inflation and relative price variability in the euro area evidence from a panel threshold model the impact of inflation on relative price variability rpv generates an important channel for real effects of inflation this article provides first evidence on the empirical relation between inflation and rpv in the euro area stirred by the widespread use of inflation caps or target bands in monetary policy practice we are particularly interested in threshold effects of inflation in line with the predictions of monetary search models our results indicate that expected inflation significantly increases rpv only if inflation is either very low below 0 95 per annum p a or very high above 4 96 p a

structural breaks in the international dynamics of inflation abstract this paper proposes an iterative procedure to discriminate between structural breaks in the coefficients and the disturbance covariance matrix of a system of equations with recursive proc

optimal commodity taxation and tax reform under unemployment this paper derives the optimal commodity tax formula and the tax reform rule which should be used in a situation of orthodox keynesian unemployment the setting considered is a four good one individual model with fixed real wage implying an excess supply of labor the presentation is very simple and based on intuitive and graphical arguments the emphasis is on comparing our results with the more traditional results derived under full employment

who formulates renewable energy policy a swedish example a broad participation by stakeholders and an extensive reliance on expert advice are often seen as preconditions for a legitimate and successfully implemented renewable energy policy however we have lacked systematic data for testing this argument this article s contribution is to examine the actors who take part in the making of swedish energy policy with the help of data on the composition of various committees of inquiry over the last twenty years 1988 2009 swedish renewable energy policy is often characterised with words like pioneering and forerunner suggesting that the policy making process in this area engages many different experts and stakeholders our data give only some support to this argument results point to a noteworthy predominance of politicians civil servants and representatives of state agencies within the policy process producers of uranium and fossils based energy have been engaged more often than producers of renewable energy experts have played a prominent role but this is mostly due to the participation of expert bureaucrats rather than of scientists the study suggests that a better understanding of the making of energy policy both in sweden and elsewhere requires greater attention to the networks and role of various state employees

monetary policy shifts and the stability of monetary policy models since the publication 1976 of the classic lucas critique researchers in empirical macroeconomics have endeavored to specify models that capture the underlying dynamic decision making behavior of consumers and firms who require forecasts of future events recently a number of researchers have developed simple models that have become the workhorses for monetary policy analysis the models vary considerably with regard to optimizing foundations and explicit treatment of expectations however relatively little effort has been devoted to testing the empirical importance of the lucas critique for these simple models can one find specifications that are policy invariant this paper develops and implements a set of tests for several monetary policy models used extensively in the literature in particular we attempt to test the robustness of optimizing versus nonoptimizing models to changes in the monetary policy regime we present evidence that shows that some forward looking models from the recent literat

reconsidering the relationship between inflation and relative price variability it has long been popularly believed that the relationship between inflation and relative price variability rpv is positive and stable using disaggregated cpi data for the united states and japan however this study finds that the relationship is neither linear nor stable over time the overall relationship is approximately u shaped around a nonzero threshold inflation rate rpv therefore changes not with the inflation rate per se but with the deviation of inflation from the threshold inflation rate more importantly the relationship is by no means stable over time but instead varies significantly in a way that coincides with regime changes of inflation or monetary policy the relationship was positive during the period of high inflation of the 1970s and the early 1980s as has been documented by a number of previous studies whereas it takes a u shape profile during the great moderation the results are robust to the use of core inflation which excludes the traditionally volatile prices of food and energy this paper then presents a modified version of the calvo type sticky price model to describe the observed empirical regularities simulation experiments show that the modified calvo model fits the data well and that the underlying relationship hinges upon the degree of price rigidity which is systematically related to inflation regime for countries and periods with low inflation rates the relationship takes a u shape as price adjustment is more sticky in a high inflation environment when price setting becomes more flexible the u shaped profile vanishes

the asymmetry of the new keynesian phillips curve in the euro area abstract using a two stage quantile regression framework we uncover significant asymmetries across quantiles for all coefficients in an otherwise standard new keynesian phillips curve nkpc for the euro area a pure nkpc specification accurately captures inflation dynamics at high inflation quantiles

climate change weather shocks and violent conflict a critical look at the evidence we use cross country data to explore whether temperature and rainfall shocks trigger violent conflict or not we include a wide range of country and time samples and explore whether the impact of weather shocks is conditional on income or political regimes our overall conclusion is sobering notwithstanding the attention this topic has attracted from the media and policy makers we find little robust evidence linking weather shocks to the onset of conflict

