Rational Ponzi Games

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Abstract
When can a government borrow a dollar and never pay back any interest or principal? We call such an arrangement under perfect foresight a rational Ponzi game. We use the transversality condition facing individual agents to show that rational Ponzi games require an infinity of lenders. The horizon of individual agents is unimportant; Ponzi games cannot be ruled out by assuming that agents have infinite horizons. We point out both the basic similarity and some key differences between rational Ponzi games and asset price bubbles or fiat money. With reference to the international debt issue, the analysis implies that conditions in the borrower’s economy are irrelevant to the feasibility of rational Ponzi games; what matters is the relationship between the paths of interest rates and population and productivity growth rates in the lenders’ economy.
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