Research Database

What is the role of credit scores in credit markets? We argue that it is a stand in for a market assessment of a person's unobservable type (which here we take to be patience). We pose a model of persistent hidden types where observable actions shape the public assessment of a person's type via Bayesian updating. We show how dynamic reputation can incentivize repayment without monetary costs of default beyond the administrative cost of filing for bankruptcy. Importantly we show how an economy with credit scores implements the same equilibrium allocation. We estimate the model using both credit market data and the evolution of individual’s credit scores. We find a 3% difference in patience in almost equally sized groups in the population with significant turnover and a shift towards becoming more patient with age. If tracking of individual credit actions is outlawed, the benefits of bankruptcy forgiveness are outweighed by the higher interest rates associated with lower incentives to repay.

We show that, in a general family of linearized structural macroeconomic models, knowledge of the empirically estimable causal effects of contemporaneous and news shocks to the prevailing policy rule is sufficient to construct counterfactuals under alternative policy rules. If the researcher is willing to postulate a loss function, our results furthermore allow her to recover an optimal policy rule for that loss. Under our assumptions, the derived counterfactuals and optimal policies are robust to the Lucas critique. We then discuss strategies for applying these insights when only a limited amount of empirical causal evidence on policy shock transmission is available.

What is the optimal fiscal policy response to a recession when the government is subject to sovereign risk? We study this question in a model of endogenous sovereign default with nominal rigidities. Increasing spending in a recession reduces unemployment, but exposes the government to a debt crisis. We quantitatively analyze this trade-off between stimulus and austerity and find that expanding government spending may be undesirable even in the presence of sizeable Keynesian stabilization gains and inequality concerns. Consistent with these findings, we show that sovereign risk is a key driver of the observed fiscal procyclicality in the data.

We measure the contribution of firm-embedded productivity to cross-country income differences. By firm-embedded productivity we refer to the components of productivity that differ across firms and that can be transferred internationally, such as blueprints, management practices, and intangible capital. Our approach relies on microlevel data on the cross-border operations of multinational enterprises (MNEs). We compare the market shares of the exact same MNE in different countries and document that they are about four times larger in developing than in high-income countries. This finding indicates that MNEs face less competition in less-developed countries, suggesting that firm-embedded productivity in those countries is scarce. We propose and implement a new measure of firm-embedded productivity based on this observation. We find a strong positive correlation between our measure and output per-worker across countries. In our sample, differences in firm-embedded productivity account for roughly a third of the cross-country variance in output per-worker.

The CDC reports that 1.13 million Americans have died of COVID-19 through June of 2023. I use a model of the impact over the past three years of vaccines and private and public behavior to mitigate disease transmission during the COVID-19 pandemic in the United States to address two questions. First, holding the strength of the response of behavior to the level of daily deaths from COVID-19 fixed, what was the impact of vaccines on cumulative mortality from COVID-19 up through June 2023? And second, holding the pace of deployment of vaccinations fixed, what would have been the impact of stricter or looser behavioral responses to COVID-19 deaths on cumulative mortality from COVID-19 over this same time period? In answering the first question, I find that vaccines saved 748,600 lives through June 2023. That is, without vaccines, cumulative mortality from COVID-19 would have been closer to 1.91 million over this time period. In answering the second question, I find that behavioral efforts to slow the transmission of the virus before vaccines became widely administered were critical to this positive impact of vaccines on cumulative mortality. For example, with a complete relaxation of these mitigation efforts, vaccines would have come too late to have saved a significant number of lives. Earlier deployment of vaccines would have saved many lives. I find that marginal changes in the strength of the behavioral response to COVID-19 deaths within the range of those responses estimated with the model have a significantly smaller impact on cumulative COVID-19 mortality over this time period.

This paper seeks to understand the forces that maintain racial segregation and the implications for the Black-White gap in college attainment. We incorporate race into an overlapping-generations spatial-equilibrium model with neighborhood spillovers. The model incorporates race in three ways: (i) a Black-White wage gap, (ii) an amenity externality—households care about the racial composition of their neighbors—and (iii) an additional barrier to moving for Black households. These forces quantitatively account for all of the racial segregation and 80% of the Black-White gap in college attainment in the data for the St. Louis metro area. Counterfactual exercises show that all three forces are quantitatively important. The presence of spillovers and externalities generates multiple equilibria. Although St. Louis is in the segregated equilibrium, there also exists an integrated equilibrium with a lower college gap, and we analyze a transition path between the two.