feed in or certificates competition or complementarity combining a static efficiency and a dynamic innovation perspective on the greening of the energy industry abstract european policy on the greening of the energy industry has been characterised by a debate between proponents of two apparent polar opposites feed in tariffs and certificate markets different european countries have chosen both mechanisms and as a consequence the european union has maintained a fairly pluralist position abstaining from stricter harmonisation taking a dynamic innovation perspective on european energy industry we argue that feed in tariffs and certificate markets should not be seen as competing alternatives but rather as complementary regulatory instruments targeting subsequent steps in the product cycle on the way from early technology conceptualisation and development towards competitive positioning in mature energy markets we see both policy instruments as necessary to achieve the extensive transformation towards sustainable development that is judged as important tools in the context of the global climate challenge

marginal tax reform externalities and income distribution the paper examines welfare improving and revenue neutral directions marginal policy reforms for an economy with nonidentical individuals and an externality that has a feedback effect on the consumption of taxed goods it considers three types of policy instruments the indirect taxes the uniform poll transfer and public abatement this extends the framework set up by ahmad and stern 1984 bovenberg and de mooij 1994 and schob 1996 the theoretical model is illustrated for a specific externality namely congestion caused by peak car transport

eu renewable energy support policy faith or facts the recent eu commission proposal for promoting the supply of power from renewable energy sources was originally based on a pan european harmonised tradable green certificate tgc scheme we suggest on the basis of a multi disciplinary analysis that a pan eu tgc system is not the way forward for europe it is vital that the commission and the majority of member states avoids implementation of such policy designs put forward by a coalition of vested interests they should instead look at and act upon the available evidence from those countries that have experimented with tgcs e g flanders uk and sweden and design policies that stand a better chance of meeting the criteria of effectiveness efficiency and equity in particular the policies must enable eu to meet the immense innovation industrialisation challenge by inducing the development of a capital goods industry that can eventually diffuse a broad range of technologies that use renewable energy sources only then we can acquire an ability to implement an industrial revolution in the energy system in a way that broadly meets the criteria of effectiveness and dynamic efficiency

does labor s share drive inflation a number of researchers have recently argued that the new keynesian phillips curve matches the empirical behavior of inflation well when the labor income share is used as a driving variable but fits poorly when deterministically detrended output is used the theoretical motivation for these results rests on the idea that the output gap the deviation between actual and potential output is better captured by the labor income share in turn implying that central banks should raise interest rates in response to increases in this variable we show that the empirical evidence generally suggests that the labor share version of the new keynesian phillips curve is a very poor model of price inflation we conclude that there is little reason to view the labor income share as a good measure of the output gap or as an appropriate variable for incorporation in a monetary policy rule

a time series approach to test a change in inflation persistence the mexican experience when a central bank commits credibly to a nonaccommodative monetary policy observed inflation should be a stationary process in countries where for a variety of reasons the determinants of inflation could lead it to follow a nonstationary process the adoption of a credible disinflationary programme should therefore induce a fundamental change in the stochastic process governing inflation and in particular should diminish its persistence this article studies the time series properties of both inflation and core inflation during the 1995 2006 period for the mexican economy using recently developed techniques to detect a change in the persistence of economic time series consistently with the adoption of an inflation targeting framework the results suggest that inflation in mexico seems to have indeed switched from a nonstationary to a stationary process around the end of year 2000 or the beginning of 2001

has the economy become more predictable changes in greenbook forecast accuracy several researchers have recently documented large reductions in economic volatility but a more important question may be whether the economy has become more predictable using forecasts from the federal reserve greenbooks i find that inflation and output have become more predictable though the results for output are somewhat mixed the reductions in unpredictability if any are significantly smaller than reductions in volatility associated with this the predictable component of fluctuations in output and inflation has virtually disappeared

sectoral and aggregate inflation dynamics in the euro area this paper synthesises the implications of recent statistical evidence regarding inflation persistence in the euro area for aggregate data the degree of inflation persistence appears to be very high for sample periods spanning multiple decades but falls dramatically once we allow for time variation in the mean level of inflation furthermore the timing of these breaks in mean generally coincides with observed shifts in the monetary policy regime finally sectoral inflation series exhibit much less persistence than aggregate inflation mainly because of the influence of transitory sector specific shocks jel e31 c22 c43

