Borrowing constraints and two-sided altruism with an application to social security

Abstract

We develop the implications of borrowing constraints and two-sided altruism in an overlapping generations framework with agents who live three periods. Our analysis identifies six equilibrium patterns of intertemporal and intergenerational linkages in the no-loan economy, one of which corresponds to the traditional life-cycle model, and one of which corresponds to Barro's dynastic model. Novel linkage patterns involve parent-to-child transfers early in the life cycle, child-to-parent gifts late in the life cycle, or both. Capital accumulation behavior and the consequences of fiscal policy interventions depend, often critically, on which linkage pattern prevails. We show, for example, how unfunded social security interventions can significantly depress aggregate capital accumulation, even when every generation is linked to its successor generation by altruistic transfers. We also derive a non-Ricardian neutrality result for gift motive economies that holds whether or not borrowing constraints bind and whether or not parent and child are connected by an operative altruism motive at all points in the life cycle.