A Pareto Inefficient Path to Steady State in Recession
A Pareto Inefficient Path to Steady State in Recession

Summary/Abstract: In this paper, the focus is on the concept of Nash equilibrium of a Pareto inefficient path (NEPIP) to examine the nature of the transition path to steady state after a shock that generates a severe recession. Risk-averse and non-cooperative households strategically and rationally choose a NEPIP if a shock that widely shifts the steady state downwards occurs. Because NEPIPs are not Pareto efficient, an infinite number of transition paths can be NEPIPs, but a unique NEPIP is eventually selected from among many possible NEPIPs by households through a tug of war between their preference to avoid a worst-case scenario and the expected utility.

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