Transmission Mechanisms of the Public Debt

The first part of this paper is devoted to present some empirical evidence on the empirical IS curve that relates the aggregate demand to the real anticipated interest rate and the ratio of the public debt to GDP. The result of the empirical analysis is in favor of the presence of an empirical IS curve in which the aggregate demand is significantly affected by both the real anticipated interest rate and the public debt-to-GDP. In particular, the empirical finding on negative debt-elasticities of the aggregate demand in the empirical IS curve suggests the modification of the criteria used for the conventional distinction between non-Ricardian and Ricardian regimes. While the conventional distinction tells that the Taylor principle delivers an explosive dynamics of equilibrium path in a non-Ricardian regime with an exogenous primary surplus process, the estimated empirical IS curve indicates that a unique local equilibrium path requires the Taylor principle even with non-Ricardian regime in the presence of negative debt-elasticities of the aggregate demand. Furthermore, since the main modelling point of this paper is that the IS curve is the key equation for the transmission of the public debt, a goal of this paper is to see a variety of alternative theoretic mechanisms that might help include the public debt into the IS curve. As a result, a set of different models are discussed in this paper: Sovereign-risk based channel or Risk-premium (financial friction) based channel, Modified liquidity-effect channel, and Market-segmentation (in market for government securities) channel.