Public Debt And Financial Development: A Theoretical Exploration

This paper proposes an analytical framework to examine the role of public debt in financial development, which remains largely unexplored in the existing literature. The authors find that in countries where the banking sector extends substantial credit to government, public debt is likely to harm financial development, with unfavorable implications for economic activity. As such, these results provide an alternative explanation for the "Contractionary fiscal expansions". They also show that the lower the financial depth, the greater the adverse effects of public borrowing on financial development and macroeconomic outcomes.