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Competitive Equilibria with Limited Enforcement

Working Paper 621 | Published April 1, 2002

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Patrick J. Kehoe Monetary Advisor
Fabrizio Perri Assistant Director and Monetary Advisor
Competitive Equilibria with Limited Enforcement


Previous literature has shown that the study and characterization of constrained efficient allocations in economies with limited enforcement is useful to understand the limited risk sharing observed in many contexts, in particular between sovereign countries. In this paper we show that these constrained efficient allocations arise as equilibria in an economy in which private agents behave competitively, taking as given a set of taxes. We then show that these taxes, which end up limiting risk sharing, arise as an equilibrium of a dynamic game between governments. Our decentralization is different from the existing ones proposed in the literature. We find it intuitively appealing and we think it goes farther than the existing literature in endogenizing the primitive forces that lead to a lack of risk sharing in equilibrium.

Published in _Journal of Economic Theory_ (Vol. 119, Iss. 1, November 2004, pp. 184-206), An updated version was published as: [Staff Report 307](