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

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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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  • Willem H. Buiter & K.M. Kletzer, 1994. "Ponzi Finance, Government Solvency and the Redundancy or Usefulness of Public Debt," Cowles Foundation Discussion Papers 1070, Cowles Foundation for Research in Economics, Yale University.
  • Handle: RePEc:cwl:cwldpp:1070
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    File URL: http://cowles.yale.edu/sites/default/files/files/pub/d10/d1070.pdf
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    1. Alan J. Auerbach & Jagadeesh Gokhale & Laurence J. Kotlikoff, 1991. "Generational Accounts: A Meaningful Alternative to Deficit Accounting," NBER Chapters,in: Tax Policy and the Economy, Volume 5, pages 55-110 National Bureau of Economic Research, Inc.
    2. 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.
    3. Buiter, Willem H. & Patel, Urjit R., 1992. "Debt, deficits, and inflation: An application to the public finances of India," Journal of Public Economics, Elsevier, vol. 47(2), pages 171-205, March.
    4. 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 647-658, October.
    5. 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.
    6. Andrew B. Abel, "undated". "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.
    7. Calvo, Guillermo A & Obstfeld, Maurice, 1988. "Optimal Time-Consistent Fiscal Policy with Finite Lifetimes," Econometrica, Econometric Society, vol. 56(2), pages 411-432, March.
    8. Corsetti, G., 1990. "Testing For Solvency Of Public Sector: An Application To Italy," Papers 617, Yale - Economic Growth Center.
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    1. Buiter, Willem H, 1997. "Generational Accounts, Aggregate Saving and Intergenerational Distribution," Economica, London School of Economics and Political Science, vol. 64(256), pages 605-626, November.
    2. Ioan Talpos & Cosmin Enache, 2008. "Fiscal Policy Sustainability In Romania," Annales Universitatis Apulensis Series Oeconomica, Faculty of Sciences, "1 Decembrie 1918" University, Alba Iulia, vol. 1(10), pages 1-23.
    3. Polackova, Hana, 1997. "Population aging and financing of government liabilities in New Zealand," Policy Research Working Paper Series 1703, The World Bank.

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