Incomplete Markets, Growth, and the Business Cycle

51 Pages Posted: 19 Jan 2001

See all articles by George-Marios Angeletos

George-Marios Angeletos

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

Laurent E. Calvet

SKEMA Business School; CEPR

Date Written: January 2001

Abstract

We introduce a Ramsey growth model with incomplete markets, decentralized production, and idiosyncratic technological risk. The combination of uninsurable shocks with the precautionary motive can slow down capital accumulation or give rise to persistent fluctuations even when agents are very patient and technology is strictly convex. The model generates closed-form for the equilibrium dynamics under a finite or infinite horizon. Multiple steady states and poverty traps can arise from the endogeneity of the interest rate instead of the usual wealth effect. Depending on the economy's parameters, the local dynamics around a steady state are locally unique, totally unstable or locally undetermined, and the equilibrium path can be attracted to a limit cycle. In calibrated examples, financial incompleteness substantially slows down convergence to the steady state and thus increases the persistence of aggregate shocks.

Keywords: Idiosyncratic Risk, Precautionary Motive, Endogenous Fluctuations.

JEL Classification: C6, D52, D9, E32, O16, O4

Suggested Citation

Angeletos, George-Marios and Calvet, Laurent E., Incomplete Markets, Growth, and the Business Cycle (January 2001). Available at SSRN: https://ssrn.com/abstract=254709 or http://dx.doi.org/10.2139/ssrn.254709

George-Marios Angeletos

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

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Laurent E. Calvet (Contact Author)

SKEMA Business School ( email )

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CEPR ( email )

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