Does it Pay to Have a Balanced Government Budget?

This paper presents an endogenous growth model with public capital and public debt. The government finances productive and unproductive public spending through income taxation and through public deficits. In addition, the primary surplus to GDP ratio is set such that it is a positive function of the debt ratio which is a necessary condition for the inter-temporal budget constraint of the government to be fulfilled. The paper then studies growth and welfare effects of the model assuming a balanced government budget and compares the outcome to the scenario where public debt grows in the long-run, but at a smaller rate than capital and consumption, and to the scenario where public debt grows at the same rate as capital and consumption. The analysis is undertaken both for the model on the balanced growth path as well as for the model on the transition path