Working Paper: CEPR ID: DP680
Authors: Willem H. Buiter; Kenneth M. Kletzer
Abstract: We investigate how the ability of the government to depart from budget balance and issue debt expands the set of equilibria that can be supported using lump-sum tax-transfer instruments. We show how this depends on the restrictions that exist on the capacity to tax and make transfer payments, and what these restrictions imply for the government's ability to issue debt. Central to our analysis is the definition of solvency for an infinite-lived government in an infinite-lived economy with overlapping generations of finite-lived households. Our specification is derived from the non-negativity constraints on the capital stock and on private consumption by all generations. Under fairly tight restrictions on the government's tax-transfer menu, our solvency constraint implies the conventional solvency constraint. With unrestricted taxes and transfers Ponzi finance is always possible but `unessential': it does not expand the set of equilibria that can be supported. Ponzi finance can be `essential' when taxes and transfers are restricted. The paper establishes a number of results that demonstrate how the government's ability to issue debt allows restricted tax-transfer schemes to support all equilibria attainable using unrestricted taxes and transfers.
Keywords: government solvency; public debt; ponzi finance; tax capacity
JEL Codes: E61; E62; H20
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| government debt issuance (H63) | set of equilibria supported (D51) |
| restricted tax and transfer policies (H23) | government debt issuance expands equilibria (H63) |
| Ponzi finance (G19) | support all equilibria attainable with unrestricted taxes and transfers (H00) |
| tight restrictions on taxes and transfers (H29) | Ponzi finance is essential (G19) |
| conventional solvency constraint (G33) | sequence of real public debt converges to zero (H63) |
| fiscal policy (E62) | economic stability (E63) |
| absence of restrictions on taxes and transfers (H29) | Ponzi finance is always possible (G19) |