Dynamic analysis of reductions in public debt in an endogenous growth model with public capital

We construct an endogenous growth model with productive public capital and government debts where government debts are gradually adjusted to target level. We examine how debt-reductions of the government affect the transitional dynamics and welfare of the economy. Fiscal consolidation has contractionary effects on economy in the short run, whereas it has positive long run effects on the growth of key macroeconomic variables. Reductions in the government debts at the expense of public spending improves social welfare. Importantly, as the size of debt-reductions is larger and as the government reduces its debts at a higher speed, the welfare improves more.