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Efficient Allocations in a Dynamic Moral Hazard Economy

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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.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2006 Meeting Papers with number 138.

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Date of creation: 03 Dec 2006
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Handle: RePEc:red:sed006:138

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Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
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Web page: http://www.EconomicDynamics.org/society.htm
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Keywords: moral hazard; dynamic contracting;

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