Wedge Dynamics with Endogenous Private Information : A General Recursive Characterization ∗

This paper uses a recursive approach to arrive at a concise formula describing the forces responsible for the dynamics of wedges (i.e., distortions in the second-best allocations relative to their first-best counterparts) in a large class of economies where the agents’ private information is endogenous. The formula accommodates for a flexible specification of the planner’s preferences for redistribution (captured by general non-linear Pareto weights on the agents’ lifetime utilities) and of the agents’ preferences for insurance (captured by the curvature of the agents’ payoffs over consumption), as well as for rich specifications of the process governing the endogenous evolution of the agents’ private information. The formula also helps unifying results in the new dynamic public finance literature and relate them to results in the micro dynamic mechanism design literature. ∗For useful comments and suggestions we thank Laura Doval, Nicola Pavoni, and Stefanie Stantcheva. Pavan also thanks Bocconi University for its hospitality during the 2017-2018 academic year. The usual disclaimer applies. Email addresses: mmakris.econ@gmail.com (Makris); alepavan@northwestern.edu (Pavan).