Effects of Public Debt on the Wealth and the Execution of Fiscal Policy

by Michael Hohenthal

Institution: University of Helsinki
Year: 2015
Keywords: Taloustiede
Record ID: 1131450
Full text PDF: http://hdl.handle.net/10138/153961


In most countries there is today more than ever an ongoing discussion about public debt. The purpose of this paper is to highlight the effects of public debt on exercising fiscal policy and the consequences of public debt for the society. As a base this paper first deals with a situation where individuals of one generation live for two periods. A framework for that is developed. This framework is then extended to four multi-period versions. I first extend the framework to one with overlapping generations and inter-generational transfers of wealth. This extension is then modified to take into account transaction costs of the collection of taxes. Next I take into account the distortion effects of the taxation. Then I deal with the pricing of public debt and the final extension describes what is required for a fiscal policy to be considered sustainable. The basic framework shows that with public expenses being kept constant, periodic changes in taxes do not affect the wealth and the consumption of individuals. However, their savings will change in order to balance the variation in taxes. The extension with overlapping-generations implies that if the wealth transfer is positive, changes in public debt will have no effect on the consumption and the net wealth of the individual. If the transfer is zero, there will be an effect, just as in the case with transaction costs connected to the tax collection. It turns out that with distortionary taxation the optimal taxation policy is to keep the periodic tax burden constant. I then show that future budget surpluses are needed to finance public debt and that knowledge of the past affects the present budget surplus and the evaluation of the present public debt. Finally I prove that limiting the public debt to the present value of future increases of the real GNP is a sustainable fiscal path. With perfect capital and labour markets, public debt does not have an impact on the wealth of the society and its individuals. However, in reality the capital and the labour markets are not perfect and there are different transaction costs and negative effects of taxation. Under these circumstances, increased public debt clearly negatively impacts the net wealth. Public debt also creates fiscal requirements on the economic development of the society. The amount of public debt can equal the present value of all future budget surpluses, but cannot exceed the discounted future increases of the real GNP. I de flesta länder pågår det i dag en diskussion om den offentliga skulden. Syftet med detta arbete är att belysa hur den offentliga skulden påverkar utövandet av finanspolitik samt att belysa konsekvenserna av offentlig skuld för samhället. Som utgångspunkt för detta arbete behandlas först en situation där individer från en och samma generation lever under två perioder. En struktur för detta utvecklas. Denna struktur utvidgas därefter till fyra flerperiods versioner. Först utvidgar jag strukturen till att inkludera överlappande generationer och förmögenhetstransaktioner mellan två…