Innovation-led growth in a time of debt

Domenico Ferraro, Pietro F. Peretto

Research output: Contribution to journalArticle

Abstract

We study the effects of large reductions in government budget deficits (labeled “fiscal consolidations”) on firms’ entry, innovative investments, productivity and per capita output growth in a model of endogenous technological change. Due to the absence of lump-sum taxes, temporary budget deficits set government debt-output ratios on unsustainable paths. An equilibrium then requires the specification of a date at which the debt-output ratio is stabilized at a constant finite value. We discipline parameters using post-war observations for the U.S. economy. We find that fiscal consolidations produce persistent growth slowdowns, permanently lowering the path of per capita output relative to a benchmark economy in which the fiscal consolidation is achieved with lump-sum taxes. These output losses are sizable. In this sense, government debt is a burden on the economy. Tax-based consolidations produce output losses that are twice as large as those from spending-based consolidations.

Original languageEnglish (US)
Article number103350
JournalEuropean Economic Review
Volume121
DOIs
StatePublished - Jan 2020
Externally publishedYes

Keywords

  • Budget deficits
  • Firms’ entry
  • Government debt
  • Government spending
  • Growth
  • Innovation
  • Taxes

ASJC Scopus subject areas

  • Finance
  • Economics and Econometrics

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