Creator: Chari, V. V., Christiano, Lawrence J., and Kehoe, Patrick J. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 520 Keyword: Business cycles, Policy analysis, Exogenous growth model, Monetary policy, Optimal taxation, Friedman rule, and Fiscal policy Subject (JEL): E52 - Monetary Policy and E32 - Business Fluctuations; Cycles
Creator: Arellano, Cristina, Mateos-Planas, Xavier, and Ríos-Rull, José-Víctor Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 589 Abstract:
In the data sovereign default is always partial and varies in its duration. Debt levels during default episodes initially increase and do not experience reductions upon resolution. This paper presents a theory of sovereign 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. Partial default is also costly because it amplifies debt crises as the defaulted debt accumulates and interest rate spreads increase. This theory is capable of rationalizing the large heterogeneity in partial default, its comovements with spreads, debt levels, and output, and the dynamics of debt during default episodes. In our theory, as in the data, debt grows during default episodes, and large defaults are longer, and associated with higher interest rate spreads, higher debt levels, and deeper recessions.
Keyword: Debt crises, Emerging markets, Sovereign risk, and Debt restructuring Subject (JEL): F34 - International Lending and Debt Problems, H63 - National Debt; Debt Management; Sovereign Debt, and G01 - Financial Crises
Creator: King, Robert G. (Robert Graham) and Thomas, Julia Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 327 Abstract:
Many kinds of economic behavior involve discrete and occasional individual choices. Despite this, econometric partial adjustment models perform relatively well at the aggregate level. Analyzing the classic employment adjustment problem, we show how such microeconomic adjustment is well described by a new form of partial adjustment model that aggregates the actions of heterogeneous producers.
We develop a model where individual establishments infrequently alter the sizes of their workforces because such adjustments involve fixed costs. In the market equilibrium, employment responses to aggregate disturbances include changes both in target employments selected by individual establishments and in the measure of establishments actively undertaking adjustment. Yet the model retains a partial adjustment flavor in its aggregate responses. Moreover, in contrast to existing discrete adjustment models, our generalized partial adjustment model is sufficiently tractable to allow general equilibrium analysis, and it naturally extends to accommodate persistent differences in productivity across establishments in general equilibrium.
Keyword: Employment Dynamics, (S,s) Adjustment, and Partial Adjustment Subject (JEL): E20 - Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy: General (includes Measurement and Data) and E10 - General Aggregative Models: General
Creator: Dahl, David S. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 052 Description:
Second cover page indicates report dated February 12, 1976.
Keyword: State government, Local government, Ninth district economy, and Expenditures Subject (JEL): H50 - National Government Expenditures and Related Policies: General and H72 - State and Local Budget and Expenditures
Creator: Boyd, John H., Prescott, Edward C., and Smith, Bruce D. (Bruce David), 1954-2002 Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 385 Abstract:
Three economic environments are reviewed, and in each organizations play an essential role. For an adverse selection insurance economy, we find that when mutual insurance arrangements are permitted an equilibrium necessarily exists and is optimal. This example, and the two others, illustrate the problems that may result from imposing organizational structure on an environment rather than permitting the structure to be determined endogenously.
Creator: Heathcote, Jonathan, Storesletten, Kjetil, and Violante, Giovanni L. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 496 Abstract:
What shapes the optimal degree of progressivity of the tax and transfer system? On the one hand, a progressive tax system can counteract inequality in initial conditions and substitute for imperfect private insurance against idiosyncratic earnings risk. On the other hand, progressivity reduces incentives to work and to invest in skills, distortions that are especially costly when the government must finance public goods. We develop a tractable equilibrium model that features all of these trade-offs. The analytical expressions we derive for social welfare deliver a transparent understanding of how preference, technology, and market structure parameters influence the optimal degree of progressivity. A calibration for the U.S. economy indicates that endogenous skill investment, flexible labor supply, and the desire to finance government purchases play quantitatively similar roles in limiting optimal progressivity. In a version of the model where poverty constrains skill investment, optimal progressivity is close to the U.S. value. An empirical analysis on cross-country data offers support to the theory.
