equilibrium and government commitment abstract how should a government use the power to commit to ensure a desirable equilibrium outcome in this paper i show a misleading aspect of what has become a standard approach to this question and i propose an alternative i show that the complete description of an optimal indeed of any policy scheme requires outlining the consequences of paths that are often neglected the specification of policy along those paths is crucial in determining which schemes implement a unique equilibrium and which ones leave room for multiple equilibria that depend on the expectations of the private sector

optimal fiscal policy under multiple equilibria abstract we study optimal fiscal policy in an economy where i search frictions create a coordination problem and generate multiple pareto ranked equilibria and ii the government finances the provision of a public good by taxing market activity the government must choose the tax rate before it knows which equilibrium will obtain and therefore an important part of the problem is determining how the policy will affect the equilibrium selection process we show that when the equilibrium selection rule is based on the concept of risk dominance higher tax rates make coordination on the pareto superior outcome less likely as a result taking equilibrium selection effects into account leads to a lower optimal tax rate

credible public policy abstract credible public policy is defined in a way that incorporates competitive equilibrium behavior for households and subgame perfect nash equilibrium behavior for the government it is shown that the set of all equilibrium outcome paths for credible policies can be constructed by using arguments analogous to those of abreu 1988 for repeated games the results are then extended to systems with state variables simple models of monetary policy and capital taxation are studied by way of example

globalization labor markets and policy backlash in the past the late nineteenth and twentieth centuries have many things in common both periods recorded fast growth convergence and labor market integration between oecd members both periods witnessed intense debate about who gained and who lost from globalization furthermore the earlier period saw a retreat from global liberalism long before the interwar deglobalization disaster did globalization of that time plant seeds of its own destruction are there lessons for the present

sophisticated monetary policies in standard monetary policy approaches interest rate rules often produce indeterminacy a sophisticated policy approach does not sophisticated policies depend on the history of private actions government policies and exogenous events and can differ on and off the equilibrium path they can uniquely implement any desired competitive equilibrium when interest rates are used along the equilibrium path implementation requires regime switching these results are robust to imperfect information our results imply that the taylor principle is neither necessary nor sufficient for unique implementation they also provide a direction for empirical work on monetary policy rules and determinacy

the fiscal theory of the price level in a world of low interest rates abstract a central equation for the fiscal theory of the price level ftpl is the government budget constraint or government valuation equation which equates the real value of government debt to the present value of fiscal surpluses in the past decade the governments of most developed economies have paid very low interest rates and there are many other periods in the past in which this has been the case in this paper we revisit the implications of the ftpl in a world where the rate of return on government debt may be below the growth rate of the economy considering different sources for the low returns dynamic inefficiency the liquidity premium of government debt or its favorable risk profile this article is part of a special issue entitled fiscal and monetary policies

the role of market forces in assuring contractual performance the conditions under which transactors can use the market repeat purchase mechanism of contract enforcement are examined increased price is shown to be a means of assuring contractual performance a necessary and sufficient condition for performance is the existence of price sufficiently above salvageable production costs so that the nonperforming firm loses a discounted steam of rents on future sales which is greater than the wealth increase from nonperformance this will generally imply a market price greater than the perfectly competitive price and rationalize investments in firm specific assets advertising investments thereby become a positive indicator of likely performance

optimal taxation in models of endogenous growth we study the problem of optimal taxation in three infinite horizon representative agent endogenous growth models the first model is a convex model in which physical and human capital are perfectly symmetric our second model incorporates elastic labor supply through a lucas style technology analysis of these two models points out the danger of assuming that government expenditures are exogenous in our third model we include government expenditures as a productive input in capital formation showing that the limiting tax rate on capital is no longer zero in numerical simulations we find similar effects on growth and welfare in all three models

