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The Optimum Structure for Government Debt

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  • Kuhle, Wolfgang

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    (Munich Center for the Economics of Aging (MEA))

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    Abstract

    This paper studies the structural differences between implicit and explicit government debt in a two-generations-overlapping model with stochastic factor-prices. If a government can issue safe bonds and new claims to wage-indexed social security to service a given initial obligation, there exists a set of Pareto-efficient ways to do so. This set is characterized by the conflicting interests of the current young and the yet unborn generations regarding the allocation of factor-price risks. However, it is shown that there will always exist a simple intertemporal compensation mechanism which allows to reconcile these conflicting interests. This compensation mechanism narrows the set of Pareto-efficient debt structures until only one remains. This result hinges on the double-incomplete markets structure of stochastic OLG models where households can neither trade consumption loans nor factor-price risks privately.

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    Paper provided by Munich Center for the Economics of Aging (MEA) at the Max Planck Institute for Social Law and Social Policy in its series MEA discussion paper series with number 09194.

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    Date of creation: 21 Oct 2010
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    Handle: RePEc:mea:meawpa:09194

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