Working Paper 648

On the Needed Quantity of Government Debt

Edward C. Prescott | Senior Monetary Advisor
Kathryn Birkeland

Published December 1, 2006

People are having longer retirement periods, and population growth is slowing and has even stopped in some countries. In this paper we determined the implications of these changes for the needed amount of government debt. The needed debt is near zero if there are high tax rates and the transfer share of gross national income (GNI) is high. But, with such a system there are huge dead-weight losses as the result of the high tax rate on labor income. With a savings system, a large government debt to annual GNI ratio is needed, as large as 5 times GNI, and welfare is as much as 24 percent higher in terms of lifetime consumption equivalents than the tax-and-transfer system.

Published In: Quarterly Review (Vol. 31, November 2007, pp. 2-15)

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