WP Global Economy 2017.10.24
Japan's net government debt is 130% of GDP in 2013. The present paper analyzes the effect of the large government debt on welfare. We use a heterogeneous-agent, incomplete-market model with idiosyncratic wage risk, a borrowing constraint, and endogenous labor supply. We calibrate the model to the Japanese economy using evidence based on macro-level and micro-level data. We find that the optimal level of government debt is -50% of GDP for Japan. The welfare cost of keeping government debt to 130% of GDP rather than the optimal level is 0.19% of consumption.