A Mechanism of Recession that Accompanies Persistent Pareto Inefficiency

Harashima, Taiji (2020): A Mechanism of Recession that Accompanies Persistent Pareto Inefficiency.

Abstract

Recessions are generated by various shocks. In particular, if fundamental shocks change the steady state, severe recessions will be generated. In this paper, I show that when such a shock occurs, it is possible for households to rationally select a Nash equilibrium consisting of a Pareto inefficient transition path to the new steady state in an economy in which households behave according to a procedure that is not based on the expected utilities discounted by the rate of time preference. They select this path because they are non-cooperative and risk averse and want to reach what I call the “maximum degree of comfortability” or MDC. The MDC mechanism behind choosing a Pareto inefficient path is basically the same as that in an economy in which households behave according to the usually assumed procedure based on the rational expectations hypothesis.

• Item Type: MPRA Paper
• Language: English
• Keywords: Economic fluctuation; MDC-based procedure; Pareto inefficiency; Rational expectations hypothesis; Recession
• Subjects: E - Macroeconomics and Monetary Economics > E0 - General > E00 - General; E - Macroeconomics and Monetary Economics > E1 - General Aggregative Models > E10 - General; E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E32 - Business Fluctuations ; Cycles

References

Becker, Robert A. (1980) “On the Long-run Steady State in a Simple Dynamic Model of Equilibrium with Heterogeneous Households,” The Quarterly Journal of Economics, Vol. 95, No. 2, pp. 375–382.

Blanchard, Olivier (2009) "The State of Macro," Annual Review of Economics, Annual Reviews, Vol. 1, pp. 209-228.

Ellison, Martin and Joseph Pearlman (2011) “Saddlepath Learning,” Journal of Economic Theory, Vol. 146, No. 4, pp. 1500–1519.

Evans, George W. and Honkapohja, Seppo (2001) Learning and Expectations in Macroeconomics, Princeton and Oxford, Princeton University Press.

Hall, Robert E. (2016) “Macroeconomics of Persistent Slumps,” NBER Working Paper, No. 22230.

Harashima, Taiji (2004) “A More Realistic Endogenous Time Preference Model and the Slump in Japan,” EconWPA Working Papers, ewp-mac0402015.

Harashima, Taiji (2009) “Depression as a Nash Equilibrium Consisting of Strategies of Choosing a Pareto Inefficient Transition Path,” MPRA (The Munich Personal RePEc Archive) Paper No. 18987.

Harashima, Taiji (2010) “Sustainable Heterogeneity: Inequality, Growth, and Social Welfare in a Heterogeneous Population,” MPRA (The Munich Personal RePEc Archive) Paper No. 24233.

Harashima, Taiji (2012a) “A Mechanism of Cyclical Volatility in the Vacancy-Unemployment Ratio: What Is the Source of Rigidity?” MPRA (The Munich Personal RePEc Archive) Paper, No. 36895.　

Harashima, Taiji (2012b) “Sustainable Heterogeneity as the Unique Socially Optimal Allocation for Almost All Social Welfare Functions,” MPRA (The Munich Personal RePEc Archive) Paper No. 40938.

Harashima, Taiji (2017) “Sustainable Heterogeneity: Inequality, Growth, and Social Welfare in a Heterogeneous Population,” in Japanese, Journal of Kanazawa Seiryo University, Vol. 51, No.1, pp. 31-80. （原嶋　耐治「持続可能な非均質性―均質ではない構成員からなる経済における不平等、経済成長及び社会的厚生―」『金沢星稜大学論集』第51巻第1号、31～80頁）

Harashima, Taiji (2018a) “Depression as a Nash Equilibrium Consisting of Strategies of Choosing a Pareto Inefficient Transition Path,” in Japanese, Journal of Kanazawa Seiryo University, Vol. 51, No. 2, pp. 71–101. （原嶋　耐治「パレート非効率な移行経路を選択する戦略からなるナッシュ均衡としての恐慌」『金沢星稜大学論集』第51巻第2号、71～101頁）

Harashima, Taiji (2018b) “Do Households Actually Generate Rational Expectations? “Invisible Hand” for Steady State,” MPRA (The Munich Personal RePEc Archive) Paper No. 88822.

Harashima, Taiji (2019a) “Do Households Actually Generate Rational Expectations? “Invisible Hand” for Steady State,” in Japanese, Journal of Kanazawa Seiryo University, Vol. 52, No. 2, pp. 49–70. （原嶋　耐治「家計は実際に合理的期待を形成して行動しているのか―定常状態への「見えざる手」―」『金沢星稜大学論集』第52巻第2号、49～70頁）

Harashima, Taiji (2019b) “A Mechanism of Cyclical Volatility in the Vacancy-Unemployment Ratio: What Is the Source of Rigidity?” in Japanese, Journal of Kanazawa Seiryo University, Vol. 53, No. 1, pp. 33–50. （原嶋　耐治「欠員失業比率の循環的変動の機序—硬直性の淵源は何か—」、『金沢星稜大学論集』第53巻第1号、 33～50頁）

Ireland, Peter N. (2011) “A New Keynesian Perspective on the Great Recession,” Journal of Money, Credit and Banking, Vol. 43, No. 1, pp. 31–54.

Lucas, Robert E Jr. (1972) “Expectations and the Neutrality of Money,” Journal of Economic Theory, Vol. 4, No. 2, pp.103–124.

McGrattan, Ellen R. and Edward C. Prescott (2014) “A Reassessment of Real Business Cycle Theory,” American Economic Review, Vol. 104, No. 5, pp. 177–182.

Marcet, Albert and Thomas J. Sargent (1989) “Convergence of Least Squares Learning Mechanisms in Self-referential Linear Stochastic Models,” Journal of Economic Theory, Vol. 48, No. 2, pp. 337–368.

Muth, John F. (1961) “Rational Expectations and the Theory of Price Movements,” Econometrica, Vol. 29, No. 3, pp. 315–335.

Rebelo, Sergio T. (2005) “Real Business Cycle Models: Past, Present, and Future,” Scandinavian Journal of Economics, Vol. 107, No. 2, pp. 217–238.

Sargent, Thomas J., David Fand and Stephen Goldfeld (1973) “Rational Expectations, the Real Rate of Interest, and the Natural Rate of Unemployment,” Brookings Papers on Economic Activity, Vol. 1973, No. 2, pp. 429–480.

Schmitt-Grohé, Stephanie and Martín Uribe (2012) “What's News in Business Cycles,” Econometrica, Vol. 80, pp. 2733–2764.