Date of Original Version

7-2005

Type

Working Paper

Rights Management

All Rights Reserved

Abstract or Description

This paper considers optimal social insurance in a dynamic moral hazard economy. The existing literature has focused on environments in which a planner and a population of agents share the same discount factor. A key finding is that agents are then almost surely immiserated; their welfare is driven to its lowest bound. Such immiseration requires a social commitment to treat (almost) everyone arbitrarily badly in the long run. We argue that this is implausible. We establish an equivalence between optimal allocations in two environments: those in which the planner lacks commitment and is constrained to choose socially credible policies and those in which the planner’s discount factor exceeds the agents’. We show that immiseration result no longer holds in the second environment. Optimal allocations in this environment are characterised by social mobility and a degree of inequality that it is falling in the planner’s discount factor. The credibility constrained economy inherits the no immiseration and social mobility properties.

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