lessons from the tequila crisis abstract this paper draws several important lessons from the tequila crisis of 1994 and 1995 the overriding lesson is that the dynamics of financial crises in emerging market countries differ from those in industrialized countries because institutional features of their debt markets differ several policy lessons for emerging market countries also emerge from the analysis 1 pegged exchange rate regimes are extremely dangerous 2 strong prudential supervision of the banking system is critical for prevention of financial crises 3 financial liberalization must be managed extremely carefully and 4 different policies are needed to promote recovery in emerging market countries than those that are applicable to industrialized countries

time consistent public policy in this paper we study how a benevolent government that cannot commit to future policy should trade off the costs and benefits of public expenditure we characterize and solve for markov perfect equilibria of the dynamic game between successive governments the characterization consists of an inter temporal first order condition a generalized euler equation for the government and we use it both to gain insight into the nature of the equilibrium and as a basis for computations for a calibrated economy we find that when the only tax base available to the government is capital income an inelastic source of funds at any point in time the government still refrains from taxing at confiscatory rates we also find that when the only tax base is labour income the markov equilibrium features less public expenditure and lower tax rates than the ramsey equilibrium

nonmonetary effects of the financial crisis in propagation of the great depression this paper examines the effects of the financial crisis of the 1930s onthe path of aggregate output during that period our approach is complementary to that of friedman and schwartz who emphasized the monetary impact of the bank failures we focus on non monetary primarily credit related aspects of the financial sector output link and consider the problems of debtors as well as those of the banking system we argue that the financial disruptions of 1930 33 reduced the efficiency of the credit allocation process and that the resulting higher cost and reduced availability of credit acted to depress aggregate demand evidence suggests that effects of this type can help explain the unusual length and depth of the great depression this abstract was borrowed from another version of this item

the economics of exchange rate regimes a review essay the exchange rate regime issue has taken centre stage in discussions of international economic policy much of the profession appears to have been converted to the hypothesis of the vanishing middle regime for countries well integrated into world capital markets there is little if any middle ground between floating exchange rates and monetary unification this paper considers the exchange rate regime issue in the context of recent books on the subject by w max corden and morris goldstein both authors prescribe managed floating exchange rates supplemented with inflation targeting for emerging market economies under managed floating and with a credible monetary policy the public finances in order and strengthened debt management and prudential regulation the exchange rate is free to act as a market gauge for assessing policies and as a mode of conflict resolution both authors also argue however that no exchange rate regime is a holy grail ultimately a credible exchange rate regime depends upon the trust evoked by governments there is no exchange rate regime whether of the managed floating or hard fix variety that can eradicate a history of failed stabilisation attempts

robust policymaking in the face of sudden stops abstract this paper considers tax policies to deal with sudden stops declines in aggregate activity that are magnified by a binding collateral constraint that occasionally occur in emerging market economies households and or the government are assumed to face model uncertainty and desire robustness against alternative models welfare gains from optimal taxation are small if the government trusts its model of household expectations whether those expectations are altered by model uncertainty or not in contrast welfare losses are large if the government is uncertain about the household s probability model

the swedish banking crisis roots and consequences the article analyses the swedish banking crisis in the early 1990s newly deregulated credit markets after 1985 stimulated a competitive process between financial institutions where expansion was given priority combined with an expansive macro policy this contributed to an asset price boom the subsequent crisis resulted from a highly leveraged private sector being simultaneously hit by three major exogenous events a shift in monetary policy with an increase in pre tax interest rates a tax reform that increased after tax interest rates and the erm crisis combined with some overinvestment in commercial property high real interest rates contributed to breaking the boom in real estate prices and triggering a downward price spiral resulting in bankruptcies and massive credit losses the government rescued the banking system by issuing a general guarantee of bank obligations the total direct cost to the taxpayer of the salvage has been estimated at around 2 per cent of gdp copyright 1999 by oxford university press

a closed form solution for a model of precautionary saving this paper analyses life cycle consumption plans and distinguishes between temporal risk aversion and intertemporal substitution the results assume that felicity functions are quadratic and that income follows a linear model with normally distributed errors stochastic dynamic programming then yields closed loop linear decision rules certainty equivalence no longer holds but instead households play a min max strategy against nature one finds a rationale for precautionary saving and a larger sensitivity of changes in consumption to income innovations

