Debt Policy under Fixed and Flexible Prices
The effects of an increase in the stock of government bonds are considered in an economy wit h overlapping generations and perfect foresight, and in the absence of intergene rational bequests. The cases where prices adjust instantaneously to clear market s and whereprices are exogenously fixed, are contrasted (1) in a model with cap ital accumulation but an exogenous labor supply and (2) in a model with exogenou s capital but endogenous labor supply. James Tobin's intuitive argument that, in the absence of bequests, higher debt reduces long-run welfare if prices are fle xible, but increases it iffixed, so producing Keynesian unemployment, is correc t for (1) but incorrect for (2) at high levels of employment. Copyright 1986 by Royal Economic Society.
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Volume (Year): 38 (1986)
Issue (Month): 3 (November)
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