A Ramsey Theory of Low Interest Rates

Topic:

A Ramsey Theory of Low Interest Rates

Time&Date: 

 10:00-11:15 am, 2019/12/20 (Friday)

Venue:

 Room 619, Teaching A

Speaker:

 Dr. Wei Cui (University College London)

Abstract:

The interest rate on government debt is significantly lower than the rates of return on other assets. From the perspective of standard models of optimal taxation, this empirical fact is puzzling: typically, the government should finance expenditures either through contingent taxes, or by previously-issued state-contingent debt, or by labor taxes, with only minor effects arising from intertemporal distortions on interest rates. We study how this answer changes in the presence of financial frictions such that the entrepreneurs' net worth has a direct effect on their ability to invest. In this case, such net worth is affected by government policy through changes in intertemporal prices. A new trade-off emerges between pursuing policies that relax the financial constraints and those that minimize the distortions of financing government spending, providing a potential avenue to reconcile the low interest rate of government debt with the theory.