Public debt accumulation and fiscal consolidation

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Abstract:

In this study, we analyse the relationship between interest rates on government bonds (GB) and the fiscal consolidation rule by using an overlapping generation model with endogenous and stochastic growth settings. Our key findings are summarized as follows. First, contrary to conventional view, we find that interest rates on GB may decline as public debt accumulates relative to private capital. Second, the simulation reveals that the economy may exhibit discrete changes with divergent interest rates, implying that the observed trend of relatively low interest rates on GB with public debt accumulation may not continue indefinitely in the future. Third, fiscal consolidation rule plays a key role in determining equilibrium interest rates.

Keywords: E17; E62; H30; H5; H60; H63; default risk; fiscal consolidation rule; interest rate on government bonds; overlapping generation model

Document Type: Research Article

DOI: http://dx.doi.org/10.1080/00036846.2013.851772

Affiliations: 1: Faculty of Economics, Hosei University, Tokyo, Japan 2: Graduate School of Economics, Hitotsubashi University, Tokyo, Japan

Publication date: March 3, 2014

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