The CBO Infinite-Horizon Model with Idiosyncratic Uncertainty and Borrowing Constraints: Working Paper 2009-03

Working Paper
October 27, 2009

Maria I. Marika Santoro

This paper describes the infinite-horizon general equilibrium model that, among other models, CBO uses for its analysis of the President's budgetary proposals. Agents in the model live forever and face uninsurable, individual-specific working-ability shocks and borrowing constraints, and so they differ ex post in both income and wealth. The combination of idiosyncratic uncertainty and borrowing constraints affects household decisions about saving and working: households engage in precautionary saving to self-insure against uncertainty, and labor supply decisions are less elastic than in a standard infinite-horizon growth model. To show how the model behaves in an application, the paper analyzes a 10 percent reduction in income tax rates and compares the predictions under alternative assumptions about the level of uncertainty.