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Optimal Level of Government Debt

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Optimal Level of Government Debt

Matching Wealth Inequality and the Financial Sector

ECB,

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Should governments borrow at all?

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7

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  • Innovative

Recommendation

Debate over the impact of government debt on an economy continues in the wake of the Great Recession. Public-sector borrowing can fund fiscal expansions that are designed to drive consumption and growth, but that debt also can dampen private-sector investment and harm growth in the long run. Economist Edgar Vogel of the European Central Bank makes an important new contribution to the research on ideal sovereign debt levels. getAbstract recommends his report, despite its rather dense and theoretical delivery, for its realistic modeling of the effects of government debt on economic welfare.

Summary

Discussions about the economic impact of government indebtedness have a long history: Nineteenth-century economist David Ricardo posited that, because rational actors in an economy expect a government to repay its debt eventually, they will adjust their behavior accordingly, thereby neutralizing any of the debt’s consequences on the economy. However, this theoretical rather than practical approach ignores several factors that would inhibit participants’ rational responses, such as generational differences in the winners and losers affected by government indebtedness, “distortionary taxation...

About the Author

Edgar Vogel is an economist at the European Central Bank.

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