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Wealth Inequality and the Optimal Level of Government Debt


Röhrs, Sigrid; Winter, Christoph (2011). Wealth Inequality and the Optimal Level of Government Debt. Working paper series / Department of Economics No. 51, University of Zurich.

Abstract

In this paper, we quantitatively analyze to what extent a benevolent government should issue debt in a model where households are subject to idiosyncratic productivity shocks, insurance markets are missing and borrowing is restricted. In this environment, issuing government bonds facilitates saving for self-insurance. Despite this, we find that in a calibrated version of the model that is consistent with the skewed wealth and earnings distribution observable in the U.S., the government should buy private bonds, and not issue public debt in the long run. The reason is that in the U.S., a large fraction of the population has almost no wealth or is even in debt. The wealth-poor, however, do not profit from an increase in the interest rate following an increase in public debt. Instead, they gain from higher wages that result from a reduction in debt. We show that even when the short run costs of higher capital taxation are taken into account, it still pays off to reduce government debt on overall. Moreover, we find that endogenizing household’s borrowing constraints by assuming limited commitment leads to even higher asset levels being optimal in the long run.

In this paper, we quantitatively analyze to what extent a benevolent government should issue debt in a model where households are subject to idiosyncratic productivity shocks, insurance markets are missing and borrowing is restricted. In this environment, issuing government bonds facilitates saving for self-insurance. Despite this, we find that in a calibrated version of the model that is consistent with the skewed wealth and earnings distribution observable in the U.S., the government should buy private bonds, and not issue public debt in the long run. The reason is that in the U.S., a large fraction of the population has almost no wealth or is even in debt. The wealth-poor, however, do not profit from an increase in the interest rate following an increase in public debt. Instead, they gain from higher wages that result from a reduction in debt. We show that even when the short run costs of higher capital taxation are taken into account, it still pays off to reduce government debt on overall. Moreover, we find that endogenizing household’s borrowing constraints by assuming limited commitment leads to even higher asset levels being optimal in the long run.

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Additional indexing

Item Type:Working Paper
Communities & Collections:03 Faculty of Economics > Department of Economics
Working Paper Series > Department of Economics
Dewey Decimal Classification:330 Economics
JEL Classification:E2, H6, D52
Uncontrolled Keywords:Government Debt, Endogenous Borrowing Constraints, Incomplete Markets, Crowding Out
Language:English
Date:December 2011
Deposited On:20 Dec 2011 15:28
Last Modified:05 Apr 2016 15:17
Series Name:Working paper series / Department of Economics
Number of Pages:31
ISSN:1664-7041 (P) 1664-705X (E)
Official URL:http://www.econ.uzh.ch/static/wp/econwp051.pdf
Related URLs:http://www.econ.uzh.ch/static/workingpapers.php
Permanent URL: http://doi.org/10.5167/uzh-53568

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