Incomplete Market and Optimal Debt in an Economy with an Overlapping Generation Structure

Akio Ino and Keiichiro Kobayashi
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Akio Ino: Assistant Professor, Yokohama National University

Public Policy Review, 2022, vol. 18, issue 1, 1-18

Abstract: Aiyagari and McGrattan (1998) point out that in an incomplete market model, government debt may help to level out consumption by serving as a means of households savings and thereby improve social welfare. Aiyagari and McGrattan state that issuing a certain quantity of government debt is an optimal option. A similar analysis is conducted by Nakajima and Takahashi (2017) with respect to Japan. Aiyagari and McGrattan’s model assumes an infinite period of life for individuals. However, Peterman and Sager (2018) point out that if a finite period of life is assumed for individuals, the optimal quantity of government debt is a negative figure because demand for savings declines compared with the case of individuals with an infinite period of life. In addition, in Aiyagari and McGrattan’s argument, the comparison is conducted only under a stationary equilibrium and the cost that arises during the transition path in which the debt quantity changes is overlooked. This paper conducts a review of existing literature on those two points.

Keywords: government debt; incomplete market; overlapping generation structure; transition path (search for similar items in EconPapers)
JEL-codes: E21 E6 H6 (search for similar items in EconPapers)
Date: 2022
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