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RECURSIVE EQUILIBRIA IN AN AIYAGARI‐STYLE ECONOMY WITH PERMANENT INCOME SHOCKS
Author(s) -
KUHN MORITZ
Publication year - 2013
Publication title -
international economic review
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 2.658
H-Index - 86
eISSN - 1468-2354
pISSN - 0020-6598
DOI - 10.1111/iere.12018
Subject(s) - consumption (sociology) , permanent income hypothesis , economics , convergence (economics) , function (biology) , competitive equilibrium , work (physics) , mathematical economics , econometrics , macroeconomics , mechanical engineering , social science , evolutionary biology , sociology , biology , market liquidity , engineering
We prove existence of a recursive competitive equilibrium (RCE) for an Aiyagari‐style economy with permanent income shocks and derive important economic implications. We show that there exist equilibria where borrowing constraints are never binding and establish a nontrivial lower bound on the equilibrium interest rate. These results imply distinct consumption dynamics compared to existing studies. We present a new approach to solve the agent's problem that uses lattices of consumption functions to deal with permanent income shocks and an unbounded utility function. The approach provides a theoretical foundation for convergence of the time iteration algorithm widely used in applied work.