We present new evidence on the labor market effects of large minimum wage increases by examining the policy changes implemented by Minneapolis and Saint Paul. Beginning with synthetic difference-in- differences methods, we find that the increase in the minimum wage decreased substantially restaurant and retail employment, even after accounting for potential confounding effects from the pandemic and civil unrest. Next, using variation in exposure to the minimum wage across establishments and workers within zip codes and industries of the Twin Cities, we find employment effects that are about half as large as those from the time series. The cross-sectional estimates difference out contemporaneous city-industry effects across establishments and workers, but they do not include equilibrium effects induced by the minimum wage such as changes in entry. We quantify a model of establishment dynamics to reconcile the different estimates and argue that they plausibly reflect lower and upper bounds of employment losses. We use the model to show that our estimates are consistent with an establishment elasticity of labor demand of -1 and illustrate how they can inform deeper parameters characterizing product and labor market competition, factor substitution, and establishment dynamics.

Epidemics can negatively affect economic development unless they are mitigated by global governance institutions. We examine the effects of sudden exposure to epidemics on human capital outcomes using evidence from the African meningitis belt. Meningitis shocks reduce child health outcomes, particularly when the World Health Organization (WHO) does not declare an epidemic year. These effects are reversed when the WHO declares an epidemic year. Children born in meningitis shock areas in a year when an epidemic is declared are 10 percentage points (pp) less stunted and 8.2 pp less underweight than their peers born in non-epidemic years. We find evidence for the crowd-out of routine vaccination during epidemic years. We analyze data from World Bank projects and find evidence that an influx of health aid in response to WHO declarations may partly explain these reversals.

The U.S. net foreign asset position has declined sharply since 2007 and is currently negative 65 percent of U.S. GDP. This deterioration primarily reflects a U.S.-specific rise in corporate asset values that has inflated the value of U.S. equity liabilities to the rest of the world. To interpret these trends we develop an international macro finance model of flows, stocks, asset valuations, the current account, and the net foreign asset position. We find that the welfare impact of rising asset values for a representative U.S. household has been quite negative given extensive foreign ownership of U.S. corporate equity.

US social transfer programs vary substantially across states, incentivizing households to locate in states with more generous transfer programs. Further, transfer formulas often decrease in income, therefore rewarding low-income households for living in low-paying cities. We quantify these distortions by combining a spatial equilibrium model with a detailed model of transfer programs in the US. The current system leads to locational inefficiency of 4.38% of total transfer spending. A reform that both harmonizes transfer policies across states and indexes household income to local average earnings reduces this inefficiency by over 85 percent while still preserving the programs' means-tested nature.

Using 50 years of data for emerging markets, we document that sovereign governments partially default often and with varying intensity, resulting in lengthy default episodes with hump-shaped patterns for partial default and debt. Default episodes lead to haircuts for lenders but not to reductions in debt, because the defaulted debt accumulates and the sovereign continues to borrow. We present a theory of partial default that replicates these properties, which are absent in standard sovereign default theory. Partial default is a flexible way to raise funds, as the sovereign chooses its intensity and duration, but it also amplifies debt crises as the defaulted debt accumulates at increasingly high interest rates. This theory rationalizes the patterns of default episodes, the heterogeneity of partial default, and partial default's comovements with spreads, debt, and output. We conduct policy counterfactuals in the form of pari passu and no-dilution clauses and debt relief policies, and we discuss their welfare implications.

This paper explores the positive and normative consequences of government bond issuances in a New Keynesian model with heterogeneous agents, focusing on how the stock of government bonds affects the cross-sectional allocation of resources in the spirit of Samuelson (1958). We characterize the Pareto optimal levels of government bonds and the associated monetary policy adjustments that should accompany Pareto-improving bond issuances. The paper introduces a simple phase diagram to analyze the global equilibrium dynamics of inflation, interest rates, and labor earnings in response to changes in the stock of government debt. The framework also provides a tractable tool to explore the use of fiscal policy to escape the Effective Lower Bound (ELB) on nominal interest rates and the resolution of the “forward guidance puzzle.” A common theme throughout is that following the monetary policy guidance from the standard Ricardian framework leads to excess fluctuations in income and inflation.

A random-matching model (of money) is formulated in which there is complete public knowledge of the trading histories of a subset of the population, called banks, and no public knowledge of the trading histories of the complement of that subset, called nonbanks. Each person, whether a banker or a non banker, is assumed to have the technological capability to create indivisible, distinct and durable objects called notes. If outside money is indivisible and sufficiently scarce, then an optimal mechanism is shown to have note issue and destruction (redemption) by banks.

