Optimal debt, endogenous fertility, and human capital externalities in a model with altruistic bequests

This paper explores optimal debt in a model with altruistic bequests, endogenous fertility, and human capital externalities. Because of such externalities, education investment is too low and fertility is too high. While education subsidies are the conventional means to deal with these problems, we show that the optimal policy also comprises debt even when distortionary taxes are used. The reason is that debt tips the usual trade-off between children’s quantity and quality in favor of the latter by increasing the bequest cost of children. The optimal debt–output ratio exceeds 10% for plausible parameterization.