Optimum Public Debt in Iran: An Emphasis on the Precautionary Saving Model

Articles in Press

Document Type : Research Paper

Authors

1 Department of Economics, University of Isfahan, Isfahan, Iran.

2 Department of Economics, University of Isfahan, Isfahan, Iran

3 Department of Economics, Yasouj University, Yasouj, Iran

Abstract

The study examines the effects of the government debt ratio on welfare in Iran’s economy. Due to limited access to loan in Iran, the analysis presented here is an incomplete market model based on Aiyagari’s heterogeneous agent approach. Indeed, in addition to idiosyncratic wage risk, households are budget- and borrowing-constrained. Given that the Iran’s economy faces both high inflation and borrowing constraints, Iranian households prefer to hold assets such as gold, land, and term deposits, besides government debt and physical capital, for precautionary savings purposes. Therefore, this study incorporates the above-mentioned assets in the model. The finite element method (FEM) is utilized to solve the model numerically. The results show that the optimal quantity of debt is significantly negative according to the welfare criteria, and the welfare gain from moving to the optimum is 2.66% of per capita consumption, which is not negligible. As a result, the negative role that debt plays in the model (crowding out private capital) is more than the positive role of enhancing liquidity, and private sector spending should replace government spending. It is optimal that the government to accumulate assets in the long run, so that all government expenditures are financed through the interest income of private assets. Furthermore, if excessive holding of assets is restricted through policies such as imposing taxes on holding assets and developing financial markets, the welfare loss of maintaining the current level of debt instead of the optimal quantity will decrease.

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Iranian Economic Review

Articles in Press, Accepted Manuscript
Available Online from 27 May 2024

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