Time-inconsistent optimal quantity of debt

A key property of the Aiyagari-type heterogeneous-agent models is that equilibrium interest rate public debt lies below time discount rate. This fundamental property, however, implies Ramsey planner’s fiscal policy may be time-inconsistent because forward-looking planner would have a dominant incentive to issue plenty such all households are fully self-insured against idiosyncratic risk. But full self-insurance allocation paradoxical because, achieve it, optimal labor tax approach 100% and aggregate consumption zero. puzzling from an intuitive perspective near point marginal gains increasing should less than costs financing under distortionary taxes. We show this behavior originates assumption must commit future plans at Under commitment, opts exploit low cost borrowing front-load by sacrificing in long run utilities heavily discounted compared inverse on government bonds. demonstrate our points analytically using tractable heterogeneous-agents model featuring non-linear preferences well-defined distribution household wealth.