MARKET‐BASED INCENTIVES

In this article, we study market‐induced, external incentives similar to career concerns jointly with standard, contractual incentives linking compensation to performance. We consider a dynamic principal–agent problem in which the agent's outside option is determined endogenously in a competitive labor market. In equilibrium, strong performance increases the agent's market value. When this value becomes sufficiently high, the threat of the agent quitting forces the principal to increase the agent's compensation. The prospect of obtaining this raise gives the agent an incentive to exert effort, which reduces the need for standard incentives. In fact, whenever the agent's option to quit is sufficiently close to being “in the money,” the market‐induced incentive eliminates the need for standard incentives altogether: Compensation becomes completely insensitive to current performance.     

The effects of monetary policy in the Czech Republic: an empirical study

In this paper, we examine the effects of Czech monetary policy on the economy within the vector auto regression (VAR), structural VAR, Bayesian VAR with sign restrictions, and factor-augmented VAR, frameworks. We document a well-functioning transmission mechanism similar to the euro area countries, especially in terms of persistence of monetary policy shocks. Subject to various sensitivity tests, we find that a contractionary monetary policy shock has a negative effect on the degree of economic activity and the price level, both with a peak response after one year or so. Regarding prices at the sectoral level, tradables adjust faster than non-tradables, which is in line with microeconomic evidence on price stickiness. There is no price puzzle, as our data come from a single monetary policy regime. There is a rationale in using the real-time output gap instead of current GDP growth, as using the former results in much more precise estimates. The results indicate a rather persistent appreciation of the domestic currency after a monetary tightening, with a gradual depreciation afterwards.     

Allen and Gale on risk-taking and competition in banking

Using an elegant simple model, Allen and Gale [Comparing Financial Systems, MIT Press, 2001] obtain a result with significant policy implications: portfolio risk of banks increases as competition in banking, measured by the number of banks, increases. That result is, however, lacking in robustness. If banks play a game not all that different from that assumed by Allen and Gale, then, we show, a markedly different result obtains: risk-taking by banks is independent of the number of banks.     

Panel Data Evidence on the Effects of Fiscal Policy Shocks in the EU New Member States

We identify fiscal policy shocks in the EU new member states using four different methods. We use panel data techniques to estimate the output response to these shocks. We find that investment and export growth increase after fiscal consolidation and decelerate after fiscal stimulus when the shocks are expenditure‐based. In contrast, private consumption does not respond to fiscal policy shocks. Expenditure‐based fiscal consolidations reduce wages, supporting the view that fiscal consolidation of such composition enhances the competitiveness and profitability of domestic enterprises. In contrast, we do not find evidence of fiscal shocks affecting households' confidence.     

Nonseparable preferences and optimal social security systems

In this paper, we consider economies in which agents are privately informed about their skills, which evolve stochastically over time. We require agents' preferences to be weakly separable between the lifetime paths of consumption and labor. However, we allow for intertemporal nonseparabilities in preferences like habit formation. In this environment, we derive a generalized version of the Inverse Euler Equation and use it to show that intertemporal wedges characterizing optimal allocations of consumption can be strictly negative. We also show that preference nonseparabilities imply that optimal differentiable asset income taxes are necessarily retrospective in nature. We show that under weak conditions, it is possible to implement a socially optimal allocation using a social security system in which taxes on wealth are linear, and taxes/transfers are history-dependent only at retirement. The average asset income tax in this system is zero.     

Risky human capital and deferred capital income taxation

We study the structure of optimal wedges and capital taxes in a dynamic Mirrlees economy with endogenous distribution of skills. Human capital is a private, stochastic state variable that drives the skill process of each individual. Building on the findings of the labor literature, we construct a tractable life-cycle model of human capital evolution with risky investment and stochastic depreciation. In this setting, we demonstrate the optimality of (a) a human capital premium, i.e., an excess return on human capital relative to physical capital, (b) a large intertemporal wedge early in the life-cycle, and (c) a non-zero intratemporal wedge even at the top of the skill distribution at all dates except the last date in the life-cycle. The main implication for the structure of optimal linear capital taxes is the necessity of deferred taxation of physical capital. The average marginal tax rate on physical capital held in every period is zero in present value. However, expected capital tax payments do not equal zero in every period. Necessarily, agents face negative expected capital tax payments early in the life-cycle and positive expected capital tax payments late in the life-cycle.     

Optimal risk sharing and borrowing constraints in a continuous-time model with limited commitment

We study a continuous-time version of the optimal risk-sharing problem with one-sided commitment. In the optimal contract, the agent?s consumption is a time-invariant, strictly increasing function of a single state variable: the maximal level of the agent?s income realized to date. We characterize this function in terms of the agent?s outside option value function and the discounted amount of time in which the agent?s income process is expected to reach a new to-date maximum. Under constant relative risk aversion we solve the model in closed-form: optimal consumption of the agent equals a constant fraction of his maximal income realized to date. In the complete-markets implementation of the optimal contract, the Alvarez–Jermann solvency constraints take the form of a simple borrowing constraint familiar from the Bewley–Aiyagari incomplete-markets models.     

Optimal personal bankruptcy design under moral hazard

In this paper, we develop a normative theory of unsecured consumer credit and personal bankruptcy based on the optimal trade-off between incentives and insurance. First, in order to characterize this trade-off, we solve a dynamic moral hazard problem in which agents' private effort decisions influence the life-cycle profiles of their earnings. We then show how the optimal allocation of individual effort and consumption can be implemented in a market equilibrium in which (i) agents and intermediaries repeatedly trade secured and unsecured debt instruments, and (ii) agents obtain (restricted) discharge of their unsecured debts in bankruptcy. The structure of this equilibrium and the associated restrictions on debt discharge closely match the main qualitative features of personal credit markets and bankruptcy law that actually exist in the United States.