Ilya Eryzhenskiy, Economist

I study decentralization of optimal allocations in an endowment OLG economy where private agents face endogenous borrowing constraints. Lenders constrain credit because of limited commitment of borrowers: they can declare bankruptcy and only lose the ability to make savings for retirement in the future. The social planner can use lump-sum transfers and government debt in order to decentralize optimal allocations of consumption goods. I show that policies using government debt decentralize a larger set of optimal allocations, as opposed to balanced-budget policies with the same number of instruments per period. In addition, government debt always rules out equilibria where the private credit market does not operate and can rule out equilibrium steady states with binding borrowing constraints. The results are explained by incentives for saving and debt repayment under limited commitment, so they do not hold under common specifications of exogenous debt constraints.