the inflation tax in a real business cycle model money is incorporated into a real business cycle model using a cash in advance constraint the model economy is used to analyze whether the business cycle is different in high inflation and low inflation economies and to analyze the impact of variability in the growth rate of money in addition the welfare cost of the inflation tax is measured and the steady state properties of high and low inflation economies are compared

cooperative and noncooperative r d in duopoly with spillovers contrary to the usual assumption made in most oligopoly models relations among firms are seldom of a wholly cooperative or noncooperative type in many situations they compete in some fields while they cooperate in others an important example is the case of cooperative research efforts bringing fierce competitors together two types of agreement are observed first r d cooperation can take place at the so called precompetitive stage companies share basic information and efforts in the r d stage but remain rivals in the market place 1 a second type of agreement involves an extended collusion between partners creating common policies at the product level the usual justifications of this extension are the difficulties of protecting intellectual property the idea is then to allow partners who have achieved inventions together to also control together the processes and products which embody the results of their collaboration in order to recuperate jointly their r d investments 2 what could be expected from these types of agreement is a reduction in r d expenditures because of less wasteful duplication and a reduction of total production because of more reprinted from the american economic review 78 5 1133 1137 1988 center for operations research econometrics 1348 louvain la neuve belgium we are grateful to jean

the silent success of customs unions an earlier version of this paper is part of arevik gnutzmann mkrtchyan s thesis essays on the economics of trade agreements 2014 http hdl handle net 1814 34561

investment uncertainty and liquidity we analyze the dynamic investment decision of a firm subject to an endogenous financing constraint the threat of future funding shortfalls lowers the value of the firm s timing options and encourages acceleration of investment beyond the first best optimal level as well as highlighting another way by which capital market frictions can distort investment behavior this result implies that 1 the sensitivity of investment to cash flow can be greatest for high liquidity firms and 2 greater uncertainty has an ambiguous effect on investment

credit and inflation under borrowerʼs lack of commitment here we investigate the existence of credit in a cash in advance economy where there are complete markets but for the fact that agents cannot commit to repay their debts defectors are banned from the credit market but they can use money balances for saving purposes without uncertainty deflation crowds out credit completely the equilibrium allocation however is efficient if the government deflates at the time preference rate efficiency can also be restored with positive inflation for any non negative inflation rate below the optimal level the volume of credit and the real interest rate increase with inflation our results hold when idiosyncratic uncertainty is introduced and households are sufficiently impatient but in one instance efficiency cannot be restored if the deflation rate is nearby the rate of time preference our numerical examples suggest that the optimal inflation rate is not too large for reasonable levels of patience and risk aversion finally we present a framework where the use of money arises endogenously and show that it is tantamount to our cash in advance framework our results hold in this modified environment

optimal monetary policy in a cash in advance economy i introduction this paper addresses the issue of optimal monetary policy within a particular general equilibrium model of the monetary transmission mechanism the model analyzed is a member of the recent class of liquidity models of the monetary business cycle 1 these liquidity models are something of a growth industry partly because they are potentially consistent with a monetary equilibrium in which monetary injections drive down nominal rates of interest and stimulate real activity stylized facts supported by evidence presented in for example christiano and eichenbaum 1992 an unexplored question is the role of monetary policy in these models this paper makes an attempt at remedying this deficiency by analyzing optimal monetary policy in a model with liquidity effects as in the liquidity models mentioned above the model analyzed here is constructed by imposing two trading frictions on an otherwise frictionless arrow debreu environment 2 the first is a requirement that all transactions be carried out in a decentralized fashion with the use of cash this friction is the well known cash in advance constraint first suggested by clower 1967 but now quite commonplace in models of monetary equilibrium as in lucas and stokey 1987 and cooley and hansen 1989 i impose this constraint because it is a tractable way of introducing a transactions demand for cash the qualitative results would be unaffected if a more general transactions technology was employed the second friction is unique to the liquidity models i assume that private agents cannot quickly move cash across markets this assumption of sluggish cash flow presumably motivated by transactions costs that are not explicitly modeled implies that cash may not be equally valued across markets with its value in a particular market determined by the amount of cash or liquidity contained in the market this friction introduces the so called liquidity effects on asset prices and real activity the paper proceeds as follows the next section develops the basic model and discusses the effects created by the assumed trading frictions section iii explores optimal monetary policy the nature of the trading frictions introduces a role for activist monetary policy in particular to the extent that the central bank can adjust liquidity more rapidly than the private sector there is a welfare improving role for monetary policy in some cases interest rate smoothing is a good idea while in others optimal policy will increase interest rate variability section iv links the results to the optimum quantity of money literature and offers up a few conclusions ii a model of monetary non neutrality the economy is populated with three types of agents households firms and financial intermediaries there are numerous identical agents of each type so that all behave as atomistic competitors given this assumption i will confine my discussion to a representative agent of each type the representative household is made up of two members a shopper and a worker the shopper s role is to use the household s assets to acquire consumption goods during each period while the worker supplies some portion of the household s time endowment equal to 1 each period to firms in exchange for payment the household s preferences over uncertain consumption and leisure streams are given by e summation of beta sup t u c sub t v 1 l sub t where t 0 to infinity where beta is an element of 0 1 c sub t and l sub t are time t consumption and work effort respectively v is increasing and concave and mathematical expression omitted the expectation is over realizations of the economy wide shocks the expression s sub t is an element of s subset r denotes the state of the world at time t where s is a compact set these states are i i d across time with a distribution function given by

a political economy theory of trade agreements we develop a model where trade agreements in addition to correcting terms of trade externalities help governments to commit vis a vis domestic industrial lobbies the model allows us to explore how the characteristics of the political environment aect the structure of the trade agreement and the extent of trade liberalization the model also highlights the role of intersectoral capital mobility in determining trade liberalization in a dynamic extension of the model we explore the extent to which trade liberalization occurs gradually and how its speed depends on the fundamentals of the problem

public debt discretionary policy and inflation persistence we describe a simple mechanism that generates inflation persistence in a standard sticky price model of optimal fiscal and monetary policy key to this mechanism is that policies are implemented under discretion the government s discretionary incentive to erode the real value of nominal public debt by means of surprise inflation renders inflation expectations and in further consequence equilibrium inflation rates highly correlated with the stock of public debt debt in turn is highly persistent allowing for tax smoothing in the face of disturbances due to the aforementioned correlation the persistence in debt carries over to inflation our analysis uncovers a non monotonic effect of nominal rigidities on inflation persistence and shows that government debt under discretion does not display the near random walk property familiar from the ramsey literature a calibrated version of the model that incorporates a moderate degree of monopolistic competition and price stickiness is quantitatively consistent with the inflation dynamics experienced in the usa since the volcker disinflation of the early 1980s

