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AbstractThis paper simulates the effects of China's growing government debt in a computable equilibrium model of overlapping generations. Our model assumes that the government increases debt to finance its spending in the short run, and then increases taxes or cuts spending to keep the debt–GDP ratio constant. The spending‐driven government debt increases public capital and output in the short run, but decreases private investment, total capital stock, output, and net exports in the long run, and makes the future generations worse off. Among various means of debt control, a decrease in government spending seems to be the least harmful to private investment, capital stock, and output while an increase in capital taxation is most detrimental.

In future agreements to cut greenhouse gases, a Chinese commitment will probably be essential. Committing for China is easier if the cost is low and the benefit to China is high. Using a new CGE-model of the Chinese economy we discuss the cost and benefit to China of taking on a climate commitment. We argue that a climate commitment gives significant ancillary benefits to China since associated particle and NOx-reductions improve public health and increase agricultural yields. The model of impact on agricultural yields is a novel feature of CGE-models. Comparing benefits to economic costs produces striking results. We find that China may reduce its CO2-emissions by 17.5 per cent without suffering a welfare loss. Half of the benefit originates in the novel agricultural model. We also discuss the distributional impact of a climate commitment. In general the distributional impact is not averse.