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Efficient Allocations in a Dynamic Moral Hazard Economy

Author

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  • Noah Williams

    (Dept. of Economics Princeton University)

Abstract

I analyze the implications of moral hazard in dynamic economy with production. In particular, I add agency frictions to a benchmark stochastic growth model, by assuming that firms observe output but hours worked and productivity are unobservable. I cast the problem as a continuous time principal agent model and study the contracting problem that results. I solve for the optimal contract using some recent results on the validity of the first-order approach in continuous time, which makes the analysis tractable. I show that the dynamic agency frictions introduce both a "labor wedge" which distorts the allocation of labor within a period and an "intertemporal wedge" distorting the allocation of consumption over time. I analyze the quantitative importance of moral hazard in this economy for consumption and output dynamics and asset prices.

Suggested Citation

  • Noah Williams, 2006. "Efficient Allocations in a Dynamic Moral Hazard Economy," 2006 Meeting Papers 138, Society for Economic Dynamics.
    • Handle: RePEc:red:sed006:138
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    Keywords

    moral hazard; dynamic contracting;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • E23 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Production
    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis

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