inflation and asset prices in a monetary economy abstract this paper derives solutions for inflation and asset prices in a cash in advance economy with logarithmic preferences although the monetary and real processes are independent the money supply affects real interest rates and stock returns as well as nominal interest rates

endogenous trade policy through majority voting an empirical investigation abstract the median voter approach to trade policy determination within a heckscher ohlin framework as in mayer am econ rev 74 5 1984 970 predicts that an increase in inequality holding constant the economy s overall relative endowments raises trade barriers in capital abundant economies and lowers them in capital scarce economies we find support for this prediction using cross country data on inequality capital abundance and diverse measures of protection we perform certain robustness checks that include controlling for the effects of political rights and schooling as well as using alternative datasets on factor endowments

concubinage or marriage informal and formal cooperations for innovation based on a sample of german inno innovating firms that contains information on formal and informal innovation cooperation between customers and suppliers we state that firms perceive informal cooperation as being more important than formal cooperation modes we then investigate the determinants of firms decisions to engage into the respective cooperation modes in line with previous empirical work we do not find much empirical evidence for the relevance of incoming spillovers in addition our results suggest that this finding holds as well for informal cooperations a firms ability to protect its proprietary innovations however seems to be a key determinant of formal as well as informal cooperations furthermore absorptive capacity and the organizational structure of in house r d play an important role another relevant driver of vertical cooperations are the innovation dynamics at the he industry level firms who operate an r d department and firms who are involved in costly r d projects tend to cooperate formally rather than informally

an economic model of representative democracy this paper develops an approach to the study of democratic policy making where politicians are selected by the people from those citizens who present themselves as candidates for public office the approach has a number of attractive features first it is a conceptualization of a pure form of representative democracy in which government is by as well as of the people second the model is analytically tractable being able to handle multidimensional issue and policy spaces very naturally third it provides a vehicle for answering normative questions about the performance of representative democracy

the value of trade agreements in the presence of political pressures an argument often heard in favor of trade agreements is that by committing to free trade a government can credibly distance itself from domestic lobbies but several existing models of endogenous protection suggest that governments have no interest in foreclosing interest group pressures since governments derive rents from the political process we develop a small country model in which factors are sector specific in the short run but mobile in the long run we show that in this setting a government may be worse off in the political equilibrium than under commitment to free trade and hence it may value a trade agreement

the sources of protectionist drift in representative democracies abstract we analyze a two country two good model of international trade in which citizens in each country differ by their specific factor endowments the trade policy in each country is set by the politician who has been elected by the citizens in a previous stage due to a delegation effect citizens generally favor candidates who are more protectionist than they are the one candidate per country equilibria exhibit a protectionist drift owing to this delegation effect in addition we find an additional source of protectionist drift that we call the abstention effect not only do candidates wish to delegate to more protectionist colleagues but these more protectionist colleagues who can win election prefer still more protectionist candidates than themselves therefore they have an incentive to abstain that is not run for election we show that because of this abstention effect there exists a range of electable citizens all of whom are more protectionist than the median voter s most preferred candidate we extend the analysis allowing two candidate equilibria and the possibility that there are costs and benefits of holding office

bilateralism and free trade we study a setting with many countries in each country there are firms that can sell in the domestic as well as foreign markets countries can sign bilateral free trade agreements that lower import tariffs and thereby facilitate trade we allow a country to sign any number of bilateral free trade agreements a profile of free trade agreements defines the trading regime our principal finding is that in symmetric settings bilateralism is consistent with global free trade we also explore the effects of asymmetries across countries and political economy considerations on the incentives to form trade agreements

more on the inflation tax and the value of equity a cash in advance macro model is presented in which dividends are distributed at the end of each p eriod but where all other money receipts may be spent immediately on output and labor markets if money grows at a constant rate only th e real price of equity will be inversely related to inflation in the steady state if the money supply is allowed to grow at an increasing rate however agent welfare will decline

exchanging market access at the outsiders expense the case of customs unions under a customs union countries can exchange preferential market access by coordinating external tariffs to shift profits from excluded countries i show that the exporting rents resulting from this coordination can offset trade diversion losses produced by the union even if its members are relatively small in world markets such gains come however at the expense of excluded countries i show that small countries can use customs unions also to foster multilateral cooperation by increasing the incentives of excluded countries to support global free trade le cas des unions douanieres dans le cas d une union douaniere les pays peuvent marchander l acces preferentiel a un marche en coordonnant leurs tarifs externes de maniere a extraire des profits des pays exclus on montre que les rentes a l exportation qui resultent de cette coordination peuvent compenser les pertes attribuables a la diversion du commerce qui decoule de l union douaniere meme si ses membres sont relativement de petite taille dans les marches mondiaux de tels gains se font cependant aux depens des pays exclus on montre que les petits pays peuvent utiliser les unions douanieres pour stimuler la cooperation multilaterale en accroissant les incitations des pays exclus a poursuivre des strategies de libre echange global

discretionary policy in a monetary union with sovereign debt this paper examines the interactions between multiple national fiscal policymakers and a single monetary policy maker in response to shocks to government debt in some or all of the countries of a monetary union we assume that national governments respond to excess debt in an optimal manner but that they do not have access to a commitment technology this implies that national fiscal policy gradually reduces debt the lack of a commitment technology precludes a random walk in steady state debt but the need to maintain national competitiveness avoids excessively rapid debt reduction if the central bank can commit it adjusts its policies only slightly in response to higher debt allowing national fiscal policy to undertake most of the adjustment however if it cannot commit then optimal monetary policy involves using interest rates to rapidly reduce debt with significant welfare costs we show that in these circumstances the central bank would do better to ignore national fiscal policies in formulating its policy

