Public capital, sustainable debt and endogenous growth

We analyze an endogenous growth model with public capital and public debt where we posit that the primary surplus of the government is a positive function of cumulated past debt with an exponentially declining weight put on debt further back in time. We consider two scenarios: first, we study the model assuming that the government runs a balanced budget and, then, we compare the outcome to that of the model with permanent deficits. We analyze growth effects of the two scenarios and we study how fiscal policy of the government affects the dynamics of the model economy. It is demonstrated that the balanced growth rate is higher when cumulated past public debt is smaller. Further, we show that the debt policy of the government crucially determines the dynamics of the model economy and that endogenous growth cycles can arise.

► An endogenous growth model with productive public capital and public debt is analyzed.
► The primary surplus depends on weighted cumulated past debt that guarantees sustainability.
► It is shown that a balanced budget yields a higher growth rate than a scenario with permanent deficits.
► The balanced budget scenario implies a unique balanced growth path.
► With permanent deficits two balanced growth paths may exist and endogenous growth cycles can arise.