a dynamic programming model of china s strategic petroleum reserve general strategy and the effect of emergencies abstract to protect the security of energy supply china is building national strategic petroleum reserve spr we present a dynamic programming model to determine the optimal stockpiling and drawdown strategies for china s spr under various scenarios focusing on minimizing the total cost of reserves in contrast to previous research the oil price given in our model is exogenous on a monthly instead of annual basis with a view to more realistic simulation of optimal strategies each year our model results show that in the case where stockpiling affects oil prices a given spr size will be achieved earlier than when stockpiling does not affect oil prices in different emergency conditions the optimal stockpiling and drawdown strategies of china s spr are very different when an emergency occurs the shock of stockpiling on the oil price per barrel could range 0 49 6 35 while the impact of drawdown on the oil price per barrel could range 6 22 to 0 48

energy supply security and geopolitics a european perspective the security of energy supply to the eu is examined in the context of two storylines markets and institutions exemplifies an economically and politically integrated multilateral world with effective institutions and markets regions and empires involves a world broken up in rival political and economic blocks competing for resources and markets via political economic and military power it is shown that these storylines have a significant impact on the development of the energy market on the way in which energy supply may be secured and on the effect and applicability of the several types of instruments available the current eu is geared towards enlargement and a deepening of economic integration based on the tenets of the post 1945 multilateral world system the present world tends towards regions and empires and suggests that the eu may have to reorient its energy security policy energy policy must become an integral part of eu external trade and foreign relations and security policy the eu should develop its own strategy actively investing in dialogues with producer countries in the persian gulf and africa and with russia sustainable prosperity and governance in these regions will support eu energy security

the dynamics of inflation a study of a large number of countries over the last twenty years the statistical properties of inflation persistence has been the subject of intense investigation and debate without reaching a unanimous conclusion yet in this article we attempt to shed further light to this debate using a battery of econometric techniques in order to provide robust evidence on the degree of inflation persistence and whether this has changed during the period in which several countries have followed inflation targeting regimes or new monetary regimes we consider the inflation rates of thirty developed and emerging economies using quarterly data for the period 1958 to 2007 which include alternative monetary policy regimes the coefficient of the inflation parameter is estimated by ordinary least squares ols autoregressive moving average arma and autoregressive fractionally integrated moving average arfima models furthermore the grid bootstrap median unbiased mub estimator approach developed by hansen 1999 is used to estimate the finite sample ols

when should we use strategic oil stocks the countries of the oecd have built significant strategic oil stocks over the past 30 years and others like india and china have begun substantial programs as well the operating environment for using those stocks in an emergency however has changed considerably during those years the original plan for a multilateral draw down of strategic reserves has been amended and repeatedly modified as events have warranted but there remains a great deal of uncertainty as to how and when strategic stocks should be used this paper discusses the track record of using strategic reserves and concludes with recommendations for new guidelines for their use which will strengthen their utility to both the policymaker and the marketplace

energy security externalities and policies abstract in this paper we review conceptual arguments and empirical evidence related to two potential sources of market failure involving energy security in doing so we consider several questions involving the distinction between externality and market inefficiency and the distinction between market failures that are amenable or not amenable to correction given our current understanding of the workings of an economy several conclusions follow from our analysis regarding the potential sources of market failure and possible remedies the problem of excess wealth transfer from exporter market power may be an issue but current knowledge of oil market behaviour is too weak to support a strong conclusion other supposed costs of oil import dependence also are not well grounded including externalities related to the vulnerability of the economy to energy price shocks

the persistence of inflation in the united states abstract has the persistence of inflation in the united states changed since 1965 we estimate the persistence of inflation over time using different measures and estimation procedures and we produce confidence intervals for our estimates as well as formal tests of unchanged persistence we find that inflation persistence has been high and approximately unchanged in the u s over our sample period we reconcile our results with other studies that reached different conclusions

modeling inflation dynamics a critical review of recent research in recent years a broad academic consensus has arisen around the use of rational expectations sticky price models to capture inflation dynamics these models are seen as providing an empirically reasonable characterization of observed inflation behavior once suitable measures of the output gap are chosen and moreover are perceived to be robust to the lucas critique in a way that earlier econometric models of inflation are not we review the principal conclusions of this literature concerning 1 the ability of these models to fit the data 2 the importance of rational forward looking expectations in price setting and 3 the appropriate measure of inflationary pressures we argue that existing rational expectations sticky price models fail to provide a useful empirical description of the inflation process especially relative to traditional econometric phillips curves of the sort commonly employed for policy analysis

