Research Database

Some economists argue that as long as governments can earn the market rate of return by saving abroad, standard reputation models cannot support debt. We argue that these standard reputation models are partial in the sense that actions of agents in one arena affect reputation in that arena only. We develop a general model of reputation in which if a government is viewed as untrustworthy in one relationship, this government will be viewed as untrustworthy in other relationships. We show that our general model of reputation can support large amounts of debt.

Previous studies quantifying the effects of increased taxation during the U.S. Great Depression find that its contribution is small, in accounting for both the downturn in the early 1930s and the slow recovery after 1934. This paper shows that this conclusion rests critically on the assumption that the only taxable capital income is business profits. Effects of capital taxation are much larger when taxes on property, capital stock, excess profits, undistributed profits, and dividends are included in the analysis. When fed into a general equilibrium model, the increased taxes imply significant declines in investment and equity values and nontrivial declines in gross domestic product (GDP) and hours of work. Of particular importance during the Great Depression was the dramatic rise in the effective tax rate on corporate dividends.

Matching efficiency is the productivity of the process for matching jobseekers to available jobs. Job-finding is the output; vacant jobs and active jobseekers are the inputs. Measurement of matching efficiency follows the same principles as measuring a Hicks-neutral index of productivity of production. We develop a framework for measuring matching productivity when the population of jobseekers is heterogeneous. The efficiency index for each type of jobseeker is the monthly job-finding rate for the type adjusted for the overall tightness of the labor market. We find that overall matching efficiency declined over the period, at just below its earlier downward trend. We develop a new approach to measuring matching rates that avoids counting short-duration jobs as successes. And we show that the outward shift in the Beveridge curve in the post-crisis period is the result of pre-crisis trends, not a downward shift in matching efficiency attributable to the crisis.

During the Second Industrial Revolution, 1860–1900, many new technologies, including electricity, were invented. These inventions launched a transition to a new economy, a period of about 70 years of ongoing, rapid technical change. After this revolution began, however, several decades passed before measured productivity growth increased. This delay is paradoxical from the point of view of the standard growth model. Historians hypothesize that this delay was due to the slow diffusion of new technologies among manufacturing plants together with the ongoing learning in plants after the new technologies had been adopted. The slow diffusion is thought to be due to manufacturers’ reluctance to abandon their accumulated expertise with old technologies, which were embodied in the design of existing plants. Motivated by these hypotheses, we build a quantitative model of technology diffusion which we use to study this transition to a new economy. We show that it implies both slow diffusion and a delay in growth similar to that in the data.

The direct benefits of infrastructure in developing countries can be large, but if new infrastructure induces in-migration, congestion of other local publicly provided goods may offset the direct benefits. Using the example of rural household electrification in South Africa, we demonstrate the importance of accounting for migration when evaluating welfare gains of spatial programs. We also provide a practical approach to computing welfare gains that does not rely on land prices. We develop a location choice model that incorporates missing land markets and allows for congestion in local land. Using this model, we construct welfare bounds as a function of the income and population effects of the new electricity infrastructure. A novel prediction from the model is that migration elasticities and congestion effects are especially large when land markets are missing. We empirically estimate these welfare bounds for rural electrification in South Africa, and show that congestion externalities from program-induced migration reduced local welfare gains by about 40%.

A method is presented for solving a certain class of hierarchical rational expectations models, principally models that arise from Stackelberg dynamic games. The method allows for numerical solution using spectral factorization algorithms, and estimation of these models using standard maximum likelihood techniques.

The Boston mechanism is a school allocation procedure that is widely used around the world. To resolve overdemands, priority is often given to families who live in the neighborhood school. We note that such priorities define some schools as being safer. We exploit an unexpected change in the definition of neighborhood in Barcelona to show that when allowing school choice under the BM with priorities: (1) the resulting allocation is not very different from a neighborhood-based assignment, and (2) important inequalities emerge beyond parents’ naivete found in the literature.

We characterize equilibria of general equilibrium models with externalities and taxes as solutions to optimization problems. This characterization is similar to Negishi’s characterization of equilibria of economies without externalities or taxes as solutions to social planning problems. It is often useful for computing equilibria or deriving their properties. Frequently, however, finding the optimization problem that a particular equilibrium solves is difficult. This is especially true in economies with multiple equilibria. In a dynamic economy with externalities or taxes there may be a robust continuum of equilibria even if there is a representative consumer. This indeterminacy of equilibria is closely related to that in overlapping generations economies.

