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Constrained efficiency in the neoclassical growth model with uninsurable idiosyncratic shocks

  • Julio Davila

    ()

    (Department of Economics, University of Pennsylvania)

  • Jay H. Hong

    ()

    (Department of Economics, University of Pennsylvania)

  • Per Krusell

    ()

    (Department of Economics, University of Rochester)

  • Jose-Victor Rios-Rull

    ()

    (Department of Economics, University of Pennsylvania)

We investigate the welfare properties of the one-sector neoclassic growth model with uninsurable idiosyncratic shocks. We focus on the constrained efficiency notion of the general equilibrium literature, and we demonstrate constrained inefficiency for our model. We provide a characterization of constrained efficiency that uses the first-order condition of a constrained planner's problem that points to the margins of relevance for whether capital is too high or too low: the income composition of the (consumption-)poor. We calibrate our benchmark model parameters governing idiosyncratic risks to the U.S. earnings and wealth distribution, and for this distribution the income of the poor is mainly composed of labor earnings. We compute the constrained-efficient allocations - including transition dynamics - for our model economy, and we conclude that the long-run capital stock in a laissez-faire world is not only too low, but much too low. We also show that one can find parameterizations with different qualitative features: in one case, the steady-state capital stock is too high, and in another case no steady state exists.

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File URL: http://economics.sas.upenn.edu/system/files/working-papers/05-023.pdf
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Paper provided by Penn Institute for Economic Research, Department of Economics, University of Pennsylvania in its series PIER Working Paper Archive with number 05-023.

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Length: 51 pages
Date of creation: 23 Jul 2005
Date of revision:
Handle: RePEc:pen:papers:05-023
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