Dynamic contracting, persistent shocks and optimal taxation
By: Yuzhe Zhang.
Contributors: Federal Reserve Bank of Minneapolis. Research Dept.
Series: Working paper / Federal Reserve Bank of Minneapolis, Research Dept. ;; 640; Working paper (Federal Reserve Bank of Minneapolis : Online) ;; 640.
Publisher: Federal Reserve Bank of Minneapolis, Research Dept.
Published: 2005
Place of publication: [Minneapolis, MN]
Language: eng
Format: Electronic resource
Description: "In this paper I develop continuous-time methods for solving dynamic principal-agent problems in which the agent's privately observed productivity shocks are persistent over time. I characterize the optimal contract as the solution to a system of ordinary differential equations, and show that, under this contract, the agent's utility converges to its lower bound--immiseration occurs. I also show that, unlike in environments with i.i.d. shocks, the principal would like to renegotiate with the agent when the agent's productivity is low--it is not renegotiation-proof. I apply the theoretical methods I have developed and numerically solve this (Mirrleesian) dynamic taxation model. I find that it is optimal to allow a wedge between the marginal rate of transformation and individuals' marginal rate of substitution between consumption and leisure. This wedge is significantly higher than what is found in the i.i.d. case. Thus, using the i.i.d. assumption is not a good approximation quantitatively when there is persistence in productivity shocks."
Notes: Also available in print.
Includes bibliographical references.
Title from PDF file (viewed on Nov. 2, 2005).
"October 2005. "
System requirements: Adobe Acrobat Reader.
Mode of access: World Wide Web.