In the U.S., occupational licensing is more prevalent in the public sector than in the private sector, but the influence of occupational regulation for public sector workers has not been analyzed in detail. Our study initially examines the probability of a licensed worker selecting into the public sector. Using the probability as a control for these individuals’ risk aversion, we next examine how licensing impacts key labor market outcomes, such as wages, hours worked, and employment in the public sector. Our results show that having an occupational license increases the likelihood of working in the public sector. After adjusting for the selection bias of choosing into the public sector, we find that being in a licensed occupation in the public sector raises wages by about 6% and increases hours worked, but reduces employment, even when controlling for other labor market institutions that also are more prevalent in the public sector such as unionization. Overall, our estimates suggest that the social welfare effects of licensing in the public sector are like those for the whole sample, and they generally result in a welfare loss in the public sector.

This paper studies the role of credit constraints in accounting for the dynamics of firm exit during the Great Recession. We present novel firm-level evidence on the role of credit constraints on exit behavior during the Great Recession. Firms in financial distress, with tighter access to credit, are more likely to default than firms with more access to credit. This difference widened substantially in the Great Recession while, in contrast, default rates did not vary much by size, age, or productivity. We identify conditions under which standard models of firms subject to financial frictions can be consistent with these facts.

In this paper, we revisit the scope for macroprudential policy in production economies with pecuniary externalities and collateral constraints. We study competitive equilibria and constrained-efficient equilibria and examine the extent to which the gap between the two depends on the production structure and the policy instruments available to the planner. We argue that macroprudential policy is desirable regardless of whether the competitive equilibrium features more or less borrowing than the constrained-efficient equilibrium. In our quantitative analysis, macroprudential taxes on borrowing turn out to be larger when the government has access to ex-post stabilization policies.

We study the nonlinearities present in a standard monetary labor search model modified to have two groups of workers facing exogenous differences in the job finding and separation rates. We use our setting to study the racial unemployment gap between Black and white workers in the United States. A calibrated version of the model is able to replicate the difference between the two groups both in the level and volatility of unemployment. We show that the racial unemployment gap rises during downturns, and that its reaction to shocks is state-dependent. In particular, following a negative productivity shock, when aggregate unemployment is above average the gap increases by 0.6pp more than when aggregate unemployment is below average. In terms of policy, we study the implications of different inflation regimes on the racial unemployment gap. Higher trend inflation increases both the level of the racial unemployment gap and the magnitude of its response to shocks.

We analyze the magnitude and persistence of the racial wealth gap using a long-run model of heterogeneous dynasties with an occupational choice and bequests. Our innovation is to introduce endogenous beliefs about risky returns, reflecting differences in dynasties' investment experiences over time. Feeding the exclusion of Black dynasties from labor and capital markets into the model as the only driving force, we find that the model quantitatively reproduces current and historical racial gaps in wealth, income, entrepreneurship, mobility, and beliefs about risky returns. We explore how the future trajectory of the racial wealth gap might change in response to various policies. Wealth transfers to all Black dynasties that eliminate the average wealth gap today do not lead to long-run wealth convergence. The logic is that centuries-long exclusions lead Black dynasties to hold pessimistic beliefs about risky returns and to forgo investment opportunities after the wealth transfer. Investment subsidies toward Black entrepreneurs are more effective than wealth transfers in permanently eliminating the racial wealth gap.

Policies that reduce information on applicants have mixed results in the labor market. However, little is known about their impact in the housing market. We submitted fictitious email inquiries to publicly advertised rentals using names manipulated on perceived race and ethnicity before and after a policy that restricted the use of background checks, eviction history, income minimums, and credit history in rental housing applications in Minneapolis. After the policy was implemented, discrimination against African American and Somali American men increased. Triple difference analysis shows that discrimination increased in Minneapolis relative to St. Paul after the policy.

This paper examines how cash transfers that are not conditional on employment affect infant health. Leveraging variation in the amount of pandemic-era stimulus and child tax credit payments that families received based on household composition, I find that an additional $100 in transfers reduces the prevalence of low birthweight by 2-3 percent. Effects are larger for payments received later in pregnancy, but are of a similar magnitude across the population. These additional resources increased prenatal care and improved maternal health in ways that are consistent with families both increasing investments in children's health and improving the prenatal environment.

This paper studies the welfare effects of encouraging rural-urban migration in the developing world. To do so, we build and analyze a dynamic general-equilibrium model of migration that features a rich set of migration motives. We estimate the model to replicate the results of a field experiment that subsidized seasonal migration in rural Bangladesh, leading to significant increases in migration and consumption. We show that the welfare gains from migration subsidies come from providing better insurance for vulnerable rural households rather than correcting spatial misallocation by relaxing credit constraints for those with high productivity in urban areas that are stuck in rural areas.