inflation dynamics in the u s global but not local mean reversion a stylized fact of u s inflation dynamics is one of extreme persistence and possible unit root behavior if so the implications for macroeconomics and monetary policy are somewhat unpalatable our econometric analysis proposes a parsimonious univariate representation of the inflation process for the last 60 years the nonlinear exponential smooth autoregressive the empirical results confirm a number of the key features such as global stationarity local unit root behavior and lower persistence in the post 1983 period than in the pre 1983 period we compare the forecasting ability of our model with that of competing univariate models and find that the nonlinear model outperforms the linear autoregressive model in the pre 1983 period and the random walk in the post 1983 period at short horizons

the assessment the new energy paradigm during the 1980s and 1990s energy policy concentrated on privatization liberalization and competition in response to the underlying conditions of excess supply and low fossil fuels these conditions changed around 2000 in response to the coincidence of a structural upward shift in oil prices the aging of the assets network failures and greater import dependency the focus moved from asset sweating towards investment and has been accompanied by a paradigm shift in the objectives of energy policy towards security of supply and climate change this article sets out the implications for the choice of instruments and institutions in the context of liberalized markets in respect of security of supply and climate change market based instruments are advanced in the former capacity markets and in the latter carbon taxes and permits finally consideration is given to the case for a single integrated energy agency both to enhance credibility and to ensure consistency copyright 2005 oxford university press

price stickiness and sectoral inflation persistence additional evidence in this paper using u s as well as french sectoral data and indicators of price rigidity we reexamine the lack of relation between price stickiness and inflation persistence this has recently been put forward by bils and klenow 2004 as evidence against time dependent price setting models we obtain that when filtering out sector specific shocks along the lines of boivin giannoni and mihov 2009 and allowing for an alternative assumption on the marginal cost process the case against the time dependent calvo model is substantially weakened

new keynesian economics and the phillips curve models with sticky prices are an important part of new keynesian economics the author shows that several of the new keynesian models imply a formulation that is similar to the expectations augmented phillips curve of milton friedman and edmund phelps he then presents new estimates of the new keynesian phillips curve the author uses two proxies for price expectations survey based measures and an econometric based measure originally developed by bennett mccallum 1976 overall the results are consistent with the model but the survey based results are more precise suggesting that the surveys may be better measures of actual expectations copyright 1995 by ohio state university press

the eu renewables directive what is the fuss about trading abstract considerable argument about trading in green electricity certificates gecs preceded the publication of the proposed eu renewables directive in early 2008 the proposed directive set a binding target of 20 per cent of eu energy to be derived from renewable energy by 2020 broken down into targets for each member state those arguing for trade in green certificates called certificates of guaranteed origin go included major electricity companies however the idea of mandatory trading was opposed by the main renewable energy industry lobby groups the proposed directive limited trading in accordance with the demands of the renewables industry pressure groups analysis suggests that if member states were forced to trade to achieve a mandatory target of 20 per cent target then gec prices would rise to high levels because the demand for tradeable certificates would be much higher than their supply trading is unlikely to improve the prospects for meeting the targets a system of nationally based feed in tariff systems would not face the problems of uncertain certificate prices faced by compulsory trading in gecs

dynamic persistence of primary commodity prices this article examines the persistence of shocks to international commodity prices from 1900 to 2008 using the updated grilli yang index the main innovation of this study is that it determines whether commodity prices are characterized by multiple changes in persistence specifically bootstrap methods are used to estimate persistence and the associated half life shocks are calculated we find that the persistence of shocks can vary widely depending on the individual commodity and the time period the results suggest that policy makers need to exercise caution when introducing measures to cushion the effect of shocks to world commodity prices

a political economy theory of fiscal policy and unemployment this paper presents a political economy theory of fiscal policy and unemployment the underlying economic model is one in which unemployment can arise but can be mitigated by tax cuts and public spending increases such policies are fiscally costly but can be financed by issuing government debt policy decisions are made by a legislature consisting of representatives from different political districts the theory provides a positive account of the simultaneous determination of fiscal policy and unemployment the most important implication of the theory is that debt and unemployment levels should be positively correlated some evidence in support of this prediction is provided using data from a panel of developed countries

