Research in Economics 66 (2012) 230–238

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Research in Economics
journal homepage: www.elsevier.com/locate/rie

Public capital, sustainable debt and endogenous growth

Alfred Greiner
Department of Business Administration and Economics, Bielefeld University, P.O. Box 100131, 33501 Bielefeld, Germany

article info abstract

Article history: We analyze an endogenous growth model with public capital and public debt where we
Received 1 August 2011 posit that the primary surplus of the government is a positive function of cumulated
Accepted 20 March 2012 past debt with an exponentially declining weight put on debt further back in time. We
consider two scenarios: first, we study the model assuming that the government runs a
Keywords:
Inter-temporal budget constraint
balanced budget and, then, we compare the outcome to that of the model with permanent
Public capital deficits. We analyze growth effects of the two scenarios and we study how fiscal policy
Endogenous growth of the government affects the dynamics of the model economy. It is demonstrated that
Dynamics the balanced growth rate is higher when cumulated past public debt is smaller. Further,
Hopf bifurcation we show that the debt policy of the government crucially determines the dynamics of the
model economy and that endogenous growth cycles can arise.
© 2012 University of Venice. Published by Elsevier Ltd. All rights reserved.

1. Introduction

The Greek debt crisis in 2010 has demonstrated how unsound fiscal policies can affect the evolution of market economies.
Even if a bankruptcy of Greece could be avoided by a joint action of the International Monetary Fund (IMF) and countries
of the euro area, the Greek government had to undertake painful measures in order to receive loans from the IMF and from
euro area countries. But Greece is not the only country that has drastically suffered from the financial crises that started in
2007/08. Other countries have also been confronted with a drastic increase in their public debt to GDP ratio that has cast
doubt on sustainability of their public finances, such as Ireland, Italy, Portugal and Spain for example.
These examples demonstrate that public debt can affect the evolution of market economies. In this contribution we
intend to contribute to the research on public debt and economic growth by analyzing an endogenous growth model where
we allow for public deficits and public debt. Starting point of our paper is the contribution by Greiner (2008) where growth
and welfare effects of fiscal policy are investigated where the primary surplus relative to GDP positively depends on the
ratio of public debt to GDP of the same period. The reason for this assumption is that it guarantees mean reversion of the
time series of public debt and, thus, guarantees sustainability of public debt. In addition, there is empirical evidence that
countries indeed stick to that rule (see e.g. Greiner and Fincke, 2009) so that integrating it into a theoretical model seems to
be justified.
In this paper we also assume that the primary surplus depends on outstanding public debt. However, in contrast to
Greiner (2008) we postulate that it is not public debt relative to GDP of the same period alone that determines the primary
surplus relative to GDP, but rather cumulated past debt with declining weight put on debt further back in time. That
assumption is certainly plausible since a government will consider its entire history of debt when setting the primary surplus
rather than debt of the same period alone. Thus, the model becomes more realistic but also more complex which will possibly
lead to different outcomes as regards growth effects of fiscal policy and with respect to stability of the model.
Effects of public debt on the dynamics of market economies in endogenous growth models have been analyzed by various
authors in the economics literature. For example, Futagami et al. (2008) have studied an endogenous growth model with
productive public spending and public debt but assumed that government debt must converge to a certain exogenously

E-mail address: agreiner@wiwi.uni-bielefeld.de.

1090-9443/$ – see front matter © 2012 University of Venice. Published by Elsevier Ltd. All rights reserved.
doi:10.1016/j.rie.2012.03.003
 A. Greiner / Research in Economics 66 (2012) 230–238 231

