Sustainability of public debt, investment subsidies, and endogenous growth with heterogeneous firms and financial frictions

This study investigates the effect of public debt on growth, interest rate, and sustaibility of public debt in a very simple endogenous growth model with financial imperfection and the firm heterogeneity. Increases in public debts cause higher real interest rates through financial markets and reduces both the number of firms and private investment, leading to lower long-run growth. It makes public debt less sustainable when public debt is very large. This study also examine the effect of investment subsidy financed by public debt. It hinder economic growth in the long-run although they affect posively on growth in the short run. Therefore, investment subsidy should not be financed by public debt but tax increases.