Can growth stabilize debt? A fiscal theory perspective

Abstract

This paper studies price stability and debt sustainability when the real rate exceeds trend growth (r > g) in a New Keynesian model with endogenous technology growth through R&D. Endogenous growth constitutes a self-financing mechanism for deficits which backs debt and attenuates fiscal inflation. A dynamic r − g stability criterion characterizes the set of feasible monetary-fiscal frameworks. If surpluses do not adjust to stabilize debt, the central bank must permit r − g to fall with inflation. Monetary policy which follows the Taylor principle can be consistent with a unique stable equilibrium under active fiscal policy as growth endogenously creates fiscal capacity and policy space.