Constrained Efficiency in the Neoclassical Growth Model With Uninsurable Idiosyncratic Shocks


  • Julio Dávila,

    1. Center for Operations Research and Econometrics, Université c. de Louvain, Belgium and Paris School of Economics, Centre d'Economie de la Sorbonne-CNRS, Maison des Sciences Economiques, Office 509, 106-112 Boulevard de l'Hôpital, 75647 Paris CEDEX 13, France; and
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  • Jay H. Hong,

    1. Dept. of Economics, University of Rochester, 227 Harkness Hall, Rochester, NY 14627-0156, U.S.A.;
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  • Per Krusell,

    1. University of Gothenburg, CAERP, CEPR, NBER, and Institute for International Economic Studies, Stockholm University, SE-106 91, Stockholm, Sweden;
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  • José-Víctor Ríos-Rull

    1. Federal Reserve Bank of Minneapolis, CAERP, CEPR, NBER, and Dept. of Economics, University of Minnesota, 4-101 Hanson Hall, 1925 Fourth St. S., Minneapolis, MN 55455, U.S.A.;
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    • We thank Tim Kehoe, Michael Magill, Iván Werning, and Martine Quinzii, as well as the editor and three anonymous referees, for very helpful comments. Krusell thanks the National Science Foundation. Ríos-Rull thanks the National Science Foundation and the University of Pennsylvania Research Foundation for support. The views expressed herein are those of the authors and not necessarily those of the Federal Reserve Bank of Minneapolis or the Federal Reserve System.


We investigate the welfare properties of the one-sector neoclassical growth model with uninsurable idiosyncratic shocks. We focus on the notion of constrained efficiency used in the general equilibrium literature. Our characterization of constrained efficiency uses the first-order condition of a constrained planner's problem. This condition highlights the margins of relevance for whether capital is too high or too low: the factor composition of income of the (consumption-)poor. Using three calibrations commonly considered in the literature, we illustrate that there can be either over- or underaccumulation of capital in steady state and that the constrained optimum may or may not be consistent with a nondegenerate long-run distribution of wealth. For the calibration that roughly matches the income and wealth distribution, the constrained inefficiency of the market outcome is rather striking: it has much too low a steady-state capital stock.