I am reading Some Unpleasant Monetarist Arithmetic (Sargent and Wallace, 1981) and I had some questions about a claim made by the authors. They say:
The public's demand for interest-bearing government debt constrains the government of a monetarist economy in at least two ways. One way the public's demand for bonds constrains the government is by setting an upper limit on the real stock of government bonds relative to the size of the economy. Another way is by affecting the interest rate the government must pay on bonds.
First of all, are we assuming that the government borrows from the private sector and spends it on something that improves productivity? For example, the government could borrow from the private sector and spend it on a road (something that increases productivity) or they could spend it on unemployment benefits (beneficial, but not productive). I think "real stock of government bonds" is what is confusing me. So the way I understand the first reason is that if government debt becomes too high and the interest payments exceed the growth rate of the economy, this will not be sustainable because the government will have to pay more to the private sector than is produced by the private sector.
For example, consider a extremely simplified economy where corn is the only thing produced and the agents are: (i) the government (ii) the private sector. So the government borrows 1 ton of corn from the private sector and promises to pay back 2 tons next year. They use that corn to improve corn producing ability of the private sector. However, the private sector was only able to produce 1.5 tons of corn the following year. Hence the real government debt is too high relative to the real size of the economy. Is this what Sargent and Wallace are referring to?
The second reason sounds very logical but I just want to ensure I understand it correctly. Is it simply saying that if the interest payments on government debt becomes too high, they will have to raise taxes to a level that is not optimal?
However, the second reason appears to be very similar to my corn example so it feels like I am not understanding the authors reasoning very well. If anyone could explain or refer me to a source, I would greatly appreciate it.