Sustainability of public debt, investment subsidies, and endogenous growth with heterogeneous firms and financial frictions

MAEBAYASHI, NORITAKA (2024): Sustainability of public debt, investment subsidies, and endogenous growth with heterogeneous firms and financial frictions.

Abstract

This study investigates the effect of public debt on growth, interest rates, and fiscal sustainability using a simple endogenous growth model with financial frictions and firm heterogeneity. Increases in public debt lead to higher real interest rates through financial markets, increase the cost of repaying public debt, and reduce private investment, resulting in lower long-run growth. Thus, large public debt is less sustainable. This study also examines the effect of investment subsidies financed by public debt and finds that they hinder economic growth in the long run unless the financial market is close to perfect. Therefore, increases in investment subsidies should be financed not only by issuing public bonds, but also through tax increases. Moreover, the impact of these fiscal policies on inequality among agents is briefly discussed.

• Item Type: MPRA Paper
• Language: English
• Keywords: Sustainability of public debt, Finantial frictions, Firm heterogeneity, Investment subsidies
• Subjects: E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook > E62 - Fiscal Policy; H - Public Economics > H2 - Taxation, Subsidies, and Revenue > H20 - General; H - Public Economics > H6 - National Budget, Deficit, and Debt > H60 - General

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