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Sustainable plans and debt

  • V. V. Chari
  • Patrick J. Kehoe

This paper presents a simple general equilibrium model of optimal taxation similar to that of Lucas and Stokey (1983), except that we let the government default on its debt. As a benchmark, we consider Ramsey equilibria in which the government can precommit its policies at the beginning of time. We then consider sustainable equilibria in which both government and private agent decision rules are required to be sequentially rational. We concentrate on trigger mechanisms which specify reversion to the finite horizon equilibrium after deviations by the government. The main result is that no Ramsey equilibrium with positive debt can be supported by such trigger mechanisms.

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Paper provided by Federal Reserve Bank of Minneapolis in its series Staff Report with number 125.

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Date of creation: 1989
Date of revision:
Publication status: Published in Journal of Economic Theory (Vol. 61, n.2, December 1993, pp. 230-261)
Handle: RePEc:fip:fedmsr:125
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  1. Herschel I. Grossman & John B. Van Huyck, 1985. "Sovereign Debt as a Contingent Claim: Excusable Default, Repudiation, and Reputation," NBER Working Papers 1673, National Bureau of Economic Research, Inc.
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  3. Chari, V V & Kehoe, Patrick J, 1990. "Sustainable Plans," Journal of Political Economy, University of Chicago Press, vol. 98(4), pages 783-802, August.
  4. Robert E. Lucas Jr. & Nancy L. Stokey, 1982. "Optimal Fiscal and Monetary Policy in an Economy Without Capital," Discussion Papers 532, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
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  18. Fudenberg, Drew & Maskin, Eric, 1986. "The Folk Theorem in Repeated Games with Discounting or with Incomplete Information," Econometrica, Econometric Society, vol. 54(3), pages 533-54, May.
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