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Government Solvency, Ponzi Finance and the Redundancy and Usefulness of Public Debt

  • Buiter, Willem H.
  • Kletzer, Kenneth

We investigate how the ability of the government to depart from budget balance and issue debt expands the set of equilibria that can be supported using lump-sum tax-transfer instruments. We show how this depends on the restrictions that exist on the capacity to tax and make transfer payments, and what these restrictions imply for the government's ability to issue debt. Central to our analysis is the definition of solvency for an infinite-lived government in an infinite-lived economy with overlapping generations of finite-lived households. Our specification is derived from the non-negativity constraints on the capital stock and on private consumption by all generations. Under fairly tight restrictions on the government's tax-transfer menu, our solvency constraint implies the conventional solvency constraint. With unrestricted taxes and transfers Ponzi finance is always possible but `unessential': it does not expand the set of equilibria that can be supported. Ponzi finance can be `essential' when taxes and transfers are restricted. The paper establishes a number of results that demonstrate how the government's ability to issue debt allows restricted tax-transfer schemes to support all equilibria attainable using unrestricted taxes and transfers.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 680.

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Date of creation: Aug 1992
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Handle: RePEc:cpr:ceprdp:680
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  1. Andrew B. Abel, . "The Implications of Insurance for the Efficacy of Fiscal Policy," Rodney L. White Center for Financial Research Working Papers 06-88, Wharton School Rodney L. White Center for Financial Research.
  2. Alan J. Auerbach & Jagadeesh Gokhale & Laurence J. Kotlikoff, 1991. "Generational accounts: a meaningful alternative to deficit accounting," Working Paper 9103, Federal Reserve Bank of Cleveland.
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  4. Blanchard Olivier & Weil Philippe, 2001. "Dynamic Efficiency, the Riskless Rate, and Debt Ponzi Games under Uncertainty," The B.E. Journal of Macroeconomics, De Gruyter, vol. 1(2), pages 1-23, November.
  5. Roger H. Gordon & Hal R. Varian, 1985. "Intergenerational Risk Sharing," NBER Working Papers 1730, National Bureau of Economic Research, Inc.
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  7. Enders, Walter & Lapan, Harvey E, 1982. "Social Security Taxation and Intergenerational Risk Sharing," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 23(3), pages 647-58, October.
  8. Zilcha, Itzhak, 1990. "Dynamic efficiency in overlapping generations models with stochastic production," Journal of Economic Theory, Elsevier, vol. 52(2), pages 364-379, December.
  9. Louis Kaplow, 1991. "A Note on Taxation as Social Insurance for Uncertain Labor Income," NBER Working Papers 3708, National Bureau of Economic Research, Inc.
  10. Paul A. Samuelson, 1958. "An Exact Consumption-Loan Model of Interest with or without the Social Contrivance of Money," Journal of Political Economy, University of Chicago Press, vol. 66, pages 467.
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