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Discussion Paper

Ponzi Finance, Government Solvency and the Redundancy or Usefulness of Public Debt

We study how the government’s ability to borrow depends on its capacity to tax. Using a two-period OLG growth model, we establish the following.
When lump-sum taxes are unrestricted, Ponzi finance is possible, regardless of whether the economy is dynamically inefficient and regardless of the relationship between the interest rate and the growth rate. Ponzi finance, and government debt generally, is unessential or redundant: it does not enlarge the set of allocations that can be supported as competitive equilibria.