DP17651 Low Safe Rates: A case for Dynamic Inefficiency?
We reexamine the tests for dynamic inefficiency in productive overlapping-generations economies with stochastic growth. The size of real, long-term, safe interest rates relative to average GDP growth is an inconclusive test for dynamic inefficiency. A more accurate test should take into account the correlation between growth and the marginal utility of wealth. This typically restricts the room for inefficiency and welfare-improving policies. We also distinguish capital overaccumulation from an inefficient distribution of consumption risk. The refined test for capital overaccumulation is rather stringent: capital is not overaccumulated if the net dividend remains positive with some probability, as opposed to always, as in the original Abel et al. (1989)'s formulation
