Fiscal policy and economic growth: The role of financial intermediation

This paper analyzes the impact of public debt on financial efficiency in an overlapping-generations model. We argue that public debt may reduce intermediation costs by increasing the collateral of entrepreneurs. This effect is stronger, the stronger the non-Ricardian component of public debt, i.e. the more it is associated with intergenerational redistribution. This effect can be interpreted as future generations acting as a guarantee for the loans provided to the entrepreneurs of the current generation. Furthermore, multiple growth paths may arise as low taxes increase private collateral, which in turn boosts growth via financial efficiency, while higher growth allows to maintain the same debt/GDP ratio with reduced taxes.