Crowding out and crowding in: When does redistribution improve risk-sharing in limited commitment economies?

Tobias Broer
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Tobias Broer: Stockholm University

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Abstract: When the risk of default constrains financial contracts, public insurance policies can significantly affect private risk-sharing. This is because by changing income expectations and volatility, redistribution changes the attractiveness of default and thus endogenous borrowing constraints. Extending results by Krueger and Perri (2011) [8], this paper analyses the conditions under which redistribution can improve private insurance by making default less attractive to the income-rich, whose income it reduces. I first explain why public redistribution typically crowds out private insurance in the two-income economy, and identify the role of income persistence and saving after default. Second, I show how, in endowment economies with three income states or more and in economies with capital, redistributive taxes can improve, or "crowd in", private consumption insurance. Finally, in a quantitative exercise using a realistic income process calibrated to US micro-data, moderate redistribution crowds in private insurance with production but not in an endowment economy.

Date: 2011-05
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Published in Journal of Economic Theory, 2011, 146 (3), pp.957-975. ⟨10.1016/j.jet.2011.03.017⟩

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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-04490060

DOI: 10.1016/j.jet.2011.03.017

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