time consistent monetary policy with endogenous price rigidity abstract i characterize time consistent equilibrium in an economy with price rigidity and an optimizing monetary authority operating under discretion firms have the option to increase their frequency of price change at a cost in response to higher inflation previous studies which assume a constant degree of price rigidity across inflation regimes find two time consistent equilibria one with low inflation the other with high inflation in contrast when price rigidity is endogenous the high inflation equilibrium ceases to exist hence time consistent equilibrium is unique this result depends on two features of the analysis 1 a plausible quantitative specification of the fixed cost of price change and 2 the presence of an arbitrarily small cost of inflation that is independent of price rigidity

majority voting with single crossing preferences we clarify and extend a number of sufficient conditions for the existence of a majority voting equilibrium on one dimensional choice domains these conditions variously stated in the previous literature all impose order restrictions on voter preferences for instance monotone marginal rates of substitution which we show to imply or be equivalent to a general ordinal version of the single crossing condition this simple property is economically intuitive and easily checked in applications this ease of application is demonstrated through an examination of voting models of redistributive income taxation and trade union bargaining behaviour

delegation and threat in bargaining abstract two principals nations appoint one agent each to bargain over the provision of a public good two institutional set ups are studied each with a different level of authority given to the agents here authority means the right to decide the own side s provision if negotiations break down in equilibrium the principals choose agents with preferences differing from their own the low authority equilibrium pareto dominates with regard to the principals the case of the principals deciding on the provisions simultaneously autarchy the high authority equilibrium is pareto dominated by the low authority equilibrium and it may even be dominated by autarchy journal of economic literatureclassification numbers c71 and c72

rules of origin and the profitability of trade deflection abstract when a country grants preferential tariffs to another either reciprocally in a free trade agreement fta or unilaterally rules of origin roos are defined to determine whether a product is eligible for preferential treatment roos exist to avoid that exports from third countries enter through the member with the lowest tariff trade deflection however roos distort exporters sourcing decisions and burden them with red tape using a global data set we show that for 86 of all bilateral product level comparisons within ftas trade deflection is not profitable because external tariffs are rather similar and transportation costs are non negligible in the case of unilateral trade preferences extended by rich countries to poor ones that ratio is a striking 98 the pervasive and unconditional use of roos is therefore hard to rationalize

money and asset prices with uninsurable risks abstract we present a theory of differences of liquidity across assets based on an endogenous ranking of assets as media of exchange arising from their relative quality as hedging devices when assets have two distinct roles as intertemporal media of exchange and hedging devices buyers have generically a strict preference for paying sellers with the asset which is the relative better hedging device for sellers the consequence of this preference is that there are three monetary policy regimes and these regimes differ in which assets serve as media of exchange whether assets carry a liquidity premium and in the impact that monetary policy has on asset prices

optimal taxation without state contingent debt in an economy studied by lucas and stokey tax rates inherit the serial correlation structure of government expenditures belying barro s earlier result that taxes should be a random walk for any stochastic process of government expenditures to recover a version of barro s random walk tax smoothing outcome we modify lucas and stokey s economy to permit only risk free debt having only risk free debt confronts the ramsey planner with additional constraints on equilibrium allocations beyond one imposed by lucas and stokey s assumption of complete markets the ramsey outcome blends features of barro s model with lucas and stokey s in our model the contemporaneous effects of exogenous government expenditures on the government deficit and taxes resemble those in lucas and stokey s model but incomplete markets put a near unit root component into government debt and taxes an outcome like barro s however we show that without ad hoc limits on the government s asset holdings outcomes can diverge in importa

indeterminacy and volatility of exchange rates under imperfect currency substitution i introduction this paper presents a model of exchange rate determination under currency substitution its primary objective is to examine the implications of currency substitution for the behavior of exchange rates in a general equilibrium model under uncertainty the basic framework used here is the cash in advance model of lucas 1982 which is extended to allow for substitution among currencies it is well known that under perfect currency substitution foreign exchange rates may become indeterminate and behave independently of fundamental economic variables the reason is that the objects traded in foreign exchange markets are fiat currencies which unless supported by binding legal tender laws have no fundamental economic value when agents have unrestricted access to currency markets and are free to use any currency as the means of payment currency demands are entirely determined by speculation and consequently equilibrium exchange rates become indeterminate e g see kareken and wallace 1981 increased integration of financial markets reduces the costs and the risks of holding balances in multiple currencies 4 this creates more opportunities for currency substitution and it is reasonable to assume that agents are free to use any currency as the means of the payment in some of their international transactions for example suppose some percentage of transactions involving the u s exports to germany can be paid with either u s dollars or german marks agents will look at the opportunity costs i e u s and german nominal interest rates and expected exchange rate changes to decide what combination of the two currencies to use in these transactions if the potential costs and benefits of holding the two currencies are similar then agents will be indifferent between the two currencies we show that this could lead to exchange rate indeterminacy and nonfundamental volatility and change the effectiveness of monetary policies in our cash in advance framework agents are allowed to use any currency in some of their transactions called unrestricted transactions to make different currencies attractive at different times we allow the governments to follow timevarying monetary policies as a result agents will change their currency holdings to maximize the risk adjusted return on their portfolio subject to the constraint that specific currencies must be used as the means of payment in their restricted transactions 2 to answer specific questions about the behavior of exchange rates we obtain closed form solutions for agents demand functions equilibrium interest rates and the equilibrium exchange rate it turns out that two types of equilibrium exist in the first type the two currencies have different risk return profiles such that agents will prefer to use only one of them in unrestricted transactions in this case the exchange rate will be determined by fundamentals however as a large percentage of transactions become unrestricted the equilibrium exchange rate becomes more volatile under this type of equilibrium the effectiveness of monetary policies are changed currencies of countries that have high nominal interest rates will not be in demand for use in unrestricted transactions 3 this lack of demand means that any increase in the money supply of a high nominal rate country will lead to a larger increase in its rate of inflation and thus a larger reduction in the value of its currency in other words increased currency substitution increases the sensitivity of the currency values to changes in the money supply of high nominal rate countries also we show that as national economies become more integrated and more opportunities for currency substitution arise currencies of countries with high nominal interest rates would decline substantially the reason is that higher opportunity costs are associated with holding these currencies and thus agents will fully take advantage of currency substitution to reduce their holdings of these currencies reducing the value of these currencies

