How much is the burden of public debt?
The impact of public debt on economic growth in neoclassical growth theory
Abstract
This study examines the impact of public debt on long-run steady state output in the framework of neoclassical growth theory. Public debt is incorporated into two fundamental neoclassical models – the Ramsey-Cass-Koopmans model and the Solow model – which differ only in their assumptions concerning the consumption behaviour of households. Furthermore, we develop a general model that is capable of quantifying the burden of public debt independently of the particular assumptions regarding household saving behaviour. Our results show, on the one hand, that the output loss caused by public debt is strongly affected by the extent to which budget deficits crowd out investment. On the other hand, the burden of public debt is country-specific and is determined by the private sector’s savings rate and the population growth rate. According to our results, the burden of public debt is relatively small in developed countries, even in the presence of a considerable crowding-out effect. All this implies that, in EU countries, the reduction of public debt cannot be expected to increase the income level and accelerate economic growth significantly.
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