Keyword: Skill investment, Welfare, Income distribution, Cross-country evidence, Partial insurance, Tax progressivity, Labor supply, and Government expenditures Subject (JEL): E20 - Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy: General (includes Measurement and Data), D30 - Distribution: General, H40 - Publicly Provided Goods: General, J24 - Human Capital; Skills; Occupational Choice; Labor Productivity, H20 - Taxation, Subsidies, and Revenue: General, and J22 - Time Allocation and Labor Supply
Creator: Atkeson, Andrew, Hellwig, Christian, and Ordonez, Guillermo Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 464 Abstract:
In all markets, firms go through a process of creative destruction: entry, random growth and exit. In many of these markets there are also regulations that restrict entry, possibly distorting this process. We study the public interest rationale for entry taxes in a general equilibrium model with free entry and exit of firms in which firm dynamics are driven by reputation concerns. In our model firms can produce high-quality output by making a costly but efficient initial unobservable investment. If buyers never learn about this investment, an extreme “lemons problem” develops, no firm invests, and the market shuts down. Learning introduces reputation incentives such that a fraction of entrants do invest. We show that, if the market operates with spot prices, entry taxes always enhance the role of reputation to induce investment, improving welfare despite the impact of these taxes on equilibrium prices and total production.
Keyword: General equilibrium, Reputation, Creative destruction, Firm dynamics, Entry and exit, and Regulation Subject (JEL): D82 - Asymmetric and Private Information; Mechanism Design, L15 - Information and Product Quality; Standardization and Compatibility, D21 - Firm Behavior: Theory, and L51 - Economics of Regulation
Creator: Kareken, John H., Muench, Thomas J., and Wallace, Neil Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 017 Keyword: Open market policy, Information lag, and FOMC Subject (JEL): E44 - Financial Markets and the Macroeconomy and E58 - Central Banks and Their Policies
Creator: Katzman, Brett, 1966-, Kennan, John, and Wallace, Neil Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 595 Abstract:
The effects on ex ante optima of a lag in seeing monetary realizations are studied using a matching model of money. The main new ingredient in the model is meetings in which producers have more information than consumers. A consequence is that increases in the amount of money that occur with small enough probability can have negative impact effects on output, because it is optimal to shut down trade in such low probability meetings rather than have lower output when high probability realizations occur. The information lag also produces prices that do not respond much to current monetary realizations.
Subject (JEL): E30 - Prices, Business Fluctuations, and Cycles: General (includes Measurement and Data), E40 - Money and Interest Rates: General, and D82 - Asymmetric and Private Information; Mechanism Design
Creator: Golosov, Mikhail, Kocherlakota, Narayana Rao, 1963-, and Tsyvinski, Aleh Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 293 Abstract:
In this paper, we consider an environment in which agents’ skills are private information, are potentially multi-dimensional, and follow arbitrary stochastic processes. We allow for arbitrary incentive-compatible and physically feasible tax schemes. We prove that it is typically Pareto optimal to have positive capital taxes. As well, we prove that in any given period, it is Pareto optimal to tax consumption goods at a uniform rate.
Creator: Correia, Isabel, Nicolini, Juan Pablo, and Teles, Pedro Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 403 Abstract:
In this article, we analyze the implications of price-setting restrictions for the conduct of cyclical fiscal and monetary policy. We consider standard monetary economies that differ in the price-setting restrictions imposed on the firms. We show that, independently of the degree or type of price stickiness, it is possible to implement the same efficient set of allocations and that each allocation in that set is implemented with policies that are also independent of the price stickiness. In this sense, environments with different price-setting restrictions are equivalent.
Keyword: Optimal fiscal and monetary policy and Sticky prices Subject (JEL): E62 - Fiscal Policy, E52 - Monetary Policy, E40 - Money and Interest Rates: General, E63 - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy, E58 - Central Banks and Their Policies, and E31 - Price Level; Inflation; Deflation
Creator: Chari, V. V., Nicolini, Juan Pablo, and Teles, Pedro Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 581 Abstract:
We use the Ramsey and Mirrlees approaches to study how fiscal and trade policy should be set cooperatively when governments must raise revenues with distorting taxes. Free trade and unrestricted capital mobility are optimal. Efficient outcomes can be implemented with taxes only on final consumption goods and labor income. We study alternative tax systems, showing that uniform taxation of household asset returns, and not taxing corporate income yields efficient outcomes. Border adjustments exempting exports from and including imports in the tax base are desirable. Destination- and residence-based tax systems are desirable compared to origin- and source-based systems.
