MONETARY–FISCAL INTERACTIONS WITH A CONSERVATIVE CENTRAL BANK

We study macroeconomic stabilization when monetary and fiscal policies interact via their effects on output and inflation and the monetary authority is more conservative than the fiscal. We find that monetary–fiscal interactions result in poor macroeconomic stabilization. With both policies discretionary, the Nash equilibrium is suboptimal with higher output and lower inflation than optimal; the Nash equilibrium may be extreme with output higher and inflation lower than either authority want. Leadership equilibria are not second best. Monetary commitment is completely negated by fiscal discretion and yields the same outcome as discretionary monetary leadership for all realizations of shocks. But fiscal commitment is not similarly negated by monetary discretion. Optimal macroeconomic stabilization requires either commitment of both monetary and fiscal policies, or identical targets for both authorities – output socially optimal and inflation appropriately conservative – or complete separation of tasks.     

Optimal Loan Loss Provisions and Welfare

We study the welfare implications of optimal loan loss provisions in a New Keynesian model featuring endogenous default risk and inflationary credit spreads. A unique link between provisions, credit spreads and inflation can be employed to enhance macroeconomic stability. Optimal provisions are most effective when dealing with cost-push financial shocks inherent in volatile spreads and the zero bound problem of monetary policy. Relaxing provisioning requirements following a recessionary financial disturbance consistently achieves the first-best outcome while nullifying the value of monetary policy under commitment. In contrast, deflationary demand shocks warrant an optimal rise in provisions, which inflate prices yet mildly contract output.     

Production subsidies and redistribution

Who gains from stimulating output? We explore a dynamic model with production subsidies where the population is heterogeneous in one dimension: wealth. There are two channels through which production subsidies redistribute resources across the population. First, poorer agents gain from a rise in wages, since—to the extent there is an operative wealth effect in labor supply—they work harder. Second, because a current output boost will raise consumption today relative to the future, thus lowering real interest rates, poor agents gain in relative terms since their income is based less on interest income. We examine optimal redistribution from the perspective of an arbitrary consumer in the population. We show that, if this consumer has commitment at time zero to set all present and future subsidy rates, and for a class of preferences that admits aggregation in wealth, then output stimulation, and hence redistribution, will only occur at time zero; after that, subsidies are zero. A byproduct of our analysis of this environment is a median-voter theorem: with direct voting over subsidy sequences at time zero, the sequence preferred by the median-wealth consumer is the unique outcome. We also study lack of commitment, since interest-rate manipulation is associated with time inconsistency. We analyze this case formally by looking at the Markov-perfect (time-consistent) equilibrium in a game between successive identical decision makers (e.g., the median agent). Here, subsidies persist—they are constant over time—and are more distortionary than under commitment. Moreover, whereas under commitment asset inequality changes initially—in favor of the consumer who decides on policy—it does not under lack of commitment.     

Markov-perfect optimal taxation

In this paper we study optimal taxation in a dynamic game played by a sequence of governments and the private sector. We focus on the Markov-perfect equilibrium of this game under two different assumptions on the extent of government's intra-period commitment, which in turn define two within-period timings of actions. Our results show that the extent of government's intra-period commitment has important quantitative implications for policies, welfare, and macroeconomic variables, and consequently that it must be explicitly stated as one of the givens of the economy, alongside preferences, markets and technology. We see this as an important result, since most of the previous literature on Markovian optimal taxation has assumed, either interchangeably or unnoticeably, different degrees of government's intra-period commitment.     

Fiscal policy under loose commitment

Due to time-inconsistency or political turnover, policymakers' promises are not always fulfilled. We analyze an optimal fiscal policy problem where the plans made by the benevolent government are periodically revised. In this loose commitment setting, the properties of labor and capital income taxes are significantly different than under the full-commitment and no-commitment assumptions. Because of the occasional reoptimizations, the average capital income tax is positive even in the long-run. Also, the autocorrelation of taxes is lower, their volatility with respect to output increases and the correlation between capital income taxes and output changes sign. Our method can be used to analyze the plausibility and the importance of commitment in a wide-class of dynamic problems.     

Money and credit with limited commitment and theft

We study the interplay among imperfect memory, limited commitment, and theft, in an environment that can support monetary exchange and credit. Imperfect memory makes money useful, but it also permits theft to go undetected, and therefore provides lucrative opportunities for thieves. Limited commitment constrains credit arrangements, and the constraints tend to tighten with imperfect memory, as this mitigates punishment for bad behavior in the credit market. Theft matters for optimal monetary policy, but at the optimum theft will not be observed in the model. The Friedman rule is in general not optimal with theft, and the optimal money growth rate tends to rise as the cost of theft falls.     