Domestic abuse encompasses a range of damaging behaviours beyond physical violence, including economic and emotional abuse. This paper provides the first evidence on the impact of cohabiting with an abusive partner on victim’s economic outcomes. In so doing, we highlight the systematic role played by economic suppression and coercive control in such relationships. Using administrative data and a matched control event study design, along with a within-individual comparison of outcomes across relationships, we document three new facts. First, women who begin relationships with (eventually) physically abusive men suffer large and significant earnings and employment falls immediately upon cohabiting with the abusive partner, which translates into a total household income loss. Second, this decline in economic outcomes is non-monotonic in women’s pre-cohabitation outside options. Third, abusive men impose economic costs on all their female partners, even those who do not report physical violence. To rationalize these findings, we develop a new dynamic model of abusive relationships where women do not perfectly observe their partner’s type, and abusive men have an incentive to use coercive control to sabotage women’s outside options and their ability to later exit the relationship. We show that this model is consistent with all three empirical facts. We harness the model’s predictions to revisit some classic results on domestic violence and show that the relationship between domestic violence and women’s outside options is crucially linked to breakup dynamics.

We show how to use panel data on household consumption to directly estimate households’ risk preferences. Specifically, we measure heterogeneity in risk aversion among households in Thai villages using a full risk-sharing model, which we then test allowing for this heterogeneity. There is substantial, statistically significant heterogeneity in estimated risk preferences. Full insurance cannot be rejected. As the risk sharing, as-if-complete-markets theory might predict, estimated risk preferences are unrelated to wealth or other characteristics. The heterogeneity matters for policy: Although the average household would benefit from eliminating village-level risk, less-risk-averse households who are paid to absorb that risk would be worse off by several percent of household consumption.

ln environments with private information and spatial separation, the ability of agents to establish mutually beneficial arrangements can be limited by their ability to communicate contemporary dealings and histories of past dealings. Indeed, with the extension of some recent work in contract theory and mechanism design, this paper argues that location or person-specific assignment systems, portable object record-keeping systems, written message systems, and telecommunication systems can be viewed as communication systems which are successively more complete in this sense. An attempt is made also to match these various communication systems with systems in use in historical primitive, and/or contemporary societies and to interpret these communication systems as financial structures.

I develop a heterogeneous-agent New-Keynesian model featuring racial inequality in income and wealth, and studies interactions between racial inequality and monetary policy. Black and Hispanic workers gain more from accommodative monetary policy than White workers mainly due to higher labor market risks. Their gains are larger also because of a larger proportion of them are hand-to-mouth, while wealthy White workers gain more from asset price appreciation. Monetary and fiscal policies are substitutes in providing insurance against cyclical labor market risks. Racial minorities gain even more from an accommodative monetary policy in the absence of income-dependent fiscal transfers.

We show that if the central bank operates without commitment and faces constraints on its balance sheet, helicopter drops can be a useful stabilization tool during a liquidity trap. In our model, even with balance sheet constraints, helicopter drops are at best irrelevant under commitment.

Parental investments significantly impact children’s outcomes. Exploiting panel data covering individuals from birth to retirement, we estimate child skill production functions and embed them into an estimated dynastic model in which altruistic mothers and fathers make investments in their children. We find that time investments, educational investments, and assortative matching have a greater impact on generating inequality and intergenerational persistence than cash transfers. While education subsidies can reduce inequality, due to an estimated dynamic complementarity between time investments and education, it is crucial to announce them in advance to allow parents to adjust their investments when their children are young.

Past research has provided evidence of clientelistic politics in delivery of program benefits by local governments (gram panchayats (GPs)), and manipulation of GP program budgets by legislators and elected officials at upper tiers in West Bengal, India. Using household panel survey data spanning 1998-2008, we examine the consequences of clientelism for distributive equity. We find that targeting of anti-poverty programs was progressive both within and across GPs, and is explained by greater 'vote responsiveness' of poor households to receipt of welfare benefits. Across-GP allocations were more progressive than a rule-based formula recommended by the 3rd State Finance Commission (SFC) based on GP demographic characteristics. Moreover, alternative formulae for across-GP budgets obtained by varying weights on GP characteristics used in the SFC formula would have improved pro-poor targeting only marginally. Hence, there is not much scope for improving pro-poor targeting of private benefits by transitioning to formula-based budgeting.

