Optimal Government Debt Dynamics: Lessons from the Literature

The Week That Was in Europe

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We present the main academic insights about how government debt should evolve over time, if the government seeks to maximize social welfare. We discuss (i) how to deal with positive/negative expenditure surprises, (ii) how refinancing risk, due to interest rate risk, impacts optimal government debt dynamics, and (iii) the optimal long-run level of government debt.

The academic papers we mention are:

Barro, R. J., On the Determination of Public Debt, Journal of Political Economy, 1979, https://www.journals.uchicago.edu/doi/abs/10.1086/260807

Aiyagari, S.R., A. Marcet, T.J. Sargent, J. Seppälä, Optimal Taxation without State-Contingent Debt, Journal of Political Economy, 2002, https://doi.org/10.1086/343744

Adam, K., Government Debt and Optimal Monetary and Fiscal Policy, European Economic Review, 2011, https://doi.org/10.1016/j.euroecorev.2010.11.003

Adam, K. and M. Grill, Optimal Sovereign Default, American Economic Journal: Macroeconomics, 2017, https://www.jstor.org/stable/pdf/26156466.pdf

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