Working Paper: CEPR ID: DP6779
Authors: Gaetano Bloise; Pietro Reichlin
Abstract: In this paper, we consider economies with (possibly endogenous) solvency constraints under uncertainty. Constrained inefficiency corresponds to a feasible redistribution yielding a welfare improvement beginning from every contingency reached by the economy. A sort of Cass Criterion (Cass (1972)) completely characterizes constrained inefficiency. This criterion involves only observable prices and requires low interest rates in the long-run, exactly as in economies with overlapping generations. In addition, when quantitative limits to liabilities arise from participation constraints, a feasible welfare improvement, subject to participation, coincides with the introduced notion of constrained inefficiency.
Keywords: Asset Prices; Cass Criterion; Constrained Inefficiency; Default; Private Debt; Solvency Constraints
JEL Codes: D50; D52; D61; E44; G13
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| debt constraints (H60) | constrained inefficiency (D61) |
| constrained inefficiency (D61) | welfare improvements (I38) |
| feasible redistributions (D39) | welfare improvements (I38) |
| debt limits (H63) | lack of optimal resource allocation (D61) |