Research Database

Under certain assumptions, monopolistic competition with CES preferences is efficient, as first discovered by Dixit and Stiglitz. One assumption, invariably left implicit, is that there are, at any given point in time, no bounds on the number of products that can be discovered. But square wheels do not work, and round wheels keep getting rediscovered. Giving away patents to entrepreneurs who happen to be the first to discover a product generates an inefficiently large amount of variety. The stock of undiscovered products is a commons that can attract too many discovery attempts. Perpetual patents can be efficient, but only when combined with just the right tax on patent-protected monopoly profits. Such a tax is, however, too crude an instrument in an economy with even the least amount of heterogeneity.

The key question asked by standard monetary models used for policy analysis is, How do changes in short-term interest rates affect the economy? All of the standard models imply that such changes in interest rates affect the economy by altering the conditional means of the macroeconomic aggregates and have no effect on the conditional variances of these aggregates. We argue that the data on exchange rates imply nearly the opposite: the observation that exchange rates are approximately random walks implies that fluctuations in interest rates are associated with nearly one-for-one changes in conditional variances and nearly no changes in conditional means. In this sense, standard monetary models capture essentially none of what is going on in the data. We thus argue that almost everything we say about monetary policy using these models is wrong.

Recent developments in the theory of economies with private information permit a re-examination of the issues raised in the "real bills-quantity theory" debate. A model is developed here in which there are banks, in which fiat money is present, and in which agents possess private information. Two regulatory regimes are then considered. In the first, banks are essentially unregulated. In the second, banks face 100 percent reserve requirements. Issues related to existence and optimality of equilibrium are addressed, and problems with existence are given an interpretation in terms of the "stability" of the banking system. Existence (stability) problems which arise under laissez-faire banking can be rectified by a 100 percent reserve requirement. However, unless there is private information regarding access to investment opportunities, there are typically better ways to accomplish this. Finally, it is shown that even in the presence of 100 percent reserve requirements banks are not simply "money warehouses." Bank deposits and money bear different (real) return streams, even under 100 percent reserves.

Wage inequality between education groups in the United States has increased substantially since the early 1980s. The relative number of college-educated workers has also increased dramatically in the postwar period. This paper presents a unified framework where the dynamics of both skill accumulation and wage inequality arise as an equilibrium outcome driven by measured investment-specific technological change. Working through equipment-skill complementarity and endogenous skill accumulation, the model does well in capturing the steady growth in the relative quantity of skilled labor during the postwar period and the substantial rise in wage inequality after the early 1980s. Based on the calibrated model, we examine the quantitative effects of some hypothetical tax-policy reforms on skill accumulation, wage inequality, and welfare.

Starting in the early 1990s, countries in southern Europe experienced low productivity growth alongside declining real interest rates. We use data for manufacturing firms in Spain between 1999 and 2012 to document a significant increase in the dispersion of the return to capital across firms, a stable dispersion of the return to labor, and a significant increase in productivity losses from capital misallocation over time. We develop a model with size-dependent financial frictions that is consistent with important aspects of firms’ behavior in production and balance sheet data. We illustrate how the decline in the real interest rate, often attributed to the euro convergence process, leads to a significant decline in sectoral total factor productivity as capital inflows are misallocated toward firms that have higher net worth but are not necessarily more productive. We show that similar trends in dispersion and productivity losses are observed in Italy and Portugal but not in Germany, France, and Norway.

We study a variation of the standard model of sovereign default, as in Aguiar and Gopinath (2006) or Arellano (2008), and show that this variation is consistent with multiple interest rate equilibria. Some of those equilibria correspond to the ones identified by Calvo (1988), where default is likely because rates are high, and rates are high because default is likely. The model is used to simulate equilibrium movements in sovereign bond spreads that resemble sovereign debt crises. It is also used to discuss lending policies similar to the ones announced by the European Central Bank in 2012.

