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Accounting for private information

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  • Laurence Ales

    (University of Minnesota and Federal Reserve BAnk of Minneapolis)

  • Pricila Maziero

    (University of Minnesota and Federal Reserve Bank of Minneapolis)

Abstract

The realization of uncertainty faced by workers over the lifecycle can be either public or private information. This has important consequences on the degree of risk sharing and ultimately on the degree of lifetime inequality. Recent literature in public finance has focused on the implications of private information shocks on efficient allocations. In this paper we quantify the importance of private information in accounting for inequality. In particular we determine how much private information is needed to account for the distribution of income and consumption in the US. To answer this question we explore the quantitative implications of a class of economies with informational frictions. We consider two dynamic models: a standard Mirrlees economy with exogenous skill shocks and a taste shock economy with endogenous labor supply. In both economies the shocks have a component that is privately observable and another that is publicly observable. We solve the informational constrained problem for these environments and calibrate the degree of private information necessary to match the distributions of consumption, income and hours in the US. In both these models private information shocks introduce two important implications on lifetime consumption and income. They introduce an endogenous fanning out of continuation utilities. This translates in consumption and income inequality rising over time without any increase in the variance of the shocks. The presence of private information also reduces the consumption response to income innovations with respect to the full information case. In models with incomplete markets this response is large when compared with the data. Preliminary results indicate that in both models we need a large fraction of the shocks being public information to be consistent with features observed in the data.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2007 Meeting Papers with number 804.

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Date of creation: 2007
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Handle: RePEc:red:sed007:804

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References

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Citations

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Cited by:
  1. Alejandro Badel & Mark Huggett, . "Interpreting Life Cycle Inequality Patterns as an Efficient Allocation: Mission Impossible?," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics.
  2. Golosov, Mikhail & Troshkin, Maxim & Tsyvinski, Aleh & Weinzierl, Matthew, 2013. "Preference heterogeneity and optimal capital income taxation," Journal of Public Economics, Elsevier, vol. 97(C), pages 160-175.
  3. Larry E. Jones & Alice Schoonbroodt, 2010. "Complements Versus Substitutes And Trends In Fertility Choice In Dynastic Models," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 51(3), pages 671-699, 08.
  4. Laurence Ales & Pricila Maziero, . "Non-exclusive Dynamic Contracts, Competition, and the Limits of Insurance," GSIA Working Papers 2010-E59, Carnegie Mellon University, Tepper School of Business.
  5. Mikhail Golosov & Maxim Troshkin & Aleh Tsyvinski, 2011. "Optimal Dynamic Taxes," NBER Working Papers 17642, National Bureau of Economic Research, Inc.
  6. Zhu, Guozhong, 2013. "Age-specific rise of income and consumption inequality," Economics Discussion Papers 2013-21, Kiel Institute for the World Economy.

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