Has the Canadian Public Debt Been Too High? A Quantitative Assessment

This paper provides a quantitative analysis on whether the historically sizable public debt that the Canadian governments have accumulated might be close to its welfare maximizing level. As the public provision of liquidity to borrowing constrained individuals coupled with an increased supply of safe assets can be welfare improving, I consider a two-region model with an integrated asset market and incomplete insurancemarkets. The home country features a rich life-cycle setup, where the income dynamics rely on state of the art estimates obtained from previous studies using income tax returns. The main features are ex-ante labor earnings heterogeneity, both in levels and in growth rates, together with persistent and permanent shocks. When the public expenditure is assumed to be wasteful, I find that the optimal quantity of public debt for Canada is negative, meaning that the government should be a net saver. When the government, with a portion of its expenditure and consistent with the Canadian experience, finances valuable public goods the long-run public debt is still found to be inefficiently large, but closer to the welfare maximizing level.