a game theoretic view of the fiscal theory of the price level the goal of this paper is to probe the validity of the fiscal theory of the price level by modelling explicitly the market structure in which households and the government make their decisions i describe the economy as a game and i am thus able to state precisely the consequences of actions that are out of the equilibrium path i show that there exist government strategies that lead to a version of the fiscal theory in which the price level is determined by fiscal variables alone these strategies are however more complex than the simple budgetary rules usually associated with the fiscal theory and the government budget constraint cannot be merely viewed as an equilibrium condition

unique equilibrium in a model of self fulfilling currency attacks even though self fulfilling currency attacks lead to multiple equilibria when fundamentals are common knowledge we demonstrate the uniqueness of equilibrium when speculators face a small amount of noise in their signals about the fundamentals this unique equilibrium depends not only on the fundamentals but also on financial variables such as the quantity of hot money in circulation and the costs of speculative trading in contrast to multiple equilibrium models our model allows analysis of policy proposals directed at curtailing currency attacks

optimal fiscal policy in a business cycle model this paper develops the quantitative implications of optimal fiscal policy in a business cycle model in a stationary equilibrium the ex ante tax rate on capital income is approximately zero there is an equivalence class of ex post capital income tax rates and bond policies that support a given allocation within this class the optimal ex post capital tax rates can range from close to independently and identically distributed to close to a random walk the tax rate on labor income fluctuates very little and inherits the persistence properties of the exogenous shocks thus there is no presumption that optimal labor tax rates follow a random walk most of the welfare gains realized by switching from a tax system like that of the united states to the ramsey system come from an initial period of high taxation on capital income

banking panics and policy responses we study how banking panics unfold in av ersion of the diamond and dybvig 1983 model with limited commitment as is well known the banking authority could eliminate the possibility of a run on the banking system by committing to suspend payments to depositors if a run were to start once a run is under way however the banking authority will choose to reschedule rather than suspend payments we construct equilibria in which depositors run on the banking system with positive probability and we show that an equilibrium bank run in this setting is necessarily partial with only some depositors participating we also show that a run naturally occurs in waves with each wave of withdrawals prompting a further policy response from the banking authority the number of waves that occur in equilibrium is stochastic and can be arbitrarily large

inflation targeting as a monetary policy rule the purpose of the paper is to survey and discuss in ation targeting in the context of monetary policy rules the paper provides a general conceptual discussion of monetary policy rules attempts to clarify the essential characteristics of in ation targeting compares in ation targeting to other monetary policy rules and draws some conclusions for the monetary policy of the european system of central banks jel classi cation e42 e52

forward guidance communication commitment or both abstract forward guidance has been suggested as a form of commitment odyssean by the policymaker or as a way of conveying information delphic i analyze the interaction between households and the central bank as a game in which the central bank sends messages without private information the set of equilibrium payoffs is independent of any announcements pure odyssean forward guidance is redundant with private information communication can have social value forward guidance is well suited to leverage preexisting credibility to communicate a central bank s private information about its own preferences or beliefs

endogenous price fluctuations in an optimizing model of a monetary economy this paper demonstrates that an optimizing model of a monetary economy can produce perfect foresight equilibria in which the price level fluctuates forever cyclically or chaotically fluctuating equilibria are more likely to exist when the rate of money supply growth is high furthermore the set of equilibrium prices may have a complicated topological structure which poses a more serious problem concerning the validity of comparative statics method than any sort of indeterminacy previously discussed in the literature copyright 1991 by the econometric society

is financial globalization beneficial this lecture examines whether financial globalization is beneficial to developing countries by first examining the evidence on financial development and economic growth and concludes that financial development is indeed a key element in promoting economic growth it then asks why if financial development is so beneficial it often does not occur it then goes on to examine whether globalization particularly of the financial kind can help encourage financial and economic development and argues that it can however financial globalization does not always work to encourage economic development because it often leads to devastating financial crises the issue is thus not whether financial globalization is inherently good or bad but whether it can be done right

