Sudden Stops and Optimal Policy in a Two-agent Economy

IMF Working Papers, July 22, 2022

Source details

We introduce heterogeneity in terms of workers and entrepreneurs in an otherwise standard Fisherian model to study Sudden Stop dynamics and optimal policy.
The distinction between workers and entrepreneurs introduces a distributive externality that is absent from the representative-agent setup.
While in tranquil times redistribution is driven by the relative marginal utilities of consumption, the planner additionally favors entrepreneurs during Sudden Stops to mitigate Fisherian deation.
Although agentheterogeneity does not add much in explaining the Sudden Stop phenomena, it adds to the understanding of how policies can best be designed to alleviate the negative effects of Sudden Stops.

Agent heterogeneity (workers vs. entrepreneurs) creates a distributive externality absent in representative-agent models.
Redistribution determinants:
- Tranquil times: redistribution is driven by the relative marginal utilities of consumption.
- Sudden Stops: planner favors entrepreneurs to mitigate Fisherian deation.
Contribution to Sudden Stop literature:
- Agent heterogeneity does not materially change the explanation of Sudden Stop phenomena.
- Agent heterogeneity meaningfully informs optimal policy design to alleviate negative effects.

Optimal policy design should account for the distributive externality arising from heterogeneity between workers and entrepreneurs.
During Sudden Stops, policy should tilt in favor of entrepreneurs as a mechanism to mitigate Fisherian deation.
In tranquil times, redistribution policies can be guided by relative marginal utilities of consumption.