Abstract
The recent euro crisis has caused concerns both with respect to public-debt sustainability and the stability of exchange rates of highly indebted countries. This paper investigates these concerns in a two-country OLG model of the world economy with country-specific saving rates to mimic Asian economies. It is found that the concerns with respect to debt-sustainability are warranted since limits for public debt levels do exist. The concerns regarding exchange-rate stability are not warranted since unilateral debt expansion does not impact the real exchange at all, or the impacts are independent of the external balance of the debt-expanding country.
This is a preview of subscription content, log in via an institution to check access.
Similar content being viewed by others
Notes
In times of low and similar inflation rates among advanced countries, nominal and real exchange rates evolve largely parallel.
Cobb-Douglas production functions are defined as similar if production elasticities (or, respectively, capital income shares) are internationally equal, while the scale parameter reflecting the technological level might differ across countries.
Henceforth all variables referring to Foreign are denoted by an asterisk.
The proofs of this and all following propositions, lemmas and corollaries can be found in Farmer (2010).
In reality, both mechanisms are at work as recently illustrated by the Greek example.
This is another way to show that the real exchange rate effect of public debt variations is independent of the net foreign asset position, and this remains true whether similar or dissimilar production technologies are assumed.
The transitional dynamics were calculated numerically using the NLP solver of GAMS 2.5, version 21.5.
Zee’s (1987) conclusion appears to be based on his presumption of asymptotic stability of the real exchange rate dynamics. Both the irresponsiveness of the initial real exchange rate and the dependence of the exchange rate dynamics thereafter on the sign of the net foreign asset position (Zee 1987, p. 611) can be traced back to this presumption.
References
Azariadis, C. (1993). Intertemporal macroeconomics. Oxford: Blackwell.
Bohn, H. (2008). The sustainability of fiscal policy in the United States. In R. Neck & J.-E. Sturm (Eds.), Sustainability of public debt (pp. 15–49). Cambridge: MIT.
Candelon, B., & Palm, F. C. (2010). Banking and debt crises in Europe: The dangerous liaisons? CESifo Working Paper No. 3001, Category 6: Fiscal Policy, Macroeconomics and Growth, March 2010.
Chalk, N. A. (2000). The sustainability of bond-financed deficits: an overlapping generations approach. Journal of Monetary Economics, 45, 293–328.
Dabrowski, M. (2010), Euro crisis or debt crisis? CASE Networks E-briefs No. 09, www.case-research.eu accessed on 06/24/2010.
De la Croix, D., & Michel, Ph. (2002). A theory of economic growth. Dynamics and policy in overlapping generations. Cambridge: Cambridge University Press.
Diamond, P. A. (1965). National debt in a neoclassical growth model. The American Economic Review, 55, 1135–1150.
Farmer, K. (2010). Public-debt sustainability, exchange rates, and country-specific saving rates. In A. Bayar, C. Erbil & D. Ozdemir (Eds.), Proceedings of Ecomod 2010 International Conference on Economic Modeling, Brussels, forthcoming.
Farmer, K., & Zotti, J. (2010). Sustainable government debt in a two-good, two-country overlapping generations model. International Review of Economics. doi:10.1007/s12232-010-0092-7.
Feldstein, M. (1986). U.S budget deficits and the European economies: resolving the political economy puzzle. The American Economic Review, 1986, 342–346.
Frenkel, J. A., & Razin, A. (1986). Fiscal policies in the world economy. Journal of Political Economy, 94(3), 564–594.
Gandolfo, G. (1997). Economic dynamics. Berlin: Springer.
Goyette, Ch. (2009). The dollar meltdown: Surviving the impeding currency crisis with gold, oil and other unconventional investments. Publisher unknown.
IMF. (2006). World economic outlook. Washington: International Monetary Fund.
IMF. (2008). World economic outlook. Washington: International Monetary Fund.
IMF. (2009). World economic outlook. Washington: International Monetary Fund.
Lin, S. (1994). Government debt and the real exchange rate in an overlapping generations’ model. Journal of Economic Integration, 9(1), 94–105.
Nyahoho, E. (2006). The impossible relationship between the deficit and the exchange rate. Journal of Policy Modeling, 28, 415–425.
Ono, T. (2002). The effects of emission permits on growth and the environment. Environmental & Resource Economics, 21, 75–87.
Rankin, N., & Roffia, B. (2003). Maximum sustainable government debt in the overlapping generations model. The Manchester School, 71(3), 217–241.
Wiedemer, D., Wiedemer, R., & Spitzer, C. (2009). Aftershock: Protect yourself and profit in the next global financial meltdown. New York: Wiley.
Zee, H. H. (1987). Government debt, capital accumulation and the terms of trade in a model of interdependent economies. Economic Inquiry, 25, 599–618.
Author information
Authors and Affiliations
Corresponding author
Additional information
The author is grateful to the participants of the session on Macroeconomic Policy at the IAES conference in Prague, March 2010, for constructive criticism which helped to improve the paper. Moreover, the comments of the editor and of an anonymous referee were helpful in adjusting the original manuscript according to IAER’s guidelines.
Rights and permissions
About this article
Cite this article
Farmer, K. Public-Debt Sustainability, Real Exchange Rate, and Country-Specific Saving Rates. Int Adv Econ Res 17, 45–65 (2011). https://doi.org/10.1007/s11294-010-9284-x
Published:
Issue Date:
DOI: https://doi.org/10.1007/s11294-010-9284-x