given debt to GDP ratio asymptotically. They showed that there exist two balanced growth paths to which the economy can
converge in the long-run, with one being saddle point stable and the other being saddle point stable or asymptotically stable.
Yakita (2008) presented an OLG model with endogenous growth and public investment and posited that the government
must stick to the golden rule of public finance. With this assumption Yakita could show that there exists a threshold of
government debt such that sustainability of public debt is excluded if the initial stock of public debt exceeds that threshold.
The assumption that public capital is productive has a long tradition in the economics literature. One of the first to assume
that public capital raises production possibilities in market economies were Arrow and Kurz (1970) who, however, did not
analyze endogenous growth models but limited their analysis to models with exogenously determined growth rates. The
first authors who studied an endogenous growth model with a productive public capital stock were Futagami et al. (1993)
who studied growth and welfare effects of fiscal policy assuming that the government does not run deficits and has no
outstanding stock of public debt. Recently, Atolia et al. (2011) have presented an endogenous growth model with public
capital and elastic labor supply and performed calibration exercises where they showed that linearizing around the balanced
growth path may lead to quantitatively different outcomes from those obtained by the exact solution of the nonlinear model.
In this paper we are interested in effects of fiscal policy but we intend to find qualitative results with respect to fiscal policy
rather than the quantitative effect of some policy measures.
The rest of the paper is organized as follows. In Section 2, we present the structure of our model and we define a balanced
growth path. Section 3 analyzes our model where we first study the balanced budget scenario and then analyze the model
with permanent public deficits. Section 4, finally, concludes.

2. The structure of the growth model

Our economy consists a household sector which receives labor income and income from its saving, a productive sector
and the government.
The household sector consists of many identical households which are represented by one household that maximizes the
discounted stream of utility arising from per capita consumption, C (t ), over an infinite time horizon subject to its budget
constraint, taking factor prices as given. The utility function is logarithmic, U (C ) = ln C , and the household has one unit of
labor, L, which it supplies inelastically.1 The maximization problem can be written as
 ∞
max e−ρ t ln C dt , (1)
C 0

subject to

(1 − τ ) (w + rW ) = Ẇ + C + δ K . (2)
ρ is the subjective discount rate, w is the wage rate and r is the interest rate. W ≡ B + K gives wealth which is equal to
public debt, B, and private capital, K . The parameter δ ∈ (0, 1) is the depreciation rate of capital and τ ∈ (0, 1) gives the
constant income tax rate. The dot gives the derivative with respect to time.
A no-arbitrage condition requires that the return to capital equals the return to government bonds yielding rB =
r − δ/(1 − τ ). This assures that the household is indifferent whether its savings are used for investment or for financing
government expenditures because both types of assets yield the same return. It should also be pointed out that the tax
rate τ cannot be set arbitrarily high because the return to government bonds must be positive. Hence, in the following we
assume that the tax rate and the depreciation rate are sufficiently small such that the zero bound condition with respect to
the return on government bonds does not become binding. Thus, the budget constraint of the household can be written as

Ẇ = (1 − τ ) (w L + rW ) − δ W − C . (3)
Then, necessary optimality conditions for this optimization problem are obtained as

C −1 = γ (4)
γ̇ = (ρ + δ)γ − γ (1 − τ ) r , (5)
with γ denoting the shadow price of private wealth. If the transversality condition limt →∞ e−ρ t W /C = 0 holds, which is
fulfilled for a time path on which assets grow at the same rate as consumption, the necessary conditions are also sufficient.

2.1. The productive sector

The productive sector is represented by one firm which behaves competitively and which maximizes static profits. The
production function of the firm is given by

Y = K 1−α (LG)α , (6)

1 From now on we omit the time argument t if no ambiguity arises.

232 A. Greiner / Research in Economics 66 (2012) 230–238

with (1 − α) the elasticity of output with respect to private capital share. Y is output, G denotes public capital and α gives
the elasticity of output with respect to public capital. Eq. (6) has been first introduced by Barro (1990). In contrast to Barro,
however, who posits that the flow of public spending is productive, we follow Futagami et al. (1993) who assume that public
capital as a stock is productive. Using that labor is set to one, L = 1, profit maximization gives
w = α K 1−α Gα (7)
−α α
r = (1 − α)K G . (8)

