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Outside versus Inside Bonds: A Modigliani-Miller Type Result for Liquidity Constrained Economies

  • Aleksander Berentsen
  • Christopher Waller

When agents are liquidity constrained, two options exist — sell assets or borrow. We compare the allocations arising in two economies: in one, agents can sell government (outside) bonds and in the other they can borrow by issuing (inside) bonds. All transactions are voluntary, implying no taxation or forced redemption of private debt. We show that any allocation in the economy with inside bonds can be replicated in the economy with outside bonds but that the converse is not true. However, the optimal policy in each economy makes the allocations equivalent.

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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 3272.

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Date of creation: 2010
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Handle: RePEc:ces:ceswps:_3272
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