Long-run consequences of debt

Empirical evidence suggests that both public and private debt may have long-run detrimental effects on the economy. However, theoretical works have not provided a unique explanation to the issue. In this paper, therefore, we propose a framework that is able to describe the long-run effects of different kinds of debt. We introduce a stock-flow consistent dynamic model where the economy is represented as a network of trading relationships among agents. Debt contracts are one of such relationships. The model is characterized by a unique and stable steady-state and predicts that: (i) aggregate income is always limited from the above by the money supply; (ii) debts cause in the long-run a redistribution of borrowers’ wealth and income in favor of lenders; (iii) the redistribution is magnified by the level of the interest rate and (iv) by the degree of debt persistence. In the aggregate this may also lower the average marginal propensity to spend and nominal income, providing therefore a clear-cut explanation to the empirical evidence.