staggered price contracts and inflation persistence some general results despite their popularity as theoretical tools for illustrating the effects of nominal rigidities some have questioned whether models based on staggered price contracts with rational expectations can match the persistence of the empirical inflation process this article presents some general results about this class of models it is shown that these models do not have a problem matching high autocorrelations for inflation however they fail to explain a key feature of reducedform phillips curve regressions the positive dependence of inflation on its own lags it is shown that staggered price contracting models instead predict that the coefficients on these lag terms should be negative

the rise and fall of go trading in european renewable energy policy the role of advocacy and policy framing this paper examines policy processes surrounding the rise and fall of the proposed eu wide policy instrument designed to help achieve the eu s renewable energy targets the trading of guarantees of origin go it discusses its origins and examines factors in the policy processes over time leading first to its development and then to its abandonment a first analysis looks at the near term policy making process before and after the proposal on go trading in january 2008 focusing on the european policy making institutions and influences of interest groups and member state governments it then takes a step back and looks over a longer time period at how competing policy frames have shaped the agendas underlying the debate results show how a strong internal market frame acted as a primary driving force in the commission to promote the go trading instrument the rejection of the go trading proposal in the council and parliament can be largely attributed to the lack of a strong lobby in favour of go the accumulated experience with and institutionalisation of national res support policies such as feed in tariffs and growing general political concerns for supply security innovation and competitiveness

optimal monetary policy under learning and structural uncertainty in a new keynesian model with a cost channel and inflation inertia abstract we investigate whether expectations based optimal monetary policy rules under discretion and under commitment can enforce a determinate and least squares learnable rational expectations equilibrium ree in a new keynesian model with inflation inertia and a cost channel of monetary policy transmission our numerical results show that commitment rules can enforce a determinate and learnable ree for all parameter constellations considered whereas discretionary rules are not always able to enforce the same desirable outcome in the economy we also examine different types of misapprehensions in policy making and find that an incorrect assessment of the economy s true structure by the central bank greatly affects its capability to enforce a determinate and learnable although suboptimal ree thus our numerical results highlight the relevance of this type of analysis for the design and conduct of monetary policy

has euro area inflation persistence changed over time this paper analyzes the stability over time of the econometric process for euro area inflation since 1970 focusing in particular on the behavior of the so called persistence parameter the sum of the coefficients on the lagged dependent variables perhaps surprisingly in light of the lucas critique our principal finding is that there appears to be relatively little instability in the parameters of the euro area inflation process full sample estimates of the persistence parameter are generally close to 1 and we fail to reject the hypothesis that this parameter has been stable over time we discuss how these results provide some indirect evidence against rational expectations models with strong forward looking elements such as the new keynesian phillips curve

when the grace period is over assessing the new member states compliance with eu requirements for oil stockholding the accumulation of appropriate emergency stocks of crude oil and petroleum products has been at the heart of the european commission s efforts to increase the security of supply this study investigates how effectively the new member states comply with the requirements of council directive 2006 67 ec which imposes the obligation to maintain minimum stocks of crude oil and or petroleum products the empirical focus of this analysis is not only motivated by the practical relevance of this issue but also by the fact that eleven of the twelve new member states were given grace periods between one and seven years to bring their national stockholding arrangements in line with the european requirements the granting of extended deadlines raises the question whether this instrument indeed facilitates the transposition process the empirical findings show that except for latvia compliance with the eu stockholding requirements is generally very good a more detailed analysis of the latvian case highlights that the transposition delays principally stem from budgetary constraints more generally the individual new member states capacity to cope with the financial burdens and the degree of adjustment pressure determine the variation in oil stock levels

new tests of the new keynesian phillips curve abstract lagged dependent variables typically play an important role in empirical models of inflation do these lags reflect backward looking inflation expectations or do they proxy for rational forward looking expectations as in the new keynesian phillips curve gali and gertler 1999 inflation dynamics a structural econometric analysis journal of monetary economics 44 195 222 attempt to answer this question using gmm to estimate specifications incorporating both lagged and future inflation they report small coefficients on lagged inflation and conclude that the new keynesian model provides a good first approximation to inflation dynamics we show that these tests have low power against alternative backward looking specifications and demonstrate that their results are also consistent with a backward looking phillips curve using an alternative approach we find that the new keynesian pricing model cannot explain the importance of lagged inflation in standard inflation regressions and find that forward looking terms play a very limited role in explaining inflation dynamics

