Research Database

Inspired by the current European developments, we study equilibrium fiscal policy under alternative constitutional arrangements in a “federation” of countries. There are two levels of government: local and federal. Local policy redistributes across individuals and affects the probability of aggregate shocks, while federal policy shares international risk. Policies are chosen under majority rule. There is a moral hazard problem: federal risk-sharing can induce the local governments to enact policies that increase local risk. We investigate this incentive problem under alternative fiscal constitutions. In particular, we contrast a vertically ordered system like the EC with a horizontally ordered federal system like the US. These alternative arrangements are not neutral, in the sense that they create different incentives for policymakers and voters, and give rise to different political equilibria. A general conclusion is that, centralization of functions and power can be welfare improving under appropriate institutions. However, this conclusion only applies to the moral hazard problem and a federation where the countries are not too dissimilar.

There are two approaches to maximum likelihood (ML) estimation of the parameter of fractionally-integrated noise: approximate frequency-domain ML (Fox and Taqqwu, 1986) and exact time-domain ML (Solwell, 1990a). If the mean of the process is known, then a clear finite-sample mean-squared error (MSE) ranking of the estimators emerges: the exact time-domain estimator has smaller MSE. We show in this paper, however, that the finite-sample efficiency of approximate frequency-domain ML relative to exact time-domain ML rises dramatically when the mean result is unknown and instead must be estimated. The intuition for our result is straightforward: The frequency-domain ML estimator is invariant to the true but unknown mean of the process, while the time-domain ML estimator is not. Feasible time-domain estimation must therefore be based upon de-meaned data, but the long memory associated with fractional integration makes precise estimation of the mean difficult. We conclude that the frequency-domain estimator is an attractive and efficient alternative for situations in which large sample sizes render time-domain estimation impractical.

This article analyzes several proposals to build work incentives into the U.S. welfare system. It concludes that the most cost effective way to do that is to offer a work subsidy to all low-income single parents—in other words, to simply pay them for working in the labor market. This conclusion is based on a model of the labor force participation behavior of low-income single mothers that the author developed with Robert Moffitt. Among the proposals evaluated in the article, besides the work subsidy, are proposals to reduce the rate that welfare benefits are reduced when welfare recipients work, to provide wage subsidies to low-wage workers, to expand the earned income tax credit, and to subsidize the fixed costs of working.

A two-country Real Business Cycle (RBC) model is used to study the behavior of the United States trade balance. In this model, economic fluctuations are driven by productivity shocks and by variations in government purchases and in distorting taxes. The model is simulated using quarterly data on total factor productivity, government purchases, and the average tax rate in the seven major industrial countries during the period 1975–91. A version of the model that postulates complete international asset markets—as frequently assumed in the International RBC literature (see, e.g., Backus, Kehoe, and Kydland 1992)—fails to explain the observed behavior of the U.S. trade balance. In contrast, a version with incomplete asset markets, in which only debt contracts can be used for international capital flows, tracks the behavior of the U.S. trade balance fairly closely.