2.2. The government

The accounting identity describing the accumulation of public debt in continuous time is given by
Ḃ = rB B(1 − τ ) − S , (9)
where S is government surplus exclusive of net interest payments. It should be noted that our definition of the primary
surplus implies that it is a net of the tax revenue the government gets from taxing the return to government bonds. We
do so because in a closed economy the relevant interest payment on public debt are the net interest payments since the
government gets back τ rB B of total interest payments given by rB B. We should also like to point out that this definition of
the primary surplus is quite common in endogenous growth models (see e.g. Futagami et al., 2008, or Greiner, 2008).
With respect to the primary surplus we assume that it depends on GDP and on public debt. Thus, the primary surplus
can be written as
S = f (Y , B, ·), (10)
with ∂ f /∂ Y ≥≤ 0 and ∂ f /∂ B > 0. If the government runs into debt today it has to repay that amount in the future in
present value terms in order to meet its inter-temporal budget constraint. This implies that the primary surplus must rise as
public debt increases. Therefore, the primary surplus becomes a function positively depending on public debt. It should be
noted that the government has some discretionary scope in setting the primary surplus so that assuming that public debt is
the only determinant of the primary surplus would be too short-sighted. We posit that it is the level of GDP that determines
the primary surplus, besides public debt, which seems to be reasonable. Indeed, Bohn (1998) presents empirical evidence
for that assumption for the USA and Fincke and Greiner (2011) also find statistically significant parameter estimates for
countries in the euro area.
Granger (2008) has shown that any nonlinear function can be approximated by a linear model with time-varying
coefficients and that the approximation is good if the parameter changes smoothly. Therefore, rewriting function (10) as
a linear function seems to be justified and there does not seem to be the need for a more general function describing the
response of the primary surplus to public debt. Since we assume that the primary surplus depends on weighted cumulated
past debt, Eq. (10) can replaced by the following equation,
 t
S =φY +ψ eκ(µ−t ) B(µ)dµ, (11)
0
with φ ∈ R the average of the coefficient determining whether a rise in GDP goes along with a higher or lower level of the
primary surplus. The parameter ψ ∈ R++ determines how strong the primary surplus reacts to cumulated past levels of
public debt with an exponentially declining weight put on debt further back in time.2 The parameter κ ∈ R+ determines
how strong more recent levels of public debt affect the primary surplus where the influence of more recent public debt is
the stronger the higher κ . It should be noted that for κ → ∞ we get the limit case where only public debt of the current
period affects the primary surplus. However, it is more realistic that public debt of the past affects the primary surplus so
that the formulation in (11) is more appropriate.
Using (11) the differential equation describing the evolution of public debt can be written as
 t
Ḃ = rB (1 − τ )B − φ Y − ψ eκ(µ−t ) B(µ)dµ. (12)
0
The government in our economy receives tax revenues from income taxation and has revenues from issuing government
bonds it then uses for public investment, Ip , and for public consumption, Cp . As concerns public consumption we assume that
this type of spending is a fixed fraction of public investment, Cp /Ip = ν = const ., and that it does neither yield utility nor
raise productivity but is only a waste of resources. Using that the wage rate and the return to private capital are determined
by (7) and (8), respectively, we can write τ (w L + rK ) = τ Y . Using this and that the primary surplus is given by (11) we get
 t
τ Y − (Ip + Cp ) = τ Y − Ip (1 + ν) = S = φ Y + ψ eκ(µ−t ) B(µ)dµ (13)
0
which determines public investment Ip .

2 In Greiner and Fincke (2009) it is demonstrated in detail that a positive ψ guarantees sustainability of public debt if the primary surplus depends on
the level of public debt of the same period.
 A. Greiner / Research in Economics 66 (2012) 230–238 233

As regards public capital we neglect depreciation such that the change in the stock of public capital equals public
investment. Thus, the differential equation describing the evolution of public capital is immediately obtained from (13)
as
 t
Ġ = Ip = ω(τ − φ)Y − ωψ eκ(µ−t ) B(µ)dµ, (14)
0
where we have set ω = 1/(1 + ν).

2.3. Equilibrium conditions and the balanced growth path

Before we analyze our model we give the definition of an equilibrium and of a balanced growth path. An equilibrium
allocation for our economy is defined as follows.

Definition 1. An equilibrium is a sequence of variables {C (t ), K (t ), G(t ), B(t )}∞

t =0 and a sequence of prices {w(t ), r (t )}t =0
∞

such that, given prices and fiscal parameters, the firm maximizes profits, the household solves (1) subject to (2) and the
budget constraint of the government (9) is fulfilled with the primary surplus set according to (11) and public capital evolving
according to (14).
eκ(µ−t ) B(µ)dµ we can write the budget constraint of the government as
t
Defining R := ψ 0

Ḃ = rB (1 − τ )B − φ Y − R (15)
and the evolution of public capital is described by
Ġ = ω(τ − φ)Y − ωR. (16)
The growth rate of consumption is obtained from (4), (5) and (8) as
Ċ
= −(ρ + δ) + (1 − τ )(1 − α)K −α Gα (17)
C
and the economy-wide resource constraint is obtained by combining (2) and (12) as
K̇ C K 1−α Gα R K 1−α Gα
=− + + + (φ − τ ) − δ. (18)
K K K K K
Weighted cumulated past government debt, finally, evolves according to
Ṙ
= ψ (B/R) − κ. (19)
R
Thus, in equilibrium the economy is completely described by Eqs. (15)–(19) plus the limiting transversality condition of the
household.
In Definition 2 we define a balanced growth path.