This paper investigates the impact on aggregate variables of changes in government consumption in the context of a stochastic, neoclassical growth model. We show, theoretically, that the impact on output and employment of a persistent change in government consumption exceeds that of temporary change. We also show that, in principle, there can be an analog to the Keynesian multiplier in the neoclassical growth model. Finally, in an empirically plausible version of the model, we show that the interest rate impact of a persistent government consumption shock exceeds that of a temporary one. Our results provide counterexamples to existing claims in the literature.

We consider the large class of dynamic games in which each player's actions are unobservable to the other players, and each player's actions can influence a state variable that is unobservable to the other players. We develop an algorithm that solves for the subset of sequential equilibria in which equilibrium strategies are Markov in the privately observed state.

We develop a theory of general equilibrium with endogenous debt limits in the form of individual rationality constraints similar to those in the dynamic consistency literature. If an agent defaults on a contract, he can be excluded from future contingent claims markets trading and can have his assets seized. He cannot be excluded from spot markets trading, however, and he has some private endowments that cannot be seized. All information is publicly held and common knowledge, and there is a complete set of contingent claims markets. Since there is complete information, an agent cannot enter into a contract in which he would have an incentive to default in some state. In general there is only partial insurance: variations in consumption may be imperfectly correlated across agents; interest rates may be lower than they would be without constraints; and equilibria may be Pareto ranked.

In this article we use the techniques developed in examining optimal contracting with imperfect information to build a simple equilibrium model of a labor market with imperfect information. We then use the model to examine the effects that imperfect information imposes on labor markets, particularly when compared with full information and noncontractual base lines. We demonstrate that quits increase in periods of high output, without postulating exogenous price rigidity.

The United States is indisputably undergoing a financial crisis and is perhaps headed for a deep recession. Here we examine three claims about the way the financial crisis is affecting the economy as a whole and argue that all three claims are myths. We also present three underappreciated facts about how the financial system intermediates funds between households and corporate businesses. Conventional analyses of the financial crisis focus on interest rate spreads. We argue that such analyses may lead to mistaken inferences about the real costs of borrowing and argue that, during financial crises, variations in the levels of nominal interest rates might lead to better inferences about variations in the real costs of borrowing. Moreover, we argue that even if current increase in spreads indicate increases in the riskiness of the underlying projects, by itself, this increase does not necessarily indicate the need for massive government intervention. We call for policymakers to articulate the precise nature of the market failure they see, to present hard evidence that differentiates their view of the data from other views which would not require such intervention, and to share with the public the logic and evidence that burnishes the case that the particular intervention they are advocating will fix this market failure.

Innovative activities have public good characteristics in the sense that the cost of producing the innovation is high compared to the cost of producing subsequent units. Moreover, knowledge of how to produce subsequent units is widely known once the innovation has occurred and is, therefore, non-rivalrous. The main question of this paper is whether mechanisms can be found which exploit market information to provide appropriate incentives for innovation. The ability of the mechanism designer to exploit such information depends crucially on the ability of the innovator to manipulate market signals. We show that if the innovator cannot manipulate market signals, then the efficient levels of innovation can be implemented without deadweight losses–for example, by using appropriately designed prizes. If the innovator can use bribes, buybacks, or other ways of manipulating market signals, patents are necessary.

Forecasts are routinely revised, and these revisions are often the subject of informal analysis and discussion. This paper argues (1) that forecast revisions are analyzed because they help forecasters and forecast users to evaluate forecasts and forecasting procedures, and (2) that these analyses can be sharpened by using the forecasting model to systematically express its forecast revision as the sum of components identified with specific subsets of new information, such as data revisions and forecast errors. An algorithm for this purpose is explained and illustrated.

American consumer bankruptcy provides for a Fresh Start through the discharge of a household’s debt. Until recently, many European countries specified a No Fresh Start policy of life-long liability for debt. The trade-off between these two policies is that while Fresh Start provides insurance across states, it drives up interest rates and thereby makes life-cycle smoothing more difficult. This paper quantitatively compares these bankruptcy rules using a life-cycle model with incomplete markets calibrated to the U.S. and Germany. A key innovation is that households face idiosyncratic uncertainty about their net asset holdings (expense shocks) and labor income. We find that expense uncertainty plays a key role in evaluating consumer bankruptcy laws.