overcompliance and voluntary agreements voluntary agreements with industry offer many examplesof overcompliance with respect to environmentalstandards such phenomena seem to be irrational butappear less surprising considering firms strategiesare aimed to internalise environmental quality wemodel the choice of the environmental quality ofproducts in a one shot game between a monopolist andconsumers to show the existence of inefficientequilibria where quality is low because of moralhazard the firm can however change its equilibriumstrategy in a repeated but finite game in order tobuild an environmental reputation if we suppose thatconsumers information is not only imperfect withregard to quality but also incomplete with respect toany environmental constraint that may affect thebehaviour of firms like the threat either of astricter regulation or of potential entry in atwo period model we show the existence of a perfectbayesian equilibrium in mixed strategies where thefirm can revert to the production of green products inorder to influence consumers beliefs and acquire anenvironmentally friendly reputation due to thepeculiarity of environmental information greenproducts are credence goods we claim that anexplicit agreement is also necessary in order toestablish monitoring and controlling procedures toverify the performance of firms these procedures canexplain per se the diffusion of voluntary agreementsthat are nevertheless self enforcing because of thereputation effect

balanced budget rules distortionary taxes and aggregate instability a traditional argument against a balanced budget fiscal policy rule is that it amplifies business cycles by stimulating aggregate demand during booms via tax cuts and higher public expenditures and by reducing demand during recessions through a corresponding fiscal contraction this paper suggests an additional source of instability that may arise from this type of fiscal policy rule it shows that within the standard neoclassical growth model a balanced budget rule can make expectations of higher tax rates self fulfilling if the fiscal authority relies heavily on changes in labor income taxes to eliminate short run fiscal imbalances calibrated versions of the model show that indeterminacy occurs for income tax rates that are empirically plausible for the u s economy and other group of seven countries

redistributive taxation in a simple perfect foresight model abstract we investigate the redistributive potential of capital taxation in an intertemporal maximizing model of capital formation first even unanticipated redistributive capital taxation is severely limited in its effectiveness since it depresses wages second under any convergent redistributive tax policy which maximizes a paretian social objective the capital income tax will converge to zero independent of the factor supply elasticities these results are independent of workers holdings of capital

when are agents negligible the authors examine the following paradox in a dynamic setting equilibria can be radically different in a model with a finite number of agents than in a model with a continuum of agents they present a simple strategic setting in which this paradox is a general phenomenon however the paradox disappears when there is noisy observation of the players actions and the aggregate level of noise does not disappear too rapidly as the number of players increases the authors give several economic examples in which this paradox has recently received attention durable goods monopoly corporate takeovers and time consistency of optimal government policy copyright 1995 by american economic association

sovereign default the role of expectations we study a variation of the standard model of sovereign default as in aguiar and gopinath 2006 or arellano 2008 and show that this variation is consistent with multiple interest rate equilibria some of those equilibria correspond to the ones identi ed by calvo 1988 where default is likely because rates are high and rates are high because default is likely the model is used to simulate equilibrium movements in sovereign bond spreads that resemble sovereign debt crises it is also used to discuss lending policies similar to the ones announced by the european central bank in 2012

the anticipated and concurring effects of the emu exchange rate volatility institutions and growth abstract reduced exchange rate volatility and higher and less heterogeneous quality of institutional rules and macroeconomic policies are two of the main anticipated and concurring effects expected from a currency union in this paper we measure the magnitude of these two effects for the eurozone countries looking at real effective exchange rates reer and at different indicators of quality of institutional rules and macroeconomic policies qirmp we find that the first effect is much stronger than the second when we compare relative changes for eurozone countries and the rest of the world in the relevant period we further evaluate the impact of both effects on economic growth on a larger sample of countries our findings show that both have significant impact on levels more robust and on rates of growth weaker of per capita gdp

