The good, the bad and the worse: current, past and future consumption externalities and equilibrium efficiency

Abstract

[Abstract]: We consider an Ak model in which instantaneous utility of the representative agent depends not only on current consumption, but also on a forward-looking external reference level which is specified as an exponentially declining average of future economy-wide average consumption. We show that the decentralized equilibrium is never efficient irrespective of the specification of the utility function. This result differs significantly from the implications of alternative specifications of the external reference level: In case that the latter is given by contemporaneous average consumption, the decentralized equilibrium is always efficient. However, if it is backward- looking, then efficiency obtains only if the arguments of the utility function are perfectly substitutable.