GOVERNMENT BONDS IIII individuals are infinite-lived, since the effect of finite lives has already been examined above It is convenient to suppose that government debt now takes the form of a perpetuity that carries a real interest payment of i per year. Suppose that the government issues an additional bond of this type. This bond would be purchased by a low-discount-rate individual and would be evaluated as B= i/rr. Suppose then that the government uses the ump-sum proceeds from this sale, B, to effect a lump-sum transfer(or lump-sum tax reduction) to individuals, and suppose that a fraction a of this transfer goes to rr discount rate individuals and a fraction(1-a)to , discount rate individuals. Finally, the taxes for financing the government interest payments are(1 y)i, where y represents, as in section IE, the proportional transaction costs associated with government bond sale and tax collection. Suppose that these taxes are distributed across discount rates in the same manner as the lump-sum proceeds+that is, a fraction a to r individuals and a fraction(1-a) to rh individuals Consider, in turn, the wealth effects for the r, and h groups. The bond sale itself involves no wealth effect for the r group. The lump-sum transfer to r individuals is aB ai/rr, while the present value of the r, share of tax liabilities, discounted at rate rr, is(I y)air. Clearly, if y>0, the net-wealth effect for ri individuals is negative, as it was in the case discussed in section IE, where all discount rates were equal For the Th group, the lump-sum proceeds are(1-a)B=(1-a)i/r while the present value of the tax liability, discounted at rate Th,is (1 +?(1-airh Using rh=(1+ A)ri, the net-wealth effect here can be expressed as 1+))r1(1+) which is positive if 2>7. That is, the net-wealth effect for the h group is positive if y, which measures the government transaction costs for bond sue and tax collection, is smaller than i, which measures the private transaction costs implicit in the existing pattern of (net-of-default-risk) discount rates. To the extent, 1-a, that the transfer payment and tax liability involve the rh group, the government bond issue amounts to effe a loan from the low-discount-rate to the high-discount-rate individuals. On the other hand, this sort of transfer could already have 23 This analysis abstracts from any "liquidity yield"of bonds(see part Ill, below) 24 If the fractions for transfer and tax liability vary, then the wealth cffects on the wo discount-rate groups are likely to be in opposite directions. The net effect on current nsumption demand would depend, in part, on relative propensities to consume, which are not obvious. In any event, this case would amount to the effect of income distributie on consumption demand, rather than the effect of government bond issue per se on net wealth and consumption demand