The optimum quantity of debt

S. Rao Aiyagari, Ellen R. McGrattan

Research output: Contribution to journalArticlepeer-review

132 Scopus citations

Abstract

We find that the welfare gains to being at the optimum quantity of debt rather than the current US level are small, and, therefore, concerns regarding the high level of debt in the US economy may be misplaced. This finding is based on a model of a large number of infinitely lived households whose saving behavior is influenced by precautionary saving motives and borrowing constraints. This model incorporates a different role for government debt than is found in standard models, and it captures different cost-benefit trade-offs. On the benefit side, government debt enhances the liquidity of households by providing an additional means of smoothing consumption and by effectively loosening borrowing constraints. On the cost side, the implied taxes have adverse wealth distribution and incentive effects. In addition, government debt crowds out capital via higher interest rates and lowers per capita consumption.

Original languageEnglish (US)
Pages (from-to)447-469
Number of pages23
JournalJournal of Monetary Economics
Volume42
Issue number3
DOIs
StatePublished - Oct 12 1998

Keywords

  • Borrowing constraints
  • E6
  • Government debt
  • H6
  • Precautionary saving

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