Research Database

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 analyze a general equilibrium model with search frictions and differentiated commodities. Because of the many differentiated commodities, barter is difficult because it requires a double coincidence of wants, and this provides a medium of exchange role for fiat money. We prove the existence of equilibrium with valued fiat money and show it is robust to certain changes in the environment, including imposing transactions costs, storage costs, and taxes on the use of money. Rate of return dominance, liquidity, and the potential welfare improving role of fiat money are discussed.

During the period 1870–1913, Canada had a well-diversified branch banking system while banks in the U.S. unit banking system were less diversified. Canadian banks could issue large-denomination notes with no restrictions on their backing, while all U.S. currency was essentially an obligation of the U.S. government. Also, experience in the two countries with regard to bank failures and banking panics was quite different. A general equilibrium business cycle model with endogenous financial intermediation is constructed that captures these historical Canadian and American monetary and banking arrangements as special cases. The predictions of the model contradict conventional wisdom with regard to the cyclical effects of banking panics. Support for these predictions is found in aggregate annual time series data for Canada and the United States.

We examine the limiting behavior of cooperative and noncooperative fiscal policies as countries’ market power goes to zero. We show that these policies converge if countries raise revenues through lump-sum taxation. However, if there are unremovable domestic distortions, such as distorting taxes, there can be gains to coordination even when a single country’s policy cannot affect world prices. These results differ from the received wisdom in the optimal tariff literature. The key distinction is that, unlike in the tariff literature, the spending decisions of governments are explicitly modeled.

Using a simple model, we show why previous empirical studies of budget policy effects are flawed. Due to an identification problem, those studies’ findings can be shown to be consistent with either policies mattering or not.

This paper presents a simple general equilibrium model of optimal taxation similar to that of Lucas and Stokey (1983), except that we let the government default on its debt. As a benchmark, we consider Ramsey equilibria in which the government can precommit its policies at the beginning of time. We then consider sustainable equilibria in which both government and private agent decision rules are required to be sequentially rational. We concentrate on trigger mechanisms which specify reversion to the finite horizon equilibrium after deviations by the government. The main result is that no Ramsey equilibrium with positive debt can be supported by such trigger mechanisms.

We propose a definition of involuntary unemployment which differs from that traditionally used in implicit labor contract theory. We say that a worker is involuntarily unemployed if the marginal wage implied by the optimal contract exceeds the marginal rate of substitution between leisure and consumption. We construct a model where risk-neutral firms have monopoly power and show that such monopoly power is necessary for involuntary unemployment to arise in the optimal contract. We numerically compute examples and show that such unemployment occurs for a wide range of parameter values.

This paper presents a simple general equilibrium model of optimal taxation in which both private agents and the government can default on their debt. As a benchmark we consider Ramsey equilibria in which the government can precommit to its policies at the beginning of time, but in which private agents can default. We then consider sustainable equilibria in which both government and private agent decision rules are required to be sequentially rational. We completely characterize the set of sustainable equilibria. In particular, we show that when there is sufficiently little discounting and government consumption fluctuates enough, the Ramsey allocations and policies (in which the government never defaults) can be supported by a sustainable equilibrium.

Recent advances in duality theory have made it easier to discover relationships between asset prices and the portfolio choices based on them. But this approach to arbitrage-free securities markets has yet to be extended and applied to economies with transactions costs. This paper does so, within the context of a general state-preference model of securities markets. Several applications are developed to illustrate the nature of the theory and its potential to resolve a host of issues surrounding the effects of transactions costs on securities markets.

Optimal linear regulator methods are used to represent a class of models of endogenous equilibrium seasonality that has so far received little attention. Seasonal structure is built into these models in either of two equivalent ways: periodically varying the coefficient matrices of a formerly nonseasonal problem or embedding this periodic-coefficient problem in a higher-dimensional sparse system whose time-invariant matrices have a special pattern of zero blocks. The former structure is compact and convenient computationally; the latter can be used to apply familiar convergence results from the theory of time-invariant optimal regulator problems. The new class of seasonality models provides an equilibrium interpretation for empirical work involving periodically stationary time series.