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Constrained Efficiency in the Neoclassical Growth Model with Uninsurable Idiosyncratic Shocks

http://dx.doi.org/110.3982/ECTA5989

We investigate the welfare properties of the one-sector neoclassic growth model with uninsurable idiosyncratic shocks. We focus on the notion of constrained efficiency 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 under-accumulation of capital in steady state and that the constrained optimum may or may not be consistent with a non-degenerate 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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