Active Intermediation in a Monetary Overlapping Generations Economy

It is now widely believed that government intervention is essential to ensure Pareto efficiency in the standard overlapping generations economy with nonaltruistic agents. This paper argues that the normal profit-seeking activities of private intermediaries—missing from the standard overlapping generations economy—would tend to eliminate the need for such government intervention. A private earnings-driven corporate intermediary is introduced into a standard monetary overlapping generations economy which, in the absence of the intermediary, generates Pareto inefficient equilibria. The intermediary issues unsecured corporate debt and maximizes its market value in direct accordance with the interests of its successive shareholders. The significant impact of private intermediation is demonstrated by establishing that all equilibria for the resulting “Corporate Economy” are Pareto efficient. Dynamic properties of equilibrium paths are also determined. It is shown, for example, that endogenous cyclic equilibria are possible for the Corporate Economy in the absence of gross substitutability.