This paper makes two fundamental contributions: (i) We prove that the interior Ramsey steady state commonly assumed in the literature may not exist in a standard Aiyagari model-in particular, a steady state with the modified golden rule and a positive capital tax is shown to be feasible but not optimal. (ii) We design a modified, analytically tractable version of the standard Aiyagari model to reveal the necessary and/or sufficient conditions for the existence of a Ramsey steady state. We characterize the basic properties of both interior and non-interior Ramsey steady states and show that researchers may draw fundamentally misleading conclusions about optimal fiscal policy (such as the optimal capital tax rate) from their analysis if an interior Ramsey steady state is incorrectly assumed.
https://doi.org/10.20955/wp.2022.009
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