ADEMU Conference on Debt Sustainability and Lending Institutions

1. Fiscal Multipliers and the Home
Bias of Public Debt
Comments by Martin Weale
August 2016

2. • Does the impact of a budget deficit depend on
whether it is financed at home or abroad?
• Home bias to holding is strongest in Japan.
• More than half of public French and German
debt is held abroad.
• Home bias is perhaps less pronounced in the
euro area than in other countries.
• Currency bias and home bias.

3. • Growth depends on lagged growth and
change in the cyclically adjusted primary
balance or narrative fiscal shock.

4. Model
• An endowment is received period 0 which can
be invested in capital (what else can be done
with it?).
• The capital can be pledged (to foreigners?)
• In period 0 the endowment plus the capital
pledged to foreigners can be used to buy fixed
capital or public debt with a fixed home bias.
• In period 1 c=rk+w+lb-x-t

5. • In period 0 k+lb=w+x
• In period 1 c=rk+w+lb-x-t
• Consumption is factor income plus domestic
holdings of government debt less capital pledged
abroad and taxes
• Or c=rk+w-t+w-k
• Consumption is factor income less taxes plus
endowment less capital stock.
• Is the capital saved up for a period 2 which is not
described?

6. • The government invests in period 0 by issuing
debt.
• In period 1 it collects the taxes to pay the debt.
• Government debt is assumed to be at zero real
interest rate. Would a negative rate be more
realistic? The marginal product of capital is
positive and it is simplest to assume that this
equals the interest rate on government debt.

7. • In a closed economy an increase in g means less k
so the impact on output is the output delivered
by extra g less the marginal product of capital.
• In an open economy which is not fully borrowed
an increase in g is financed from abroad with no
reduction in k and so no loss of output
• If the capital stock is fully pledged, then there is
some loss, increasing in the home bias of
financing and in the share of capital which can be
pledged to foreigners

8. • Below the point where constraints start to bite
borrowing from abroad seems costless.
• But this may represent what happened in the
euro area before the crisis- Greece
• The same would of course be true of private
borrowing- e.g. the Irish Republic
• If only

9. • The model does not in fact assume that debt is never
repaid so why does this result arise.
• As though the focus is on output rather than income.
• With a fixed labour supply foreign finance raises output
but the marginal product owned by foreigners accrues
to foreigners.
• The impact on income is g-f’(k) just like the effect of
domestic finance in this model
• The model tries to arbitrage the difference between
GDP and GNP. With fixed labour GNP is more relevant
and the theoretical result then disappears.

10. • What would happen with country fixed effects
as well as with year dummies?

11. • When does borrowing from abroad make you
rich?
• Some explanation is needed of why not all of the
marginal product of capital accrues to the
investors.
• In the Mundell-Fleming model a budget deficit
would lead to higher demand and a higher real
exchange rate raising supply. So GDP/GNP would
increase.
• In the euro area cost imbalances built up despite
the single market.