Debt Stabilization in a Non-Ricardian Economy
In models with a representative infinitely lived household, modern versions of tax smoothing imply that the steady-state of government debt should follow a random walk.� This is unlikely to be the case in OLG economies, where the equilibrium interest rate may differ from the policy-maker's rate of time preference such that it may be optimal to reduce debt today to reduce distortionary taxation in the future.� Moreover, the level of the capital stock (and therefore output and consumption) in these economies is likely to be sub-optimally low, and reducing government debt will 'crowd in' additional capital.� Using an elaborated version of the model of perpetual youth developed by Blanchard (1985) and Yaari (1985), we derive the optimal steady state level of government assets.� We show how and why this level of government assets falls short of the level of debt that achieves the optimal capital stock and the level that eliminates income taxes.
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