This paper undertakes a simple general equilibrium analysis of the consequences of deposit insurance programs, the way in which they are priced and the way in which they fund revenue shortfalls. We show that the central issue is how the government will make up any FDIC losses. Under one scheme for making up the losses, we show that FDIC policy is irrelevant: it does not matter what premium is charged, nor does it matter how big FDIC losses are. Under another scheme, all that matters is the magnitude of the losses. And there is no presumption that small losses are “good.” We also show that multiple equilibria can be observed and Pareto ranked. Some economies may be “trapped” in equilibria with inefficient financial systems. Our analysis provides counterexamples to the following propositions. (1) Actuarially fair pricing of deposit insurance is always desirable. (2) Implicit FDIC subsidization of banks through deposit insurance is always undesirable. (3) “Large” FDIC losses are necessarily symptomatic of a poorly designed deposit insurance system.

This paper examines the validity of one very special version of Coase's Theorem. The version we examine is that in any economy in which the property rights are fully allocated, competition will lead to efficient allocations. One repercussion of this result is that one way to "solve" the public goods problem would be to allocate property rights fully, transforming the economy to a private goods one and let markets do their work. This is particularly appealing due to its decentralized nature, but one must question the claim that the market will lead to efficient outcomes in this case. That is, the privatized economy created above is of a very special type which, as it turns out is highly susceptible to strategic behavior. We show that the "mechanism" suggested above is not likely to work well in economies with either pure public goods or "global" externalities. Basically, the free-rider problem manifests itself as one of monopoly power in this private goods setting. On the other hand, if the public goods or externalities are "local" in nature, there is reason to hope that this (and perhaps other) mechanism(s) will work well. The work is related to the recent literature on the foundations of Walrasian Equilibrium in that it points up a relationship between the appropriateness of Walrasian equilibrium as a solution concept, the incentives for strategic play, the aggregate level of complementarities in the economy and the problem of coordinating economic activity.

This paper describes how long-run growth emerges in four closely related models that combine individual discovery with some form of social learning. In a large economy, there is a continuum of long-run growth rates and associated stationary distributions when it is possible to learn from individuals in the right tail of the productivity distribution. What happens in the long run depends on initial conditions. Two distinct literatures, one on reaction-diffusion equations, and another on quasi-stationary distributions suggest a unique long-run outcome when the initial productivity distribution has bounded support.

In this paper we describe how to optimally design a disability insurance system. The key friction in the model is imperfectly observable disability. We solve a dynamic mechanism design problem and provide a theoretical and numerical characterization of the social optimum. We then propose a simple tax system that implements an optimal allocation as a competitive equilibrium. The tax system that we propose includes only taxes and transfers that are similar to those already present in the U.S. tax code: a savings tax and an asset-tested transfer program. Using a numerical simulation, we compare our optimal disability system to the current disability system. Our results suggest a significant welfare gain from switching to an optimal system.

This paper investigates the role of aggregate shocks on household consumption and labor supply. It posits, estimates and tests a model where the equilibrium behavior of agents sometimes leads them to locate on the boundary of their respective choices sets. The framework is rich enough to nest much previous empirical work on life cycle labor supply and consumption based asset pricing. It also yields a structural interpretation of wage regressions on unemployment. An important feature of our model is that markets are complete. Consequently, aggregate shocks only enter through two price sequences, namely real wages, and a sequence comprising weighted prices for future contingent consumption claims which are ultimately realized. We examine the properties of this latter sequence, whose elements may be represented as mappings from real wages and aggregate dividends.

Our empirical findings may be grouped into three. First, aggregate shocks play a significant role in determining the choices people make. Second, we reject for males some of the restrictions implicit in structural interpretations of wage unemployment regressions. Moreover when these restrictions are imposed, we find wages are countercyclical, but cannot reject the null hypothesis of no effect. Third, the null hypothesis that markets are complete is not invariably rejected. However, the orthogonality conditions associated with the asset pricing equation are rejected, even though our specification of preferences incorporates types of heterogeneity which violate the necessary conditions for aggregating to a representative agent formulation. Finally, we reject the cross-equation restrictions between the labor supply of spouses implied by equilibrium behavior.