Definition 2. A balanced growth path (BGP) is a path such that the economy is in equilibrium and such that
(i) consumption, private capital and public capital grow at the same strictly positive constant growth rate and public debt
is constant, i.e. Ċ /C = K̇ /K = Ġ/G = g1 > 0, g1 = constant , Ḃ = 0 or
(ii) all variables grow at the same strictly positive constant growth rate Ḃ/B = Ċ /C = K̇ /K = Ġ/G = g2 > 0, g2 = constant.
Definition 2 shows that case (i) is the balanced budget regime where the government has at each point in time a balanced
budget. But this does not necessarily imply that public debt equals zero. If the level of initial debt is positive the level of public
debt remains constant but the debt to capital ratio and also the debt to GDP ratio decline over time and converge to zero in
the long-run. Case (ii) describes a situation where the government always runs a deficit such that the growth rate of public
debt is equal to that of all other variables in the long-run.
To analyze our economy around a BGP we define the new variables c := C /K , x := G/K , b := B/K and z := R/K .
Differentiating these variables with respect to time leads to a four dimensional system of differential equations given by
ċ = c ((1 − α)xα (1 − τ ) − (ρ + δ) + c − xα − (φ − τ )xα − z + δ) (20)
ẋ = x ω(τ − φ)xα−1 − ωz /x + c − xα − (φ − τ )xα − z + δ ,
 
(21)

ḃ = b ((1 − α)xα (1 − τ ) − δ − φ xα /b − z /b + c − xα − (φ − τ )xα − z + δ) , (22)

ż = z (ψ(b/z ) − κ + c − xα − (φ − τ )xα − z + δ) . (23)
A solution of ẋ = ḃ = ċ = ż = 0 with respect to x, c , b, z gives a BGP for our model and the corresponding ratios
x⋆ , b⋆ , c ⋆ , z ⋆ on the BGP.3 In the next section we analyze how fiscal policy affects the long-run growth rate and the dynamics
of the economy for the two scenarios as given in Definition 2.

3 The ⋆ denotes BGP values and we exclude the economically meaningless BGP x⋆ = c ⋆ = 0.
234 A. Greiner / Research in Economics 66 (2012) 230–238

Table 1
Balanced growth rate and debt to private capital ratio for different φ (1st BGP).
φ < −0.19 φ ∈ (−0.19, 0) φ ∈ (0, 0.015) φ > 0.015
g2 Negative g2 ∈ (−0.2%, 11.2%) g2 ∈ (11.2%, 14.4%) No BGP
b⋆ Positive b⋆ ∈ (0.44, 0) b⋆ ∈ (0, −0.49) No BGP

3. Analysis of the model

In this section we analyze our model where we first consider the case where the government runs a balanced budget
and, then, the case of permanent deficits.