search frictions real rigidities and inflation dynamics the standard new keynesian model suffers from the so called macro micro pricing conflict in order to match the dynamics of inflation implied by macroeconomic data the model needs to assume an average duration of price contracts which is much longer than what is observed in micro data here i show how departing from the standard model s assumption of a perfectly competitive labor market can help resolve the pricing conflict i do so by assuming search frictions in the labor market in this framework labor becomes firm specific and marginal cost curves become upward sloping this mechanism reduces the slope of the new keynesian phillips curve given a frequency of price adjustment conversely given an estimate of this slope my model implies shorter price durations than the standard model for a plausible calibration and for different slope values my model consistently delivers price durations that are roughly half of those implied by the standard model

assessing the lucas critique in monetary policy models empirical estimates of monetary policy rules suggest that the behavior of u s monetary policymakers changed during the past few decades however for that same time period statistical analyses of lagged representations of the economy such as vars often have not rejected the null of structural stability these two sets of empirical results appear to contradict the lucas critique this paper reconciles these results with the lucas critique by showing that the apparent policy invariance of reduced forms is consistent with the magnitude of historical policy shifts and the relative insensitivity of the reduced forms of plausible forward looking macroeconomic specifications to policy shifts

accounting for a shift in term structure behavior with no arbitrage and macro finance models this paper examines a shift in the dynamics of the term structure of interest rates in the u s during the mid 1980s we document this shift using standard interest rate regressions and using dynamic a ne no arbitrage models estimated for the pre and post shift subsamples the term structure shift largely appears to be the result of changes in the pricing of risk associated with a level factor using a macro nance model we suggest a link between this shift in term structure behavior and changes in the dynamics and risk pricing of the federal reserve s in ation target as perceived by investors

commodity taxation in welfare states i introduction while the nature of unemployment is diverse a substantial part of unemployment in many developed countries it is argued stems from generous social welfare systems meyer 1990 nickell and layard 1999 and see figure 1 1 in fact the organization for economic cooperation and development oecd data show that countries with generous unemployment insurance ui face high unemployment rates and tend to have high commodity tax rates see figure 2 this paper attempts to account for these empirical patterns in the optimal taxation framework in a general equilibrium context the unemployment mentioned above can be viewed as a result of a a low work incentive induced by generous social insurance welfare benefits combined with b the subsequent employment adjustment by firms e g not renewing employment contracts or hiring a portion of temporary part time workers as regular workers to raise labor productivity to deal with this type of unemployment the government may need to seek reforms of social insurance welfare systems including a reduction in unemployment benefits but the public s redistributive motives often do not permit implementation of such reforms 2 under this socioeconomic constraint this paper raises a question can commodity taxation help reduce unemployment and improve efficiency perhaps a slightly different but equally interesting question that concerns many welfare states in recent decades may be suppose that a society agreed on the expansion of welfare programs in financing the increased welfare expenditure which tax increase consumption taxes or income taxes is more relevant figure 1 omitted figure 2 omitted to address these questions we examine the role of commodity taxation in a general equilibrium model where a taking into account wage unemployment benefits and taxes workers choose work effort that the firm can observe only through costly monitoring and b firms use both wage and monitoring as effort eliciting devices and they fire those caught shirking therefore the chosen level of a worker s effort affects the probabilities of employment and unemployment and thus involuntary unemployment arises from moral hazard 3 in this contractual setting with imperfect information we consider the government s problem of maximizing the representative worker s expected utility using income and commodity taxes we derive new results on commodity taxation and present supportive results using quantitative analysis our key results suggest that commodity taxation can be used to alleviate moral hazard and hence unemployment which can account for why countries with generous social welfare systems tend to adopt high commodity tax rates see figure 2 this main result is based on the following feature of the model given the aforementioned environment optimal commodity and income tax rates can be determined in contrast to the indeterminacy result of atkinson and stiglitz 1976 henceforth as 4 therefore our results provide an explanation for the widely observed coexistence of direct and indirect taxation to illustrate the intuition behind our results consider a situation where a a society provides liberal unemployment benefits for unemployed workers and b the government sets the levels of income and commodity tax rates so as to finance the expenditures for ui and public goods liberal unemployment benefits are equivalent to treating the consumption of unemployed workers favorably i e between states consumption choice distortion which creates moral hazard in the supply of effort under imperfect information about effort obviously drastic reforms in social insurance systems e g cutting benefits can correct moral hazard but the public s redistributive motives do not permit such reforms in this setting we show that strengthening commodity taxation while lessening income taxation penalizes moral hazard which lowers the between states consumption choice distortion leading to a greater supply of effort