Public Debt Management for Development

• Grant number: 24/02971-8
• Support Opportunities: Scholarships in Brazil - Doctorate
• Start date: November 01, 2024
• End date: February 28, 2026
• Field of knowledge: Applied Social Sciences - Economics - Growth, Fluctuations and Economic Planning
• Principal Investigator: Pierluca Pannella
• Grantee: Rafael Brasileiro Miranda
• Host Institution: Escola de Economia de São Paulo (EESP). Fundação Getúlio Vargas (FGV). São Paulo , SP, Brazil

Abstract

In this paper, we investigate the potential use of public debt as a tool to alleviate misallocation in a Heterogeneous Agent model. The model has three main features: occupational choice, a credit constraint, and portfolio choice between two assets with different levels of liquidity. These features resemble common characteristics of the Brazilian economy; in fact, the first two have already been employed in the literature. However, studies examining fiscal policy typically derive an optimal tax rule, treating public debt as a passive instrument.Public debt securities compete with equity in the market for savings, but carry a liquidity premium, so only projects that offer a higher return get funded. In models of occupational choice, agents whose returns do not exceed this threshold must become workers, and the total mass of workers determines the equilibrium wage. However, it is possible to model an intermediate category in this environment, the self-employed worker, who also demands capital in the market but uses only their own labor to produce. This situation is common in emerging economies and analytically convenient. It can be shown that the existence of these agents creates a dynamic inefficiency that stems from the credit constraint (exogenously imposed). If the less productive self-employed workers were to become wage workers, the lower wage due to higher supply would allow the more productive ones to employ them; total factor productivity and output would increase, capital would accumulate faster, and future wages would be higher. However, self-employed workers do not internalize this effect, so they do not offer their labor at a lower wage because it is not incentive compatible.I argue that the government could remedy this externality with a contingent and progressive public debt policy. By regulating the liquidity supply in the form of government bonds, it can partially manipulate the return thresholds for market entry for an entrepreneur via arbitrage, altering the incentives that agents face when choosing their occupation. If workers can receive transfers compensating them for the lower wage they would receive in equilibrium, the change in the occupational profile of the economy that enables faster capital accumulation can occur. Over time, this would lead the economy to reach a new steady state with higher wages, higher capital stock, and higher welfare.My goal is to create a dynamic general equilibrium model to quantitatively derive the optimal policy for public debt supply for a government aiming to use it to promote long-term development.