Scandinavian Working Papers in Economics

Working Papers,
Lund University, Department of Economics

No 2001:9: Welfare Effects of Controlling Labor Supply? An Application of the Stochastic Ramsey Model

Henrik Amilon () and Hans-Peter Bermin ()
Additional contact information
Henrik Amilon: Department of Economics, Lund University, Postal: Department of Economics, School of Economics and Management, Lund University, Box 7082, S-220 07 Lund, Sweden
Hans-Peter Bermin: Department of Economics, Lund University, Postal: Department of Economics, School of Economics and Management, Lund University, Box 7082, S-220 07 Lund, Sweden

Abstract: In this paper we extend Merton's (1975) classic stochastic version of the Ramsey model by allowing the government to control the expected growth rate of the labor supply. We characterize the solution to this control problem for general time-separable preferences, and derive an analytical solution for the CRRA case. The results show to what extent the planner, or government, increases consumption and welfare by taking an active role in controlling the economy. We also explore the implications of government control of labor growth for the term structure of interest rates and the effects of taxes on capital.

Keywords: Utility maximization; Ramsey model; stochastic control; interest rate dynamics; Malliavin calculus

JEL-codes: C68; D81; E21; E24; E43; E61

34 pages, First version: July 10, 2001. Revised: March 11, 2002. Earlier revisions: February 19, 2002.

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