Research Database

In this paper we present a formal model of vote trading within a legislature. The model captures the conventional wisdom that if projects with concentrated benefits are financed by universal taxation, then majority rule leads to excessive spending. This occurs because the proponent of a particular bill only needs to acquire the votes of half the legislature and hence internalizes the costs to only half the representatives. We show that Pareto superior allocations are difficult to sustain because of a free rider problem among the representatives. We show that alternative voting rules, such as unanimity, eliminate excessive spending on concentrated benefit projects but lead to underfunding of global public goods.

We develop a model of gross job and worker flows and use it to study how the wages, permanent incomes, and employment status of individual workers evolve over time. Our model helps explain various features of labor markets, such as the amount of worker turnover in excess of job reallocation, the length of job tenures and unemployment duration, and the size and persistence of the changes in income that workers experience due to displacements or job-to-job transitions. We also examine the effects that labor market institutions and public policy have on the gross flows, as well as on the resulting wage distribution and employment in the equilibrium. From a theoretical standpoint, we propose a notion of competitive equilibrium for random matching environments, and study the extent to which it achieves an efficient allocation of resources.

Previous research has suggested that discrete and occasional plant-level capital adjustments have significant aggregate implications. In particular, it has been argued that changes in plants’ willingness to invest in response to aggregate shocks can at times generate large movements in total investment demand. In this study, I re-assess these predictions in a general equilibrium environment. Specifically, assuming nonconvex costs of capital adjustment, I derive generalized (S,s) adjustment rules yielding lumpy plant-level investment within an otherwise standard equilibrium business cycle model. In contrast to previous partial equilibrium analyses, model results reveal that the aggregate effects of lumpy investment are negligible. In general equilibrium, households’ preference for relatively smooth consumption profiles offsets changes in aggregate investment demand implied by the introduction of lumpy plant-level investment. As a result, adjustments in wages and interest rates yield quantity dynamics that are virtually indistinguishable from the standard model.

This paper studies the empirical relevance of temptation and self-control using household-level data from the Consumer Expenditure Survey. We estimate an infinite-horizon consumption-savings model that allows, but does not require, temptation and self-control in preferences. To help identify the presence of temptation, we exploit an implication of the theory that a tempted individual has a preference for commitment. In the presence of temptation, the cross-sectional distribution of the wealth-consumption ratio, in addition to that of consumption growth, becomes a determinant of the asset-pricing kernel, and the importance of this additional pricing factor depends on the strength of temptation. The estimates that we obtain provide statistical evidence supporting the presence of temptation. Based on our estimates, we explore some quantitative implications of this class of preferences on equity premium and on the welfare cost of business cycles.

In recent financial crises and in recent theoretical studies of them, abrupt declines in capital inflows, or sudden stops, have been linked with large drops in output. Do sudden stops cause output drops? No, according to a standard equilibrium model in which sudden stops are generated by an abrupt tightening of a country’s collateral constraint on foreign borrowing. In this model, in fact, sudden stops lead to output increases, not decreases. An examination of the quantitative effects of a well-known sudden stop, in Mexico in the mid-1990s, confirms that a drop in output accompanying a sudden stop cannot be accounted for by the sudden stop alone. To generate an output drop during a financial crisis, as other studies have done, the model must include other economic frictions which have negative effects on output large enough to overwhelm the positive effect of the sudden stop.

We develop a new general equilibrium model of asset pricing and asset trading volume in which agents’ motivations to trade arise due to uninsurable idiosyncratic shocks to agents’ risk tolerance. In response to these shocks, agents trade to rebalance their portfolios between risky and riskless assets. We study a positive question — When does trade volume become a pricing factor? — and a normative question — What is the impact of Tobin taxes on asset trading on welfare? In our model, economies in which marketwide risk tolerance is negatively correlated with trade volume have a higher risk premium for aggregate risk. Likewise, for a given economy, we find that assets whose cash flows are concentrated on states with high trading volume have higher prices and lower risk premia. We then show that Tobin taxes on asset trade have a first-order negative impact on ex-ante welfare, i.e., a small subsidy to trade leads to an improvement in ex-ante welfare. Finally, we develop an alternative version of our model in which asset trade arises from uninsurable idiosyncratic shocks to agents’ hedging needs rather than shocks to their risk tolerance. We show that our positive results regarding the relationship between trade volume and asset prices carry through. In contrast, the normative implications of this specification of our model for Tobin taxes or subsidies depend on the specification of agents’ preferences and non-traded endowments.

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.

A traditional explanation for why sovereign governments repay debts is that they want to keep a good reputation so they can easily borrow more. Bulow and Rogoff have challenged this explanation. They argue that, in complete information models, government borrowing requires direct legal sanctions. We argue that, in incomplete information models with multiple trust relationships, large amounts of government borrowing can be supported by reputation alone.

We propose a definition of time consistent policy for infinite horizon economies with competitive private agents. Allocations and policies are defined as functions of the history of past policies. A sustainable equilibrium is a sequence of history-contingent policies and allocations that satisfy certain sequential rationality conditions for the government and for private agents. We provide a complete characterization of the sustainable equilibrium outcomes for a variant of Fischer’s (1980) model of capital taxation. We also relate our work to recent developments in the theory of repeated games.

