Working Paper 621

Competitive Equilibria with Limited Enforcement

Patrick J. Kehoe | Stanford University, University College London, Federal Reserve Bank of Minneapolis
Fabrizio Perri | Assistant Director and Monetary Advisor

Published April 1, 2002

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 soveriegn 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.

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