Hello everyone !
I have the following question about interpreting steady state debt.
Does high steady state debt mean that the Government has too much resources relative to its expenditures or the other way round?
I think another way to ask this is: Is high steady state debt an indicator of the strength OR the weakness of a Government/ Public finance ?
I am asking because one way to think about it is that: High debt is just bad (since it indicates high deficits and high interest payments, so unsustainability risks and so on…)
The other possible interpretation would be that: Since steady state is basically a condition, then high debt just means that the Government is able to sustain high level of debt, and that the required surplus for sustainability is even further negative, thus meaning the hight ss debt indicates high public financial health.
Which of the two (conflicting?) interpretations is correct then?
This question cannot be generally answered. In steady state, a constant primary surplus balances interest payments so that government revenue and expenditures are balancing. There is nothing inherently good or bad about this. Of course, with distortionary taxation you would usually prefer lower taxes and therefore a lower debt level.
Dear Prof. jpfeifer, thank you for your response.
Do you then think that general equilibrium models, or at least dsge models are not really helpful for modeling public debt and drawing policy advice conclusions, specially if relying on steady state and deviations from it? and thus No conclusion whatsoever can be drawn relating the sign of debt and the relative magnitude of public spending?
I have a model in which SS debt levels (both foreign and domestic) are negative, as opposed to the RBC counterpart that I wrote for my master’s. My first thought was that … oh that means government has too much resources… but then this can also mean the exact opposite, depending on the interpretation.
Also, does the distortionary nature of taxing mean that higher surplus (and lower debt) is always better than otherwise?
It all depends on the model at hand and the questions you are asking. The sign of the debt is relevant, though. We rarely ever observe governments with assets, i.e. savings. Most governments are debtors.
So if we assume a simple SS debt level : B=(T-G)/i. So higher taxes (or lump sum public income/windfall) lead to even more debt (which sounds counterintuitive) ? or should this rather be interpreted as higher taxes can allow to afford higher debt services at the steady state?
In My model the Government does have an asset in foreign currency, and this is exactly where the confusion lies. Because I don’t (theoretically) know wether the resource fund is contributing to making the debt more or less negative, given that it is just an exogenous resource).
I do get that a lot depends on the model’s specs, I am just wondering if there is a somewhat common meaning for a shock sending debt up as opposed to sending it down; and which one could be said to have had a better effect on the economy
Yes, a higher debt level in steady state requires higher taxes. But an equivalent reading is that higher taxes allow for a higher debt level.
With respect to foreign assets: this is typically not about the steady state but dynamic properties. In steady state assets are perfect substitutes. You would not have foreign assets and domestic debt. But with different types of shocks, foreign assets may allow you to better weather shocks.
I think I just have to be more careful about the interpretation of debt response on-impact and in the long run (say for a permanent shock).
So in a frictionless framework like basic RBC, debt is dynamically positively related to the deficit, BUT, negatively related at the SS (i.e. on-impact response is in the opposite direction to the long term effect. I got this result in my MA thesis results).
I think this is also an instance where math does not serve economics that well, because it kind of says that when the government has more resources and the increase in the expenses and interest rate are not high enough to at least offset the increase in the revenue spike, the Government is FORCED to take on more debt just so that at the steady state the extra revenue finally finds a use as extra debt interest payment. Meanwhile in real life spikes in Government revenues will probably lead to new projects being created and financed until no extra. Maybe it’s a better idea to keep the debt constant and calibrate it as a fixed % of GDP and then let public spending fluctuate to absorb changes in government revenues instead of the other way round. I will definitely look more into this, as it might lead to better results.