inefficient credit booms this paper studies the welfare properties of competitive equilibria in an economy with financial frictions hit by aggregate shocks in particular it shows that competitive financial contracts can result in excessive borrowing ex ante and excessive volatility ex post even though from a first best perspective the equilibrium always displays under borrowing from a second best point of view excessive borrowing can arise the inefficiency is due to the combination of limited commitment in financial contracts and the fact that asset prices are determined in a spot market this generates a pecuniary externality that is not internalized in private contracts the model provides a framework to evaluate preventive policies which can be used during a credit boom to reduce the expected costs of a financial crisis copyright 2008 wiley blackwell

how should control theory be used to calculate a time consistent government policy we study different solutions to a simple one dimensional linear quadratic game with a large number of private agents and a government a time consistent solution is defined as a solution to the hamilton jacobi bellman equation i e as a policy for which the government has noprecommitment capability this solution is compared to a policy where the government has an instantaneous pre commitment i e an equilibrium in which the government has a period by period leadership in both cases we show how control theory should be applied to calculate the equilibrium and how to relate these equilibria to the differential game literature

the interaction of monetary and macroprudential policies i analyze a new keynesian dynamic stochastic general equilibrium dsge model where the financing of productive investment is affected by a moral hazard problem i solve for jointly ramsey optimal monetary and macroprudential policies i find that when a financial friction is present in addition to the standard nominal friction the optimal policy can replicate the first best allocation if the social planner can conduct both monetary and macroprudential policy using monetary policy alone is not enough a policy trade off between stabilizing inflation and output gap emerges when policy follows simple rules the source of fluctuations is relevant for the choice of the appropriate policy mix

dynamic adjustment to land taxation policy neutrality and welfare implications abstract in this paper we use a dynamic three sector model to examine the neutrality and welfare effects of land income taxes we find that 1 taxes that are neutral in long run equilibrium need not be neutral in the short run 2 short run neutrality depends upon the tax treatment of development costs and losses and 3 many of the neutrality results hold under both static and rational expectations assumptions we also find that even without externality assumptions nonneutrality in the short run does not necessarily entail a welfare cost and may be welfare enhancing when agents have less than perfect foresight

breaking free of the triple coincidence in international finance the traditional approach to international finance is to view capital flows as the financial counterpart to savings and investment decisions assuming further that the gdp boundary defines both the decision making unit and the currency area this triple coincidence of gdp area decision making unit and currency area is an elegant simplification but misleads when financial flows are important in their own right first the neglect of gross flows when only net flows are considered can lead to misdiagnoses of financial vulnerability second inattention to the effects of international currencies may lead to erroneous conclusions on exchange rate adjustment third sectoral differences between corporate and official sector positions can distort welfare conclusions on the consequences of currency depreciation as macroeconomic risks may be underestimated this paper illustrates the pitfalls of the triple coincidence through a series of examples from the global financial system in recent years and examines alternative analytical frameworks based on balance sheets as the unit of analysis

information constrained optima with retrading an externality and its market based solution this paper studies the efficiency of competitive equilibria in environments with a moral hazard problem and unobserved states both with retrading in ex post spot markets the interaction between private information problems and the possibility of retrade creates an externality unless preferences have special restrictive properties the externality is internalized by allowing agents to contract ex ante on market fundamentals determining the spot price or interest rate over and above contracting on actions and outputs then competitive equilibria are equivalent with the appropriate notion of constrained pareto optimality examples show that it is possible to have multiple market fundamentals or price islands created endogenously in equilibrium

on the neutrality of the property tax in a recent issue of this journal there appeared an interesting controversy between bentick and thirsk on the neutrality of the property tax bentick 1979 thirsk 1979 the former argues that the property tax is nonneutral with respect to the intertemporal allocation of land whereas the latter argues that it is neutral and attributes the difference in the results to the choice of the discount rate this comment points out the following first bentick s result can be derived from thirsk s basic equation so that it is inappropriate to attribute the difference in the results to the choice of the discount rate second whether a property tax is neutral or not depends upon whether the value in use or the market value is chosen as the tax base as thirsk correctly recognizes the introduction of a property tax reduces the value of land by the amount of the present value of tax liabilities thus we obtain his equation 1 which is reproduced below