For how long to tie your hands? Stable relationships in an unstable environment

The Kreps–Wilson–Milgrom–Roberts framework is one of the most renowned ways of modeling reputation-building. Once the number of repetitions of the game is considered as a choice variable, such a framework can fruitfully be employed to study the optimal length of the commitment to a relationship. We analyze a model where a principal plays with an agent a finitely repeated trust game, characterize the optimal length of the relationship between principal and agent when the principal’s preferences on the agent’s type stochastically change over time and show that a commitment to a stable relationship may be optimal (even) in very unstable environments.      

Biased procurement auctions

In a complex procurement a buyer may consider biasing the auction rules in order to account for differences in product characteristics offered by the sellers. This paper studies the gathering, disclosure and use of information about this bias. While we also describe the optimal procurement auction in our setting, the main focus of the paper is on the case where the buyer does not have commitment power. We find that without commitment full disclosure of the buyer’s preferences is optimal. Furthermore, lack of commitment distorts the buyer’s incentives to learn about its preferences: unlike the commitment case, without commitment the value of this information can be negative. Based on Chapter 3 of my Ph.D. dissertation at Stanford University. I gratefully acknowledge the support of a John M. Olin Dissertation Fellowship and a Melvin and Joan Lane Stanford Graduate Fellowship. Thanks to Pat Bajari, Tim Bresnahan, Vinicius Carrasco, George Deltas, Jonathan Levin, Paul Milgrom, Ilya Segal and an anonymous referee for valuable suggestions.     

Optimal fiscal and monetary policies in the face of rare disasters

This paper studies optimal fiscal and monetary policies in an economy exposed to large adverse shocks (rare disasters). We contrast optimal policies under commitment and discretion and identify several striking differences between these institutional environments. A government that can commit to its policy plans relies heavily on debt to smooth the adverse effects of large shocks over time. Lack of commitment seriously limits the government's ability to use debt as a shock absorber. Under discretion, an increase in debt leads to an increase in inflation expectations and therefore higher nominal interest rate distortions. Hence, the discretionary government keeps debt in close vicinity of its steady-state level, and the response of taxes, inflation, and interest rates to shocks is much more pronounced under discretion than under commitment. This is particularly relevant for large shocks and when the initial stock of government debt is already high at the time the shock occurs. We also argue that the adverse welfare effects of disasters are larger under discretion than under commitment, but these welfare differentials can be significantly reduced by making the discretionary government inflation averse.     

Access Holidays and the Timing of Infrastructure Investment

For risky infrastructure investment, 'regulatory truncation' can diminish investment incentives. We model the truncation problem, showing the link to regulatory commitment, and derive optimal state-contingent access prices. If regulators cannot commit ex ante to specific ex post access prices then a regulatory commitment to a fixed period free of access – an access holiday – can improve investment incentives. We establish conditions under which an access holiday may improve investment timing and show how an optimal holiday depends on the underlying profit flows from the investment. In particular, we show that an optimal holiday may leave investors with positive expected economic profits.     

Optimal nonlinear taxation of income and savings without commitment

When a government is unable to commit to its future tax policies, information about taxpayers' characteristics revealed by their behavior may be used to extract more taxes from them in the future. We examine the implications of this ratchet effect for the design of redistributive income and savings tax policies in a two‐period model with two types of individuals who only differ in their skill levels. When commitment is not possible, it may be optimal to separate, pool, or partially pool different types in period one. The nature of the distortions to labor supplies and savings are investigated for each of these three regimes. The identification of the optimal regime is investigated numerically.     

Optimal monetary policy in a Phillips-curve world

In this paper, we study optimal monetary policy in a model that integrates the modern theory of unemployment with a liquidity model of monetary transmission. Two policy environments are considered: period-by-period optimization (time consistency) and full commitment (Ramsey allocation). When the economy is subject to productivity shocks, the optimal policy is pro-cyclical. We also characterize the long-term properties of monetary policy and show that with commitment the optimal inflation rate is inversely related to the bargaining power of workers. Both results find empirical support in the data.     

Tariffs,Quotas, and Forward Contracts under Asymmetric Information*

We consider optimal trade policy for a large country with private information. We show that the optimal tariff leads to a signaling equilibrium with higher tariffs and lower welfare than under complete information, whereas the optimal import quota replicates the complete information equilibrium and thus is superior to the tariff. We also show that, with the tariff, the country may be better off being uninformed. Finally, we show that if the importing nation cannot commit to its tariff, the use of futures contracts together with the dynamically consistent tariff leads to the same equilibrium as under complete information with commitment.     

