The Optimal Distribution of the Tax Burden over the Business Cycle

This paper analyses optimal income taxes over the business cycle under a balanced-budget restriction, for low, middle and high income households. A model incorporating capital-skill complementarity in production and differential access to capital and labour markets is developed to capture the cyclical characteristics of the US economy, as well as the empirical observations on wage (skill premium) and wealth inequality. We .nd that the tax rate for high income agents is optimally the least volatile and the tax rate for low income agents the least countercyclical. In contrast, the path of optimal taxes for the middle income group is found to be very volatile and counter-cyclical. We further find that the optimal response to output-enhancing capital equipment technology and spending cuts is to increase the progressivity of income taxes. Finally, in response to positive TFP shocks, taxation becomes more progressive after about two years.

The Inflation Risk Premium on Government Debt in an Overlapping Generations Model

This paper presents a general equilibrium model in which nominal government debt pays an inflation risk premium. The model predicts that the inflation risk premium will be higher in economies which are exposed to unanticipated inflation through nominal asset holdings. In particular, the inflation risk premium is higher when government debt is primarily nominal, steady-state inflation is low, and when cash and nominal debt account for a large fraction of consumers' retirement portfolios. These channels do not appear to have been highlighted in previous models or tested empirically. Numerical results suggest that the inflation risk premium is comparable in magnitude to standard representative agent models. These findings have implications for management of government debt, since the inflation risk premium makes it more costly for governments to borrow using nominal rather than indexed debt. Simulations of an extended model with Epstein-Zin preferences suggest that increasing the share of indexed debt would enable governments to permanently lower taxes by an amount that is quantitatively non-trivial.

Cyclical and Welfare Effects of Public Sector Unions in a Real-Business-Cycle Model

Motivated by the highly-unionized public sectors, the high public shares in total employment, and the public sector wage premia observed in Europe, this paper examines the importance of public sector unions for macroeconomic theory. The model generates cyclical behavior in hours and wages that is consistent with data behavior in an economy with highly-unionized public sector, namely Germany during the period 1970-2007. The union model is a signifi cant improvement over a model with exogenous public employment. In addition, endogenously-determined public wage and hours add to the distortionary e ffect of contractionary tax reforms by generating greater tax rate changes, thus producing signi ficantly higher welfare losses.

On the cost of rent-seeking by government bureaucrats in a Real-Business-Cycle framework

This paper studies the wasteful e ffect of bureaucracy on the economy by addressing the link between rent-seeking behavior of government bureaucrats and the public sector wage bill, which is taken to represent the rent component. In particular, public o fficials are modeled as individuals competing for a larger share of those public funds. The rent-seeking extraction technology in the government administration is modeled as in Murphy et al. (1991) and incorporated in an otherwise standard Real-Business-Cycle (RBC) framework with public sector. The model is calibrated to German data for the period 1970-2007. The main fi ndings are: (i) Due to the existence of a signi ficant public sector wage premium and the high public sector employment, a substantial amount of working time is spent rent-seeking, which in turn leads to signifi cant losses in terms of output; (ii) The measures for the rent-seeking cost obtained from the model for the major EU countries are highly-correlated to indices of bureaucratic ineffi ciency; (iii) Under the optimal scal policy regime,steady-state rent-seeking is smaller relative to the exogenous policy case, as the government chooses a higher public wage premium, but sets a much lower public employment, thus achieving a decrease in rent-seeking.

Liquidity, moral hazard and bank crises

Bank crises, by interrupting liquidity provision, have been viewed as resulting in welfare losses. In a model of banking with moral hazard, we show that second best bank contracts that improve on autarky ex ante require costly crises to occur with positive probability at the interim stage. When bank payoffs are partially appropriable, either directly via imposition of fines or indirectly by the use of bank equity as a collateral, we argue that an appropriately designed ex-ante regime of policy intervention involving conditional monitoring can prevent bank crises.

Characterizing Behavioral Decisions with Choice Datas

A number of different models with behavioral economics have a reduced form representation where potentially boundedly rational decision-makers do not necessarily internalize all the consequences of their actions on payoff relevant features (which we label as psychological states) of the choice environment. This paper studies the restrictions that such behavioral models impose on choice data and the implications they have for welfare analysis. First, we propose a welfare benchmark that is justified using standard axioms of rational choice and can be applied to a number of existing seminal behavioral economics models. Second, we show that Sen's axioms and fully characterize choice data consistent with behavioral decision-makers. Third, we show how choice data to infer information about the normative signi.cance of psychological states and establish the possibility of identifying welfare dominated choices.

Unilateral Emissions Mitigation, Spillovers, and Global Learning

What's the role of unilateral measures in global climate change mitigation in a post-Durban, post 2012 global policy regime? We argue that under conditions of preference heterogeneity, unilateral emissions mitigation at a subnational level may exist even when a nation is unwilling to commit to emission cuts. As the fraction of individuals unilaterally cutting emissions in a global strongly connected network of countries evolves over time, learning the costs of cutting emissions can result in the adoption of such activities globally and we establish that this will indeed happen under certain assumptions. We analyze the features of a policy proposal that could accelerate convergence to a low carbon world in the presence of global learning.

Contracting over Prices

We defi ne a solution concept, perfectly contracted equilibrium, for an intertemporal exchange economy where agents are simultaneously price takers in spot commodity markets while engaging in non-Walrasian contracting over future prices. In a setting with subjective uncertainty over future prices, we show that perfectly contracted equi- librium outcomes are a subset of Pareto optimal allocations. It is a robust possibility for perfectly contracted equilibrium outcomes to di er from Arrow-Debreu equilibrium outcomes. We show that both centralized banking and retrading with bilateral contracting can lead to perfectly contracted equilibria.