Keyword: Capital income tax, Border adjustment, Production efficiency, Value-added taxes, Origin- and destination-based taxation, and Free trade Subject (JEL): E62 - Fiscal Policy, E60 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook: General, and E61 - Policy Objectives; Policy Designs and Consistency; Policy Coordination
Creator: Litterman, Robert B. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 200 Abstract:
Using optimal control theory and a vector autoregressive representation of the relationship between money and interest rates one can derive a feedback control procedure which defines the best possible tradeoff between interest rate volatility and money supply fluctuations and which could be used to reduce both from their current levels.
Keyword: Control theory, Inflation, Federal Reserve Bank, Optimal control theory, and Time series analysis Subject (JEL): E51 - Money Supply; Credit; Money Multipliers, E40 - Money and Interest Rates: General, and E58 - Central Banks and Their Policies
Creator: Townsend, Robert M., 1948- Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 080 Abstract:
This paper focuses on avoidable moral hazard and offers one explanation for limited insurance markets, for closely held firms, and for seemingly simple as opposed to contingent forms of debt. Agents have random endowments of a consumption good which are such that there are gains to trading contingent claims. But any realization of an endowment is known only by its owner unless a verification cost is borne. Contracts in such a setting are said to be consistent if agents submit to verification and honor claims in accordance with prior agreements. The Pareto optimal consistent contracts which emerge are shown to have familiar characteristics.
Keyword: Competition, General equilibrium theory, Contracts, and Avoidable moral hazard Subject (JEL): D61 - Allocative Efficiency; Cost-Benefit Analysis, D86 - Economics of Contract: Theory, D50 - General Equilibrium and Disequilibrium: General, and D11 - Consumer Economics: Theory
Creator: Chari, V. V. and Kehoe, Patrick J. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 622 Abstract:
Herd behavior is argued by many to be present in many markets. Existing models of such behavior have been subjected to two apparently devastating critiques. The continuous investment critique is that in the basic model herds disappear if simple zero-one investment decisions are replaced by the more appealing assumption that investment decisions are continuous. The price critique is that herds disappear if, as seems natural, other investors can observe asset market prices. We argue that neither critique is devastating. We show that once we replace the unappealing exogenous timing assumption of the early models that investors move in a pre-specified order by a more appealing endogenous timing assumption that investors can move whenever they choose then herds reappear.
Creator: Green, Edward J. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 501 Abstract:
I consider two theories of the determination of political institutions. One of these theories stresses effects of changes in the balance of military power between the ruler and subjects on the distribution of property rights which the political system enforces. The other theory emphasizes the effect of changing informational constraints which require institutional changes to be made in order to maintain efficiency. I examine how each of these theories would apply to explaining the development of parliamentary government in thirteenth-century England. My general conclusion is that both theories are required to understand fully the process by which liberal political institutions emerge.
Keyword: History, Government, England, and Great Britain Subject (JEL): N43 - Economic History: Government, War, Law, International Relations, and Regulation: Europe: Pre-1913 and H11 - Structure, Scope, and Performance of Government
Creator: Atkeson, Andrew, Chari, V. V., and Kehoe, Patrick J. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 394 Abstract:
The optimal choice of a monetary policy instrument depends on how tight and transparent the available instruments are and on whether policymakers can commit to future policies. Tightness is always desirable; transparency is only if policymakers cannot commit. Interest rates, which can be made endogenously tight, have a natural advantage over money growth and exchange rates, which cannot. As prices, interest and exchange rates are more transparent than money growth. All else equal, the best instrument is interest rates and the next-best, exchange rates. These findings are consistent with the observed instrument choices of developed and less-developed economies.
Subject (JEL): E60 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook: General, E52 - Monetary Policy, E51 - Money Supply; Credit; Money Multipliers, E40 - Money and Interest Rates: General, E30 - Prices, Business Fluctuations, and Cycles: General (includes Measurement and Data), E58 - Central Banks and Their Policies, E31 - Price Level; Inflation; Deflation, E42 - Monetary Systems; Standards; Regimes; Government and the Monetary System; Payment Systems, and E61 - Policy Objectives; Policy Designs and Consistency; Policy Coordination