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Overlapping generations and idiosyncratic risk: Can prices reveal the best policy?

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  • Fiorini, Luciana C.

Abstract

Incomplete markets in overlapping generations leave room for Pareto improvement. We analyze a model with two goods and idiosyncratic shocks. We compare market equilibrium with the constrained efficient equilibrium allocation and demonstrate that, when shocks are symmetric and do not affect all goods, prescription of the optimal policy depends exclusively on information about relative prices. This policy, based on lump sum transfers of a nominal asset, changes the rate of return on savings, inducing new choices of consumption and new equilibrium prices. When shocks affect all goods, however, relative prices are not sufficient information for the policy prescription. The magnitude of the shocks and of the equilibrium levels of consumption become important as well.

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  • Fiorini, Luciana C., 2008. "Overlapping generations and idiosyncratic risk: Can prices reveal the best policy?," Journal of Mathematical Economics, Elsevier, vol. 44(12), pages 1312-1320, December.
    • Handle: RePEc:eee:mateco:v:44:y:2008:i:12:p:1312-1320
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    1. Hiraguchi, Ryoji & Shibata, Akihisa, 2015. "Taxing capital is a good idea: The role of idiosyncratic risk in an OLG model," Journal of Economic Dynamics and Control, Elsevier, vol. 52(C), pages 258-269.

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