Perpetual Youth and Endogenous Labour Supply: A Problem and a Possile Solution

In the ‘‘perpetual youth’’ overlapping-generations model of Blanchard and Yaari, if leisure is a
‘‘normal’’ good then some agents will have negative labor supply. We suggest a solution to this problem
by using a modified version of Greenwood, Hercowitz and Huffman’s utility function. The modification
incorporates real money balances, so that the model may be used to analyze monetary as
well as fiscal policy. In a Walrasian version of the economy, we show that increased government debt
and increased government spending raise the interest rate and lower output, while an open-market
operation to increase the money supply lowers the interest rate and raises output.