Constrained Efficiency in the Neoclassical Growth Model with Uninsurable Idiosyncratic Shockshttp://dx.doi.org/110.3982/ECTA5989
We investigate the welfare properties of the onesector neoclassic growth model with uninsurable idiosyncratic shocks. We focus on the notion of constrained efficiency used in the generalequilibrium literature. Our characterization of constrained efficiency uses the firstorder 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 longrun 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 steadystate capital stock.
