The private memory of aggregate shocks

Carlos Eugênio da Costa (carlos.eugenio@fgv.br) and Vitor Farinha Luz

No 706, FGV EPGE Economics Working Papers (Ensaios Economicos da EPGE) from EPGE Brazilian School of Economics and Finance - FGV EPGE (Brazil)

Abstract: We study constrained efficient aggregate risk sharing and its consequence for the behavior of macro-aggregates in a dynamic Mirrlees’s (1971) setting. Privately observed idiosyncratic productivity shocks are assumed to be independent of i.i.d. publicly observed aggregate shocks. Yet, private allocations display memory with respect to past aggregate shocks, when idosyncratic shocks are also i.i.d.. Under a mild restriction on the nature of optimal allocations the result extends to more persistent idiosyncratic shocks, for all but the limit at which idiosyncratic risk disappears, and the model collapses to a pure heterogeneity repeated Mirrlees economy identical to Werning [2007]. When preferences are iso-elastic we show that an allocation is memoryless only if it displays a strong form of separability with respect to aggregate shocks. Separability characterizes the pure heterogeneity limit as well as the general case with log preferences. With less than full persistence and risk aversion different from unity both memory and non-separability characterize optimal allocations. Exploiting the fact that non-separability is associated with state-varying labor wedges, we apply a business cycle accounting procedure (e.g. Chari et al. [2007]) to the aggregate data generated by the model. We show that, whenever risk aversion is great than one our model produces efficient counter-cyclical labor wedges.

Date: 2010-07-10
New Economics Papers: this item is included in nep-bec, nep-cba and nep-dge
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Related works:
Working Paper: The Private Memory of Aggregate Shocks (2010)
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Persistent link: https://EconPapers.repec.org/RePEc:fgv:epgewp:706

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