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  5. Micro Risks and (Robust) Pareto Improving Policies

American Economic Review

ISSN 0002-8282 (Print) | ISSN 1944-7981 (Online)

Micro Risks and (Robust) Pareto Improving Policies

  • Mark Aguiar
  • Manuel Amador
  • Cristina Arellano
American Economic Review (Forthcoming)

Abstract

We provide sufficient conditions for the feasibility of robust Pareto-improving (RPI) policies in the class of incomplete markets models of Bewley-Huggett-Aiyagari and when the interest rate is below the growth rate. We allow for arbitrary heterogeneity in preferences and income risk and a wedge between the return to capital and government bonds. An RPI improves risk sharing and can induce a more efficient level of capital. Elasticities of aggregate savings to changes in interest rates are the crucial ingredients that determine the feasibility of RPIs. Government debt and capital investment associated with an RPI may be complements along the transition.

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