Neoclassical Growth with Long-Term One-Sided Commitment Contracts

Project Outcomes Statement

Intellectual Merit:
In this project we provide an analytically tractable macroeconomic model with aggregate investment and capital accumulation on the macro level and household income risk, and implied wealth and consumption inequality on the micro level. In the developed continuous time framework financial markets are used to insure against the household-level income risk, but the inability of households to commit to repay their debt limits that insurance. The extent to which consumption is insulated from income fluctuations is endogenously determined which allows us to study the interaction between macroeconomic performance, financial intermediation and household inequality, and how this link is shaped by economic policy and impacted by macroeconomic shocks. The resulting framework is a tractable alternative to the standard workhorse incomplete markets general equilibrium model initially developed by Aiyagari (1994). In Krueger and Uhlig (2022) we characterize the stationary equilibrium of the model and establish conditions under which the equilibrium is unique. We also show analytically how the degree of household-level income risk affects the aggregate capital stock, the real interest rate as well as consumption inequality. In Krueger, Li and Uhlig (2023) we characterize, again analytically, the evolution of the macroeconomy and inequality in response to unexpected shocks that induce recessions and booms, and finally in Ando, Krueger and Uhlig (2023) we analyze how household-level income risk impacts the financial returns on the stock and the bond market, by characterizing the equilibrium with aggregate business cycle fluctuations.

Broader Impacts:
The works created under this grant are available at https://web.sas.upenn.edu/dkrueger/research/ and Krueger and Uhlig (2020) is also NBER Working Paper No. 30518. As part of the project, we trained a number of RAs in the theory of limited commitment models and in continuous time modeling with endogenous consumption and wealth distributions. Two of these RAs (one female, one male), Fulin Li and Yoshiki Ando, have become co-authors on papers developed under the grant. Both Co-PIs have given academic seminars to disseminate the work, focusing in their respective presentations on how the framework helps the research community understand how the dynamics of economic inequality affects, and is impacted by, the functioning of financial intermediaries, financial markets and the macro economy.