Research Database

We develop a new tractable model of banks' liquidity management and the credit channel of monetary policy. Banks finance loans by issuing demand deposits. Because loans are illiquid, deposit transfers across banks must be settled with reserves. Deposit withdrawals are random, and banks manage liquidity risk by holding a precautionary buffer of reserves. We show how different shocks affect the banking system by altering the trade-off between profiting from lending and incurring greater liquidity risk. Through various tools, monetary policy affects the real economy by altering that trade-off. In a quantitative application, we study the driving forces behind the decline in lending and liquidity hoarding by banks during the 2008 financial crisis. Our analysis underscores the importance of disruptions in interbank markets followed by a persistent decline in credit demand.

Although a credit tightening is commonly recognized as a key determinant of the Great Recession, to date, it is unclear whether a worsening of credit conditions faced by households or by firms was most responsible for the downturn. Some studies have suggested that the household-side credit channel is quantitatively the most important one. Many others contend that the firm-side channel played a crucial role. We propose a model in which both channels are present and explicitly formalized. Our analysis indicates that the household-side credit channel is quantitatively more relevant than the firm-side credit channel. We then evaluate the relative benefits of a fixed-sized transfer to households and to firms that improves each group's access to credit. We find that the effects of such a transfer on employment are substantially larger when the transfer targets households rather than firms. Hence, we provide theoretical and quantitative support to the view that the employment decline during the Great Recession would have been less severe if instead of focusing on easing firms' access to credit, the government had expended an equal amount of resources to alleviate households' credit constraints.

What structure of income taxation maximizes the social benefits of redistribution while minimizing the social harm associated with distorting the allocation of labor input? Many authors have advocated scrapping the current tax system, which redistributes primarily via marginal tax rates that rise with income, and replacing it with a flat tax system, in which marginal tax rates are constant and redistribution is achieved via non-means-tested transfers. In this paper we compare alternative tax systems in an environment with distinct roles for public and private insurance. We evaluate alternative policies using a social welfare function designed to capture the taste for redistribution reflected in the current tax system. In our preferred specification, moving to the optimal flat tax policy reduces welfare, whereas moving to the optimal fully nonlinear Mirrlees policy generates only tiny welfare gains. These findings suggest that proposals for dramatic tax reform should be viewed with caution.

This paper studies asset pricing and labor market dynamics when idiosyncratic risk to human capital is not fully insurable. Firms use long-term contracts to provide insurance to workers, but neither side can fully commit; furthermore, owing to costly and unobservable retention effort, worker-firm relationships have endogenous durations. Uninsured tail risk in labor earnings arises as a part of an optimal risk-sharing scheme. In equilibrium, exposure to the tail risk generates higher aggregate risk premia and higher return volatility. Consistent with data, firm-level labor share predicts both future returns and pass-throughs of firm-level shocks to labor compensation.

Does competition spur productivity? And if so, how does it do so? These have long been regarded as central questions in economics. This essay reviews the literature that makes progress toward answering both questions.

This paper shows how the cross-equation restrictions implied by dynamic rational expectations models can be used to resolve the aliasing identification problem. Using a continuous time, linear-quadratic optimization environment, this paper describes how the resulting restrictions are sufficient to identify the parameters of the underlying continuous time process when it is known that the true continuous time process has a rational spectral density matrix.

Recent empirical analysis has found nonlinearities to be important in understanding aggregated investment. Using an equilibrium business cycle model, we search for aggregate nonlinearities arising from the introduction of nonconvex capital adjustment costs. We find that, while such costs lead to nontrivial nonlinearities in aggregate investment demand, equilibrium investment is effectively unchanged. Our finding, based on a model in which aggregate fluctuations arise through exogenous changes in total factor productivity, is robust to the introduction of shocks to the relative price of investment goods.

We develop a model of equilibrium price dispersion via retailer search and show that the degree of market segmentation within and across countries cannot be separately identified by good-level price data alone. We augment a set of well-known empirical facts about the failure of the law of one price with data on aggregate intranational and international trade quantities, and calibrate the model to match price and quantity facts simultaneously. The calibrated model matches the data very well and implies that within-country markets are strongly segmented, while international borders contribute virtually no additional market segmentation.

We study inferences about the dynamics of labor adjustment obtained by the “gap methodology” of Caballero and Engel [1993] and Caballero, Engel and Haltiwanger [1997]. In that approach, the policy function for employment growth is assumed to depend on an unobservable gap between the target and current levels of employment. Using time series observations, these studies reject the partial adjustment model and find that aggregate employment dynamics depend on the cross-sectional distribution of employment gaps. Thus, nonlinear adjustment at the plant level appears to have aggregate implications. We argue that this conclusion is not justified: these findings of nonlinearities in time series data may reflect mismeasurement of the gaps rather than the aggregation of plant-level nonlinearities.

A standard explanation for why sovereign governments repay their debts is that they must maintain a good reputation to easily borrow more. We show that the ability of reputation to support debt depends critically on the assumptions made about institutions. At one extreme, we assume that bankers can default on payments they owe to governments. At the other, we assume that bankers are committed to honoring contracts made with governments. We show that if bankers can default, then a government gets enduring benefits from maintaining a good relationship with bankers and its reputation can support a large amount of borrowing. If, however, bankers must honor their contracts, then a government gets only transient benefits from maintaining a good relationship and its reputation can support zero borrowing.

