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Journal Article

5

Public Debt, the Terms of Trade and Welfare in an Overlapping Generations Model with Lifetime Uncertainty

Published on 1 January 2005

This article reconsiders the relationship between government debt and welfare in a two-country overlapping-generations model with lifetime uncertainty and international product differentiation. It has recently been proposed that a higher steady-state debt level may be welfare-enhancing in this setting. It is pointed out that this proposition does not adequately account for the effect of debt policy on individual agents’ intertemporal consumption profiles. While a higher debt may indeed raise aggregate steady-state consumption, the lifetime utility of all steady-state cohorts will actually drop, unless the elasticity of substitution between domestic output and imports is extremely low. These particular results illustrate a more general caveat pertaining to any normative policy analysis in settings with overlapping generations of intertemporally optimizing agents: Attempts to draw welfare inferences on the basis of comparisons of aggregate consumption paths can be misleading.

Authors

Image of Dirk Willenbockel

Dirk Willenbockel

Research Fellow

Publication details

authors
Willenbockel, D.
journal
Economics Bulletin, volume 5, issue 10

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