In this paper we explain why markets in noncontingent debt securities might be a stable form of market organization for intermediation to households. Efficient-contract allocation might be supported by these markets because households' relationships with their intermediaries do not exactly parallel the explicit form of the noncontingent contracts that they explicitly sign with one another. Also we show that the efficient-contract model can be distinguished from alternative models within the time-series framework that has been widely used to study households' consumption patterns.

Entrepreneurship is a key determinant of investment, saving, wealth holdings, and wealth inequality. We study the aggregate and the distributional effects of several tax reforms in a model that recognizes the key role played by the entrepreneurs, and that matches very well the extreme degree of wealth inequality observed in the U.S. data. We find that the effects of tax reforms on output and capital formation can be particularly large when they affect the majority of small and medium-size businesses, which face the most severe financial constraints, rather than a small number of big businesses. We show that the consequences of changes in the estate tax depend heavily on the size of its exemption level. The current effective estate tax system seems to insulate most of the businesses from the negative effects of estate taxation thus minimizing the aggregate costs of redistribution. Abolishing the current estate tax would generate a modest increase in wealth inequality and slightly reduce aggregate output. Decreasing progressivity of the income tax can generate large increases in output, as this stimulates entrepreneurial savings and capital formation, but at the cost of large increases in wealth concentration.

We produce a theoretical framework that helps explain the co-evolution of the real and financial sectors of an economy in the growth process, as described by Gurley and Shaw. According to them, self-financed capital investment first gives way to debt finance and later to the emergence of equity as an additional instrument for raising funds externally. As the economy develops further, the aggregate ratio of debt to equity will generally fall. We analyze that portion of their account concerning the evolution of equity markets. We show that in an important sense, debt equity are complementary sources for the financing of capital investments.

In a repeated game of incomplete information, myopic players form beliefs on next-period play and choose strategies to maximize next-period payoffs. Beliefs are treated as forecast of future plays. Forecast accuracy is assessed using calibration tests, which measure asymptotic accuracy of beliefs against some realizations. Beliefs are calibrated if they pass all calibration tests. For a positive Lebesgue measure of payoff vectors, beliefs are not calibrated. But, if payoff vector and calibration test are drawn from a suitable product measure, beliefs pass the calibration test almost surely.

The main substantive finding of the recent structural vector autoregression literature with a differenced specification of hours (DSVAR) is that technology shocks lead to a fall in hours. Researchers have used these results to argue that business cycle models in which technology shocks lead to a rise in hours should be discarded. We evaluate the DSVAR approach by asking, is the specification derived from this approach misspecified when the data are generated by the very model the literature is trying to discard? We find that it is misspecified. Moreover, this misspecification is so great that it leads to mistaken inferences that are quantitatively large. We show that the other popular specification that uses the level of hours (LSVAR) is also misspecified. We argue that alternative state space approaches, including the business cycle accounting approach, are more fruitful techniques for guiding the development of business cycle theory.

We use scanner data to estimate inflation rates at the household level. Households' inflation rates are remarkably heterogeneous, with an interquartile range of 6.2 to 9.0 percentage points on an annual basis. Most of the heterogeneity comes not from variation in broadly defined consumption bundles but from variation in prices paid for the same types of goods - a source of variation that previous research has not measured. The entire distribution of household inflation rates shifts in parallel with aggregate inflation. Deviations from aggregate inflation exhibit only slightly negative serial correlation within each household over time, implying that the difference between a household's price level and the aggregate price level is persistent. Together, the large cross-sectional dispersion and low serial correlation of household-level inflation rates mean that almost all of the variability in a household's inflation rate over time comes from variability in household-level prices relative to average prices for the same goods, not from variability in the aggregate inflation rate. We provide a characterization of the stochastic process for household inflation that can be used to calibrate models of household decisions.

