Deep Habits and the Macroeconomic Effects of Government Debt

Mardi | 2011-03-29


In this paper, we study the effects of government debt on macroeconomic aggregates in a non-Ricardian framework. We develop a micro-founded framework which combines time-varying markups, endogenous labor supply and overlapping generations based on in…nitely-lived families. The main contribution of this paper is to provide a new transmission mechanism of public debt through the countercyclical markup movements induced by external deep habits. We analyze the e¤ects of debt-…nanced tax cuts. We show that the interest rate rises, entailing higher markups, which imply a fall in employment and consumption. It is particularily noteworthy that, even without capital, a crowding out e¤ect of government debt is obtained in the long run.However, the short-run expansionary e¤ect of debt-…nanced tax cuts, whichwould eventually be expected in a non-Ricardian framework, fails to occur.This is due to our flexible-price framework. On the other hand, we show thatincorporating sticky prices in our model causes debt-…nanced tax cuts to havea short-run expansionary effect while preserving the long-run contractionaryeffect.