Debt as a blessing: A capital screening mechanism

Area of Science:

• Economics
• Fiscal Policy
• Macroeconomics

Background:

• A prevailing economic view suggests a negative interest-growth rate gap (r-g) enables debt-financed government spending without future costs.
• This perspective is challenged by models where fiscal policy influences economic equilibria and capital allocation.

Purpose of the Study:

• To challenge the

Main Methods:

• Formulation of an economic model where the interest-growth rate gap (r-g) and other key variables are endogenous.
• Analysis of fiscal policy's impact on equilibrium multiplicity and capital allocation.
• Examination of the real interest rate as a screening mechanism for investment efficiency in an economy with heterogeneous entrepreneurs.

Main Results:

• A negative interest-growth rate gap (r-g) can signal convergence to a low-efficiency equilibrium due to sustained government deficits.
• Fiscal surpluses eliminate equilibrium multiplicity, fostering a unique, high-productivity equilibrium.
• Persistent deficits can create a 'misallocation trap' with scarce safe assets, low interest rates, inefficient firms, and reduced aggregate productivity.

Conclusions:

• The costs of debt-financed fiscal deficits extend beyond deferred taxes to include permanently lower national productive capacity.
• Fiscal policy significantly influences economic outcomes by selecting among multiple equilibria.
• A 'debt as a blessing' scenario, as per Alexander Hamilton, is contingent on fiscal surpluses anchoring expectations for high productivity.