Micro Risks and Pareto Improving Policies with Low Interest Rates

Mark Aguiar (Princeton University)

May 4, 2021, 14:00–15:30

Room Zoom

Macroeconomics Seminar


We provide sufficient conditions for the feasibility of a Pareto improving fiscal policy when the risk-free interest rate on government bonds is below the growth rate (r<g). We do so in the class of incomplete markets models pioneered by Bewley-Huggett-Ayigari, but we allow for an arbitrary amount of ex ante heterogeneity in terms of preferences and income risk. We consider both the case of dynamic inefficiency as well as the more plausible case of dynamic efficiency. The key condition is that seigniorage revenue raised by government bonds exceeds the increase in the interest rate times the initial capital stock. The paper augments the classic overlapping generations, dynamic inefficiency condition of Samuelson (1958) and Diamond (1965) by allowing for heterogeneity along dimensions other than age as well as allowing for idiosyncratic income risk. (joint with Manuel Amador and Cristina Arellano).