Micro Risks and Pareto Improving Policies with Low Interest Rates

44 Pages Posted: 5 Jul 2021 Last revised: 18 Nov 2021

See all articles by Mark Aguiar

Mark Aguiar

Princeton University

Manuel Amador

Federal Reserve Banks - Federal Reserve Bank of Minneapolis

Cristina Arellano

Federal Reserve Bank of Minneapolis

Date Written: July 2021

Abstract

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-Aiyagari, 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 Pareto improving fiscal policies weakly expand every agent's budget set at every point in time. The policies improve risk sharing and potentially guide the economy to a more efficient level of capital. In simulations, we find that the government must rely on moderate levels of debt issuance along the transition to the new steady state.

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Suggested Citation

Aguiar, Mark and Amador, Manuel and Arellano, Cristina, Micro Risks and Pareto Improving Policies with Low Interest Rates (July 2021). Available at SSRN: https://ssrn.com/abstract=3880229 or http://dx.doi.org/10.2139/ssrn.3880229

Mark Aguiar (Contact Author)

Princeton University ( email )

Princeton, NJ 08544-1021
United States

Manuel Amador

Federal Reserve Banks - Federal Reserve Bank of Minneapolis ( email )

90 Hennepin Avenue
Minneapolis, MN 55480
United States

Cristina Arellano

Federal Reserve Bank of Minneapolis ( email )

90 Hennepin Avenue
Minneapolis, MN 55480
United States

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