This paper presents an incentive-based theory of the dynamics of the distribution of consumption in the presence of aggregate shocks. The paper builds on the models concerning the distribution of income or consumption and incentive problems of Green (1987), Thomas and Worrall (1991), Phelan and Townsend (1991), and Atkeson and Lucas (1992). By incorporating aggregate production shocks, the model allows an examination of the interactions between individual and aggregate consumption series given incomplete insurance. Further, the methodology outlined allows the incorporation of incentive considerations to macroeconomic environments similar to Rogerson (1988) and Hansen (1985).
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where the minimization is subject to the incentive condition (4), the promise keeping condition (5), the constant payments conditions for all (Je0, (16), and the constant current deficit condition, equation (17) for all (J :F9. II Acknowledgements. Formerly, "Incentives, Inequality, and the Business Cycle". The author would like to thank Andrew Atkeson, John Cochrane, Robert Lucas, Lars Ljungqvist, Pete Streufert, Larry Samuelson, Robert Townsend and participants at seminars at the University of Wisconsin, the Federal Reserve Bank of Minneapolis, and the February 1992 NBER Economic Fluctuations Meetings in Palo Alto, California. The author received financial support from National Science Foundation grant SES-9111-926.
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