Government Debt

Abstract

In Chapter 9 we introduce government debt into the basic model. We first show that the tax-financed transfer payments and Diamond’s debt have the same effect on the long-run equilibrium. We also show that if lump-sum taxes are appropriately adjusted, debt policy is not effective and hence the government deficit is a meaningless policy indicator. We then examine the burden of debt and show that an increase in a constant amount of government debt per worker will crowd out capital accumulation in the long run. Section 2 also analyzes economic activities of government by introducing government capital.