How does wealth taxation differ from capital income taxation? When the return on investment is equal across individuals, a well-known result is that the two tax systems are equivalent. Motivated by recent empirical evidence documenting persistent return heterogeneity, we revisit this question. With heterogeneity, the two tax systems typically have opposite implications for both efficiency and inequality. Under capital income taxation, entrepreneurs who are more productive and therefore generate more income pay higher taxes. Under wealth taxation, entrepreneurs who have similar wealth levels pay similar taxes regardless of their productivity, which expands the tax base, shifts the tax burden toward unproductive entrepreneurs, and raises the savings rate of productive ones. This reallocation increases aggregate productivity and output. In the simulated model parameterized to match the US data, replacing the capital income tax with a wealth tax in a revenue-neutral fashion delivers a significantly higher average welfare. Turning to optimal taxation, the optimal wealth tax (OWT) is positive and yields large welfare gains by raising efficiency and lowering inequality. In contrast, the optimal capital income tax (OKIT) is negative—a subsidy—and delivers lower welfare gains than OWT, owing to the welfare losses from higher inequality. Furthermore, when the transition path is considered, the gains from OKIT turn into significant welfare losses for existing cohorts, whereas OWT continues to deliver robust welfare gains. These results suggest that moderate wealth taxation may be a more appealing alternative than capital income taxation, which can be significantly more distorting under return heterogeneity than under the equal-returns assumption.

Applying the Foster, Haltiwanger, and Krizan (FHK) (2001) decomposition to plant-level manufacturing data from Chile and Korea, we find that the entry and exit of plants account for a larger fraction of aggregate productivity growth during periods of fast GDP growth. To analyze this relationship, we develop a model of firm entry and exit based on Hopenhayn (1992). When we introduce reforms that reduce entry costs or reduce barriers to technology adoption into a calibrated model, we find that the entry and exit terms in the FHK decomposition become more important as GDP grows rapidly, just as they do in the data from Chile and Korea.

The epidemiological literature suggests that virus transmission occurs only when individuals are in relatively close contact. We show that if society can control the extent to which economic agents are exposed to the virus and agents can commit to contracts, virus externalities are local, and competitive equilibria are efficient. The Second Welfare Theorem also holds. These results still apply when infection status is imperfectly observed and when agents are privately informed about their infection status. If society cannot control virus exposure, then virus externalities are global and competitive equilibria are inefficient, but the policy implications are very different from those in the literature. Economic activity in this version of our model can be inefficiently low, in contrast to the conventional wisdom that viruses create global externalities and result in inefficiently high economic activity. If agents cannot commit, competitive equilibria are inefficient because of a novel pecuniary externality.

We measure the importance of increasing returns to scale and trade in medical services. Using Medicare claims data, we document that “imported” medical care—services produced by a medical provider in a different region—constitute about one-fifth of US healthcare consumption. Larger regions specialize in producing less common procedures, which are traded more. These patterns reflect economies of scale: larger regions produce higher-quality services because they serve more patients. Because of increasing returns and trade costs, policies to improve access to care face a proximity-concentration tradeoff. Production subsidies and travel subsidies can impose contrasting spillovers on neighboring regions.

This paper develops a quantitative framework to study the impact of Unemployment Insurance (UI) expansions to workers earning below eligibility thresholds. A model of how UI affects welfare and labor supply is developed and calibrated with microeconomic data, including consumption. The model predicts that the current ineligible would choose to stay on UI longer than the current eligible and the margins of why this is the case are quantified. The model is applied to the Great Recession by identifying ineligible workers in the data using machine learning and to an actual expansion during COVID-19 using administrative data. The UI duration for newly eligible under the expansion was 1.7 times longer than the previous eligible but is one-third shorter than the model's economic incentives predict. This suggests caution in extrapolating from the COVID-19 data and the model is used to predict impacts of smaller scale expansions during non-pandemic times.

Many central banks whose exchange rate regimes are classified as flexible are reluctant to let the exchange rate fluctuate. This phenomenon is known as “fear of floating”. We present a simple theory in which fear of floating emerges as an optimal policy outcome. The key feature of the model is an occasionally binding borrowing constraint linked to the exchange rate that introduces a feedback loop between aggregate demand and credit conditions. Contrary to the Mundellian paradigm, we show that a depreciation can be contractionary, and letting the exchange rate float can expose the economy to self-fulfilling crises.

We develop a theory of labor markets in a monetary economy with four realistic features: search frictions, worker productivity shocks, wage rigidity, and two-sided lack of commitment. Due to the non-Coasean nature of labor contracts, inefficient job separations occur in the form of endogenous quits and layoffs that are unilaterally initiated whenever a worker’s wage-to-productivity ratio moves outside an inaction region. We derive sufficient statistics for the aggregate labor market response to a monetary shock based on the distribution of workers’ wage-to-productivity ratios. These statistics crucially depend on the incidence of inefficient job separations, which we show how to identify using readily available microdata on wage changes and worker flows between jobs.