equity and the time consistent taxation of income in a theoretical model the share of intraindustry trade in an industry s bilateral trade flows is determined by relative factor prices in the trading countries factor intensity and the elasticity of substitution in demand between products in the industry the more similar the relative factor prices in different countries the less extreme the factor intensity while the lower the elasticity of substitution between the products in an industry the larger the intraindustry trade the empirical study confirms these implications furthermore tariffs and transport costs are shown to have a greater negative effect on intraindustry trade copyright 1991 by the editors of the scandinavian journal of economics

financial intermediary capital we propose a dynamic theory of financial intermediaries that are better able to collateralize claims than households that is have a collateralization advantage intermediaries require capital as they have to finance the additional amount that they can lend out of their own net worth the net worth of financial intermediaries and the corporate sector are both state variables affecting the spread between intermediated and direct finance and the dynamics of real economic activity such as investment and financing the accumulation of net worth of intermediaries is slow relative to that of the corporate sector the model is consistent with key stylized facts about macroeconomic downturns associated with a credit crunch namely their severity their protractedness and the fact that the severity of the credit crunch itself affects the severity and persistence of downturns the model captures the tentative and halting nature of recoveries from crises

inefficient investment waves we show that firms individually optimal liquidity management results in socially inefficient boom and bust patterns financially constrained firms decide on the level of their liquid resources facing cash flow shocks and time varying investment opportunities firms liquidity management decisions generate simultaneous waves in aggregate cash holdings and investment even if technology remains constant these investment waves are not constrained efficient in general because the social and private value of liquidity differs the resulting pecuniary externality affects incentives differentially depending on the state of the economy and often overinvestment occurs during booms and underinvestment occurs during recessions in general policies intended to mitigate underinvestment raise prices during recessions making overinvestment during booms worse however a well designed price support policy will increase welfare in both booms and recessions

monetary policy bank leverage and financial stability abstract this paper shows that with limited liability banks lever up excessively to finance new loans lower monetary policy rates can worsen or reduce these incentives depending on the size of the shock when equity financing is ruled out when this constrained is relaxed but the bank faces costly dividend adjustment lower monetary policy rates always worsen risk taking incentives and the effect is persistent the reason is that costly dividend adjustment lowers the opportunity cost of lending in this model capital requirements are closer to the source of the distortion and thus work better than loan to value caps in reducing excessive risk taking

housing as an asset and the effects of property taxation on the residential development process abstract a model of residential development is constructed recognizing the asset side of land and housing the equilibrium process is characterized under the perfect foresight assumption and the effects of a capital gains tax both unanticipated and anticipated and a tax on property values are examined

reputation risk taking and macroprudential policy abstract this paper examines the role of macroprudential capital requirements in preventing inefficient credit booms in a model with reputational externalities in our model unprofitable banks have strong incentives to invest in risky assets when macroeconomic fundamentals are good in order to avoid the stigma of being assessed as low ability by the market we show that across the system countercyclical capital requirements that deter such gambling are constrained optimal when fundamentals are neither extremely weak nor extremely strong

