Stability and determinants of the public debt-to-GDP ratio: an Input Output – Stock Flow Consistent approach

Di Domenico, Lorenzo (2021): Stability and determinants of the public debt-to-GDP ratio: an Input Output – Stock Flow Consistent approach.

Abstract

The paper develops a dynamic Input Output - Stock Flow Consistent model based on the Supermultiplier approach. This framework integrates the dimension of output determination with the system of relative prices. Through this model, we define the determinants of the public debt-to-GDP ratio and the conditions for its stability. The main results of the research show that: i) Given the saving rate, the tax rate, the interest rate and the coefficients of production, there exist a steady�state value of the public debt-to-GDP ratio ingrained in the economic system. The first two factors operate through the determination of output and public deficit, the last through the determination of the capital intensity of the aggregate production process. The interest rate operates through both channels. This result calls into question the idea of imposing budgetary rules with threshold levels independently from the very specific features of each economic system; ii) Expansions in the level of public expenditure have a permanent effect on the public debt-to-GDP ratio only in the presence of the accelerator effect, that is, through an induced increase in the stock of savings, aggregate debt and private debt-to-GDP ratio. Because of the accelerator channel, the public debt-to-GDP ratio depends on the capital intensity of the aggregate production process and, thus, on the system of relative prices. With this respect, the capital intensity determines the elasticity of private indebtedness with respect to one-point change in public spending; iii) Conversely to the neoclassical argument, the relationship between the interest rate and the public debt-to�GDP ratio goes from the first to the second. In particular, changes in the interest rate modify the public debt-to�GDP ratio through both variations in the quantitative and value dimension. Such variations have a puzzling effect on the steady-state value of the public debt-to-GDP ratio. For instance, the reverse capital deepening implies that an increase in the interest rate produces a decrease in the public debt-to-GDP ratio. Finally, we point out that, in contrast to the standard argument proposed by mainstream macroeconomics, the condition of fiscal balance jointly a positive differential between the growth rate of output and the interest rate has no relevance for the stability conditions of the public debt-to-GDP ratio. In this regard, we develop a taxonomy of the growth regimes depicted by the model deriving such conditions in each scenario. The necessary condition of stability is the absence of budgetary constraints, it becomes sufficient when one of the following is respected: the growth rate of primary public expenditure is higher than zero, the interest rate is higher than zero or the propensity to consume out of wealth is non-zero.

• Item Type: MPRA Paper
• Language: English
• Keywords: Fiscal policy, Monetary policy, Public debt-to-GDP ratio, SFC models, Input-Output
• Subjects: E - Macroeconomics and Monetary Economics > E1 - General Aggregative Models > E12 - Keynes ; Keynesian ; Post-Keynesian; E - Macroeconomics and Monetary Economics > E1 - General Aggregative Models > E17 - Forecasting and Simulation: Models and Applications; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E42 - Monetary Systems ; Standards ; Regimes ; Government and the Monetary System ; Payment Systems; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E43 - Interest Rates: Determination, Term Structure, and Effects; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy; E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook > E62 - Fiscal Policy

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