We re-examine recent trends in regional income convergence, considering the full distribution of income rather than focusing on the mean. Measuring similarity by comparing each percentile of state distributions to the corresponding percentile of the national distribution, we find that state incomes have become less similar (i.e. they have diverged) within the top 20 percent of the income distribution since 1969. The top percentile alone accounts for more than half of aggregate divergence across states over this period by our measure, and the top five percentiles combine to account for 93 percent. Divergence in top incomes across states appears to be driven largely by changes in top incomes among White people, while top incomes among Black people have experienced relatively little divergence.

We study the COVID-19 epidemic in emerging markets that face financial frictions and its mitigation through social distancing and vaccination. We find that restricted vaccine availability in emerging markets, as captured by limited quantities and high prices, renders the pandemic exceptionally costly in these countries, compared with economies without financial frictions. Improved access to financial markets enables a better response to the delay in vaccine supplies, as it supports more stringent social distancing measures before wider vaccine availability. We show that financial assistance programs to such financially constrained countries can increase vaccinations and lower fatalities, at no present-value cost to the international community.

We develop a model of banking industry dynamics to study the quantitative impact of regulatory policies on bank risk taking and market structure. Since our model is matched to U.S. data, we propose a market structure where big banks with market power interact with small, competitive fringe banks as well as non-bank lenders. Banks face idiosyncratic funding shocks in addition to aggregate shocks which affect the fraction of performing loans in their portfolio. A nontrivial bank size distribution arises out of endogenous entry and exit, as well as banks' buffer stock of capital. We show the model predictions are consistent with untargeted business cycle properties, the bank lending channel, and empirical studies of the role of concentration on financial stability. We find that regulatory policies can have an important impact on banking market structure, which, along with selection effects, can generate changes in allocative efficiency and stability.

We present a simple open economy framework to study the transmission channels of monetary and macroprudential policies and evaluate the implications for international spillovers and global welfare. Using an analytical decomposition, we first identify three transmission channels: intertemporal substitution, expenditure switching, and aggregate income. Quantitatively, expenditure switching plays a prominent role for monetary policy, while macroprudential policy operates almost entirely through intertemporal substitution. Turning to the normative analysis, we show that the risk of a liquidity trap generates a monetary policy tradeoff between stabilizing output today and reducing capital flows to lower the likelihood of a future recession. However, leaning against the wind is not necessarily optimal, even in the absence of capital controls. Finally, we argue that contrary to emerging policy concerns, capital controls are not beggar-thy-neighbor and can enhance global macroeconomic stability.

We review methods used to numerically compute optimal Mirrleesian tax and transfer schedules in heterogeneous agent economies. We show that the coarseness of the productivity grid, while a technical detail in terms of theory, is critical for delivering quantitative policy prescriptions. Existing methods are reliable only when a very fine grid is used. The problem is acute for computational approaches that use a version of the Diamond-Saez implicit optimal tax formula. If using a very fine grid for productivity is impractical, then optimizing within a flexible parametric class is preferable to the non-parametric Mirrleesian approach.

This paper studies lockdown policy in a dynamic economy without government commitment. Lockdown imposes a cap on labor supply, which improves health prospects at the cost of economic output and consumption. A government would like to commit to the extent of future lockdowns in order to guarantee an economic outlook that supports efficient levels of investment into intermediate inputs. However, such a commitment is not credible, since investments are sunk at the time when the government chooses a lockdown. As a result, lockdown under lack of commitment deviates from the optimal policy. Rules that limit a government’s lockdown discretion can improve social welfare, even in the presence of noncontractible information. Quantitatively, lack of commitment causes lockdown to be significantly more severe than is socially optimal. The output and consumption loss due to lack of commitment is greater for higher intermediate input shares, higher discount rates, higher values of life, higher disease transmission rates at and outside of work, and longer vaccine arrival times.

We revisit the estimation of the welfare costs of inflation originating from lack of liquidity satiation. We use data for the United States and several other developed countries. Our computations are heavily influenced by the recent experience of very low, even negative, short-term rates observed in the countries we study. We obtain estimates that range between 0.20% and 1.5% of lifetime consumption for the United States and find even higher values for some European countries.

We develop a theory of exchange rate fluctuations arising from financial institutions’ demand for dollar liquid assets. Financial flows are unpredictable and may leave banks “scrambling for dollars.” Because of settlement frictions in interbank markets, a precautionary demand for dollar reserves emerges and gives rise to an endogenous convenience yield on the dollar. We show that an increase in the dollar funding risk leads to a rise in the convenience yield and an appreciation of the dollar, as banks scramble for dollars. We present empirical evidence on the relationship between exchange rate fluctuations for the G10 currencies and the quantity of dollar liquidity, which is consistent with the theory.

