Trading Off Generations: Infinitely-Lived Agent Versus OLG

By Maik Schneider, Christian Traeger and Ralph Winkler

http://d.repec.org/n?u=RePEc:eth:wpswif:10-128&r=dge

The prevailing literature discusses intergenerational trade-offs predominantly in infinitely-lived agent models despite the finite lifetime of individuals. We discuss these trade-offs in a continuous time OLG framework and relate the results to the infinitely-lived agent setting. We identify three shortcomings of the latter: First, underlying normative assumptions about social preferences cannot be deduced unambiguously. Second, the distribution among generations living at the same time cannot be captured. Third, the optimal solution may not be implementable in overlapping generations market economies. Regarding the recent debate on climate change, we conclude that it is indispensable to explicitly consider the generations’ life cycles.

It is clear the world is composed of overlapping generations, but modelers often use infinitively-lived agents, for covenience, or under the belief that is does not make a difference for aggregates, or because there is intergenerational altruism. This paper, taking a continuous-time approach, shows when the two modeling assumptions are observationally equivalent. But the authors highlight that the two assumptions may have dramatic implications for policy advice.