preferential trade agreements and multilateral tariff cooperation are preferential trade agreements ptas building or stumbling blocks for multilateral trade liberalization i address this question in an infinitely repeated tariff game between three countries engaged in intraindustry trade under oligopoly the central result is that when countries are symmetric a free trade agreement fta undermines multilateral tariff cooperation by adversely affecting the cooperation incentive of the nonmember whereas a customs union cu does so via its effect on the cooperation incentives of members however when countries are asymmetric with respect to either market size or cost there exist circumstances where ptas facilitate multilateral tariff cooperation

fiscal sustainability in a new keynesian model recent work on optimal monetary and fiscal policy in new keynesian models suggests that it is optimal to allow steady state debt to follow a random walk in this paper we consider the nature of the time inconsistency involved in such a policy and its implication for discretionary policymaking we show that governments are tempted given inflationary expectations to utilize their monetary and fiscal instruments in the initial period to change the ultimate debt burden they need to service we demonstrate that this temptation is only eliminated if following shocks the new steady state debt is equal to the original efficient debt level even though there is no explicit debt target in the government s objective function analytically and in a series of numerical simulations we show which instrument is used to stabilize the debt depends crucially on the degree of nominal inertia and the size of the debt stock we also show that the welfare consequences of introducing debt are negligible for precommitment policies but can be significant for discretionary policy finally we assess the credibility of commitment policy by considering a quasi commitment policy which allows for different probabilities of reneging on past promises

rent destruction and the political viability of free trade agreements this paper studies the political viability of free trade agreements ftas the key element of the analysis is the rent destruction that these arrangements induce by eliminating intrabloc trade barriers an fta lowers the incentives of import competing industries to lobby for higher external tariffs thereby inducing a reduction of the rents created in the lobbying process using a conventional competitive model i show that the prospect of rent destruction can critically undermine and in some cases rule out entirely the political viability of welfarereducing ftas this result contrasts sharply with findings from the earlier regionalism literature

monetary policy and the transaction role of money in the us the declining importance of money in transactions can explain the well known fact that u s interest rate policy was passive in the pre volcker period and active after 1982 we generalise a standard cashless new keynesian model woodford2003 by incorporating an explicit transaction role for money in the pre volcker period we estimate that money did play an important role and determinacy required a passive interest rate policy however after 1982 money no longer played an important role in facilitating transactions correspondingly the conventional view prevails and an active policy ensured equilibrium determinacy

optimal fiscal and monetary policy some recent results this paper studies the quantitative properties of fiscal and monetary policy in business cycle models in terms of fiscal policy optimal labor tax rates are virtually constant and optimal capital income tax rates are close to zero on average in terms of monetary policy the friedman rule is optimal nominal interest rates are zero and optimal monetary policy is activist in the sense that it responds to shocks to the economy

asset pricing and the propagation of macroeconomic shocks this paper considers the implications of habit formation and financial frictions for the propagation of macroeconomic shocks in a model that is capable of matching asset pricing moments a short lived shock that destroys a small fraction of the economy s stock of pledgeable collateral generates a persistent recession a stock market crash and a flight to safety effect this novel mechanism creates a tight link between the asset pricing implications of macroeconomic models and their ability to propagate and amplify the effects of macroeconomic shocks

modelling imperfectly appropriable r d via spillovers abstract we provide an extensive comparison of the well known r d models of d aspremont jacquemin and kamien muller zang exposing full or partial conflict in key conclusions and policy prescriptions using a mix of formal and or intuitive criteria we argue that the first model is of questionable validity for large spillover values the latter being characterized by jointly increasing returns to scale in the r d process an argument leading to equivalence between the two r d processes but not to agreement on some key conclusions is exposited in conclusion the models emerge as fundamentally different although a unilateral shift in the cost function of the first leads to agreement in all equilibrium outcomes

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

money and asset prices in a cash in advance economy an asset pricing model with money introduced via a cash in advance constraint is presented the monetary velocity is variable hence money demand does not obey the trivial quantity equation the effects of disturbances in output and money growth on real balances the price level and interest rates are examined monetary policy has effects on real asset prices the fisher relation and the premium on nominal bonds are discussed the precise role of the timing of information and transactions for properties of price levels and interest rates are clarified

do south south preferential trade agreements undermine the prospects for multilateral free trade due to trade diversion there has been concerns expressed over the proliferation of preferential trade agreements ptas between south countries in this paper we compare welfare across the various forms of bilateral free trade agreements ftas and customs unions cus and examine their implications for the stability of multilateral free trade while north north ptas tend to yield higher welfare we fi nd certain cases where south south agreements are more likely to lead to global free trade than north north or north south agreements but other cases where multilateral cooperation over free trade is the least likely under south south agreements we also examine how the expansion of existing agreements or the combination of separate agreements affects the potential for free trade

five facts about prices a reevaluation of menu cost models are price decreases 3 the frequency of price increases covaries strongly with inflation whereas the frequency of price decreases and the size of price increases and price decreases do not 4 the frequency of price change is highly seasonal it is highest in the first quarter and then declines 5 we find no evidence of upwardsloping hazard functions of price changes for individual products we show that the first second and third facts are consistent with a benchmark menu cost model whereas the fourth and fifth facts are not

the case for a financial approach to money demand the distribution of money across households is much more similar to the distribution of financial assets than to that of consumption levels even controlling for life cycle effects this is a puzzle for theories which directly link money demand to consumption such as cash in advance cia money in the utility function miuf or shopping time models this paper shows that the joint distribution of money and nancial assets can be explained by an incomplete market model when frictions are introduced into financial markets money demand is modeled as a portfolio choice with a fixed transaction cost in financial markets

central bank independence and the monetary instrument problem we study the monetary instrument problem in a dynamic noncooperative game between separate discretionary fiscal and monetary policy makers we show that monetary instruments are equivalent only if the policy makers objectives are perfectly aligned otherwise an instrument problem exists when the central bank is benevolent while the fiscal authority is short sighted relative to the private sector excessive public spending and debt emerge under a money growth policy but not under an interest rate policy despite this property the interest rate is not necessarily the optimal instrument

optimal fiscal and monetary policies in the face of rare disasters this paper studies optimal fiscal and monetary policies in an economy exposed to large adverse shocks rare disasters we contrast optimal policies under commitment and discretion and identify several striking differences between these institutional environments a government that can commit to its policy plans relies heavily on debt to smooth the adverse effects of large shocks over time lack of commitment seriously limits the government s ability to use debt as a shock absorber under discretion an increase in debt leads to an increase in inflation expectations and therefore higher nominal interest rate distortions hence the discretionary government keeps debt in close vicinity of its steady state level and the response of taxes inflation and interest rates to shocks is much more pronounced under discretion than under commitment this is particularly relevant for large shocks and when the initial stock of government debt is already high at the time the shock occurs we also argue that the adverse welfare effects of disasters are larger under discretion than under commitment but these welfare differentials can be significantly reduced by making the discretionary government inflation averse