ruling out divergent speculative bubbles abstract the growth in the empirical literature on testing for divergent in mean speculative bubbles indicates that existing theoretical arguments for ruling out such price paths are not sufficiently compelling here we strengthen the case for ruling out explosive or implosive bubbles a priori by filling in two gaps first we demonstrate why divergent stochastic bubbles arising from purely extrinsic uncertainty as in blanchard 1979 cannot be equilibria in a monetary optimizing model second we show why existing arguments for ruling out implosive price bubbles are insufficient in some cases and we provide stronger arguments

indeterminacy and increasing returns abstract we investigate properties of the one sector growth model with increasing returns under two organizational structures capable of reconciling the existence of aggregate increasing returns with competitive behavior by firms the first involves input externalities the second involves monopolistic competition we show for parameters in close accord with recent literature on real business cycles that the model displays an indeterminate steady state that can be exploited to generate a model of business fluctuations driven by self fulfilling beliefs in our first class of models growth is generated by exogenous increases in factor productivity in the second class the marginal product of capital is large enough for endogenous growth journal of economic literature classification numbers e00 e3 o40

chaos sunspots and automatic stabilizers abstract we consider a real business cycle model with an externality in production depending on parameter values the model has sunspot equilibria cyclical and chaotic equilibria and equilibria with deterministic or stochastic regime switching we study the implications of this model environment for automatic stabilizer tax systems stabilization is desirable because the efficient allocations are characterized by constant employment and output growth we identify an automatic stabilizer income tax subsidy schedule with two properties i it specifies the tax rate to be an increasing function of aggregate employment and ii earnings are subsidized when aggregate employment is at its efficient level the first feature eliminates inefficient fluctuating equilibria while the second induces agents to internalize the externality

optimal fiscal and monetary policy in an economy without capital abstract this paper is concerned with the structure and time consistency of optimal fiscal and monetary policy in an economy without capital in a dynamic context optimal taxation means distributing tax distortions over time in a welfare maximizing way for a barter economy our main finding is that with debt commitments of sufficiently rich maturity structure an optimal policy if one exists is time consistent in a monetary economy the idea of optimal taxation must be broadened to include an inflation tax and we find that time consistency does not carry over an optimal inflation tax requires commitment by rules in a sense that has no counterpart in the dynamic theory of ordinary excise taxes the reason time consistency fails in a monetary economy is that nominal assets should from a welfare maximizing point of view always be taxed away via an immediate inflation in a kind of capital levy this emerges as a new possibility when money is introduced into an economy without capital

expectation traps and discretion abstract we develop a dynamic model with optimizing private agents and a benevolent optimizing monetary authority that cannot commit to future policies we characterize the set of sustainable equilibria and discuss the implications for institutional reform we show that there are equilibria in which the monetary authority pursues inflationary policies because that is what private agents expect we call such equilibria expectation traps alternative institutional arrangements for the conduct of monetary policy which impose limited forms of commitment on the policymaker can eliminate expectation traps journal of economic literatureclassification numbers e31 e42 e50 e51 e58

distinguished lecture on economics in government reflections on managing global integration the language of public policy is increasingly the language of economics and sophisticated policy formulation depends to an ever greater extent on an understanding of economic concepts over the last six years i have spent at the u s department of the treasury i have had the chance to be present when concepts ranging from superlative price indices to multiple equilibrium to the liquidity trap to dynamic hedging to shadow pricing were discussed with the president of the united states where it was once the case that the president s council of economic advisers waged a lonely battle for good economics in the federal government today first rate economists staff departments ranging from treasury to labor to commerce to justice to the environmental protection agency and they hold line as well as advisory positions while academic interlopers serving as political appointees like myself may get a majority of the attention a majority of the greater economic literacy of government policy in areas ranging from tax policy to telecommunications policy from monetary policy to manpower policy from financial policy to forestry policy is the result of the steady perseverance of career government economists as remarkable as the penetration of economics and economists into the american government has been their penetration into even higher levels of governments around the world is even more notable a decade ago mexican president zedillo was a practicing monetary economist in the bank of mexico two recent italian prime ministers romano prodi and lamberto dini have distinguished records as economic thinkers lest anyone think all those trained in economics think alike russian prime minister primakov holds a doctorate in political economy there are too many examples to catalogue of economists at the level of finance minister and central bank governor consider the influence of

