Stability and determinants of the public debt-to-GDP ratio: a Stock-Flow Consistent investigation

This paper aims to outline the stability conditions and the determinants of the public debt-to-GDP ratio within a theoretical framework representing the main features of a monetary economy of production. To this end, we develop two macro – Stock Flow Consistent (SFC) models that, unlike traditional ones that are studied through simulations, are solved analytically. In detail, we firstly derive such conditions from a SFC model of a dynamic version of the traditional income-expenditure scheme with endogenous public debt service and only fiat money. Secondly, we extend the model to include investments and bank loans, thus considering both fiat and private money creation. Thereby, we develop an analytically solvable SFC model based on the Supermultiplier approach. Our main findings outline that: i) The steady-state value of the public debt-to-GDP ratio is determined by the saving rate, the growth rate of primary public spending, the tax rate, the capital intensity of the production process and the interest rate. Given these values, there exists a “natural” level of the public debt-to-GDP ratio towards which the system converges in the long-run. In particular, the public debt-to-GDP ratio depends positively on the saving rate and negatively on the tax rate and growth rate of autonomous spending, while the interest rate has a non-linear effect. This result calls into question the idea of imposing exogenously given thresholds for targeting budgetary rules independently from the very specific features of each economic system; ii) The necessary condition for the stability of the public debt-tp-GDP ratio is the absence of fiscal rules jointly to no full-hoarding of income from interest on public bonds. It becomes sufficient when one of the following is fulfilled: the growth rate of primary public expenditure or the interest rate or the propensity to consume out-of-wealth is higher than zero. Finally, we highlight that permanent expansions in the level of public expenditure have only a transitory effect on the public debt-to-GDP ratio, in the long-run its value goes back to the level determined by the above-mentioned parameters. The only fiscal manoeuvres that Government has at its disposal to lower the ratio are: a persistent increase in the growth rate of public spending or an increase in the tax rate.