Manufacturing plants have a clear life cycle: they are born small, grow substantially as they age, and eventually die. Economists have long thought that this life cycle is driven by the accumulation of plant-specific knowledge, here called organization capital. Theory suggests that where plants are in the life cycle determines the size of the payments, or dividends, plant owners receive from organization capital. These payments are compensation for the interest cost to plant owners of waiting for their plants to grow. We build a quantitative growth model of the life cycle of plants and use it, along with U.S. data, to infer the overall size of these payments. They turn out to be quite large—more than one-third the size of the payments plant owners receive from physical capital, net of new investment, and more than 40% of payments from all forms of intangible capital.

We study the large observed changes in labor supply by married women in the United States over the post–World War II period, a period that saw little change in the labor supply by single women. We investigate the effects of changes in the gender wage gap, the quantitative impact of technological improvements in the production of nonmarket goods, and the potential inferiority of nonmarket goods in explaining the dramatic change in labor supply. We find that small decreases in the gender wage gap can simultaneously explain the significant increases in the average hours worked by married women and the relative constancy in the hours worked by single women and by single and married men. We also find that the impact of technological improvements in the household on married female hours and on the relative wage of females to males is too small for realistic values. Some specifications of the inferiority of home goods match the hours patterns, but they have counterfactual predictions for wages and expenditure patterns.

We provide an introduction to optimal fiscal and monetary policy using the primal approach to optimal taxation. We use this approach to address how fiscal and monetary policy should be set over the long run and over the business cycle. We find four substantive lessons for policymaking: Capital income taxes should be high initially and then roughly zero; tax rates on labor and consumption should be roughly constant; state-contingent taxes on assets should be used to provide insurance against adverse shocks; and monetary policy should be conducted so as to keep nominal interest rates close to zero. We begin optimal taxation in a static context. We then develop a general framework to analyze optimal fiscal policy. Finally, we analyze optimal monetary policy in three commonly used models of money: a cash-credit economy, a money-in-the-utility-function economy, and a shopping-time economy.

This paper surveys recent issues in macroeconomics from the viewpoint of dynamic economic theory. The need to look beyond demand and supply curves and the insights that come from doing so are emphasized. Examples of issues in debt management and fiscal policy are analyzed.

Commodity money is modeled as one or two of the capital goods in a one-consumption good and one or two capital-good, overlapping generations model. Among the topics addressed using versions of the model are (i) the nature of the inefficiency of commodity money; (ii) the validity of quantity-theory predictions for commodity money systems; (iii) the circumstances under which one commodity emerges naturally as the commodity money; (iv) the role of inside money (money backed by private debt) in commodity money systems; and (v) the circumstances under which a government can choose the commodity to serve as the commodity money.

Search-theoretic models of monetary exchange are based on explicit descriptions of the frictions that make money essential. However, tractable versions of these models typically need strong assumptions that make them ill-suited for studying monetary policy. We propose a framework based on explicit micro foundations within which macro policy can be analyzed. The model is both analytically tractable and amenable to quantitative analysis. We demonstrate this by using it to estimate the welfare cost of inflation. We find much higher costs than the previous literature: our model predicts that going from 10% to 0% inflation can be worth between 3% and 5% of consumption.

This paper presents a government debt game with the property that if the timing of debt auctions within a period is sufficiently unfettered, the set of equilibrium outcome paths of real economic variables given the government has access to a rich debt structure is identical to the set of equilibrium outcome paths given the government can issue only one-period debt.

We study optimal labor and capital taxation in a dynamic economy subject to government expenditure and aggregate productivity shocks. We relax two assumptions from Ramsey models: that a representative agent exists and that taxation is proportional with no lump-sum tax. In contrast, we capture a redistributive motive for distortive taxation by allowing privately observed differences in relative skills across workers. We consider two scenarios for tax instruments: (i) taxation is linear with arbitrary intercept and slope; and (ii) taxation is non-linear and unrestricted as in Mirrleesian models. Our main result provides conditions for perfect tax smoothing: marginal taxes on labor income should remain constant over time and invariant to shocks. In addition, capital should not be taxed. We also discuss implications for optimal debt management. Finally, an extension highlights movements in the distribution of relative skills as a potential source for variations in optimal marginal tax rates.

We study a one-sector growth model which is standard except for the presence of an externality in the production function. The set of competitive equilibria is large. It includes constant equilibria, sunspot equilibria, cyclical and chaotic equilibria, and equilibria with deterministic or stochastic regime switching. The efficient allocation is characterized by constant employment and a constant growth rate. We identify an income tax-subsidy schedule that supports the efficient allocation as the unique equilibrium outcome. That schedule has two properties: (i) it specifies the tax rate to be an increasing function of aggregate employment, and (ii) earnings are subsidized when aggregate employment is at its efficient level. The first feature eliminates inefficient, fluctuating equilibria, while the second induces agents to internalize the externality.

Latin American countries are the only Western countries that are poor and that aren’t gaining ground on the United States. This paper evaluates why Latin America has not replicated Western economic success. We find that this failure is primarily due to TFP differences. Latin America’s TFP gap is not plausibly accounted for by human capital differences, but rather reflects inefficient production. We argue that competitive barriers are a promising channel for understanding low Latin TFP. We document that Latin America has many more international and domestic competitive barriers than do Western and successful East Asian countries. We also document a number of microeconomic cases in Latin America in which large reductions in competitive barriers increase productivity to Western levels.