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A Mechanism of Recession that Accompanies Persistent Pareto Inefficiency

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  • Harashima, Taiji

Abstract

Recessions are generated by various shocks. In particular, if fundamental shocks change the steady state, severe recessions will be generated. In this paper, I show that when such a shock occurs, it is possible for households to rationally select a Nash equilibrium consisting of a Pareto inefficient transition path to the new steady state in an economy in which households behave according to a procedure that is not based on the expected utilities discounted by the rate of time preference. They select this path because they are non-cooperative and risk averse and want to reach what I call the “maximum degree of comfortability” or MDC. The MDC mechanism behind choosing a Pareto inefficient path is basically the same as that in an economy in which households behave according to the usually assumed procedure based on the rational expectations hypothesis.

Suggested Citation

  • Harashima, Taiji, 2020. "A Mechanism of Recession that Accompanies Persistent Pareto Inefficiency," MPRA Paper 98468, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:98468
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    Keywords

    Economic fluctuation; MDC-based procedure; Pareto inefficiency; Rational expectations hypothesis; Recession;

    JEL classification:

    • E00 - Macroeconomics and Monetary Economics - - General - - - General
    • E10 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - General
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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