choosing an exchange rate system abstract the focus of academic discussions of exchange rate policy has shifted in recent years the new literature on exchange rate regime choice emphasizes considerations relating to the problems of credibility in exchange rate targeting and the connections between exchange rate regime choices and choices of monetary and fiscal policy arguments for exchange rate targeting are reviewed under most circumstances and for most countries a system of freely floating exchange rates is likely to be a better choice than attempting to peg the exchange rate

the mirage of fixed exchange rates this paper discusses the profound difficulties of maintaining fixed exchange rates in a world of expanding global capital markets contrary to popular wisdom industrialized country monetary authorities easily have the resources to defend exchange parities against virtually any private speculative attack but if their commitment to use those resources lacks credibility with markets the costs to the broader economy of defending an exchange rate peg can be very high the dynamic interplay between credibility and commitment is illustrated by the 1992 swedish and british crises and the 1994 95 mexican collapse we also discuss the small number of successful fixers

optimal fiscal policy with robust control abstract this paper analyzes how consumer uncertainty affects optimal fiscal policy in the lucas and stokey 1983 framework the consumers lacking confidence in their knowledge of the stochastic environment endogenously tilt their subjective probability model away from an approximating probability model the government though is confident that the approximating probability model characterizes the stochastic environment this confidence dichotomy reveals a range of possible objective functions for an altruistic government i assume that the government maximizes the consumers expected utility under the consumers own subjective probability model it is found that this government relies less heavily on labor taxes to absorb the fiscal shock than would be optimal if consumers were fully confident in their probability model this policy helps mitigate the direct welfare cost associated with consumer uncertainty i compare this policy to the one implemented by a government that maximizes the consumers expected utility under the approximating probability model

robustness information processing constraints and the current account in small open economies article i nfo in this paper we examine the effects of two types of induced uncertainty model uncertainty due to robust ness rb and state uncertainty due to finite information processing capacity called rational inattention or ri on consumption and the current account we show that the combination of rb and ri improves the model s predictions for i the contemporaneous correlation between the current account and income and ii the volatility and persistence of the current account in small open emerging and developed economies in addition we show that the two informational frictions improve the model s ability to match the impulse response of consumption to income and the relative volatility of consumption to income growth

time consistent redistribution if the government cares more about workers than about capitalists and taxes capital income to finance redistribution to workers how are inequality and capital accumulation affected in the long run assuming that the government cannot commit to future taxes a time consistent equilibrium a differentiable subgame perfect markov equilibrium is characterized in this equilibrium the current government in part uses the tax via capital accumulation to manipulate future governments into setting lower taxes the equilibrium has substantially lower taxes on capital income than 100 even though workers do not save and even though the weight on capitalists in government utility is negligible

solving the incomplete markets model with aggregate uncertainty using the krusell smith algorithm and non stochastic simulations abstract this article describes the approach to computing the version of the stochastic growth model with idiosyncratic and aggregate risk that relies on collapsing the aggregate state space down to a small number of moments used to forecast future prices one innovation relative to most of the literature is the use of a non stochastic simulation routine

does society benefit from investor overconfidence in the ability of financial market experts abstract this paper develops a securities market model in which participants beliefs diverge and prices are monotonic in beliefs relative to rational expectations i e correct and unanimous beliefs overconfidence among uninformed traders about the precision of experts information leads to pareto superior equilibria efficiency enhancing departures from rational expectations occur over a dense subset of parameter space but only for one configuration of beliefs uninformed traders must be more confident than informed experts overconfidence in the form of excessive trust in the predictive ability of experts sets off a virtuous cycle of increased trading that improves liquidity and reduces transaction costs for everyone

financial intermediation and delegated monitoring this paper develops a theory of financial intermediation based on minimizing the cost of monitoring information which is useful for resolving incentive problems between borrowers and lenders it presents a characterization of the costs of providing incentives for delegated monitoring by a financial intermediary diversification within an intermediary serves to reduce these costs even in a risk neutral economy the paper presents some more general analysis of the effect of diversification on resolving incentive problems in the environment assumed in the model debt contracts with costly bankruptcy are shown to be optimal the analysis has implications for the portfolio structure and capital structure of intermediaries

growth in the shadow of expropriation we propose a tractable variant of the open economy neoclassical growth model that emphasizes political economy and contracting frictions the political economy frictions involve a preference for immediate spending while the contracting friction is a lack of commitment regarding foreign debt and expropriation we show that the political economy frictions slow an economy s convergence to the steady state due to the endogenous evolution of capital taxation the model rationalizes why openness has different implications for growth depending on the political environment why institutions such as the treatment of capital income evolve over time why governments in countries that grow rapidly accumulate net foreign assets rather than liabilities and why foreign aid may not affect growth