an economic analysis of forest taxation s impact on optimal rotation age because of the tax cutting mood of the general public current interest in forest taxation by legislators is high many states including washington oregon california montana north carolina georgia arkansas and texas have either recently revised or are considering changing their forest taxation laws the response from academicians however is mixed many articles by forest taxation specialists klemperer 1974 1976 1977a 1977b olson and haney 1980 pasour and holley 1976 sutherland and tedder 1979 tedder and sutherland 1979 and the published proceedings of a forest taxation symposium haney and gunter 1978 have appeared in recent years yet general tax economists have largely ignored the problem of forest property taxation as evidenced by aaron s recent study of property taxes in which forest taxation is not even mentioned 1975 at present a rigorous analysis of the impact of forest taxation on the optimal management of timber has yet to appear in the literature because of the profound influence of forest taxation on many state and local economies and on forest productivity it is important that the impact of the various taxation schemes be well understood during the process of revising the forest taxation laws this paper examines the economic impact of various forest taxation schemes on the optimal rotation age under the assumptions of both tax capitalization and tax shifting general tax economists should find taxation of forest property of interest for two reasons first commercial forest land in private ownership comprises more than 15 of the nation s total land area williams 1974 second the results of forest taxation studies apply readily to taxation of renewable resources in general currently the major types of taxes that can be imposed on a forest property may be divided into annual property taxes and harvest taxes the former include the unmodified property tax and the site value tax every year the unmodified property tax takes a percentage of the value of the land plus the value of the trees and the site value tax takes a percentage of the value of the land only still a third type of property tax called the timber tax takes a percentage of the value of the trees only every year although this tax is rarely used it is included in this study because of its theoretical importance harvest taxes include yield taxes and severance taxes at the time of harvest the yield tax takes a percentage of the stumpage value of timber and the severance tax imposes a charge per unit of timber volume harvested past studies of forest taxation have

uncertainty capital flows and maturity mismatch abstract this paper explores a how the financial uncertainty generated by volatile international capital flows interacts with maturity mismatch on the balance sheets of nonfinancial firms to increase the volatility of output investment and total factor productivity tfp in emerging market economies i build a model of a small open economy in which financial frictions force firms to fund long term projects with short term debt in response to changes in the level of uncertainty regarding the availability of foreign borrowing firms adjust their long term investment contributing to the volatility of investment and output as well as generating endogenous fluctuations in aggregate productivity using data from a panel of major emerging markets i show that the volatility of portfolio debt flows negatively affects output by dampening investment while the volatility of equity flows which do not generate maturity mismatch has no effect consistent with the mechanism in the model the negative impact of capital flow volatility is larger at low levels of financial development and in industries with longer time to build lags my estimates imply that shocks to capital flow volatility account for one fifth of the excess output volatility of the emerging markets in my sample relative to a set of small open advanced economies

central bank independence and macro prudential regulation when a central bank is in charge of both price and financial stability a new time inconsistency problem may arise monetary policy may be abused to reduce the private sector s real debt burden after a financial shock materializes

energy vs the environment optimal development programs that explicitly account for the environmental impacts of extracting and consuming energy resources are analyzed following lee and orr 1975 we allow for the possibility of storing the resource above ground once it has been extracted when environmental disruption results from resource extraction as in the case of strip mining or there are environmental costs associated with resource consumption for example the social costs of air pollution from fuel consumption then the socially optimal rates of resource consumption and extraction depend on the severity of the environmental impact and on the prospects of storing the resource above ground

on the time consistency of the government s social security benefit policy abstract it is shown that the government s social security benefit policy may be time inconsistent when a worker s future benefit depends on his labor earnings history when the future benefit is tied to current labor supply the benefit will distort the worker s labor supply decision ex ante of retirement but not ex post any excess burden associated with the government s benefit policy is taken into account in the open loop policy game but is ignored in the closed loop game this will generally imply that the benefit will be larger under the closed loop rule ceteris paribus

contractual externalities and systemic risk we study effort and risk taking behaviour in an economy with a continuum of principal agent pairs where each agent exerts costly hidden effort principals write contracts based on both absolute and relative performance evaluations ape and rpe respectively to make individually optimal risk return trade offs but do not take into account their impact on endogenously determined aggregate variables this results in contractual externalities when these aggregate variables are used as benchmarks in contracts contractual externalities have welfare changing effects when principals put too much weight on ape or rpe due to information frictions relative to the second best if the expected productivity is high risk averse principals over incentivize their own agents triggering a rat race in effort exertion resulting in over investment in effort and excessive exposure to industry risks the opposite occurs when the expected productivity is low inducing pro cyclical investment and risk taking behaviours

