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

We study how the government's ability to borrow depends on its capacity to tax. Using a two-period OLG growth model, we establish the following. When lump-sum taxes are unrestricted, Ponzi finance is possible, regardless of whether the economy is dynamically inefficient and regardless of the relationship between the interest rate and the growth rate. Ponzi finance, and government debt generally, is unessential or redundant: it does not enlarge the set of allocations that can be supported as competitive equilibria. When lump-sum taxes are restricted, Ponzi finance (public debt) may be essential. Central to the paper is our characterization of feasible government fiscal-financial plans for an infinite-lived government facing a sequence of finite-lived overlapping private generations. The central idea is that the government does not bankrupt private agents. We contrast our criterion with the conventional government solvency constraint. The conventional solvency constraint (the present value of future government debt is non-positive in the infinitely distant future) is neither necessary nor sufficient for our feasibility criterion. When the government must use distortionary taxes and the long-run interest rate exceeds the long-run growth rate, our feasibility criterion implies the conventional solvency constraint.

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File URL: http://cowles.econ.yale.edu/P/cd/d10b/d1070.pdf
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Paper provided by Cowles Foundation for Research in Economics, Yale University in its series Cowles Foundation Discussion Papers with number 1070.

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Length: 48 pages
Date of creation: Apr 1994
Date of revision:
Handle: RePEc:cwl:cwldpp:1070
Contact details of provider: Postal: Yale University, Box 208281, New Haven, CT 06520-8281 USA
Phone: (203) 432-3702
Fax: (203) 432-6167
Web page: http://cowles.econ.yale.edu/

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Order Information: Postal: Cowles Foundation, Yale University, Box 208281, New Haven, CT 06520-8281 USA

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  1. Olivier Jean Blanchard & Philippe Weil, 1992. "Dynamic Efficiency, the Riskless Rate, and Debt Ponzi Games Under Uncertainty," NBER Working Papers 3992, National Bureau of Economic Research, Inc.
  2. Feldstein, Martin, 1988. "The Effects of Fiscal Policies when Incomes Are Uncertain: A Contradiction to Ricardian Equivalence," American Economic Review, American Economic Association, vol. 78(1), pages 14-23, March.
  3. Enders, Walter & Lapan, Harvey E., 1982. "Social Security Taxation and Inter-Generational Risk Sharing," Staff General Research Papers 10822, Iowa State University, Department of Economics.
  4. Buiter, Willem H. & Patel, U, 1990. "Debt, Deficits and Inflation: An Application to the Public Finance of India," CEPR Discussion Papers 408, C.E.P.R. Discussion Papers.
  5. Calvo, Guillermo A & Obstfeld, Maurice, 1988. "Optimal Time-Consistent Fiscal Policy with Finite Lifetimes," Econometrica, Econometric Society, vol. 56(2), pages 411-32, March.
  6. Alan J. Auerbach & Jagadeesh Gokhale & Laurence J. Kotlikoff, 1991. "Generational Accounts - A Meaningful Alternative to Deficit Accounting," NBER Working Papers 3589, National Bureau of Economic Research, Inc.
  7. 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.
  8. Corsetti, G., 1990. "Testing For Solvency Of Public Sector: An Application To Italy," Papers 617, Yale - Economic Growth Center.
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