Iovino, La’O and Mascarenhas (forthcoming) ask two important questions regarding the optimal conduct of monetary policy: Should the central bank’s policy depend on information the central bank has that is not available to markets? And should the central bank disclose information that it has but market participants do not? Iovino, La’O and Mascarenhas answer these questions using a simple, stylized model with one-period price stickiness. They show that efficient equilibria can be sustained regardless of whether policy depends on the central bank’s information and regardless of its disclosure policy. We explain the logic behind their irrelevance result and show that if restrictions are imposed on equilibria, then monetary policy should in general depend on the central bank’s information. Finally, we offer some speculative answers to their questions and discuss the sense in which policy is converging towards theory.

We provide a simple framework to study the prudential use of capital controls and currency reserves that have been explored in the recent literature. We cover the role of both pecuniary externalities and aggregate demand externalities. The model features a central policy dilemma for emerging economies facing large capital outflows: the choice between increasing the policy rate to stabilize the exchange rate and decreasing the policy rate to stabilize employment. Ex ante capital controls and reserve accumulation can help mitigate this dilemma. We use our framework to survey the recent literature and provide an overview of recent empirical findings on the use of these policies.

It is well known that monetary and fiscal policy are connected by a common budget constraint. In this paper, we study how this manifests itself in the context of the Eurozone, where that connection links the European Central Bank, the 19 national central banks, the Treasuries of 19 countries, and the European Union. Our goal is twofold. First, we wish to clarify how seigniorage flows from the monetary authority to the budget of each country. Second, we seek to answer the question of how the taxpayers of each country are affected by a default of one of the participants to the union. In answering this question, we analyze the mechanisms that ensure (or do not ensure) that net liabilities across countries stay bounded, and we establish how the answer depends on the liquidity premium that each category of assets commands (cash, excess reserves within the Eurosystem, and government bonds). We find that the official risk-sharing provisions of the policy of quantitative easing (QE), whereby national central banks retain 90% of the risk intrinsic in bonds of their own country, only holds under restrictive assumptions; under plausible scenarios, a significantly larger fraction of the risk is mutualized.

We develop a restart algorithm based on Scarf’s (1973) algorithm for computing approximate Brouwer fixed points. We use the algorithm to compute all of the equilibria of a general equilibrium pure-exchange model with four consumers, four goods, and 15 equilibria. The mathematical result that motivates the algorithm is a fixed-point index theorem that provides a sufficient condition for uniqueness of equilibrium and a necessary condition for multiplicity of equilibria. Examining the structure of the model with 15 equilibria provides us with a method for constructing higher dimensional models with even more equilibria. For example, using our method, we can construct a pure-exchange economy with eight consumers and eight goods that has (at least) 255 equilibria.

The appendix accompanies Staff Report 581: Optimal Cooperative Taxation in the Global Economy.

We show that explicitly modeling primary commodities in an otherwise totally standard incomplete markets open economy model can go a long way in explaining the Mussa puzzle and the Backus-Smith puzzle, two of the main puzzles in the international economics literature.

We develop a framework with rich worker heterogeneity, firm monopsony power, and putty-clay technology to study the distributional impact of the minimum wage in the short and long run. Our production technology is disciplined to be consistent with the small estimated employment effects of the minimum wage in the short run and the large estimated elasticities of substitution across inputs in the long run. We find that in the short run, a large increase in the minimum wage has a small effect on employment and therefore increases the labor income of the workers who were earning less than the new minimum wage. In the long run, however, the minimum wage has perverse distributional implications in that it reduces the employment, income, and welfare of precisely the low-income workers it is meant to help. Nonetheless, these long-run effects take time to fully materialize because firms slowly adjust their mix of inputs. Existing transfer programs, such as the earned income tax credit (EITC), are more effective at improving long-run outcomes for workers at the low end of the wage distribution. But combining existing programs with a modest increase in the minimum wage generates even larger welfare gains for low-earning workers.

We consider an economy with perpetual youth and inelastic labor supply that grows endogenously. Consumers are subject to idiosyncratic capital accumulation risk and markets are incomplete. The government purchases consumption goods, makes transfers in the form of baby bonds, and it can use consumption and wealth taxes. The wealth distribution is given in closed form. When the intertemporal elasticity of substitution ɛ is equal to 1, the government can run a permanent primary deficit, up to a finite upper bound, if the coefficient of relative risk aversion is high enough and the factor share of labor is not too close to 1. This causes the risk-free rate r to be below the growth rate g of the economy. But the government can implement Pareto improvements when r - g does not exceed zero by enough. If ɛ ≠ 1, then there may not be an upper bound on the permanent primary deficits of the government. If ɛ Є (0,1), this happens when the economy is relatively unproductive, and then taking deficits to be very large makes all consumers worse off. If ɛ Є (1,∞), very large deficits are possible if the economy is sufficiently productive, and then they imply unbounded Pareto improvements.