optimal fiscal policy in the neoclassical growth model revisited this paper studies optimal taxation in a version of the neoclassical growth model in which investment becomes productive within the period thereby making the supply of capital elastic in the short run because taxing capital is distortionary in the short run the government s ability desire to raise revenues through capital income taxation in the initial period or when the economy is hit with a bad shock is greatly curtailed our timing assumption also leads to a tractable ramsey problem without state contingent debt which can give rise to debt financed budget deficits during recessions

cash and the economy evidence from india s demonetization we analyze a unique episode in the history of monetary economics the 2016 indian demonetization this policy made 86 of cash in circulation illegal tender overnight with new notes gradually introduced over the next several months we present a model of demonetization where agents hold cash both to satisfy a cash in advance constraint and for tax evasion purposes we test the predictions of the model in the cross section of indian districts using several novel data sets including the geographic distribution of demonetized and new notes for causal inference night light activity and employment surveys to measure economic activity including in the informal sector debit credit cards and e wallet transactions data and banking data on deposit and credit growth districts experiencing more severe demonetization had relative reductions in economic activity faster adoption of alternative payment technologies and lower bank credit growth the cross sectional responses cumulate to a contraction in aggregate employment and night lights based output due to the the cash shortage of at least 2 percentage points and of bank credit of 2 percentage points in 2016q4 relative to their counterfactual paths effects that dissipate over the next few months our analysis rejects monetary neutrality using a large scale natural experiment something that is still rare in the vast literature on the effects of monetary policy

the welfare cost of inflation in a cash in advance economy with costly credit the paper presents a modification of the lucas stokey 1983 cash in advance economy in which the representative consumer decides based on relative prices which goods to buy with cash and which with costly credit an explicit baumol 1952 condition emerges that guides this consumer choice deriving and estimating a closed form welfare cost function in an example economy the paper shows that the welfare cost of inflation depends on the margins of substitution the consumer avoids inflation through costly credit and faces higher welfare costs of inflation than in standard cash in advance economies

multilateralism and the endogenous formation of preferential trade agreements abstract this paper examines the interaction between preferential trade agreements ptas and multilateral tariff reduction in a model of imperfect competition a growing literature finds that the formation of ptas alters the incentives for and the sustainability of multilateral tariff reduction we show that the causation is not one sided multilateral tariff reduction also affects the formation of ptas specifically tariff reduction enhances the incentives to form a pta and increases the likelihood that it is self enforcing thus each round of multilateral tariff reduction should lead to a new wave of ptas this may help to explain the current trend towards regionalism

time consistency of fiscal and monetary policy the problem of time inconsistency arises from two different sources first as shown by guillermo a calvo 1978 the re is an incentive for each government to engage in an initial unanti cipated inflation second as discussed by robert e lucas and nancy l stokey 1983 there is an incentive for each government to deviat e from the path of taxes announced by the preceding government in th is paper it is shown that these two sources of time inconsistency ca n be removed by a particular method of debt management involving bot h nominal and indexed government bonds of various maturities copyright 1987 by the econometric society

can bilateralism ease the pains of multilateral trade liberalization abstract using the influence driven approach to endogenous trade policy determination we show how a free trade agreement fta with rules of origin can work as a device to compensate losers from trade liberalization the fta constructed in this paper is characterized by external tariff structures that are negatively correlated across member countries ensuring efficiency gains and through reduced average protection compatibility with the multilateral trading system s requirements it is also politically viable and we demonstrate that in the countries concerned governments are willing to include its formation in the political agenda in spite of the fact that in equilibrium political contributions from producer lobbies decline after the agreement

monetary growth innovations in a simple cash in advance asset pricing model abstract this paper contributes to the existing literature in the rational expectations cash in advance asset pricing general equilibrium model in two directions first we show that by allowing a variable velocity of circulation an increase in the conditional variance of the money growth process triggers an increase in the demand for money relative to stocks and bonds with a consequent reduction in stock and bond prices which is the opposite of the current result in the literature with constant unitary velocity second we explicitly show how the sequential markets and specific timing of information fits exactly into the notion of irreversibility in the sense that when faced with uncertainty agents might find optimal to delay decisions in order to wait for the arrival of new information

a protectionist bias in majoritarian politics we develop a novel model of campaigns elections and policy making in which the ex ante objectives of national party leaders differ from the ex post objectives of elected legislators this generates a distinction between policy rhetoric and policy reality and introduces an important role for party discipline in the policy making process we identify a protectionist bias in majoritarian politics when trade policy is chosen by the majority delegation and legislators in the minority have limited means to influence choices the parties announce trade policies that favor specific factors and the expected tariff or export subsidy is positive positions and expected outcomes monotonically approach free trade as party discipline strengthens i introduction in a democracy the majority rules often this means that the policies enacted by elected governments reflect the preferences of some citizens more than those of others this feature of democracy commonly known as tyranny of the majority arises in institutional settings in which elected officials represent disproportionately the interests of their own constituents and electees who represent the minority have limited means to influence policy in this paper we argue that tyranny of the majority imparts a protectionist bias to democratic politics this is so even when the average citizen covets free trade and when every citizen has an equal probability of being represented in the policy making process by protection we mean policies that favor quasi fixed factors of production thus protection in our parlance refers both to tariffs that shield import competing industries from foreign competition and subsidies that promote exports the bias refers to the average or expected policy outcome we focus on majoritarian systems in which elected legislators represent geographic regions the existence of a protectionist bias requires only that i national party leaders cannot fully commit their candidates to adopt particular policies if elected ii mem

on cash in advance models of money demand and asset pricing this paper shows how a cash in advance model of money can be written in a way that combines a simple yet empirically defensible money demand function with an asset pricing equation that is similar to the standard barter economy euler equations return premia are determined as in the barter exchange model except that a short term risk free nominal interest rate enters into the first order conditions in special cases asset prices satisfy the barter economy euler equations exactly in the empirical analysis the interest rate factor adds some explanatory power but both the barter and the monetary asset pricing model perform rather poorly copyright 1991 by ohio state university press