satisficing and prior free optimality in price competition i introduction the rational choice approach to market interaction investigates price competition maintaining commonly known unbounded rationality of sellers undoubtedly to explain how the reasoning of competing sellers can result in a mutually optimal constellation of sales strategies via solving a fixed point problem is an interesting and inspiring intellectual exercise however this exercise needs to be supplemented with studies that do not provide only as if explanations but try to more realistically capture how sellers may mentally represent sales competition and generate sales choices based on such mental representation drawing on simon s 1947 1955 work see also selten 1998 which partly relies on sauermann and selten 1962 this paper models sellers behavior using a bounded rationality approach based on aspiration levels profit maximizing is replaced by the goal of making satisfactory profits sellers have aspiration levels concerning their profits and search for sales policies that guarantee these aspirations 1 because of the interdependence of sellers it is reasonable to suppose that the profits a seller aims to achieve or his profit aspirations depend on what he expects from the others accordingly the present analysis assumes that aspiration levels capture a seller s uncertainty about the others behavior the way in which this uncertainty is dealt with represents a key distinguishing feature of the model outlined here 2 while the standard game theoretical approach to market interaction suggests that sellers share a common and correct conjecture about the others actions we allow sellers to entertain multiple conjectures 3 previous theoretical studies motivate why this assumption may be taken as valid in particular the so called multiple prior models proposed by gilboa and schmeidler 1989 and bewley 2002 for one person decision problems generalize expected utility theory by assuming that the decision maker has a set of priors rather than a single one the premise of these models is that the bayesian tenet according to which any uncertainty can and should be summarized by a single probability measure is too strong and represents an inaccurate description of people s behavior 4 applied to our context this means that asking sellers to hold a unique conjecture about the price charged by the others may be unrealistic the theories of decision making without a precise prior allow a representation of beliefs by a set of probabilities rather than by a single probability but they still operate in an expected utility framework 5 as opposed to these theories we assume true uncertainty in a knightian sense no probability distribution is assigned to events knight 1985 the intuition behind this assumption is that even if boundedly rational people may not want to exclude the possibility that an event occurs they may still be unable to specify how likely the event is to emphasize that the approach we adopt is non probabilistic we prefer the word conjecture to expectation or belief we do not preclude the possibility that the set valued conjecture contains only one element we simply claim that if the set is not a singleton then no probabilities need to be attached to its various elements thus we regard the conjecture as prior free the main contribution of the present paper is to propose a theory that allows satisficing sellers to make optimal decisions without being equipped with any prior specifically we consider an oligopoly where each seller chooses a unique price level and forms a set valued prior free conjecture about the average price charged by the remaining sellers we do not model the process by which the conjecture is formed rather we assume that the set valued conjecture is idiosyncratically generated by each of the competing sellers who furthermore form a profit aspiration for each element of the conjecture

robustly optimal monetary policy in a microfounded new keynesian model we consider optimal monetary stabilization policy in a new keynesian model with explicit microfoundations when the central bank recognizes that private sector expectations need not be precisely model consistent and wishes to choose a policy that will be as good as possible in the case of any beliefs close enough to model consistency we show how to characterize robustly optimal policy without restricting consideration a priori to a particular parametric family of candidate policy rules we show that robustly optimal policy can be implemented through commitment to a target criterion involving only the paths of inflation and a suitably defined output gap but that a concern for robustness requires greater resistance to surprise increases in inflation than would be considered optimal if one could count on the private sector to have rational expectations

financial development and the instability of open economies this paper introduces a framework for analyzing the role of financial factors as a source of instability in small open economies our basic model is a dynamic open economy model with a tradeable good produced with capital and a country specific factor we also assume that firms face credit constraints with the constraint being tighter at a lower level of financial development a basic implication of this model is that economies at an intermediate level of financial development are more unstable than either very developed or very underdeveloped economies this is true both in the sense that temporary shocks have large and persistent effects and also in the sense that these economies can exhibit cycles thus countries that are going through a phase of financial development may become more unstable in the short run similarly full capital account liberalization may destabilize the economy in economies at an intermediate level of financial development phases of growth with capital inflows are followed by collapse with capital outflows on the other hand foreign direct investment does not destabilize

