Is Debt Neutral in the Life Cycle Model?

Abstract

This paper questions the widely accepted view that deficits have real effects in the life cycle model. Standard analyses of deficits within life cycle models treat the government as a dictatorial entity that can effect any intergenerational redistribution it desires. In contrast, this paper drops the assumption of compulsion and models the government as a coalition of self-interested young and old generations whose bargaining determines government decisions. Since each generation is selfish, no generation will voluntarily absorb the debts of another except as a quid pro quo for receiving particular goods or services. Hence, redistribution per se between generations will not arise. Because each generation is ultimately responsible for its own liabilities, deficit finance, while altering the timing of tax receipts, has no economic impact.