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The Private Memory of Aggregate Shocks

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  • Costa, Carlos Eugênio da
  • Luz, Vitor F.
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    Abstract

    We study constrained efficient aggregate risk sharing and its consequence for thebehavior of macro-aggregates in a dynamic Mirrlees’s (1971) setting. Privately observedidiosyncratic productivity shocks are assumed to be independent of i.i.d. publiclyobserved aggregate shocks. Yet, private allocations display memory with respectto past aggregate shocks, when idosyncratic shocks are also i.i.d.. Under a mild restrictionon the nature of optimal allocations the result extends to more persistentidiosyncratic shocks, for all but the limit at which idiosyncratic risk disappears, andthe model collapses to a pure heterogeneity repeated Mirrlees economy identical toWerning [2007]. When preferences are iso-elastic we show that an allocation is memorylessonly if it displays a strong form of separability with respect to aggregate shocks.Separability characterizes the pure heterogeneity limit as well as the general case withlog preferences. With less than full persistence and risk aversion different from unityboth memory and non-separability characterize optimal allocations. Exploiting thefact that non-separability is associated with state-varying labor wedges, we apply abusiness cycle accounting procedure (e.g. Chari et al. [2007]) to the aggregate datagenerated by the model. We show that, whenever risk aversion is great than one ourmodel produces efficient counter-cyclical labor wedges.

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    Bibliographic Info

    Paper provided by FGV/EPGE Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil) in its series Economics Working Papers (Ensaios Economicos da EPGE) with number 706.

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    Date of creation: 10 Jul 2010
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    Handle: RePEc:fgv:epgewp:706

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    1. Orazio Attanasio & Nicola Pavoni, 2007. "Risk Sharing in Private Information Models with Asset Accumulation: Explaining the Excess Smoothness of Consumption," NBER Working Papers 12994, National Bureau of Economic Research, Inc.
    2. Narayana R. Kocherlakota & Luigi Pistaferri, 2007. "Household Heterogeneity and Real Exchange Rates," Economic Journal, Royal Economic Society, vol. 117(519), pages C1-C25, 03.
    3. Narayana R. Kocherlakota & Luigi Pistaferri, 2004. "Asset Pricing Implications of Pareto Optimality with Private Information," Levine's Bibliography 122247000000000508, UCLA Department of Economics.
    4. Narayana Kocherlakota & Luigi Pistaferri, 2008. "Inequality and Real Exchange Rates," Journal of the European Economic Association, MIT Press, vol. 6(2-3), pages 597-608, 04-05.
    5. Fernandes, Ana & Phelan, Christopher, 2000. "A Recursive Formulation for Repeated Agency with History Dependence," Journal of Economic Theory, Elsevier, vol. 91(2), pages 223-247, April.
    6. Gabrielle Demange, 2008. "Sharing aggregate risks under moral hazard," PSE Working Papers halshs-00586739, HAL.
    7. Marek Kapicka, 2013. "Efficient Allocations in Dynamic Private Information Economies with Persistent Shocks: A First-Order Approach," Review of Economic Studies, Oxford University Press, vol. 80(3), pages 1027-1054.
    8. Mikhail Golosov & Narayana Kocherlakota & Aleh Tsyvinski, 2001. "Optimal indirect and capital taxation," Staff Report 293, Federal Reserve Bank of Minneapolis.
    9. Ethan Ligon & Jonathan P. Thomas & Tim Worrall, 2002. "Informal Insurance Arrangements with Limited Commitment: Theory and Evidence from Village Economies," Review of Economic Studies, Oxford University Press, vol. 69(1), pages 209-244.
    10. Thomas, Jonathan & Worrall, Tim, 1990. "Income fluctuation and asymmetric information: An example of a repeated principal-agent problem," Journal of Economic Theory, Elsevier, vol. 51(2), pages 367-390, August.
    11. Narayana Kocherlakota & Luigi Pistaferri, 2008. "Household Heterogeneity and Asset Trade: Resolving the Equity Premium Puzzle in Three Countries," Levine's Bibliography 122247000000001886, UCLA Department of Economics.
    12. Casey Rothschild & Florian Scheuer, 2011. "Optimal Taxation with Rent-Seeking," NBER Working Papers 17035, National Bureau of Economic Research, Inc.
    13. Mikhail Golosov & Aleh Tsyvinski & Ivan Werning, 2007. "New Dynamic Public Finance: A User's Guide," NBER Chapters, in: NBER Macroeconomics Annual 2006, Volume 21, pages 317-388 National Bureau of Economic Research, Inc.
    14. Jonathan Levin, 2002. "Multilateral Contracting And The Employment Relationship," The Quarterly Journal of Economics, MIT Press, vol. 117(3), pages 1075-1103, August.
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