the balance of payments and borrowing constraints an alternative view of the mexican crisis in this paper we develop a model in which a country faces a balance of payments crisis if constraints on its international borrowing bind we use the model to describe the dynamics of the trade balance capital account and balance of payments of a country that borrows to finance consumption following sweeping macroeconomic and structural reforms and then hits constraints on its international borrowing we compare the predictions of this theoretical example with events in mexico from 1987 through 1995

international and domestic collateral constraints in a model of emerging market crises abstract we build a model of emerging markets crises which features two types of collateral constraints firms in a domestic economy have limited borrowing capacity from international investors they also have limited borrowing capacity with respect to each other we study how the presence and changes in these collateral constraints affect financial and real variables a binding international constraint in the aggregate leads to a sharp rise in interest rates and fire sales of domestic assets while limited domestic collateral can lead to wasted international collateral these two collateral constraints can interact in important ways the first is disintermediation a fire sale of domestic assets causes banks to fail in their function of reallocating resources across the economy leading to wasted international collateral the second is a dynamic effect we show that firms in an economy with limited domestic collateral and a binding international collateral constraint will not adequately precaution against adverse shocks increasing the severity of these shocks

financial markets intermediaries and intertemporal smoothing in an overlapping generations economy with incomplete financial markets but no intermediaries there is underinvestment in safe assets in an economy with intermediaries and no financial markets accumulating reserves of safe assets allows returns to be smoothed nondiversifiable risk to be eliminated and an ex ante pareto improvement compared to the allocation in the market equilibrium to be achieved in a mixed financial system however competition from financial markets constrains intermediaries so that they perform no better than markets alone

the effect of distributive goals on the time inconsistency of optimal taxes abstract in the context of a two period n consumer model of optimal wage and interest taxation this paper asks whether the government s distributive goals can inhibit its incentives to renege on its announced policies inconsistent interest tax increases may be moderated by distributed goals if they create an unacceptable utility distribution in the economy this result is developed for a general case its implications for welfare and savings are illustrated with numerical examples

capital controls and foreign exchange market intervention abstract high level of capital controls and volatile exchange rates in developing countries are considered suboptimal in classical trilemma frameworks the paper presents a new keynesian small open economy model that assesses middle ground policies such as partial capital controls and managed exchange regimes the paper introduces a policy endogenous risk premium which creates financial frictions breaking exchange rate peg exposes foreign investors to exchange rate risk and even signals the country s economic instability and financial sector responds by raising the country s exchange rate risk premium contrary to the classical theory the results suggest that implementing both capital controls and managed exchange regimes can be optimal while maintaining domestic monetary policy sovereignty

financial liberalization credit constraints and collateral investment in the mexican manufacturing sector abstract we examine the impact of financial liberalization on fixed investment in mexico using establishment level data from the manufacturing sector in addition to analyzing changes in cash flow sensitivities an innovative approach explores the role of real estate as collateral and addresses a potential censoring problem the results suggest that financial constraints were eased for the smallest firms but not for larger ones however the importance of possessing real estate increased given banks reliance on collateral in their lending the results also provide microeconomic evidence consistent with the role attributed to financial accelerator mechanisms during lending booms and during post crisis recessions

tax neutrality in the presence of adjustment costs it is well known that expensing of capital expenditures will lead to tax neutrality with respect to investment provided that interest payments are not tax deductible brown 1948 however if interest payments are deductible then allowing firms to deduct economic depreciation will lead to a neutral tax system samuelson 1964 these neutrality results have been derived in models without costs of adjustment see also hall and jorgenson 1971 stiglitz 1973 and king 1974 however recent research in investment theory has emphasized the role of costs of adjustment lucas 1967 gould 1968 hayashi 1982 abel 1982a b using a separable adjustment cost technology in which adjustment costs depend only on the rate of investment abel 1982a b has shown that the two neutrality propositions above continue to hold however using a general nonseparable adjustment cost technology hartman 1978 showed that only one of the two neutrality propositions remains valid in the presence of adjustment costs expensing continues to lead to neutrality if interest payments are not deductible but hartman finds that economic depreciation and interest deductibility do not lead to neutrality in the presence of adjustment costs in this paper we analyze investment behavior in an adjustment cost framework and construct a neutral tax system with interest deductibility the neutral tax system allows for economic depreciation but requires some adjustments to taxable income which recognize the fact that capital can implicitly produce net revenue by reducing adjustment costs hartman found economic depreciation to be nonneutral because he did not make this necessary adjustment to taxable income and because he calculated economic depreciation incorrectly using the price of uninstalled capital rather than the value of newly installed capital in the presence of costs of adjustment true economic depreciation is calculated using the shadow price of installed capital rather than the observable market price of new uninstalled capital it has been shown by hayashi 1982 that under appropriate linear homogeneity and price taking assumptions the shadow price of capital can