We use a massive, matched employer-employee database for the United States to analyze the contribution of firms to the rise in earnings inequality from 1978 to 2013. We find that one-third of the rise in the variance of (log) earnings occurred within firms, whereas two-thirds of the rise occurred between firms. However, this rising between-firm variance is not accounted for by the firms themselves: the firm-related rise in the variance can be decomposed into two roughly equally important forces—a rise in the sorting of high-wage workers to high-wage firms and a rise in the segregation of similar workers between firms. In contrast, we do not find a rise in the variance of firm-specific pay once we control for worker composition. Instead, we see a substantial rise in dispersion of person-specific pay, accounting for 68% of rising inequality, potentially due to rising returns to skill. The rise in between-firm variance, mostly due to worker sorting and segregation, accounted for a particularly large share of the total increase in inequality in smaller and medium firms (explaining 84% for firms with fewer than 10,000 employees). In contrast, in the very largest firms with 10,000+ employees, 42% of the increase in the variance of earnings took place within firms, driven by both declines in earnings for employees below the median and a substantial rise in earnings for the 10% best-paid employees. However, because of their small number, the contribution of the very top 50 or so earners at large firms to the overall increase in within-firm earnings inequality is small.

Expensed investments are expenditures financed by the owners of capital that increase future profits but, by national accounting rules, are treated as an operating expense rather than as a capital expenditure. Sweat investment is financed by worker-owners who allocate time to their business and receive compensation at less than their market rate. Such investments are made with the expectation of realizing capital gains when the business goes public or is sold. But these investments are not included in GDP. Taking into account hours spent building equity while ignoring the output introduces an error in measured productivity and distorts the picture of what is happening in the economy. In this paper, we incorporate expensed and sweat equity in an otherwise standard business cycle model. We use the model to analyze productivity in the United States during the 1990s boom. We find that expensed plus sweat investment was large during this period and critical for understanding the dramatic rise in hours and the modest growth in measured productivity.

This paper presents a monetarist model of the business cycle with price-setting firms. The model is estimated, and the point estimates used in simulations to illustrate the properties of the model. The real goods market is found to be stable, although subject to sharp changes in output. This model is consistent with rational expectations. Nevertheless, monetary policy can have a lasting impact, and the simulations show this to be the case. Fiscal policy too is found to influence the business cycle, but its short-run effects are substantially smaller than its impact effects. The possibility of an activist government policy in this model does not imply the efficiency of an activist policy.

We compare the statistical properties of prices of U.S. treasury bills to those generated by a theoretical dynamic exchange economy with complete markets. We show that the model can account for neither the sign nor the magnitude of average risk premiums in forward prices and holding-period returns. The economy is also incapable of generating enough variation in risk premiums to account for rejections of the expectations hypothesis with treasury bill data. These conclusions add to the growing list of empirical deficiencies of the representative agent model of asset pricing.

During the past two decades, households experienced increases in their average wages and expenditures alongside with divergent trends in their wages, expenditures, and time allocation. We develop a model with incomplete asset markets and household heterogeneity in market and home technologies and preferences to account for these labor market trends and assess their welfare consequences. Using micro data on expenditures and time use, we identify the sources of heterogeneity across households, document how these sources have changed over time, and perform counterfactual analyses. Given the observed increase in leisure expenditures relative to leisure time and the complementarity of these inputs in leisure technology, we infer a significant increase in the average productivity of time spent on leisure. The increasing productivity of leisure time generates significant welfare gains for the average household and moderates negative welfare effects from the rising dispersion of expenditures and time allocation across households.

Official statistics display a significant slowdown in U.S. aggregate productivity growth that begins in 2004. We show how offshore profit shifting by U.S. multinational enterprises affects GDP and, thus, productivity measurement. Under international statistical guidelines, profit shifting causes part of U.S. production generated by multinationals to be excluded from official measures of U.S. production. Profit shifting has increased significantly since the mid-1990s, resulting in lower measures of U.S. aggregate productivity growth. We construct an alternative measure of value added that adjusts for profit shifting. The adjustments raise aggregate productivity growth rates by 0.09 percent annually for 1994-2004, 0.24 percent annually for 2004-2008, and lowers annual aggregate productivity growth rates by 0.09 percent after 2008. Our adjustments mitigate, but do not eliminate, the measured productivity slowdown. The adjustments are especially large in R&D-intensive industries, which most likely produce intangible assets that facilitate profit shifting. The adjustments boost value added in these industries by as much as 8 percent in the mid-2000s.