The public debt multiplier

TL;DR

This paper analyzes how temporary changes in government debt affect economic activity, finding the debt multiplier varies with economic conditions and debt levels, with implications for fiscal and monetary policy during crises.

Contribution

It introduces a model linking debt levels to the debt multiplier and explores policy implications during recessions and crises.

Findings

Debt multiplier is small during normal times but larger during crises.

Higher steady state debt increases the debt multiplier and real interest rate.

Fiscal consolidation during recessions may be ill-advised.

Abstract

We study the effects on economic activity of a pure temporary change in government debt and the relationship between the debt multiplier and the level of debt in an overlapping generations framework. The debt multiplier is positive but quite small during normal times while it is much larger during crises. Moreover, it increases with the steady state level of debt. Hence, the call for fiscal consolidation during recessions seems ill-advised. Finally, a rise in the steady state debt-to-GDP level increases the steady state real interest rate providing more room for manoeuvre to monetary policy to fight deflationary shocks.