Dette Publique (document en anglais)

1 Introduction

A series of recent papers have focused on the normative exercise of determining

the optimal level of public debt in non Ricardian economies where agents face

borrowing constraints, idiosyncratic risk and incomplete insurance markets.

The starting point of this literature is the seminal paper of Aiyagari and Mc-

Grattan (1998). These authors argue that agents balance the adverse effects of

higher distorting taxes and crowding out of private capital with the favorable

effect of reduced cost of precautionary saving. Their setting yields an optimal

level of public debt of 66% of annual GDP for the U.S. economy. One aspect

that Aiyagari and McGrattan (1998) rule out by assumption in their model

is the cyclical behavior of the economy. Thus this is explored in Desbonnet

and Kankanamge (2008) that features a setting with aggregate fluctuations to

assess the optimal level of public debt. The main result of this paper is that

the level of public debt is on average higher in an economy with macroeconomic

fluctuations than in an economy without. The literature on the cost

of business cycles has highlighted the importance of reducing the adverse effects

of aggregate fluctuations. Papers such as Krusell and Smith (2002) or

Storesletten, Telmer and Yaron (2001) draw a link between aggregate risk and

the cross sectional distribution to produce strong distributional effects of aggregate

fluctuations. Those authors suggest that reducing the cost of business

cycles have non negligible effects on the economy. However the experiment

performed in those papers is the total elimination of business cycles and no

policy instrument to perform this task is specified.

In this paper we argue that public debt could be used as a stabilization policy

instrument. This argument is not new and this instrument has been extensively

used by actual policy makers. Previous literature suggests that in an

Aiyagari and McGrattan (1998) type non Ricardian economies, the ratio of

public debt over GDP needs to be higher if the economy is facing aggregate

fluctuations. However the stabilizing role of public debt has not been explored

so far. The main objective here is to analyze the impact of a countercyclical

rule on the optimal level of public debt. As this is a natural policy experiment,

we introduce a simple

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