Abstract:
In this paper, we study the dynamics of efficient distribution of consumption in a pure exchange stochastic OLG economy under limited enforcement. The efficient allocation is chosen by a benevolent government whose welfare function values the initial old and places a positive but vanishing weight on the welfare of future generations.
The efficient allocation is constrained to be self-enforceable. Therefore, generations must have no incentive to default in consumption allocation at any point in time and any contingency. Existing papers on intergenerational risk-sharing have focused on history independent allocations. We show that time-consistent intergenerational risk-sharing that takes the form of history dependent state-contingent pension payable by the young to the old generation leads to welfare improvements.
In contrast to history independent risk-sharing allocations, consumption in the history dependent equilibrium is serially correlated from generation to generation, but it is bounded in the long-run. The efficient distribution of consumption converges along a saddle path to a stationary distribution, in which the probability of realization of the optimal history independent risk-sharing contract is zero.
Our analysis can have relevant implications about the design of optimal institutions for intergenerational risk-sharing.
Photo: Yudi Wen