credit externalities macroeconomic effects and policy implications financial crises are often preceded by peri ods of credit expansion during which firms and households become increasingly vulnerable to a reversal in economic conditions when eco nomic conditions actually worsen financing constraints become tighter causing a deeper contraction of economic activity these events have led to policy proposals for preventing excessive borrowing during normal times if rational agents evaluate financing decisions from a privately optimal standpoint why would the debt level not be socially efficient the theoretical literature has offered an answer to this question based on a pecuniary externality that arises due to the presence of financial frictions private agents tend to under value net worth during a period of financial distress because they fail to internalize the fact that additional net worth would have positive spillovers on other agents balance sheets 1 as a result private agents borrow excessively the quantitative implications of these credit exter nalities however remain largely unknown in particular these key questions have not been addressed

excessive dollar debt financial development and underinsurance we propose that the limited financial development of emerging markets is a significant factor behind the large share of dollar denominated external debt present in these markets we show that when financial constraints affect borrowing and lending between domestic agents agents undervalue insuring against an exchange rate depreciation since more of this insurance is present when external debt is denominated in domestic currency rather than in dollars this result implies that domestic agents choose excessive dollar debt we also show that limited financial development reduces the incentives for foreign lenders to enter emerging markets the retarded entry reinforces the underinsurance problem

debt constrained asset markets we develop a theory of general equilibrium with endogenous debt limits in the form of individual rationality constraints similar to those in the dynamic consistency literature if an agent defaults on a contract he can be excluded from future contingent claims markets trading and can have his assets seized he cannot be excluded from spot markets trading however and he has some private endowments that cannot be seized all information is publicly held and common knowledge and there is a complete set of contingent claims markets since there is complete information an agent cannot enter into a contract in which he would have an incentive to default in some state in general there is only partial insurance variations in consumption may be imperfectly correlated across agents interest rates may be lower than they would be without constraints and equilibria may be pareto ranked

dynamic income taxation redistribution and the ratchet effect abstract in this paper we extend the classic optimum linear income tax model to a twice repeated game a utilitarian policy maker decides on the second period tax system on the basis of observed first period behaviour we summarise our findings as follows first the static optimal linear tax results cannot be expected to hold in a dynamic setting second more productive households are likely to mimic the behaviour of less productive households third the optimal dynamic first period tax rate might be negative then income is redistributed from low to high income households fourth if the utility function is well behaved then the optimal dynamic first period tax rate is lower than the optimal static tax rate fifth if the optimal static tax rate separates then the dynamic and the static optimal tax rates coincide sixth if a zero tax rate separates then the optimal dynamic tax rate is positive

monetary policy in a financial crisis what are the economic effects of an interest rate cut when an economy is in the midst of a financial crisis under what conditions will a cut stimulate output and employment and raise welfare under what conditions will a cut have the opposite effects we answer these questions in a general class of open economy models where a financial crisis is modeled as a time when collateral constraints are suddenly binding we find that when there are frictions in adjusting the level of output in the traded good sector and in adjusting the rate at which that output can be used in other parts of the economy then a cut in the interest rate is most likely to result in a welfare reducing fall in output and employment when these frictions are absent a cut in the interest rate improves asset positions and promotes a welfare increasing economic expansion