GOVERNMENT BONDS IIO (1-r)Ai-B, subject to the constraint that the gross bequest, Ai,be nonnegative. In particular, if the solution to this problem is associated with a value of Ai in the interior--that is, if the constraint, Ai 20,is not binding-any marginal change in B would be met solely by a change in Ai that maintains the value of the net bequest,(1-r)Ai-B. Thi response in Ai will keep unchanged the values of co, c2, c2, and A2 ence, the utility levels attained by members of generations 1, 2, etc. ill be unaffected by the shift in B In terms of the effect on r, the current asset market clearing condition of equation (7)would now be modified to The increase in B implies a one-to-one increase in the asset supply on the left-hand side of equation(14). However, Ai rises by 1/(1-r) times the change in B in order to maintain the size of the net bequest, (1-r)Ai-B Further, with c2 fixed, the increase in rB(taxes)in equation(11) implies that Al falls by r/(1-r) times the change in B. On net, total asset demand on the right-hand side of equation(14)rises one-to-one with B, so that no change in r is required to clear the asset market. Equivalently, he commodity market clearing condition, as expressed in equation(9) continues to hold at the initial value of r because the bond issue has no impact on aggregate demand Essentially, a positive value of B, financed by a tax levy on the next generation, enables a member of the old generation to"go out''insolvent by leaving a debt for his descendant. However, if, prior to the government bond issue, a member of the old generation had already selected a positive bequest, it is clear that this individual already had the option of shifting resources from his descendant to himself but he had determined that such shifting, at the margin, was nonoptimal. Since the change in B does not alter the relevant opportunity set in this sense, it follows that--through the appropriate adjustment of the bequest--the values of current and future consumption and attained utility will be unaffected. On the other hand, if a member of generation I were initially at a corner where Ai=0-in particular, if Ai<0 would have been chosen had it been permissible-then an increase in B creates a relevant new opportunit In this situation a generation I household would react by increasing ci along with B, as long as the corner solution for Ai still applied. The upward shift in B would then correspond to an excess of earning-asset upply over demand (even after taking account of a shift in A2), which would tend to raise the value of r. This increase in r would induce a drop in capital formation, which constitutes the real effect of government debt issue which has been described by Modigliani( 1961). However, the main point is that the existence of this government debt effect hinges on a non-