PUBLIC DEBT BUBBLES IN HETEROGENEOUS AGENT MODELS WITH TAIL RISK

This article studies the public debt implications of an analytically tractable class of incomplete insurance macroeconomic models in which agents face a near‐zero probability of a highly adverse outcome. In generic models of this kind, there exists a public debt bubble, so that the real interest rat...

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Bibliographic Details
Published in:International economic review (Philadelphia) 2023-05, Vol.64 (2), p.491-509
Main Author: Kocherlakota, Narayana R.
Format: Article
Language:English
Subjects:
Debt
Economic theory
Growth rate
Insurance
Interest rates
Welfare
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Summary:This article studies the public debt implications of an analytically tractable class of incomplete insurance macroeconomic models in which agents face a near‐zero probability of a highly adverse outcome. In generic models of this kind, there exists a public debt bubble, so that the real interest rate is perpetually below the growth rate (set to zero). There is no upper bound on the deficit level or debt level that is sustainable in a bubbly equilibrium. In a public debt bubble, ex ante steady‐state welfare is higher if the government chooses policies that give rise to a larger level of debt.
ISSN:0020-6598
1468-2354
DOI:10.1111/iere.12613