Public Debt and Economic Performance

This paper provides an overview of what economists know, or what they think they know about the effects of government deficits and debt on economic performance. It starts by introducing the government's budget constraint and proceeds to address the possible justifications for the issuance of public debt. Public deficits and the accumulation of public debt are matters of concern for both financial and economic reasons. The paper addresses first the issues of solvency and sustainability and the meaning, in this context, of excessive public debt. The paper focuses then on the different views on the macroeconomic impact of issuing public debt. It addresses both the Keynesian view of financial crowding out as well as the Ricardian view of deficit neutrality. Having considered these two extreme views on the effects of deficit financing, the paper then addresses some challenges to the use of public deficits as an accurate measure of public sector imbalances. It considers the views that the current measures of the deficits underestimate the true dimension of the problem, the view that current measures overestimate the problems, and the more radical view that the public deficit, as currently measured, is a meaningless economic indicator. Finally, the paper addresses the potential costs of budgetary restraint. It does so in the context of the current budget surpluses in the US as well as the budgetary rules in effect in the EMU