Consumption Externality, Endogenous Impatience, and Macroeconomic Efficiency

Abstract

Existing studies find that consumption externalities do not cause inefficiency in the long run unless choices of leisure are allowed for. This paper considers the role of endogenous impatience in a neoclassical growth model with consumption externalities. We find that consumption externalities create inefficiency by changing the demand for capital via endogenous impatience, thereby affecting equilibrium capital stock and output. We characterize the optimal tax structure for consumption and capital/output in order to correct the distortions caused by consumption externalities. The optimal tax/subsidy structure depends not only upon the marginal rate of substitution but also upon the effect on the degree of impatience. Moreover, it is optimal to tax or subsidize capital if the equalization of the shadow prices of capital between equilibrium and optimal is not required in the replication of equilibrium allocations to optimum. Finally, local indeterminacy is possible when there is sufficiently large decreasing impatience.

Keywords: consumption externalities, endogenous time preference rate, macroeconomic efficiency

JEL Classification: E62, H21, H23