Relationship between risk attitude and economic recovery in optimal growth theory
AbstractPolicy makers often resort to Keynesian fiscal stimulus to try to stabilize the economy after a major economic downturn. This is nearly always financed with deficit spending and thus debt (under the rubric of quantitative easing11Some note that “quantitative easing” is a modern euphemism formerly called “monetizing the debt.”) which invariably leads to huge budget deficit problems that tend to weaken investor and consumer confidence. Many economists agree it is better to let the economy grow out of the downturn than to finance further deficit spending through increased taxation or by printing money. Economic growth increases employment and generates government revenues to help balance the budget. But policies promoting economic growth often neglect the attitudes of consumers and investors towards risks. Risk-attitude is especially relevant if the shock originates from the financial sector, causing uncertainty and distrust. This paper examines the effect of risk aversion on growth recovery after an economic shock. We find that within the framework of optimal growth theory, risk-attitude determines the strength of the recovery path. We also find that risk-attitude can undermine the effectiveness of low interest rate policies. This highlights the importance of having policies geared towards restoring a stable risk-attitude in the economy. We feel results can best be achieved by resorting more to market mechanisms and less to government intervention. Market transparency and market discipline should be promoted to add certainty and trust so that people can properly form their risk-attitude.
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Bibliographic InfoArticle provided by Elsevier in its journal Global Finance Journal.
Volume (Year): 23 (2012)
Issue (Month): 3 ()
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Web page: http://www.elsevier.com/locate/inca/620162
Risk-attitude; Optimal growth theory; Economic recovery;
Find related papers by JEL classification:
- O40 - Economic Development, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - General
- E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
- E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General
- D9 - Microeconomics - - Intertemporal Choice
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