We use an extended Barro-Becker model of endogenous fertility, in which parents are heterogeneous in their labor productivity, to study the efficient degree of consumption inequality in the long run. In our environment a utilitarian planner allows for consumption inequality even when labor productivity is public information. We show that adding private information does not alter this result. We also show that the informationally constrained optimal insurance contract has a resetting property—whenever a family line experiences the highest shock, the continuation utility of each child is reset to a (high) level that is independent of history. This implies that there is a non-trivial, stationary distribution over continuation utilities and there is no mass at misery. The novelty of our approach is that the no-immiseration result is achieved without requiring that the objectives of the planner and the private agents disagree. Because there is no discrepancy between planner and private agents' objectives, the policy implications for implementation of the efficient allocation differ from previous results in the literature. Two examples of these are: 1) estate taxes are positive and 2) there are positive taxes on family size.

This paper investigates whether there are simple versions of the permanent income hypothesis which are consistent with the aggregate U.S. consumption and output data. Our analysis is conducted within the confines of a simple dynamic general equilibrium model of aggregate real output, investment, hours of work and consumption. We study the quantitative importance of two perturbations to the version of our model which predicts that observed consumption follows a random walk: (i) changing the production technology specification which rationalizes the random walk result, and (ii) replacing the assumption that agents' decision intervals coincide with the data sampling interval with the assumption that agents make decisions on a continuous time basis. We find substantially less evidence against the continuous time models than against their discrete time counterparts. In fact neither of the two continuous time models can be rejected at conventional significance levels. The continuous time models outperform their discrete time counterparts primarily because they explicitly account for the fact that the data used to test the models are time averaged measures of the underlying unobserved point-in-time variables. The net result is that they are better able to accommodate the degree of serial correlation present in the first difference of observed per capita U.S. consumption.

We show that much of the recent reported decrease in interstate migration is a statistical artifact. Before 2006, the Census Bureau's imputation procedure for dealing with missing data inflated the estimated interstate migration rate. An undocumented change in the procedure corrected the problem starting in 2006, thus reducing the estimated migration rate. The change in imputation procedures explains 90 percent of the reported decrease in interstate migration between 2005 and 2006, and 42 percent of the decrease between 2000 (the recent high-water mark) and 2010. After we remove the effect of the change in procedures, we find that the annual interstate migration rate follows a smooth downward trend from 1996 to 2010. Contrary to popular belief, the 2007–2009 recession is not associated with any additional decrease in interstate migration relative to trend.

A definition of a transactions medium is proposed. This is that a transactions medium permits the attainment of otherwise unattainable resource allocations. It is shown that by this definition money can be a transactions medium in a pure exchange, overlapping generations economy. It is also shown that money is a transaction medium only if there are informational asymmetries of a particular type. Finally, it is shown that the set of economies for which money is a transactions medium is not isolated, in a well-defined sense.

The normal linear model, with sign or other linear inequality constraints on its coefficients, arises very commonly in many scientific applications. Given inequality constraints Bayesian inference is much simpler than classical inference, but standard Bayesian computational methods become impractical when the posterior probability of the inequality constraints (under a diffuse prior) is small. This paper shows how the Gibbs sampling algorithm can provide an alternative, attractive approach to inference subject to linear inequality constraints in this situation, and how the GHK probability simulator may be used to assess the posterior probability of the constraints.

The classic explanation for the persistence and volatility of real exchange rates is that they are the result of nominal shocks in an economy with sticky goods prices. A key implication of this explanation is that if goods have differing degrees of price stickiness then relatively more sticky goods tend to have relatively more persistent and volatile good-level real exchange rates. Using panel data, we find only modest support for these key implications. The predictions of the theory for persistence have some modest support: in the data, the stickier is the price of a good the more persistent is its real exchange rate, but the theory predicts much more variation in persistence than is in the data. The predictions of the theory for volatility fare less well: in the data, the stickier is the price of a good the smaller is its conditional variance while in the theory the opposite holds. We show that allowing for pricing complementarities leads to a modest improvement in the theory’s predictions for persistence but little improvement in the theory’s predictions for conditional variances.