3.1. The economy with a balanced government budget

To model the balanced budget scenario we set φ = 0 and ψ and κ are set such that Ḃ = 0 holds. Setting Ḃ = 0 implies that
the ratio of public debt to private capital equals zero on the BGP, i.e. b⋆ = 0 holds, since the stock of capital permanently
grows. If public debt is constant the level of weighted cumulated public debt, R, will be constant, too, because we have
R = B(r (1 − τ ) − δ). This implies that Ṙ = 0 and z ⋆ = 0 also hold along the BGP. The condition Ṙ = 0 leads to ψ B = κ R
which, together with R = B(r (1 − τ ) − δ), gives κ = ψ/(r (1 − τ ) − δ). With b⋆ = z ⋆ = 0 the economy is completely
described by the (20) and (21) and a rest point of that equation gives a balanced growth path for the economy.
In Appendix A we show that there exists a unique BGP in the case of a balanced government budget. With respect to
stability we first note that there are three pre-determined variables, x, z and b, and one variable, c, that can be set at the
initial period, unless one assumes that the government can levy a non-distortionary tax in the initial period it uses to control
initial debt. If the latter possibility is not allowed for such that b(0) is fixed, the model is saddle point stable for three negative
eigenvalues of the Jacobian.4 Then, there is a unique initial value for c that has to be chosen such that it lies on the stable
manifold of the saddle point. In Appendix A we prove that in the case of a balanced government budget the model is stable if
and only if ψ > ρ(g1 + ρ) holds, with g1 the balanced growth rate. Thus, higher values of ψ , that determines how strong the
government reacts to cumulated past debt, tend to stabilize the economy. It should also be noted that the long-run growth
rate in the scenario with a balanced government budget is independent of the value for ψ .
In order to illustrate our results we resort to a numerical example. The benchmark values for the simulation are set as
follows: τ = 0.15, α = 0.2, ρ = 0.15, δ = 0.15, ω = 0.1. Interpreting one time period as three years means that the annual
rate of time preference and the depreciation rate of capital per year are about 4.7%. The value 0.1 for ω states that the ratio
of public investment relative to public consumption is about 11%.
Analyzing the model shows that for ψ < 0.039 the model is unstable (2 negative eigenvalues) while it is saddle point
stable (3 negative eigenvalues) for ψ > 0.039. This corresponds to the outcome of the analytical model because the balanced
growth rate equals about 11% so that ρ(g1 + ρ) = 0.039. Note that a balanced growth rate of 11% implies an annual growth
rate of 3.5% if one time period is assumed to comprise 3 years.

3.2. Permanent public deficits

The model in the case of permanent public deficits turns out to be rather complicated and no analytical results can be
obtained, except that, starting from balanced government budget, the balanced growth rate rises as the ratio of cumulated
past debt relative to private capital declines, i.e. the smaller z becomes, which is proven in Appendix B and which is illustrated
by a numerical example below. The economic mechanism behind that outcome is that higher cumulated past debt implies
that the government must use more of its resources for non-productive use, i.e. for the debt service, so that less resources
are available for productive public spending leading to lower growth. This implies that the highest growth rate is obtained
for the case of a balanced budget, where z = 0 holds on the BGP, unless one allows for the government to build up a stock
of wealth such that z becomes negative. In the latter case, the government is a net lender to the private sector because
cumulated past government debt is negative.
To get additional insight, we resort to a numerical example where we employ the benchmark parameters of the last
subsection. The numerical analysis of the model with permanent public deficits shows that there exist two balanced growth
paths in this case. The first balanced growth path is associated with a smaller balanced growth rate, the second balanced
growth path goes along with a higher balanced growth rate.
First, we study properties of the 1st BGP. Table 1 gives the balanced growth rate, g, and the debt to private capital ratio
on the BGP, b⋆ , for different values of φ at the first BGP that goes along with the smaller long-run growth rate. The other
parameter values are set to their benchmark values of the last subsection and ψ and κ are set to ψ = 0.05 and κ = 0.15.

4 In Appendix A we also demonstrate that complex conjugate eigenvalues cannot occur.

 A. Greiner / Research in Economics 66 (2012) 230–238 235

Table 2
Balanced growth rate and debt to private capital ratio for different φ (2nd BGP).
φ < −0.0095 φ ∈ (−0.0095, 0.015) φ > 0.015
g2 No BGP g2 ∈ (19.2%, 15.4%) No BGP
b⋆ No BGP b⋆ ∈ (−1.81, −0.7) No BGP

