Working Paper: NBER ID: w28996
Authors: Mark A. Aguiar; Manuel Amador; Cristina Arellano
Abstract: We provide sufficient conditions for the feasibility of robust Pareto-improving (RPI) fiscal policies in the class of incomplete markets models of Bewley-Huggett-Aiyagari and when the interest rate on government debt is below the growth rate (r < g). We allow for arbitrary heterogeneity in preferences and income risk and a potential wedge between the return to capital and to government bonds. An RPI improves risk sharing and can induce a more efficient level of capital. We show that the elasticities of aggregate savings to changes in interest rates are the crucial ingredients that determine the feasibility of RPIs. We establish that government debt and capital investment associated with an RPI may be complements along the transition, rather than the traditional substitutes. Our analysis shifts the focus of fiscal policy in incomplete markets from explicitly redistributive policies to using government bonds and simple subsidies to robustly improve welfare of all agents at all points in time.
Keywords: No keywords provided
JEL Codes: E6; H3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| RPI policies (R28) | increase in every household's budget set (D10) |
| RPI policies (R28) | after-tax factor prices (F16) |
| elasticities of aggregate savings (E21) | feasibility of RPIs (R50) |
| aggregate savings schedule (sufficiently elastic) (E10) | government debt and capital investment as complements (E22) |
| government debt (H63) | capital investment (E22) |
| government debt (H63) | wages and profits (D33) |
| households' perception of increased wealth (G59) | willingness to hold government debt (H63) |
| expanded budget sets (H61) | better risk sharing among households (G52) |