equilibrium in a production economy with an income tax this paper develops a method to study an infinite horizon production economy distorted by a state dependent income tax this setting permits taxes to depend on the capital stock an endogenous state variable and thus captures situations where the evolution for capital and taxes is jointly determined to solve this model the consumption function is represented as a fixed point of a nonlinear monotone operator that is defined such that its nth iteration computes the consumption function n steps away from the horizon for a corresponding finite horizon economy the oparator s monotonicity is exploited in proving the existence of and constructing an equilibrium copyright 1991 by the econometric society

how robustness can lower the cost of discretion model uncertainty has the potential to change importantly how monetary policy is conducted making it an issue that central banks cannot ignore using a standard new keynesian business cycle model this paper analyzes the behavior of a central bank that conducts policy under discretion while fearing that its model is misspecified the main results are as follows first policy performance can be improved if the discretionary central bank implements a robust policy this important result is obtained because the central bank s desire for robustness directs it to assertively stabilize inflation thereby mitigating the stabilization bias associated with discretionary policymaking second the central bank s fear of model misspecification leads it to forecast future outcomes under the belief that inflation in particular will be persistent and have large unconditional variance raising the probability of extreme outcomes private agents however anticipating the policy response make decisions under the belief that inflation will be more closely stabilized that is more tightly distributed than under rational expectations finally as a technical contribution the paper shows how to solve with robustness an important class of linear quadratic decision problems

building an incentive compatible safety net abstract bank safety nets originally proposed as a means of stabilizing financial systems have become an important destabilizing influence government protection of bank debts encourages banks to undertake excessive risk particularly in response to adverse shocks to asset values reforms that would remove the destabilizing moral hazard consequences of government protection are considered both from the perspective of economic desirability and political feasibility requiring banks to maintain a minimal proportion of subordinated debt finance and restricting the means by which government recapitalization of insolvent banks occurs are the central features of promising reforms to the safety net

model uncertainty and intertemporal tax smoothing in this paper we examine how model uncertainty due to the preference for robustness rb aects optimal taxation and the evolution of debt in the barro tax smoothing model 1979 we rst study how the government spending shocks are absorbed in the short run by varying taxes or through debt under rb furthermore we show that introducing rb improves the model s predictions by generating i the observed relative volatility of the changes in tax rates to government spending ii the observed comovement between government decits and spending and iii more consistent behavior of government budget decits in the us economy finally we show that rb can also improve the model s predictions in the presence of multiple shocks

robust permanent income and pricing i suppose there exists an extremely powerful and if i may so speak malignant being whose whole endeavours are directed toward deceiving me rene descartes meditations ii 1

satisficing and un bounded rationality a formal definition and its experimental validity abstract based on exogenously given or idiosyncratically expected scenarios satisficing is formally defined and shown to include rationality as an unlikely border case our approach suggests new ways of defining risk attitudes and has been applied to risky choice problems and stochastic market games contrary to revealed preferences where one infers goals from observed choices the experimental tests do not only elicit choice behavior but also aspirations and if necessary idiosyncratic expectations

capital controls policy an intertemporal perspective abstract this paper studies capital controls policy from an intertemporal perspective using a small open economy model with optimizing agents it derives a policy rule which conforms real world stylized facts and is sustainable in the long run in particular it explicitly models the constraints on the policy rule implied by the dynamics of the economy studying several prevalent policy experiments it is demonstrated that significant real effects are generated by the interaction between controls policy and traditional policy tools this happens as controls affect agents intratemporal asset allocation and intertemporal consumption patterns the use of controls enlarges the set of possible outcomes generating some non traditional results the analysis points to new tradeoffs and hence new dilemmas faced by a government that uses controls

a new justification of monopolistic competition abstract this note offers an evolutionary justification for monopolistic competition sellers act on a symmetric heterogenous market entertain beliefs about the market structure and maximize conjectural profit functions we show that conjectural profit functions neglecting strategic interdependence are neutrally evolutionarily stable

robust control informational frictions and international consumption correlations abstract in this paper we examine the effects of model misspecification robustness or rb on international consumption correlations in an otherwise standard small open economy model with endogenous capital accumulation we show that in the presence of capital mobility in financial markets rb lowers the international consumption correlations by generating heterogeneous responses of consumption to productivity shocks across countries facing different macroeconomic uncertainty in addition we show that rb can also improve the model s predictions in three other moments of consumption dynamics the relative volatility of consumption to income the persistence of consumption and the correlation between consumption and output after calibrating the rb parameter using the detection error probabilities we show that the model can explain the observed international consumption correlations as well as the other consumption moments quantitatively finally we show that the main conclusions of our benchmark model do not change in an extension in which the agent cannot observe the state perfectly due to finite information processing capacity