TIME‐INCONSISTENCY AND WELFARE PROGRAM PARTICIPATION: EVIDENCE FROM THE NLSY*

We empirically implement a dynamic structural model of labor supply and welfare program participation for agents with potentially time‐inconsistent preferences. Using panel data on the choices of single women with children from the National Longitudinal Surveys (NLSY) 1979, we provide estimates of the degree of time‐inconsistency, and of its influence on the welfare take‐up decision. With these estimates, we conduct counterfactual experiments to quantify a measure of the utility loss stemming from the inability to commit to future decisions, and the potential gains from commitment mechanisms such as welfare time limits and work requirements.     

The Timing of Environmental Policy: A Note on the Role of Product Differentiation

We examine the role that product differentiation can play in the design of environmental policy under full commitment and no commitment on the part of the environmental regulator. We consider a setting with two firms selling a differentiated product which generates pollution through emissions. Firms can reduce their emissions by undertaking abatement activities while an environmental regulator taxes emissions. The main results are: (1) When products are highly differentiated, the optimal time-consistent (no commitment) tax is always lower than the optimal pre-commitment tax. As the degree of product differentiation decreases, for relatively efficient abatement technology and high damages, the time-consistent emission tax exceeds the optimal pre-commitment one. (2) Abatement when product differentiation is extensive is higher under the time-consistent regime unless the abatement technology is extremely efficient. The same ranking applies to social welfare. However, as products become more and more similar, these results are (partially) reversed and pre-commitment could lead to both higher levels of abatement and welfare.     

Ordinary Shares and Managers

We argue that ordinary shares undermine any inherent commitment of its holders to resist renegotiating away ex post inefficiencies. Yet, in a dynamic adverse selection problem, such ex post inefficiencies are optimal from an ex ante point of view. We show that shareholders may use a manager in combination with a golden parachute (managerial severance payments) as a commitment device not to renegotiate ex post.     

Migration outflows and optimal migration policy: rules versus discretion

We study the effects of more open borders on return migration and show that migrants are more likely to return to the origin country when migration rules are softened, because this implies that they could more easily re-migrate if return migration is unsuccessful. As a result, softening migration rules leads to lower net inflows than is generally acknowledged. We show that if government follows rules to shape the optimal migration policy, it will choose more open “borders” than were its behaviour to be discretionary. However, this requires an appropriate commitment technology. We show that electoral accountability may be a solution to the commitment problem. As a matter of fact, observed softer immigration rules in western countries suggest the effectiveness of such a mechanism.     

Committees with supermajority voting yield commitment with flexibility

A fundamental problem for government is how to combine commitment to certain policies with the flexibility required to adjust them when needed. Rogoff (1985) [Rogoff, K., 1985. The optimal degree of commitment to an intermediate monetary target, Q. J. Econ. 100(4) 1169–1189] showed that a way to strike the right balance is to appoint an optimally “conservative” policy-maker. In real life, however, policy-makers also have power over decisions where optimal plans are time-consistent, so delegating to a conservative person could be undesirable. A flexible delegation device can be found in a large committee of randomly appointed members voting over policy after observing a shock. When facing dynamic inconsistency, under a single-crossing property, there exists a supermajority rule that implements the population median's optimally conservative policy-maker with certainty. Another single-crossing property guarantees that if simple majority voting is used to select the voting rule that will govern policy choice, the supermajority preferred by the median is chosen. For problems where dynamic inconsistency vanishes, the committee will choose to make decisions by simple majority, implementing median outcomes. An application to monetary policy is developed. We show that the optimal supermajority is higher when dynamic inconsistency is more severe, when preferences are more homogeneous, and when the economy is less volatile.     

Time‐consistent optimal fiscal policy*

This article studies the properties of optimal fiscal policy in a stochastic growth model when the government cannot commit itself beyond the next period's capital income tax rate. We find that the results contrast markedly with those under full commitment. First, capital income tax rates are very high (65% on average versus close to zero on average under full commitment). Second, labor income taxes are rather low on average (about 12% versus a value of around 31% under full commitment). Finally, labor income taxes are quite volatile, whereas under full commitment their standard deviation is essentially zero.     

Public debt and optimal taxes without commitment

Benhabib and Rustichini [Optimal taxes without commitment, J. Econ. Theory 77 (1997) 231-259] study the properties of optimal capital taxes in economies without commitment and no government debt. They find that capital taxes may be different from zero at steady state. This note shows that, once governments have the possibility of issuing debt and smoothing taxes over time, optimal steady state capital taxes turn out to be zero.