DP6779 Asset Prices, Debt Constraints and Inefficiency

Author(s): Gaetano Bloise, Pietro Reichlin
Publication Date: April 2008
Keyword(s): Asset Prices, Cass Criterion, Constrained Inefficiency, Default, Private debt, Solvency Constraints
JEL(s): D50, D52, D61, E44, G13
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=6779

In this paper, we consider economies with (possibly endogenous) solvency constraints under uncertainty. Constrained inefficiency corresponds to a feasible redistribution yielding a welfare improvement beginning from every contingency reached by the economy. A sort of Cass Criterion (Cass (1972)) completely characterizes constrained inefficiency. This criterion involves only observable prices and requires low interest rates in the long-run, exactly as in economies with overlapping generations. In addition, when quantitative limits to liabilities arise from participation constraints, a feasible welfare improvement, subject to participation, coincides with the introduced notion of constrained inefficiency.