This paper uses an estimated structural model to argue that the option to move in and out of the parental home is an important insurance channel against labor market risk for youths who do not attend college. Using data from the NLSY97, I construct a new monthly panel of parent-youth coresidence outcomes and use it to document an empirical relationship between these movements and individual labor market events. The data is then used to estimate the parameters of a dynamic game between youths and their altruistic parents, featuring coresidence, labor supply and savings decisions. Parents can provide both monetary support through explicit financial transfers, and non-monetary support in the form of shared residence. To account for the data, two types of exogenous shocks are needed. Preference shocks are found to explain most of the cross-section of living arrangements, while labor market shocks account for individual movements in and out of the parental home. I use the model to show that coresidence is a valuable form of insurance, particularly for youths from poorer families. The option to live at home also helps to explain features of aggregate data for low-skilled young workers: their low savings rates and their relatively small consumption responses to labor market shocks. An important implication is that movements in and out of home can reduce the consumption smoothing benefits of social insurance programs.

Previous literature has shown that the study and characterization of constrained efficient allocations in economies with limited enforcement is useful to understand the limited risk sharing observed in many contexts, in particular between sovereign countries. In this paper we show that these constrained efficient allocations arise as equilibria in an economy in which private agents behave competitively, taking as given a set of taxes. We then show that these taxes, which end up limiting risk sharing, arise as an equilibrium of a dynamic game between governments. Our decentralization is different from the existing ones proposed in the literature. We find it intuitively appealing and we think it goes farther than the existing literature in endogenizing the primitive forces that lead to a lack of risk sharing in equilibrium.

We construct a vintage capital model of economic growth in which the decision to replace old technologies with new ones is modeled explicitly. Depreciation in this environment is an economic, not a physical concept. We describe the balanced growth paths and the transitional dynamics of this economy. We illustrate the importance of vintage capital by analyzing the response of the economy to fiscal policies designed to stimulate investment in new technologies.

In this paper, we consider an environment in which agents’ productivities are private information, 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.

One of the long-standing issues in the literature on transfer programs for the U.S. low-income population concerns the high cumulative marginal tax rate on earnings induced by participation in the multiplicity of programs offered by the government. Empirical work on the issue has reached an impasse partly because the analytic solution to the choice problem is intractable and partly because the model requires the estimation of multiple sets of equations with limited dependent variables, an estimation problem which until recently has been computationally infeasible. In this paper we estimate a model of labor supply and multiple program participation using methods of simulation estimation that enable us to solve both problems. The results show asymmetric wage and tax rate effects, with fairly large wage elasticities of labor supply but very inelastic responses to moderate changes in cumulative marginal tax rates, implying that high welfare tax rates do not necessarily induce major reductions in work effort.

How much discretion is it optimal to give the monetary authority in setting its policy? We analyze this mechanism design question in an economy with an agreed-upon social welfare function that depends on the randomly fluctuating state of the economy. The monetary authority has private information about that state. In the model, well-designed rules trade off society’s desire to give the monetary authority flexibility to react to its private information against society’s need to guard against the standard time inconsistency problem arising from the temptation to stimulate the economy with unexpected inflation. We find that the optimal degree of monetary policy discretion is decreasing in the severity of the time inconsistency problem. As this problem becomes sufficiently severe, the optimal degree of discretion is none at all. We also find that, despite the apparent complexity of this dynamic mechanism design problem, society can implement the optimal policy simply by legislating an inflation cap that specifies the highest allowable inflation rate.

This paper examines the optimal debt contract between lenders and a sovereign borrower when the borrower is free to repudiate the debt and when his decision to invest or consume borrowed funds is unobservable. We show that recurrent debt crises are a necessary part of the incentive structure which supports the optimal pattern of lending.

We construct a sequence of pure exchange, stationary OLG economies in which generations have longer and longer life spans and all agents maximize a discounted sum of utilities with a fixed, positive, and common discount rate. Period utility functions and endowment patterns are subject to mild restrictions and within generation heterogeneity is permitted. We show that: (i) Every sequence of equilibrium interest rates converges to the discount rate. (ii) Eventually every nonmonetary steady state is optimal and a monetary steady state will never exist. (iii) For any agent consumption at any fixed age converges to permanent income evaluated using the utility discount rate.