Intergenerational Transfers and the Stability of Public Debt with Short-Lived Governments

Abstract

Time consistent policies and reforms of intergenerational transfers are analyzed in an overlapping generation model. Governments have preferences, which give much weight to the living generations, and they cannot commit themselves to future taxes and transfers, which will be decided by future governments with different objectives. The economy follows one of two equilibrium paths with perfect foresight. On one path, governments finance the costs of their transfers to the living by increasing public debt recklessly. Consumers pay more and more taxes to finance the cost of this debt, and the successive generations will enter a process of impoverishment. On the other path, in spite of their preference bias, governments borrow less and put the economy on a path of egalitarian consumption flows for the successive generations, with a constant ratio of public debt to national income. The mechanisms, which put an economy on one or the other equilibrium paths, are unconnected to the fundamentals of the model.