Brian Romanchuk — If r < g, DSGE Model Assumptions Break Down

The relationship between interest rates and the growth rate of the economy is critical for government fiscal dynamics. In the literature for Dynamic Stochastic General Equilibrium (DSGE) models, the discussion of the governmental budget constraint appears to have an embedded assumption that the real interest rate on government debt is greater than the economic growth rate (“r>g”). However, there is no reason that this has to be true, and the mathematics of the budget constraint fails if the condition does not hold. This poses a problem for the constraint, as a true mathematical constraint is something that is always true. Once this constraint is dropped, a good portion of the recent academic literature discussing fiscal policy becomes irrelevant. (Despite my opportunistic use of “r” and “g” in the title of this article – in order to capitalise on the popularity of a recent book – it has nothing to do with inequality.)

Bond Economics
If r < g, DSGE Model Assumptions Break Down
Brian Romanchuk