Public Debt and Relative Prices

Question: Describe about the Public Debt and Relative Prices. Answer: Summary The article evaluates the effects of distortionary labor taxation and public debt on relative prices in the long run. It is essential to determine the long-run path of relative prices to understand inflation differentials in a monetary union. Therefore, the study examines the relationship between labor taxation, public debt and non-traded items' relative prices. Theoretically, the research shows that higher tax levels are associated with higher public debt. Likewise, the higher taxes are linked to higher contract labor supply in the non-traded items sector. Empirical studies reveal significant effects of public debt and taxes in the price of non-traded products. In this case, higher debt and taxation also have a strong correlation to higher prices. It is noteworthy that the theoretical framework in the paper describes an extension of the standard small open economy model that deals with non-traded and traded items. The framework represents the consumers as maximizing the current discounted value of their future utility. On the other hand, the government is assumed to consume the non-traded items as well as the traded items. In the model, the government finances its spending through tax labor income and borrowing. The empirical analysis uses data from a sample of 15 advanced nations from the period between 1980 and 2007. For this research, the fiscal variables comprise of labor taxes, government expenditure public capital, and the public debt. The sectoral variables are represented by relative labor productivity and relative non-tradable prices. The research findings imply that there is a relatively strong relationship between the fiscal variables coefficient that and relative prices, with a correlation that ranges from 34 perce nt to 67 percent. According to the model, high sovereign debt can indirectly contribute to the establishment of relative prices through greater distortionary labor taxation. That is to say that although greater taxation proportionately diminishes the supply of labor across the economy, the change in the supply of non-traded items is abstruse and determined by factor intensities. For this reason, the empirical results can be interpreted to conclude that public debt has a crucial part in establishing the long-run path of relative sectoral prices. By and large, the study adds to the existing works on the structural determinants of long-run relative prices of non-traded items. Also, the originality of the paper lies in the fact that it provides the current relationship between distortionary labor taxation, government debt and sectoral prices over an extended period. Strengths One major strength of the study is that the model successfully determines the relationship between distortionary labor tax, public debt and relative prices of non-traded items in a two-sector micro economy. The researchers are able to fill the existing knowledge gap that previously existed and remained unexplored as regards to the effects of sovereign debt and its implications on relative prices. Therefore, by employing the two-sector open economy framework, the researchers succeed to demonstrate that the effect of more public debt on the prices of goods depends on relative factor intensities. For this reason, the researchers infer correctly that higher public debt is associated with higher levels of taxation in the non-traded items as well as the traded goods sector. Another strength pertains to the fact that the paper integrates the analysis by applying theory to the facts in advanced economies. This way, the study derives conclusive findings that suggest that effective labor taxation and public role play an important part in the long-run and collerates positively with relative prices. The papers strengths also lie in the ability of the researchers to integrate the various elements of a research paper successfully. Particularly, the paper has a theoretical framework and model that analyses the existing literature on the field. Also, the study uses empirical data and analyses the empirical evidence to derive conclusions for the study. This way, the reader can deduce that the research was well orchestrated and the findings are authoritative. Also, the researchers are keen and efficiently interpret their findings and results to allow the reader to understand the meaning of the results. Weaknesses One major weakness in the paper arises when the researchers depart from and ignore the assumption of lump-sum taxation and balanced budgets. In this model, increases in government consumption are associated with average to long-run increases in the cost of non-traded items and the appreciation of the absolute exchange rate. The model also demonstrates that the long-run effects of government investment are more ambiguous. For this reason, ignoring the essential elements of the model leaves out important aspects that could be used in making inferences. Conclusion It is worth noting that the estimates of the empirical results are quantitatively consistent with the previous models and existing literature. Therefore, the study infers that the public debt plays a vital part in establishing the path of the relative sectoral prices. In addition, the study proves that there is a positive relationship between higher taxation levels and public debt and the relative prices of goods that are non-traded in a micro economy model. A higher stock of public debt is linked to higher taxation and contracts labor supply in this sector. Generally, the paper purports that taxes and public debt are vital determinants of relative prices and have significant implications for international price competitiveness.