Optimal Savings Distortions with Recursive Preferences

35 Pages Posted: 24 Dec 2007 Last revised: 3 Jan 2008

See all articles by Emmanuel Farhi

Emmanuel Farhi

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Iván Werning

Massachusetts Institute of Technology (MIT) - Department of Economics; National Bureau of Economic Research (NBER)

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Date Written: December 7, 2007

Abstract

This paper derives an intertemporal optimality condition for economies with private information, focusing on a class of recursive preferences. By comparing it to the situation where agents can freely save in a risk-free asset market, we derive the optimal savings distortions necessary for constrained optimality. Our recursive preferences are homogeneous and satisfy a balanced growth condition, while allowing us to separate the role of risk aversion and intertemporal elasticity of substitution. We perform some quantitative exercises that disentangle the respective roles played by these two parameters play in optimal distortions and the implied welfare gains.

Suggested Citation

Farhi, Emmanuel and Werning, Ivan, Optimal Savings Distortions with Recursive Preferences (December 7, 2007). MIT Department of Economics Working Paper No. 07-30, Available at SSRN: https://ssrn.com/abstract=1078043 or http://dx.doi.org/10.2139/ssrn.1078043

Emmanuel Farhi

Harvard University - Department of Economics ( email )

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Ivan Werning (Contact Author)

Massachusetts Institute of Technology (MIT) - Department of Economics ( email )

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