on the optimal taxation of capital income abstract we show that in models in which labor services are supplied jointly with human capital the chamley and judd result on zero capital income taxation in the limit extends to labor taxes as long as accumulation technologies are constant returns to scale moreover for a class of widely used preferences consumption taxes are zero in the limit as well however we show by the construction of two examples that these results no longer hold for certains types of restrictions on tax rates or if there are profits generated journal of economic literatureclassification numbers e62 h21

the perils of taylor rules abstract since john taylor s 1993 carnegie rochester conf ser publ policy39 195 214 seminal paper a large literature has argued that active interest rate feedback rules that is rules that respond to increases in inflation with a more than one for one increase in the nominal interest rate are stabilizing in this paper we argue that once the zero bound on nominal interest rates is taken into account active interest rate feedback rules can easily lead to unexpected consequences specifically we show that even if the steady state at which monetary policy is active is locally the unique equilibrium typically there exist an infinite number of equilibrium trajectories originating arbitrarily close to that steady state that converge to a liquidity trap that is a steady state in which the nominal interest rate is near zero and inflation is possibly negative journal of economic literature classification numbers e52 e31 e63

the mexican peso crisis sudden death or death foretold abstract we argue that allowing for the possibility of a self fulfilling panic helps to understand several features of the recent mexican crisis self fulfilling expectations became decisive in generating a panic only after the government ran down gross reserves and ran up short term dollar debt we present a simple model to explain how and why multiple equilibria can occur for some levels of reserves or debt but not for others lastly we argue that the imperfect credibility of mexican exchange rate policy made it advisable to follow more contractionary fiscal and monetary policies in 1994 our model formalizes the reasons why this is so

monetary fiscal interactions with endogenous liquidity frictions i develop a tractable macro model with endogenous asset liquidity to understand monetary fiscal interactions with liquidity frictions agents face idiosyncratic investment risks and meet financial intermediaries in competitive search markets asset liquidity is determined by the search friction and the cost of operating the financial intermediaries and it drives the financing constraints of entrepreneurs those who have investment projects and their ability to invest in contrast to private assets government bonds are fully liquid and can be accumulated in anticipation of future opportunities to invest a higher level of real government debt enhances the liquidity of entrepreneurs portfolios and raises investment however the issuance of debt also raises the cost of financing government expenditures a higher level of distortionary taxation and or a higher real interest rate a long run optimal supply of government debt emerges i also show that a proper mix of monetary and fiscal policies can avoid a deep financial recession

public debt in economies with heterogeneous agents abstract we study public debt in competitive equilibria in which a government chooses transfers and taxes optimally and in addition decides how thoroughly to enforce debt contracts if the government enforces perfectly asset inequality is determined in an optimum competitive equilibrium but the level of government debt is not welfare increases if private debt contracts are not enforced borrowing frictions let the government gather monopoly rents that come from issuing public debt without facing competing private borrowers regardless of whether the government chooses to enforce private debt contracts the level of initial government debt does not affect an optimal allocation

sunspot equilibria rational bubbles in a model of money in the utility function abstract sunspot equilibria are constructed in brock s 1975 model of money in the utility function serial correlations of real balances and the nominal interest rate in these equilibria can be either positive or negative the example here suggests that local sunspots are more likely to exist when the agent s discount rate is small and that serial correlations in local sunspots when they exist are inversely related to the rate of money growth it is also shown that stationary sunspots may exist even when equilibrium cycles do not

government policy and the probability of coordination failures this paper introduces an approach to the study of optimal government policy in economies characterized by a coordination problem and multiple equilibria such models are often criticized as not being useful for policy analysis because they fail to assign a unique prediction to each possible policy choice we employ a selection mechanism that assigns ex ante a probability to each equilibrium indicating how likely it is to obtain we show how such a mechanism can be derived as the natural result of an adaptive learning process this approach leads to a well defined optimal policy problem and has important implications for the conduct of government policy we illustrate these implications using a simple model of technology adoption under network externalities

