| High-debt economies face a policy dilemma when choosing fiscal policy in bad times. Intended stimulus effects of extra government spending can be muted if the policy is conducted at the cost of rolling over debt, paying higher interest rates, and levying heavier taxes. Disentangling this trade-off is important for policy guidance.;The first essay analyzes the aforementioned trade-off in a neoclassical model calibrated to the Greek economy during the 2008-09 recession. We find a change in the initial debt ratio from 62% to 129% reduces the size of the long-run public investment and public consumption multiplier by as much as 62%. Furthermore, the stimulus effects richly interact with the sources of debt financing, the speed at which debt is retired, and the financing schemes that the government uses. Finally, in high-debt economies, to amplify the stimulus effects, a quicker debt retirement rate is preferred to a slow rate due to strong benefits from the descending debt trajectory. Moreover, either the consumption or capital tax rate reacts to debt more quickly than it did historically, a larger welfare improvement and multiplier can be obtained than accelerating the labor tax rate does.;In the second essay, considering the initial debt levels and interest rate spreads, we compute the welfare-maximizing optimal tax rule for the Greek economy. We find the current tax rules do not react enough to debt and output. Optimal policy favors tax rates with higher volatility; moreover, raising more consumption and capital taxes and lowering labor taxes to finance debt, compared to current tax rules, is preferred. Furthermore, if the government uses the optimal rule, the household's consumption can be increased by 0.78% in all period, compared to the current rule. We also find the availability of debt-financing source has a greater impact on welfare levels than the responsiveness of output. Finally, we find for a high-debt economy, sacrificing short-term consumption levels by raising more taxes to retire debt more quickly is favored. In addition, the existence of interest rate spreads indicates that raising less capital taxes to finance debt is desirable. |
