12. Overlapping Generations Models of the Economy

Financial Theory (ECON 251)

In order for Social Security to work, people have to believe there's some possibility that the world will last forever, so that each old generation will have a young generation to support it. The overlapping generations model, invented by Allais and Samuelson but here augmented with land, represents such a situation. Financial equilibrium can again be reduced to general equilibrium. At first glance it would seem that the model requires a solution of an infinite number of supply equals demand equations, one for each time period. But by assuming stationarity, the whole analysis can be reduced to one equation. In this mathematical framework we reach an even more precise and subtle understanding of Social Security and the real rate of interest. We find that Social Security likely increases the real rate of interest. The presence of land, an infinitely lived asset that pays a perpetual dividend, forces the real rate of interest to be positive, exposing the flaw in Samuelson's contention that Social Security is a giant, yet beneficial, Ponzi scheme where each generation can win by perpetually deferring a growing cost.

00:00 - Chapter 1. Introduction to the Overlapping Generation Model
12:59 - Chapter 2. Financial and General Equilibrium in Social Security
26:37 - Chapter 3. Present Value Analysis of Social Security
59:24 - Chapter 4. Real Rate of Interest and Social Security

Complete course materials are available at the Open Yale Courses website: http://open.yale.edu/courses

This course was recorded in Fall 2009.