the perils of nominal targets a monetary authority can be committed to pursuing an inflation price level or nominal gdp target yet systematically fail to achieve the prescribed goal constrained by the zero lower bound on the policy rate the monetary authority is unable to implement its objectives when private sector expectations stray far enough from the target low inflation expectations become self fulfilling resulting in an additional markov equilibrium in which the monetary authority falls short of the nominal target average output is below its efficient level and the policy rate is typically low introducing a stabilization goal for long term nominal rates can implement a unique markov equilibrium without fully compromising stabilization policy

optimality of the friedman rule in economies with distorting taxes abstract we find conditions for the friedman rule to be optimal in three standard monetary models our main contribution is to shed light on two issues in the literature first the conventional view maintains that when money is a final good its services should be taxed moreover if money demand is interest inelastic its services should be taxed heavily we show that this view is incorrect second there is an ongoing controversy about whether the optimality of the friedman rule is connected to the intermediate goods result from public finance we resolve this controversy by showing a deep connection between these results

optimal taxation of capital income in general equilibrium with infinite lives this paper analyzes the optimal tax on capital income in general equilibrium models of the second best agents have infinite lives and utility functions which are extensions from the koopmans form the population is heterogeneous the important property of the models is the equality between the social and the private discount rates in the long run i find that the optimal tax rate is zero in the long run for a special case of additively separable utility functions i then determine the tax rates along the dynamic path and conditions that are sufficient for the local stability of the steady state

speculative runs on interest rate pegs abstract we analyze a new class of equilibria that emerges when a central bank conducts monetary policy by setting an interest rate as an arbitrary function of its available information and letting the private sector set the quantity traded these equilibria involve a run on the central bank s interest target whereby money grows fast private agents borrow as much as possible against the central bank and the shadow interest rate is different from the policy target we argue that these equilibria represent a particular danger when banks hold large excess reserves such as is the case following periods of quantitative easing our analysis suggests that successfully managing the exit strategy requires additional tools beyond setting interest rate targets and paying interest on reserves in particular freezing excess reserves or fiscal policy intervention may be needed to fend off adverse expectations

the signaling effect of raising inflation abstract this paper argues that central bankers should temporarily raise inflation when anticipating liquidity traps to ensure the credibility of otherwise time inconsistent forward guidance policies as stable inflation in normal times either stems from central bankers desire to maintain credibility or from aversion to inflation the private sector is unable to infer the central banker s willingness to follow through on promises from observing stable inflation jeopardizing the efficiency of forward guidance policy we show that this signaling motive can justify temporary deviations of inflation from target well above 2 but also that the low inflation volatility during the great moderation was insufficient to ensure fully efficient forward guidance when needed

is it is or is it ain t my obligation regional debt in a fiscal federation this article studies the repayment of regional debt in a multiregion economy with a central authority who pays the obligation issued by a region with commitment the central government will use its economy wide taxation power in support of its objective to smooth distortionary taxes and consumption across regions absent commitment this tool of the central government may be exploited to induce it to bail out regional government deficits we characterize the conditions under which bailouts occur and their welfare implications in particular we show when the gains from a federation may outweigh the welfare costs of a bailout we use these insights to comment on actual fiscal relations in three quite different federations the united states the european union and argentina

voluntary environmental agreements good or bad news for environmental protection abstract there has been growing interest in the use of voluntary agreements vas as an environmental policy tool this article uses a simple model to determine whether vas are likely to lead to efficient environmental protection we consider cases where polluters are induced to participate either by a background threat of mandatory controls the stick approach or by cost sharing subsidies the carrot approach the results suggest that the overall impact on environmental quality could be positive or negative depending on a number of factors including the allocation of bargaining power the magnitude of the background threat and the social cost of funds