A Mechanism of Recession that Accompanies Persistent Pareto Inefficiency

Taiji Harashima

MPRA Paper from University Library of Munich, Germany

Abstract: Recessions are generated by various shocks. In particular, if fundamental shocks change the steady state, severe recessions will be generated. In this paper, I show that when such a shock occurs, it is possible for households to rationally select a Nash equilibrium consisting of a Pareto inefficient transition path to the new steady state in an economy in which households behave according to a procedure that is not based on the expected utilities discounted by the rate of time preference. They select this path because they are non-cooperative and risk averse and want to reach what I call the “maximum degree of comfortability” or MDC. The MDC mechanism behind choosing a Pareto inefficient path is basically the same as that in an economy in which households behave according to the usually assumed procedure based on the rational expectations hypothesis.

Keywords: Economic fluctuation; MDC-based procedure; Pareto inefficiency; Rational expectations hypothesis; Recession (search for similar items in EconPapers)
JEL-codes: E00 E10 E32 (search for similar items in EconPapers)
Date: 2020-02-02
New Economics Papers: this item is included in nep-mac and nep-upt
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