Looking at Table 1 it can be clearly seen that fiscal policies that go along with a higher debt to capital ratio b⋆ imply a
lower balanced growth rate. The reason for this outcome is that a higher debt ratio implies that less resources are available
for productive public spending so that the long-run growth rate is smaller.
Table 1 also demonstrates that a balanced growth path with a positive growth rate only exists if the parameter φ is
within a certain interval. It should be recalled that the parameter φ determines how the level of the primary surplus rises
(for φ > 0) or declines (for φ < 0) as GDP increases (cf. Eq. (11)). Thus, we can state that φ must be neither too small
nor too large so that sustained growth is possible. If φ is negative and too small, meaning that the primary surplus strongly
declines as GDP rises, the government does not put high enough a value on stabilizing public debt. In this case, the debt
service requires too many public resources so that the government cannot invest sufficiently in the formation of the public
capital stock. On the other hand, if φ is positive and too large, the government puts too high a value on stabilizing debt and
it does not invest enough in productive public capital so that ongoing growth is not feasible either.
As regards stability, we see that the Jacobian matrix of (21)–(20), with the parameter values underlying Table 1, is
characterized by one positive and one negative real eigenvalue and two complex conjugate eigenvalues with negative real
parts for about φ ≥ −0.03, implying that the economy is saddle point stable with a unique initial value for consumption,
c (0), lying on the stable manifold. If we continuously vary the parameter φ we see that for φ = φcrit = −0.030484 the
dynamic system (20)–(23) undergoes a Hopf bifurcation that gives rise to unstable limit cycles.5 If φ is further reduced there
is only one negative eigenvalue showing that the economy is unstable in this case. Hence, it can be stated that instability of
the model is more likely when the primary surplus rises less as the GDP increases, i.e. the smaller the parameter φ , ceteris
paribus.
Next, we analyze how the parameter ψ , which determines the reaction of the government to cumulated past debt,
affects the dynamics of the model. To do so we set φ = −0.01 and study how the eigenvalues of the Jacobian evaluated
at the 1st BGP evolve as ψ is continuously varied. Starting with ψ = 0.05 and reducing that parameter shows that for
ψ = ψcrit = 0.039968 again a Hopf bifurcation occurs that now gives rise to stable limit cycles.6 Limit cycles emerge for
an interval of the parameter ψ < ψcrit with strictly positive measure implying that the economy does not converge to a
BGP with constant growth rates but, instead, there are permanently oscillating growth rates of the endogenous variables.
If ψ is further reduced the system becomes divergent. Hence, as in the case of a balanced government budget, a stronger
reaction of the government to cumulated past debt, i.e. a higher ψ , tends to stabilize the economy. However, in contrast to
the balanced budget case where the economy was either stable or unstable, we can observe stable limit cycles for a certain
range of the parameter ψ .
In a next step we look at the properties of the 2nd BGP. Table 2 gives the balanced growth rate and the debt to private
capital ratio for different values of the parameter φ .
Table 2 shows lower values of φ , that is a smaller reaction or even decline of the primary surplus as GDP rises, raises the
long-run growth rate of the high balanced growth path. However, it must be mentioned that in this case the government
has built up a stock of wealth, i.e. b is negative, it uses to finance its spending. It can also be seen that the growth rate is
larger than on the 1st BGP since the government has now built up a stock of wealth it can use to finance productive public
spending.
Further, with the parameter constellation underlying the results in Table 2 there are two positive real eigenvalues and
two complex conjugate eigenvalues with negative real parts. Thus, the economy is unstable unless the government is able
to control initial public debt, for example by levying a lump-sum tax at t = 0, and set b(0) such that the economy starts on
the one-dimensional stable manifold leading the economy to the BGP in the long-run.
As regards robustness of our result, we should like to point out that we get the same qualitative result when we set
α = 0.15 which is shown in Appendix C. Further, we have also calculated the BGPs for all α ∈ (0.05, 0.95) with φ = −0.01
where we have chosen a stepsize of 0.05, i.e. α was set to α = 0.05, 0.1, 0.15 and so on. It turned out that for all values of
α there exist two BGPs, but we did not check stability properties for all of them. Thus, the outcomes presented in Tables 1
and 2 seem to be pretty robust.

4. Conclusion

In this paper we have presented and analyzed an endogenous growth model with productive public spending and public
debt where the primary surplus of the government depends on weighted cumulated past debt. The motivation for this

5 For a statement of the Hopf bifurcation theorem see Appendix D.

6 For those computations we used the software LOCBIF (see Khibnik et al., 1993) and CL MATCONT(5.3) (see Dhooge et al., 2003).
236 A. Greiner / Research in Economics 66 (2012) 230–238

