Econometrica: Nov 2012, Volume 80, Issue 6

Constrained Efficiency in the Neoclassical Growth Model With Uninsurable Idiosyncratic Shocks

DOI: 10.3982/ECTA5989
p. 2431-2467

Julio Dávila, Jay H. Hong, Per Krusell, José‐Víctor Ríos‐Rull

We investigate the welfare properties of the one‐sector neoclassical growth model with uninsurable idiosyncratic shocks. We focus on the notion of used in the general equilibrium literature. Our characterization of constrained efficiency uses the first‐order condition of a constrained planner's problem. This condition highlights the margins of relevance for whether capital is too high or too low: the factor composition of income of the (consumption‐)poor. Using three calibrations commonly considered in the literature, we illustrate that there can be either over‐ or underaccumulation of capital in steady state and that the constrained optimum may or may not be consistent with a nondegenerate long‐run distribution of wealth. For the calibration that roughly matches the income and wealth distribution, the constrained inefficiency of the market outcome is rather striking: it has much too low a steady‐state capital stock.

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