The net foreign asset position and government size

This paper analyzes the relationship between the net foreign asset position of a country, and government size and consumption-wealth ratio in a stochastically growing small open economy. The model suggests that more indebted countries are associated with bigger governments when utility-enhancing government spending is also volatility-reducing. More indebted countries would have a higher volatility originating from domestic sources, thus encouraging government to increase its size. Consumption-wealth ratio would also be higher for more indebted countries. The empirical evidence based on a sample of 49 countries for the period 1970-2009 broadly supports the main results of the model across many different specifications.