rare disasters asset prices and welfare costs a representative consumer model with epstein zin weil preferences and i i d shocks including rare disasters accords with observed equity premia and risk free rates if the coefficient of relative risk aversion equals 3 4 if the intertemporal elasticity of substitution exceeds one an increase in uncertainty lowers the price dividend ratio for equity and a rise in the expected growth rate raises this ratio calibrations indicate that society would willingly reduce gdp by around 20 percent each year to eliminate rare disasters the welfare cost from usual economic fluctuations is much smaller though still important corresponding to lowering gdp by about 1 5 percent each year

endogenous trade bloc formation in an asymmetric world this paper investigates how variations in endowments and the structure of preferences impact on the coalition formation decisions of asymmetric countries there exist relatively few general results on the relationship between country characteristics and trade bloc formation here new light is shed on this issue by systematically simulating bloc formation and by explicitly analysing the blocking behaviour of coalitions a general equilibrium model of world trade is implemented with equilibrium coalition formation being modelled using the equilibrium concept of the core it is found that global free trade is observed when all countries are similar customs unions tend to form between countries with adjacent consumer preferences or with adjacent endowments of their export commodity finally in contrast to the existing literature but consistent with observed behaviour it is found that free trade areas often pareto dominate customs unions provided consumer preferences differ sufficiently

exchange rate volatility and deviations from unbiasedness in a cash in advance model abstract this paper examines time series properties of exchange rate changes the forward premium and the forward bias in the context of a variant of svensson s cash in advance model the model is solved and simulated using realistic forcing processes whose law of motion is estimated from u s japan data and then approximated by a markov chain although method of moments estimation shows that the over identifying restrictions implied by the model are not rejected it fails dramatically in producing a sufficiently variable risk premium on forward market speculation this result is robust to various pertubations to the model s parameters forcing processes and preference structure the model also fails to match exchange rate and forward premium volatility simultaneously

sticky goods prices flexible asset prices monopolistic competition and monetary policy a monetary general equilibrium asset pricing model with sticky goods prices is developed goods prices are set by monopolistically competitive firms that maximize stock market value equilibria with underutilization of resources excess capacity in some states result in contrast to previous monetary asset pricing models the degree of competition affects capacity utilization monetary policy can affect output and resource utilization in addition to real asset prices depending upon the amount of information available to the monetary authority

on the different geographic characteristics of free trade agreements and customs unions abstract casual observation reveals a striking phenomenon of preferential trade agreements ptas while customs unions cus are only intra regional free trade agreements ftas are inter and intra regional using a farsighted dynamic model we endogenize the equilibrium path of ptas among two close countries and one far country rising transport costs mitigate the cost of discrimination faced by the far country as a cu non member and diminish the value of preferential access as a cu member thus sufficiently large transport costs imply that an fta is the only type of pta that can induce the far country s participation in pta formation unlike cu formation fta formation can induce participation because ftas provide a flexibility benefit an fta member can form further ptas with non members but a cu member must do so jointly with all existing members hence in equilibrium cus are intra regional while ftas are intra and inter regional

distortionary fiscal policy and monetary policy goals we reconsider the role of an inflation conservative central banker in a setting with distortionary taxation to do so we assume monetary and fiscal policy are decided by independent authorities that do not abide to past commitments if the two authorities make policy decisions simultaneously inflation conservatism causes fiscal overspending but if fiscal policy is determined before monetary policy inflation conservatism imposes fiscal discipline these results clarify that in our setting the value of inflation conservatism depends crucially on the timing of policy decisions

the liquidity services of money this paper investigates the liquidity services provided by cash interest bearing check balances and securities which pay higher interest than checks securities must be traded before con sumers know their desired level or composition of consumption cash a nd checks are more liquid since they are available on demand cas h is more liquid than checks since it is more widely useable as a medium of exchange cash will often be used to buy goods which could be bought by check and the demand for cash will be less sensitive t han the demand for checks to the interest paid on check balances copyright 1988 by economics department of the university of pennsylvania and the osaka university institute of social and economic research association

is the gatt wto s article xxiv bad the gatt wto article xxiv prevents a customs union cu from raising its common external tariff in this paper we compare cu formation with and without this article xxiv constraint we show in a multi country oligopoly model that for a given cu structure article xxiv improves world welfare by lowering trade barriers however we also show that article xxiv has a composition effect on cu formation it affects the endogenous choice of cus by encouraging more symmetric cus article xxiv causes more trade to be subject to trade barriers as a result article xxiv may be bad for world welfare 2012 elsevier b v

a note on income velocity of money in a cash in advance economy with capital a stochastic growth model with money introduced via a cash in advance constraint is used to analyze the behaviour of the income velocity of real monetary balances agents can purchase consumption goods only using government issued money and capital is a credit good the cash in advance constraint may become nonbinding because of the uncertainty about the realization of the state of the economy changes in the income velocity of money due to a precautionary money demand are studied we find that despite the precautionary money demand does not introduce significant changes into the volatility of the income velocity its presence can alter the relationship between the growth rate of money supply and the income velocity

dynamic monetary fiscal interactions and the role of monetary conservatism assuming that macroeconomic policies are directed by distinct monetary and fiscal policy makers who cannot commit to future actions we reassess the implications of monetary conservatism and fiscal impatience in a setting with nominal government debt for environments where a non negative steady state level of government debt assets emerges in the absence of conservatism and impatience monetary conservatism induces accumulation of a higher stock of liabilities assets and has adverse positive welfare implications this result obtains irrespectively of the degree of fiscal impatience and questions the unambiguous desirability of monetary conservatism traditionally found in the literature

cooperative r d between vertically related firms with spillovers abstract this paper analyzes the effects of cooperative r d in two vertically related duopolies which are two final good manufacturers and two input suppliers with horizontal and vertical spillovers vertical r d cartels yield a larger social welfare than non cooperative r d and if the horizontal spillover rate between the input suppliers is not sufficiently high than horizontal r d cartels technological improvement is accelerated by forming vertical research joint ventures rjvs whether or not their member firms r d decisions are coordinated vertical rjv cartels yield the largest social welfare when the vertically related firms can coordinate their r d decisions and or share useful knowledge fully

