Debt to GDP Ratio from the Perspective of MMT with a Simple Microeconomic Foundation

Abstract

This paper will argue that since the ratio of government debt to GDP cannot diverge to infinity, fiscal collapse is not possible. Using a macroeconomic model of a growing economy with a simple microeconomic foundation about consumers’ behavior, with overlapping generations model in mind, we show the following results: 1) The budget deficit including interest payments on the government bonds equals an increase in the savings from a period to the next period. 2) If the savings in the first period is positive (unless the savings are made solely through stocks), we need budget deficit to maintain full employment under constant prices or inflation in the later periods in a growing economy. 3) Excess budget deficit induces inflation under full employment. 4) Under an appropriate assumption about the propensity to consume, the debt to GDP ratio converges to a finite value. It does not diverge to infinity. 5) In the case of balanced budget excluding interest payments, if an appropriate weak assumption about the propensity to consume holds, the debt to GDP ratio cannot diverge to infinity. 6) When the propensity to consume is small, we need budget deficit, not budget surplus, to prevent the debt to GDP ratio to diverge infinity.