Government Debt as Insurance against

Is there a role for debt beyond curing overaccumulation of capital? If debt Ponzi schemes are infeasible, does this eliminate any Pareto-improving role for a gov-ernment in a competitive economy with complete markets? Is there an optimal maturity structure of public debt? We show in a stochastic Diamond OLG model that government debt can interim Pareto-improve upon market allocations by pro-viding insurance against macroeconomic risk. This is achieved by a scheme that rolls over an insurance contract generation for generation, instead of rolling over safe debt. Exploiting information from the term structure of interest rates, we derive testable conditions both for dynamic efficiency and for interim Pareto optimality in terms of interest rates. We provide evidence that real world economies, while being dy-namically efficient, are likely not to be interim Pareto optimal