It is well known that the first welfare theorem can fail for overlapping generations economies with private production and unsecured debt. This paper demonstrates that the reason for this failure is that intermediation is modeled as a purely passive coordination activity implemented by a Walrasian Auctioneer. When intermediation is modeled instead as a contestable activity carried out by a corporate intermediary owned by consumer-shareholders and operated in their interest, every equilibrium is Pareto efficient. In broader terms, these findings caution that the inefficiency observed in standard modelings of overlapping generations economies may not be the reflection of an intrinsic market failure. Rather, the observed inefficiency could instead be due to a fundamental incompleteness in the model specification—the presumed inability of private agents to exploit the earnings opportunities associated with incurring and forever rolling over debt.
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Paper provided by Iowa State University, Department of Economics in its series Staff General Research Papers with number
1228.
Length: Date of creation: 30 Sep 1998 Date of revision: Publication status: Published in Macroeconomic Dynamics, 1998, Vol. 2, pp. 183-212. Handle: RePEc:isu:genres:1228
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Find related papers by JEL classification: C0 - Mathematical and Quantitative Methods - - General E0 - Macroeconomics and Monetary Economics - - General
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