Sustainability in General Equilibrium

David Love and Gregory Phelan

No 2022-08, Department of Economics Working Papers from Department of Economics, Williams College

Abstract: Climate change, resource depletion, nuclear energy policy, and the solvency of national pensions have raised questions about the sustainability of current decisions. One definition of sustainability is ensuring that the welfare of future generations is not expected to decrease. Viewed this way, sustainability can be thought of as a constraint on economic decision-making. We examine the impact of such a constraint in a general equilibrium economy with a risky asset and show that the implications can differ substantially from those derived in a partial equilibrium setting. In general equilibrium, sustainability boils down to supply-side factors such as economic growth and consumption risk, with increased growth and decreased risk allowing for a higher consumption-wealth ratio. In partial equilibrium, sustainability is determined by the risk-free rate and an adjustment for risk, with risk increasing the sustainable consumption wealth ratio. Here, the positive drift in expected wealth due to the risk premium more than offsets the negative impact of risk on expected welfare. In general equilibrium, however, the risk-free rate adjusts, and risk makes it harder to achieve the sustainability criterion. We explore the implications of this result for sustainability policies, with a focus on endogenous investment, catastrophic risk management, financial frictions, and the supply of risk-sharing assets, which we define as “financial depth.â€

JEL-codes: D61 D63 E22 G11 H12 O40 Q01 Q54 (search for similar items in EconPapers)
Pages: 50
Date: 2022-12-16
Note: "Revision December 16, 2022"
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