a money demand function with output uncertainty monetary uncertainty and financial innovations in a general equilibrium framework incorporating the money in the utility function approach we show that output uncertainty and monetary uncertainty as well as output interest rates and financial innovations affect money demand the estimated long run relationships are consistent with our postulated relation but not with the conventional one our model delivers a high income elasticity consistent with cross sectional evidence and helps resolve m1 demand puzzles the model estimated in dynamic error correction form exhibits a good level of stability and forecastability providing little support for the recent de emphasis of monetary aggregates due to the instability of money demand

tariff bindings and the dynamic formation of preferential trade agreements abstract we show that multilateral tariff binding liberalization substantially impacts the nature and extent of preferential trade agreement pta formation first it shapes the nature of forces constraining expansion of free trade agreements ftas the constraining force is a free riding incentive of fta non members under relatively high bindings but an exclusion incentive of fta members under relatively low bindings second multilateral tariff binding liberalization shapes the role played by ptas in the attainment of global free trade initially tariff binding liberalization leads to custom union cu formation in equilibrium but in a way that undermines the pursuit of global free trade however further tariff binding liberalization leads to fta formation in equilibrium and in a way that facilitates the attainment of global free trade our theoretical analysis also has implications regarding recent empirical discussions over the relative merits of ftas versus cus

retail bank deposit pricing an intertemporal asset pricing approach fundamentally spreads between market and deposit interest rates increase when interest rates rise and decline when rates fall recent empirical studies have found this phenomenon to be related to market concentration static equilibrium models are poorly equipped to explain this behavior in this paper the author applies an intertemporal asset pricing model incorporating bank deposits as a form of money in order to analyze the pricing behavior of a banking sector exercising market power his results extend the theoretical literature on deposit pricing and provide some insights into the behavior of interest rate spreads through time copyright 1995 by ohio state university press

nominal prices and interest rates in general equilibrium endowment shocks the outstanding problem of neoclassical monetary theory has been to determine the effect of changes in the money stock on nominal prices and interest rates the classic result is that in the absence of money illusion contracts fixed in nominal terms and other such impedimenta money is neutral thus a doubling of the money stock results in a doubling of the nominal price level and in no change in nominal interest rates except at most for a temporary liquidity effect while the price level is rising to its new level during the adjustment period the nominal interest rate might temporarily drop this neutrality result has conventionally been proved in a static framework in intertemporal models it is necessary to distinguish between static neutrality and dynamic neutrality if a model displays dynamic neutrality fluctuations in the money stock immediately induce a proportional change in the nominal price level and no change in nominal interest rates or any real variable this property is different from and stronger than static neutrality which in dynamic models states only that if the money stock at all dates is doubled so will be the price level at all dates the effects of exogenous shocks in the monetary growth rate on nominal prices and interest rates are analyzed a representative individual rational expectations framework is adopted and a demand for money is generated by entering money in the utility function the effects of monetary shocks on inflation and interest rates are shown to depend on the autocorrelation of the monetary growth rate for example under serial independence the inflation rate equals the monetary growth rate and the nominal interest rate is nonrandom while under positive negative autocorrelation the nominal interest rate is affected positively negatively by positive growth rate shocks i am grateful to the staff of the federal reserve bank of philadelphia to the finance groups at the university of southem california and virginia polytechnic institute and to c j lacivita dan peled john seater and jon sonstelie for valuable comments on earlier drafts

the fiscal myth of the price level i examine the fiscal theory of the price level according to which non ricardian policy and predetermined nominal government debt fiscally determine prices i argue that the non ricardian policy

real returns on government debt a general equilibrium quantitative exploration we extend and apply computable general equilibrium methods to the study of economies with both aggregate uncertainty and uninsured household specific uncertainty in our economies the government issues two types of assets a small denomination non interest bearing asset which we call currency and a large denomination interest bearing asset which we call t bills we find that a real interest rate behavior similar to that observed in the u s can be sustained as equilibrium behavior in our class of economies we also find that policy induced real interest rate changes that are perceived as being permanent have significant real effects and that these effects take a few years to be fully realized

absorptive capacity and connectedness why competing firms also adopt identical r d approaches abstract this paper explores the endogenous determination of r d appropriability through the firms choice of r d approaches whereas identical broad r d approaches connect firms with their r d environment and maximize absorptive capacities the opposite holds for idiosyncratic r d approaches our model shows that competing firms choose identical r d approaches in order to maximize knowledge flows between each other in essence this frees firms from the prisoner s dilemma of aggressive investment in r d our analysis contrasts with kamien and zang s 2000 kamien m zang i 2000 meet me halfway research joint ventures and absorptive capacity international journal of industrial organization 18 995 1012 finding that competing firms chose idiosyncratic r d approaches we demonstrate that their model also yields a nash equilibrium for broad identical r d approaches

optimal fiscal and monetary policy under sticky prices this paper studies optimal fiscal and monetary policy under sticky product prices the theoretical framework is a stochastic production economy without capital the government finances an exogenous stream of purchases by levying distortionary income taxes printing money and issuing one period nominally risk free bonds the main findings of the paper are first for a miniscule degree of price stickiness i e many times below available empirical estimates the optimal volatility of inflation is near zero this result stands in stark contrast with the high volatility of inflation implied by the ramsey allocation when prices are flexible the finding is in line with a recent body of work on optimal monetary policy under nominal rigidities that ignores the role of optimal fiscal policy second even small deviations from full price flexibility induce near random walk behavior in government debt and tax rates third sluggish price adjustment raises the average nominal interest rate above the one called for by the friedman rule finally an interest rate feedback rule whereby the nominal interest rate depends on inflation and output fits well the data emanating from the ramsey economy however the fitted rule is not of the taylor type for the implied inflation coefficient is less than one and close to zero and the output coefficient is negative jel classification e52 e61 e63

distributive politics and economic growth a crude distinction between economics and politics would be that economics is concerned with expanding the pie while politics is about distributing it in this paper we analyze the relationship between the two we focus on how an economy s initial configuration of resources shapes the political struggle for income and wealth distribution and how that in turn affects long run growth our main conclusion is that inequality is conducive to the adoption of growth retarding policies we derive this result from a simple political economy model of growth and present cross country evidence consistent with it the key feature of our model is that individuals differ in their relative factor endowments we distinguish between two types of factors an accumulated factor called capital and a nonaccumulated factor called labor growth is driven by the expansion of the capital stock which is in turn determined by individual saving decisions long run growth is endogenous as the aggregate production function is taken to be linearly homogeneous in capital and productive government services taken together the provision of government services is financed by a tax on capital because government services are productive a small tax on

