Public debt and public investment in an endogenous growth model with real wage rigidities

Abstract

We present an endogenous growth model with public capital, public debt and real wage rigidities due to labor market imperfections. Assuming that the primary surplus relative to gross domestic produce (GDP) is a positive function of the debt to GDP ratio, we study growth and employment effects of deficit-financed public investment using simulations as well as how fiscal policy affects stability of the economy. Further, we contrast the growth rate and the unemployment rate in the deficit scenario with that of the balanced budget scenario. Finally, we compare our results with those obtained in case of flexible wages and full employment. © 2010 The Authors. Journal compilation © 2010 Scottish Economic Society.