Debt, deficits and finite horizons: the stochastic case

We introduce aggregate uncertainty and complete markets into Blanchard's (1985) perpetual youth model. We show how to construct a simple formula for the pricing kernel in terms of observable aggregate variables. We study a pure trade version of our model and we show it behaves much like the two-period overlapping generations model. Our methods are easily generalized to economies with production and they should prove useful to researchers who seek a tractable stochastic model in which fiscal policy has real effects on aggregate allocations.