The private memory of aggregate uncertainty

Abstract

We investigate social insurance in a dynamic Mirrlees' (1971) economy for which each agent's labor market productivity is the product of her stochastic and privately observed ability and an aggregate, publicly observed, stochastic component. The interaction between aggregate and idiosyncratic shocks optimally induces memory of aggregate uncertainty. We show that the optimal allocation depends on previous aggregate shocks when: i preferences are not logarithmic; ii) capital accumulation is possible, or; iii) private type distributions depend on the aggregate state