Endogenous growth, government debt and budgetary regimes

In this paper we analyze an endogenous growth model, in which sustained per capita growth results from investment in public capital and the government is allowed to borrow from the capital market. As to the government behavior we do not suppose that governments optimize but instead stick to some well-defined budgetary regimes. The impact of a deficit financed increase in productive government spending is analyzed. It is shown that the growth effect of this fiscal policy crucially depends on the budgetary regime in use. In particular, a more strict budgetary regime, that is, an economy where the public deficit is primarily used for public investment, does nor necessarily imply a lower growth rate. Simulations demonstrate that the growth maximizing income tax rate is about in the range of the elasticity of output with respect to public capital.