dynamic formation of preferential trade agreements the role of flexibility in practice free trade agreements ftas vastly outnumber customs unions cus nevertheless the literature traditionally views cus as optimal for members because cu members coordinate external tariffs i show that a dynamic fta flexibility benefit can help explain the prevalence of ftas individual fta members have the flexibility to form their own future ftas whereas cu members must jointly engage in future cu formation i show how the relative prevalence of ftas versus cus depends on the structure of market size asymmetry across countries and use these predictions to shed some light on fta versus cu formation in europe and south america formation dynamique d accords commerciaux preferentiels le role de la flexibilite en pratique les accords de libre echange ale sont plus nombreux que les unions douanieres ud neanmoins la litterature specialisee percoit traditionnellement que les ud sont optimales pour les membres parce qu ils peuvent coordonner leurs tarifs externes on montre qu une flexibilite dynamique de l ale peut aider a expliquer la prevalence des ale les membres des ale ont la flexibilite de former leurs propres ale dans l avenir alors que les membres des ud s engagent conjointement pour la formation des ud futures on montre comment la prevalence des ale versus les ud depend de la structure de l asymetrie de la taille entre les pays et on utilise ces previsions pour eclairer les choix entre la formation de ale et de ud en europe et en amerique du sud

monetary conservatism and fiscal policy abstract does an inflation conservative central bank a la rogoff 1985 remain desirable in a setting with endogenous fiscal policy to provide an answer we study monetary and fiscal policy games without commitment in a dynamic stochastic sticky price economy with monopolistic distortions monetary policy determines nominal interest rates and fiscal policy provides public goods generating private utility we find that lack of fiscal commitment gives rise to excessive public spending the optimal inflation rate internalizing this distortion is positive but lack of monetary commitment generates too much inflation a conservative monetary authority thus remains desirable when fiscal policy is determined before monetary policy each period the monetary authority should focus exclusively on stabilizing inflation monetary conservatism then eliminates the steady state biases associated with lack of monetary and fiscal commitment and leads to stabilization policy that is close to optimal

time consistency of optimal monetary and fiscal policy in a small open economy abstract this paper characterizes conditions under which optimal monetary and fiscal policy is time consistent in a stylized small open economy with a flexible foreign exchange rate regime it shows that these conditions depend on the way in which leisure is assumed to enter preferences and or on the process which productivity is assumed to follow this paper further argues that these conditions may fail to be sufficient if the small open economy implements a fixed foreign exchange rate regime thus a credible fixed exchange rate regime does not necessarily help render optimal policy time consistent

optimal fiscal and monetary policy with sticky prices in this paper i consider the role of state contingent inflation as a fiscal shock absorber in an economy with nominal rigidities i study the ramsey equilibrium in a monetary model with distortionary taxation nominal non state contingent debt and sticky prices with sticky prices the ramsey planner must balance the shock absorbing benefits of state contingent inflation against the associated resource misallocation costs for government spending processes resembling post war experience introducing sticky prices generates striking departures in optimal policy from the case with flexible prices for even small degrees of price rigidity optimal policy displays very little volatility in inflation tax rates display greater volatility compared to the model with flexible prices with sticky prices tax rates and real government debt exhibit behavior similar to a random walk for government spending processes resembling periods of intermittent war and peace optimal policy displays extreme inflation volatility even when the degree of price rigidity is large as the variability in government spending increases smoothing tax distortions across states of nature becomes increasingly important and the shock absorber role of inflation is accentuated

r d spillovers and information exchange abstract we show that the spillover of r d can be endogenised in a sense that even without spillovers firms have an incentive to exchange the r d information after the investment costs are sunk

interest rates in a credit constrained economy when households face credit constraints in an economy with inside as well as outside money stationary equilibrium real interest rates are below the household rate of time preference they also depend significantly upon household risk aversion the demand for inside versus outside money bank costs bank reserves inflation and the marginal productivity of capital and capital depreciation rates in addition changes in financial variables affect per capita capital and output to a greater extent when households are credit constrained copyright 1994 by economics department of the university of pennsylvania and the osaka university institute of social and economic research association

does money explain asset returns theory and empirical analysis a cash in advance model of a monetary economy is used to derive a money based capm m capm which allows us to implement tests of asset pricing restrictions without consumption data a test as in fama and macbeth of the model suggests that the money betas have some explanatory power for the cross sectional variation of expected returns however the model is rejected using conditional information consistent with our predictions estimates of the curvature parameter are lower than those of the consumption capm c capm and pricing errors of the m capm tend to be smaller than those of the c capm while the relation between asset prices and real macroeconomic variables such as aggregate consumption has been extensively investigated less attention has been devoted to the relation between monetary aggregates and asset prices that arises from models which incorporate a monetary sector it is often argued that one possible reason for the rejection of the consumption oriented capm c capm is the absence of monetary considerations this paper takes a step towards encompassing money into the c capm and proposes a moneybased capm m capm that can be tested without using consumption data this m capm is interesting in the way it captures the time series and crosssectional variation in stock returns and it provides insights in the possible misspecification of existing c capm models the setup is based on the cash in advance model of lucas and stokey 1987 in which some consumption goods are financed with outside money i e cash and some are financed with inside money e g bank deposits the pricing results of this paper differ from those of other monetary models such as those considered by finn hoffman and schlagenauf 1990 or singleton 1985 which focus on the role of outside money in affecting the marginal utility of consumption instead we concentrate on inside money in asset pricing the focus on inside money is appealing because inside money reflects conditions in

the customs union issue why do we observe so few of them the number of preferential trade agreements has greatly increased over the past two decades yet most existing bilateral arrangements take the form of free trade areas and less than ten percent can be considered to be fully edged customs unions this paper develops a political economy model of trade policy under imperfect competition to provide a positive explanation for the prevalence of free trade areas in a three country setting a representative from each prospective member is elected to determine the tarifis to be applied on imported goods under a customs union the necessity to coordinate tarifis leads voters to strategically delegate power to more protectionist representatives contrary to most of the existing literature we show that strategic delegation may imply that free trade areas increase welfare compared to customs unions moreover the model also indicates that free trade areas are more likely to be politically viable than customs unions