3---More debt results in a more stable debt to GDP ratio
Eggertsson et al. 16 [Gauti B. Eggertsson, Professor of Economics, Brown University, Neil R. Mehrotra, Assistant Professor of Economics at Brown University, Sanjay R. Singh Lawrence H. Summers, Professor of Economics at Harvard University, director of the Mossavar-Rahmani Center for Business and Government at Harvard’s Kennedy School of Government, former Vice President of Development Economics and Chief Economist of the World Bank, former U.S. Treasury Secretary, and former Director of the National Economic Council for President Obama, “A CONTAGIOUS MALADY? OPEN ECONOMY DIMENSIONS OF SECULAR STAGNATION,” IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 64(4), pages 581-634, November 2016, doi: 10.3386/w22299]
7.2 Debt Policy As we have shown in Section 3, our model can be generalized to incorporate government debt. Foreign reserve accumulation in the absence of an increase in public debt issuance puts downward pressure on the natural rate of interest, as can be seen in equation (22). Equation (22) has other important implications. In particular, an increase in government debt will directly increase the natural rate of interest. Thus, a straightforward solution to secular stagnation is to issue government debt. That foreign reserve accumulation puts downward pressure on the natural rate of interest is essentially the inverse of this - an increase in reserve accumulation reduces the total amount of government bonds held by the private sector.25 One concern about debt-financed fiscal expansions may be the risk that materializes from a higher debt to GDP ratio that may become a burden in the future. In a secular stagnation, our model shows that increases in government spending financed by an increase in public debt actually lower the debt to GDP ratio. As emphasized in DeLong and Summers (2012) in a setting with hysteresis effects, debt-financed fiscal expansions in our model are fiscally sustainable. Conversely, reductions in the public debt actually worsen the fiscal position of countries in secular stagnation. In Proposition 9, we show that, in autarky, a permanent increase in government spending financed by debt issuance will lower the debt to GDP ratio. The proposition carries over directly to the open economy (modulo notation) under the case of perfect integration.