assumption is that it guarantees sustainability of public debt since it implies mean reversion of the time series of government
debt if the economy converges to a balanced growth path. We could show that when the long-run growth rate is higher, the
ratio of cumulated past public debt to private capital is smaller, such that a balanced government budget gives the highest
growth rate, unless one allows for negative public debt implying that the government is a net lender to the private sector.
The dynamics of the model with cumulated past debt affecting the primary surplus, however, is more complex compared
to the approach where the primary surplus depends on current debt alone. Thus, the scenario with a balanced government
budget is stable if only if the reaction of the primary surplus to cumulated past debt is sufficiently large, whereas stability is
always given if the primary surplus is a function of the current debt ratio alone. Further, the model with permanent public
deficits may give rise to multiple balanced growth paths in the long-run. But, it turned out that the balanced growth path
with the higher growth rate is associated with a negative government debt, implying that the government is a creditor in
this case that lends money to the private sector. Further, this balanced growth path is unstable so that it can only be attained
if the government has access to non-distortionary taxes in the initial period it uses to build up a stock of wealth and to put
the economy on the stable branch of the saddle point.
The balanced growth path with the lower long-run growth rate may be unstable or stable depending on the reaction of the
primary surplus to cumulated past debt ceteris paribus. As in the case of a balanced government budget a stronger reaction
of the primary surplus to cumulated past debt tends to stabilize the economy. In addition, we could prove by resorting to a
numerical example that a Hopf bifurcation may occur that gives rise to stable limit cycles. This means that the economy does
not converge to a path with a constant growth rate in the long-run but, instead, is characterized by persistent oscillations
of the growth rates.

Acknowledgment

The author is indebted to an anonymous referee for detailed comments that helped improve the paper.

Appendix A. On existence and stability of the BGP for the balanced government budget

Using that b⋆ = z ⋆ = 0 holds for the balanced budget regime as well as φ = 0 we can solve ċ /c = 0 for c giving
c = α xα (1 − τ ) + ρ . Inserting that c in ẋ/x gives,
q1 (·) = ρ + δ + τ xα−1 − (1 − τ )(1 − α)xα .
It is immediately seen that dq1 (·)/dx < 0 and lim q1 = ∞ for x → 0, lim q1 = −∞ for x → ∞. This shows that there exists
a unique x⋆ and, thus, a unique BGP. Note that for q1 (·) = 0 we have 0 < τ xα−1 = (1 − τ )(1 − α)xα − (ρ + δ) = Ċ /C such
that the balanced growth rate is indeed strictly positive.
The Jacobian matrix for the differential equation system (20)–(23) is obtained as
 
J1 J2
J = ,
J3 J4

with J1 , J2 , J3 , J4 given by,

−c α 2 (1 − τ )x−1+α
   
c 0 −c
J1 = J2 =
ωτ (α − 1)xα−1 − α xα (1 − τ )
x 0 −x − ω
ρ
   
−1 0 0
J4 = J3 = ,
ψ −g − ψ/(g + ρ) 0 0

where we used c = α xα (1 − τ ) + ρ and g1 = (1 − τ )(1 − α)xα − (ρ + δ).

This shows that the eigenvalues of J are given by the eigenvalues of J1 and J4 . The determinant of J1 can easily be calculated
as det J1 = c (ωτ (α − 1)xα−1 − α xα (1 − τ )(1 − α)) < 0 so that there is one positive and one negative eigenvalue. Further,
the trace of J4 , tr J4 , must be negative and the determinant det J4 must be positive for the eigenvalues of J4 to be negative. It
can easily be calculated that the determinant is positive if and only if ψ > ρ 2 + ρ g1 holds and the trace is negative if and
only if ψ > ρ 2 − g12 holds. Thus, the model is stable for ψ > ρ(g1 + ρ) (3 negative eigenvalues, one positive eigenvalue)
and unstable for ψ < ρ(g1 + ρ) (one negative eigenvalue, 3 positive eigenvalues).
To show that complex conjugate eigenvalues can be excluded we compute the expression (tr J4 )2 − 4 det J4 which is
given by,

ψ ψ ψ
 2  
(tr J4 ) − 4 det J4 = (ρ − g ) − 2(ρ − g )
2 2
+ + 4ρ g + − 4ψ
g +ρ g +ρ g +ρ
gψ ρψ ψ2 ψ
 2
= ρ + g + 2ρ g − 2
2 2
−2 + = (ρ + g ) − .
g +ρ g +ρ (g + ρ)2 g +ρ

This shows that (tr J4 )2 − 4 det J4 > 0 holds so that all eigenvalues are real.
 A. Greiner / Research in Economics 66 (2012) 230–238 237

