Auerbach-Kotlikoff OLG model in a Huggett heterogeneous agents incomplete markets economy

Abstract

This paper will investigate A-K OLG model in Huggett heterogeneous agents in incomplete markets setting. Dynamic inefficiency i.e.,  shows that for this model when government debt is decreasing welfare also decreases. Government transfer payments decrease, and payroll tax revenue is increasing, interest rate has is decreasing dramatically, wages rise and capital and labor also rise. On contrary in A-K model in Hugget economy which is not dynamically inefficient, assets-capital; consumption are age-dependent. Furthermore, RET hypothesis at is shown does not hold since agents cannot replicate risk free payoffs in incomplete markets (proof due to Divino,Orrilo,(2017), in our case Ricardian equivalence fails to hold, we  observe that the difference in consumption and government debt does not converge to zero over time, as indicated by the plotted lines.