Endogenous Fluctuations and Social Welfare under Credit Constraints and Heterogeneous Beliefs

This paper examines the relationship between the aggregate output level and social welfare in an\r\noverlapping generations (OLG) model of a financial economy with heterogeneous beliefs by\r\nfocusing on the case of rational beliefs in the sense of Kurz (1994). The aggregate output level is\r\naffected by the endogenously determined net supply of the riskless asset, which in turn is affected by\r\nthe distribution of beliefs; thus, there is a coordination issue. To measure the social welfare, we adopt\r\na measure that is based on the ex post social welfare concept in the sense of Hammond (1981),\r\ninstead of the standard ex ante criterion to reflect the heterogeneous beliefs. Simulation results\r\nindicate that there may be an inverse relationship between the aggregate output and the social\r\nwelfare. The results suggest that commonly used macroeconomic variables such as gross domestic\r\nproduct (GDP) may not be a very appropriate measure when making policy recommendations.