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.