This paper posits an information channel as the explanation for sudden inflations. Consumers saving via nominal government bonds face a choice whether to acquire costly information about future government surpluses. They trade off the cost of acquiring information about the surpluses that back bond repayment against the benefit of a more informed saving decision. Through the information channel, small changes in the economic environment can trigger large responses in consumers' behavior and prices. This setting explains why there can be long stretches of time during which government surpluses have large movements with little inflation response; yet, at some point, something snaps, and a sudden inflation takes off that is strongly responsive to incoming fiscal news.

Are unregulated capital flows excessive during a stagflation episode? We argue that they likely are, owing to a macroeconomic externality operating through the economy’s supply side. Inflows raise domestic wages through a wealth effect on labor supply and cause unwelcome upward pressure on marginal costs in countries where monetary policy is trying to drive down costs to stabilize inflation. Yet, market forces are likely to generate such inflows. Optimal capital flow management instead requires net outflows, suggesting topsy-turvy capital flows following markup shocks.

We assess the welfare consequences of occupational licensing for workers and consumers. We estimate a model of labor market equilibrium in which licensing restricts labor supply but also affects labor demand via worker quality and selection. On the margin of occupations licensed differently between U.S. states, we find that licensing raises wages and hours but reduces employment. We estimate an average welfare loss of 12 percent of occupational surplus. Workers and consumers respectively bear 70 and 30 percent of the incidence. Higher willingness to pay offsets 80 percent of higher prices for consumers, and higher wages compensate workers for 60 percent of the cost of mandated investment in occupation-specific human capital.

How should countries cooperate in setting fiscal and trade policies when government expenditures must be financed with distorting taxes? We show that even if countries cannot make explicit transfers to each other, every point on the Pareto frontier is production efficient, so that international trade and capital flows should be effectively free. Trade agreements must be supplemented with fiscal policy agreements. Residence-based income tax systems have advantages over source-based systems. Taxing all household asset income at a country-specific uniform rate and setting the corporate income tax to zero yield efficient outcomes. Value-added taxes should be adjusted at the border.

In the United States, both taxes and old age Social Security benefits depend on one's marital status and tend to discourage the labor supply of the secondary earner. To what extent are these provisions holding back female labor supply? We estimate a rich life cycle model of labor supply and savings for couples and singles using the method of simulated moments (MSM) on the 1945 and 1955 birth-year cohorts and use it to evaluate what would happen without these provisions. Our model matches well the life cycle profiles of labor market participation, hours, and savings for married and single people and generates plausible elasticities of labor supply. Eliminating marriage-related provisions drastically increases the participation of married women over their entire life cycle, reduces the participation of married men after age 60, and increases the savings of couples in both cohorts, including the later one, which has similar participation to that of more recent generations. If the resulting government surplus were used to lower income taxation, there would be large welfare gains for the vast majority of the population.

Real business cycles are recurrent fluctuations in an economy’s incomes, products, and factor inputs—especially labor—that are due to nonmonetary sources. These sources include changes in technology, tax rates and government spending, tastes, government regulation, terms of trade, and energy prices. Most real business cycle (RBC) models are variants or extensions of a neoclassical growth model. One such prototype is introduced. It is then shown how RBC theorists, applying the methodology of Kydland and Prescott (Econometrica 1982), use theory to make predictions about actual time series. Extensions of the prototype model, current issues, and open questions are also discussed.

We show that an increase in the minimum wage can have large effects throughout the earnings distribution, using a combination of theory and evidence. To this end, we develop an equilibrium search model featuring empirically relevant worker and firm heterogeneity. The minimum wage induces firms to adjust their equilibrium wage and vacancy policies, leading to spillovers on higher wages. We use the estimated model to evaluate the effects of a 119 percent increase in the real minimum wage in Brazil from 1996 to 2012. The policy change explains a large decline in earnings inequality, with spillovers reaching up to the 80th percentile of the earnings distribution. At the same time, employment and output fall only modestly as workers relocate to more productive firms. Using administrative linked employer-employee data and two household surveys, we find reduced-form evidence in support of the model predictions.

Between 1880 and 1920, the US agricultural employment share fell from 50% to 25%. However, despite aggregate demand shifting away from their sector of specialization, rural labor markets saw faster wage growth and industrialization than non-agricultural parts of the US. We propose a spatial model of the structural transformation to analyze the link between aggregate structural change and local economic development. The calibrated model shows that rural areas adapted to the decline of the agricultural sector by adopting technologies already in use in urban locations. Without such catchup growth, economic development would have been urban-biased and spatial inequality would have increased.