VGSF - WU Vienna - LC

Bernard Dumas, INSEAD

Campus WU D3.0.225 11:00 - 12:15

Organizer VGSF

As part of the ser­ies of the "Fin­ance Re­search Sem­inar", VGSF wel­comes Bern­ard Du­mas from IN­SEAD to present his re­search pa­per.
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The Debt Ca­pa­city of a Gov­ern­ment

In a de­termin­istic over­lap­ping-­gen­er­a­tions economy with pro­duc­tion and phys­ical cap­ital, the mar­ket value of debt is not ne­ces­sar­ily equal to the present dis­coun­ted value of fu­ture budget sur­pluses: it can be pos­it­ive without any budget sur­pluses be­ing in the off­ing, be­cause debt in­cor­por­ates a ra­tional bubble. Yet the dy­nam­ics of debt re­main a func­tion of the dy­nam­ics of the primary budget de­fi­cit. The true fis­cal cost of ex­cess­ive gov­ern­ment debt is­su­ance can­not be assessed just from the cur­rent rate of in­terest or any cur­rent mac­roe­co­nomic vari­able. Rather, it should be assessed in a dy­namic con­text re­flect­ing anti­cip­ated de­fi­cits and pop­u­la­tion growth go­ing for­ward. As a way to study their joint be­ha­vior, we spe­cify the vari­ation of a struc­tural de­fi­cit in the form of an un­der­fun­ded so­cial-se­cur­ity scheme. We define debt ca­pa­city as the level of debt that can be just sus­tained without a change of policy all the way to an un­stable steady state. When it starts below the ca­pa­city, the debt con­verges to a stable steady state, in which the bubble is sus­tained. Above ca­pa­city the bubble un­ravels and the de­fi­cit can­not be fin­anced. In several real­istic scen­arios oc­cur­ring in econom­ies, we cal­cu­late the needed policy re­sponse, which is the true “fis­cal cost" of ex­ceed­ing debt ca­pa­city.

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