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Dirk Willenbockel
''Public debt, the terms of trade and welfare in an overlapping generations model with lifetime uncertainty''
( 2005, Vol. 5 No.10 )
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 , 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.
JEL: E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General
H6 - National Budget, Deficit, and Debt: General
Manuscript Received : Sep 10 2005 Manuscript Accepted : Oct 25 2005

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