We find that in a sample of emerging economies business cycles are more volatile than in developed ones, real interest rates are countercyclical and lead the cycle, consumption is more volatile than output and net exports are strongly countercyclical. We present a model of a small open economy, where the real interest rate is decomposed in an international rate and a country risk component. Country risk is affected by fundamental shocks but, through the presence of working capital, also amplifies the effects of those shocks. The model generates business cycles consistent with Argentine data. Eliminating country risk lowers Argentine output volatility by 27% while stabilizing international rates lowers it by less than 3%.

This paper develops a forecasting procedure based on a Bayesian method for estimating vector autoregressions. We apply the procedure to 10 macroeconomic variables and show that it produces more accurate out-of-sample forecasts than univariate equations do. Although cross-variable responses are damped by the prior, our estimates capture considerable interaction among the variables.

We provide unconditional forecasts as of 1982:12 and 1983:3. We also describe how a model such as this can be used to make conditional projections and analyze policy alternatives. As an example, we analyze a Congressional Budget Office forecast made in 1982:12.

While no automatic casual interpretations arise from models like ours, such models provide a detailed characterization of the dynamic statistical interdependence of a set of economic variables. That information may help evaluate casual hypotheses without containing any such hypotheses.

We develop a conceptual framework for analyzing the interactions between aggregate fiscal policy and monetary policy. The framework draws on existing models that analyze sovereign debt crises and balance-of-payments crises. We intend this framework as a guide for analyzing the monetary and fiscal history of a set of eleven major Latin American countries—Argentina, Bolivia, Brazil, Chile, Colombia, Ecuador, Mexico, Paraguay, Peru, Uruguay, and Venezuela—from the 1960s until now.

Arrow (1962) argued that since a monopoly restricts output relative to a competitive industry, it would be less willing to pay a fixed cost to adopt a new technology. Arrow’s idea has been challenged and critiques have shown that under different assumptions, increases in competition lead to less innovation. We develop a new theory of why a monopolistic industry innovates less than a competitive industry. The key is that firms often face major problems in integrating new technologies. In some cases, upon adoption of technology, firms must temporarily reduce output. We call such problems switchover disruptions. If firms face switchover disruptions, then a cost of adoption is the forgone rents on the sales of lost or delayed production, and these opportunity costs are larger the higher the price on those lost units. In particular, with greater monopoly power, the greater the forgone rents. This idea has significant consequences since if we add switchover disruptions to standard models, then the critiques of Arrow lose their force: competition again leads to greater adoption. In addition, we show that our model helps explain the accumulating evidence that competition leads to greater adoption (whereas the standard models cannot).

We study fiscal and monetary policy in a monetary union with the potential for rollover crises in sovereign debt markets. Member-country fiscal authorities lack commitment to repay their debt and choose fiscal policy independently. A common monetary authority chooses inflation for the union, also without commitment. We first describe the existence of a fiscal externality that arises in the presence of limited commitment and leads countries to over-borrow; this externality rationalizes the imposition of debt ceilings in a monetary union. We then investigate the impact of the composition of debt in a monetary union, that is the fraction of high-debt versus low-debt members, on the occurrence of self-fulfilling debt crises. We demonstrate that a high-debt country may be less vulnerable to crises and have higher welfare when it belongs to a union with an intermediate mix of high- and low-debt members, than one where all other members are low-debt. This contrasts with the conventional wisdom that all countries should prefer a union with low-debt members, as such a union can credibly deliver low inflation. These findings shed new light on the criteria for an optimal currency area in the presence of rollover crises.

We develop a theory of sweat equity—the value of business owners' time and expenses to build customer bases, client lists, and other intangible assets. We discipline the theory using data from U.S. national accounts, business censuses, and brokered sales to estimate a value for sweat equity in the private business sector equal to 1.2 times U.S. GDP, which is about the same magnitude as the value of fixed assets in use in these businesses. For a typical owner, 26 percent of the sweat equity is transferable through inheritance or sale. The equity values are positively correlated with business incomes and standard measures of markups based on accounting data, but not with owners' financial assets or standard measures of business total factor productivity. We use our theory to show that abstracting from sweat activity leads to a significant understatement of the impacts of lowering business income tax rates on private business activity for both the extensive and intensive margins. Despite finding larger responses, our model's implied tax elasticities of establishments and owner hours are in line with empirical estimates in the public finance literature. Allowing for financial constraints and superstar firms does not overturn our main findings.

No abstract available.

This paper explains why the risky notes of banks established during the Free Banking Era (1837–63) were demanded even when relatively safe specie (gold and silver coin) was an alternative. Free bank notes were demanded because they were priced to reflect the expected value of their backing. The empirical evidence supports this explanation. Specifically, in New York, Wisconsin, and Indiana the expected value of backing was sufficient for free bank notes to circulate at par, which they did. In Minnesota the backing for notes was very poor: they exchanged well below par, being treated as small-denomination securities.

This paper evaluates the role of rising income inequality in explaining observed growth in college tuition. We develop a competitive model of the college market, in which college quality depends on instructional expenditure and the average ability of admitted students. An innovative feature of our model is that it allows for a continuous distribution of college quality. We find that observed increases in US income inequality can explain more than half of the observed rise in average net tuition since 1990 and that rising income inequality has also depressed college attendance.