Your browser does not support the PubReader view.
Go to this page to see a list of supporting browsers.
Seoul Journal of Economics
[ Article ]
Seoul Journal of Economics - Vol. 15, No. 3, pp.369-393
ISSN: 1225-0279 (Print)
Print publication date 31 Aug 2002
Received 11 Dec 2002 Revised 24 Jan 2003

Welfare of Incomplete Markets Economy with Permanent as well as Transitory Shocks

Jinill Kim
Economist, Division of Monetar Affairs, Federal Reserve Board, Wahsington DC 20551, U.S.A, Tel: +1-202-452-2981 Jinill.Kim@frb.gov

JEL Classification: F4l, D52

Abstract

Under the assumption that shocks are transitory, the welfare properties of the incomplete markets economy with only bonds are well known. As agents become more patient, its behavior get closer to that of the complete markets economy. As shocks become more persistent, the incomplete markets economy behave much differently from the complete markets economy. This paper shows that, when shocks have permanent as well as transitory components, neither of these two properties is true. More patience does not always move the incomplete markets economy closer to the complete markets economy, and more persistence in growth rate shocks induces similarity between the incomplete markets economy and the complete markets economy.

Keywords:

Incomplete markets, Welfare, Permanent shocks, Transitory shocks

Acknowledgments

Prepared for the presentation at Seoul Journal of Economics special lecture series on December 11, 2002. Comments from Craig Burnside, Eric van Wincoop, and seminar participants at the University of Virginia, Sogang University, and Seoul National University are appreciated. This paper relies heavily on discussions with Sunghyun Henry Kim and Andrew Levin.

The views in this paper are solely the responsibility of the authors and should not be interpreted as reflecting the views of the Board of Governors of the Federal Reserve System or of any other person associated with the Federal Reserve System.

References

  • Alvarez, F., and Jermann, U. “Efficiency, Equilibrium, and Asset Pricing with Risk of Default.” Econometrica 68 (No. 4 2000): 775-97. [https://doi.org/10.1111/1468-0262.00137]
  • Angeletos, G., and Calvet, L. Idiosyncratic Production Risk, Growth, and the Business Cycle. Mimeograph, 2002. [https://doi.org/10.2139/ssrn.303180]
  • Athanasoulis, S., and van Wincoop, E. “Growth Uncertainty and Risksharing.” Journal of Monetary Economics 45 (No. 3 2000): 477-505. [https://doi.org/10.1016/S0304-3932(00)00003-9]
  • Barro, R., and Sala-i-Martin, X. Economic Growth. New York: McGraw-Hill, 1995. [https://doi.org/10.3386/w5326]
  • Beveridge, S., and Nelson, C. “A New Approach to Decomposition of Economic Time Series into Permanent and Transitory Components with Particular Attention to Measurement of the ‘Business Cycle’.” Journal of Monetary Economics 7 (No. 2 1981): 151-74. [https://doi.org/10.1016/0304-3932(81)90040-4]
  • Cole, H., and Obstfeld, M. “Commodity Trade and International Risk Sharing; How Much Do Financial Markets Matter?” Journal of Monetary Economics 28 (No. 1 1991): 3-24. [https://doi.org/10.1016/0304-3932(91)90023-H]
  • Constantinides, G., and Duffie, D. “Asset Pricing with Heterogeneous Consumers.” Journal of Political Economy 104 (No. 2 1996): 219-40. [https://doi.org/10.1086/262023]
  • Heaton, J., and Lucas, D. J. “Evaluating the Effects of Incomplete Markets on Risk Sharing and Asset Pricing.” Journal of Political Economy 104 (No. 3 1996): 443-67. [https://doi.org/10.1086/262030]
  • Huggett, M. “The Risk Free Rate in Heterogeneous-agents, Incomplete Insurance Economies.” Journal of Economic Dynamics and Control 17 (1993): 953-69. [https://doi.org/10.1016/0165-1889(93)90024-M]
  • Kehoe, P., and Perri, F. “International Business Cycles with Endogenous Incomplete Markets.” Econometrica 70 (No. 3 2002): 907-28. [https://doi.org/10.1111/1468-0262.00314]
  • Kim, J., and Kim, S. H. “Spurious Welfare Reversals in International Business Cycle Models.” Journal of International Economics, Forthcoming, 2002. [https://doi.org/10.2139/ssrn.270849]
  • Kim, J., Kim, S. H., and Levin, A. T. Patience, Persistence, and Welfare Costs of Incomplete Markets in Open Economies. Federal Reserve Board International Finance Discussion Paper 696, 2001. [https://doi.org/10.17016/IFDP.2001.696]
  • Kim, J., Kim, S. H., and Levin, A. “Patience, Persistence, and Welfare Costs of Incomplete Markets in Open Economies.” Journal of International Economics. Forthcoming, 2002. [https://doi.org/10.2139/ssrn.266493]
  • King, R., Plosser, C., and Rebelo, S. “Production, Growth and Business Cycles: Part 1.” Journal of Monetary Economics 21 (Nos. 2-3 1988): 195-232. [https://doi.org/10.1016/0304-3932(88)90030-X]
  • Krusell, P., and Smith, A. “Income and Wealth Heterogeneity in the Macroeconomy.” Journal of Political Economy 106 (No. 5 1998): 867-96. [https://doi.org/10.1086/250034]
  • Kubler, F., and Schmedders, K. “Incomplete Markets, Transitory Shocks, and Welfare.” Review of Economic Dynamics 4 (2001): 747-66. [https://doi.org/10.1006/redy.2001.0134]
  • Levine, D., and Zame, W. “Does Market Incompleteness Matter?” Econometrica 70 (No. 5 2002): 1805-39. [https://doi.org/10.1111/1468-0262.00354]
  • Romer, D. Advanced Macroeconomics. New York: McGraw-Hill, 1996.
  • Schmitt-Grohe, S., and Uribe, M. “Closing Small Open Economy Models.” Journal of International Economics. Forthcoming, 2002. [https://doi.org/10.3386/w9270]
  • van Wincoop, E. “How Big Are Potential Gains from International Risksharing?” Journal of International Economics 47 (1999): 109-35. [https://doi.org/10.1016/S0022-1996(98)00007-5]
  • Willen, P. Welfare, Financial Innovation and Self Insurance in Dynamic Incomplete Market Models. Mimeograph, 1999.