Sharp Bounds on Heterogeneous Individual Treatment Responses

This paper discusses how to identify individual-specific causal effects of an ordered discrete endogenous variable. The counterfactual heterogeneous causal information is recovered by identifying the partial differences of a structural relation. The proposed refutable nonparametric local restrictions exploit the fact that the pattern of endogeneity may vary across the level of the unobserved variable. The restrictions adopted in this paper impose a sense of order to an unordered binary endogeneous variable. This allows for a uni.ed structural approach to studying various treatment effects when self-selection on unobservables is present. The usefulness of the identi.cation results is illustrated using the data on the Vietnam-era veterans. The empirical findings reveal that when other observable characteristics are identical, military service had positive impacts for individuals with low (unobservable) earnings potential, while it had negative impacts for those with high earnings potential. This heterogeneity would not be detected by average effects which would underestimate the actual effects because different signs would be cancelled out. This partial identification result can be used to test homogeneity in response. When homogeneity is rejected, many parameters based on averages may deliver misleading information.

Nominal Stability and Financial Globalization

Over the past four decades, advanced economies experienced a large growth in gross external portfolio positions. This phenomenon has been described as Financial Globalization. Over roughly the same time frame, most of these countries also saw a substantial fall in the level and variability of inflation. Many economists have conjectured that financial globalization contributed to the improved performance in the level and predictability of inflation. In this paper, we explore the causal link running in the opposite direction. We show that a monetary policy rule which reduces inflation variability leads to an increase in the size of gross external positions, both in equity and bond portfolios. This appears to be a robust prediction of open economy macro models with endogenous portfolio choice. It holds across different modeling specifications and parameterizations. We also present preliminary empirical evidence which shows a negative relationship between inflation volatility and the size of gross external positions.

A Simple Characterization of Dynamic Completeness in Continuous Time

This paper investigates dynamic completeness of financial markets in which the underlying risk process is a multi-dimensional Brownian motion and the risky securities dividends geometric Brownian motions. A sufficient condition, that the instantaneous dispersion matrix of the relative dividends is non-degenerate, was established recently in the literature for single-commodity, pure-exchange economies with many heterogenous agents, under the assumption that the intermediate flows of all dividends, utilities, and endowments are analytic functions. For the current setting, a different mathematical argument in which analyticity is not needed shows that a slightly weaker condition suffices for general pricing kernels. That is, dynamic completeness obtains irrespectively of preferences, endowments, and other structural elements (such as whether or not the budget constraints include only pure exchange, whether or not the time horizon is finite with lump-sum dividends available on the terminal date, etc.)

Efficient Nash Equilibrium under Adverse Selection

This paper revisits the problem of adverse selection in the insurance market of Rothschild and Stiglitz [28]. We propose a simple extension of the game-theoretic structure in Hellwig [14] under which Nash-type strategic interaction between the informed customers and the uninformed firms results always in a particular separating equilibrium. The equilibrium allocation is unique and Pareto-efficient in the interim sense subject to incentive-compatibility and individual rationality. In fact, it is the unique neutral optimum in the sense of Myerson [22].

Complexity and Bounded Rationality in Individual Decision Problemsing.

I develop a model of endogenous bounded rationality due to search costs, arising implicitly from the problems complexity. The decision maker is not required to know the entire structure of the problem when making choices but can think ahead, through costly search, to reveal more of it. However, the costs of search are not assumed exogenously; they are inferred from revealed preferences through her choices. Thus, bounded rationality and its extent emerge endogenously: as problems become simpler or as the benefits of deeper search become larger relative to its costs, the choices more closely resemble those of a rational agent. For a fixed decision problem, the costs of search will vary across agents. For a given decision maker, they will vary across problems. The model explains, therefore, why the disparity, between observed choices and those prescribed under rationality, varies across agents and problems. It also suggests, under reasonable assumptions, an identifying prediction: a relation between the benefits of deeper search and the depth of the search. As long as calibration of the search costs is possible, this can be tested on any agent-problem pair. My approach provides a common framework for depicting the underlying limitations that force departures from rationality in different and unrelated decision-making situations. Specifically, I show that it is consistent with violations of timing independence in temporal framing problems, dynamic inconsistency and diversification bias in sequential versus simultaneous choice problems, and with plausible but contrasting risk attitudes across small- and large-stakes gambles.

Comparative Statics of Asset Prices: the effect of other assets' risk

Currently, financial economics is unable to predict changes in asset prices with respect to changes in the underlying risk factors, even when an asset's dividend is independent of a given factor. This paper takes steps towards addressing this issue by highlighting a crucial component of wealth effects on asset prices hitherto ignored by the literature. Changes in wealth do not only alter an agents risk aversion, but also her perceived 'riskiness' of a security. The latter enhances significantly the extent to which market- clearing leads to endogenously-generated correlation across asset prices, over and above that induced by correlation between payoffs, giving the appearance of 'contagion.'

A Consistent Nonparametric Bootstrap Test of Exogeneity

This paper proposes a novel way of testing exogeneity of an explanatory variable without any parametric assumptions in the presence of a "conditional" instrumental variable. A testable implication is derived that if an explanatory variable is endogenous, the conditional distribution of the outcome given the endogenous variable is not independent of its instrumental variable(s). The test rejects the null hypothesis with probability one if the explanatory variable is endogenous and it detects alternatives converging to the null at a rate n..1=2:We propose a consistent nonparametric bootstrap test to implement this testable implication. We show that the proposed bootstrap test can be asymptotically justi.ed in the sense that it produces asymptotically correct size under the null of exogeneity, and it has unit power asymptotically. Our nonparametric test can be applied to the cases in which the outcome is generated by an additively non-separable structural relation or in which the outcome is discrete, which has not been studied in the literature.