Table 3
Balanced growth rate and b⋆ for different φ with α = 0.15 (1st BGP).
φ < −0.185 φ ∈ (−0.185, 0) φ ∈ (0, 0.0003) φ ≥ 0.0004
g2 Negative g2 ∈ (−0.07%, 17%) g2 ∈ (17%, 17.4%) No BGP
b⋆ Positive b⋆ ∈ (0.41, 0) b⋆ ∈ (0, −0.048) No BGP

Table 4
Balanced growth rate and b⋆ for different φ with α = 0.15 (2nd BGP).
φ < −0.05 φ ∈ (−0.045, 0.0003) φ > 0.0004
g2 No BGP g2 ∈ (24%, 18%) No BGP
b⋆ No BGP b⋆ ∈ (−1.55, −0.11) No BGP

Appendix B. Balanced growth rate with a balanced budget and with permanent deficits

We know that the following relation holds on the BGP:

Ċ /C = Ġ/G ↔ q2 (·) = (1 − τ )(1 − α)xα − (ρ + δ) − ω(τ − φ)xα−1 + ωz /x = 0.
Implicit differentiation of q2 (·) yields
dx ω/x
=− .
dz ∂ q2 /∂ x
For the case of a balanced government budget, where φ = z = 0 holds, we get for ∂ q2 /∂ x
∂ q2
= (1 − τ )(1 − α)α xα−1 − ω τ (α − 1) xα−2 > 0.
∂x
This implies that, starting from a balanced budget, an increase (decrease) in z goes along with a smaller (higher) value of x.
Since the balanced growth rate Ċ /C positively depends on x, a lower (higher) value of z goes along with a higher (lower)
balanced growth rate.

Appendix C. On robustness of the existence of two BGPs

Here we present the outcome of our simulation with α set to α = 0.15. The remaining parameters are as in Section 3.2.
For φ ≤ −0.017 there are two complex conjugate eigenvalues with positive real part, one positive real eigenvalue and
one negative real eigenvalue for the first BGP. For φ ∈ (−0.0165, −0.0015) there are two complex conjugate eigenvalues
with negative real part, one negative real eigenvalue and one positive real eigenvalue. For φ ≥ 0.0002 there are three
negative real eigenvalues and one positive real (see Table 3). In Table 4 the eigenvalues are qualitatively the same as in
Table 2.
Qualitatively, the eigenvalues are the same as for α = 0.2 analyzed in Section 3.2.

Appendix D. The Hopf bifurcation theorem

Here we present the Hopf bifurcation theorem as it can be found in Guckenheimer and Holmes (1983, pp. 151–52).

Theorem A.3. Suppose that the system ẋ = G(x, ω), x ∈ Rn , ω ∈ R has an equilibrium (x0 , ω0 ), at which the following proper-
ties are satisfied:
(i) Dx G(x0 , ω0 ) has a simple pair of purely imaginary eigenvalues and no other eigenvalues with zero real parts.
Then (i) implies that there is a smooth curve of equilibria (x(ω), ω) with x(ω0 ) = x0 . The eigenvalues λ(ω), λ̄(ω) of
Dx G(x(ω), ω0 ) which are imaginary at ω = ω0 vary smoothly with ω. If, moreover,
d
Re(λ(ω)) = d1 ̸= 0, für ω = ω0 ,
dω
then there is a unique three-dimensional center manifold passing through (x0 , ω0 ) in Rn × R and a smooth system of coordinates
(preserving the planes for ω = const .) for which the Taylor expansion of degree 3 on the center manifold is given by
ẋ1 = [d1 ω + β1 (x21 + x22 )]x1 − [d4 + d2 ω + d3 (x21 + x22 )]x2 ,
ẋ2 = [d4 + d2 ω + d3 (x21 + x22 )]x1 + [d1 ω + β1 (x21 + x22 )]x2 .
If β1 ̸= 0, there is a surface of periodic solutions in the center manifold which has quadratic tangency with the eigenspace of
λ(ω0 ), λ̄(ω0 ) agreeing to second order with the paraboloid ω = −(β1 /d1 )(x21 + x22 ). If β1 < 0, then these periodic solutions
are stable limit cycles, while if β1 > 0, the solutions are repelling.
238 A. Greiner / Research in Economics 66 (2012) 230–238

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