Optimal Government Debt Dynamics: Lessons from the Literature

We present the main academic insights about how government debt should evolve over time, if the government seeks to maximize social welfare. We discuss (i) how to deal with positive/negative expenditure surprises, (ii) how refinancing risk, due to interest rate risk, impacts optimal government debt dynamics, and (iii) the optimal long-run level of government debt. The academic papers we mention are: Barro, R. J., On the Determination of Public Debt, Journal of Political Economy, 1979, https://www.journals.uchicago.edu/doi/abs/10.1086/260807 Aiyagari, S.R., A. Marcet, T.J. Sargent, J. Seppälä, Optimal Taxation without State-Contingent Debt, Journal of Political Economy, 2002, https://doi.org/10.1086/343744 Adam, K., Government Debt and Optimal Monetary and Fiscal Policy, European Economic Review, 2011, https://doi.org/10.1016/j.euroecorev.2010.11.003 Adam, K. and M. Grill, Optimal Sovereign Default, American Economic Journal: Macroeconomics, 2017, https://www.jstor.org/stable/pdf/26156466.pdf