Search Results
Working Paper
Speculative runs on interest rate pegs the frictionless case
In this paper we show that interest rate rules lead to multiple equilibria when the central bank faces a limit to its ability to print money, or when private agents are limited in the amount of bonds that can be pledged to the central bank in exchange for money. Some of the equilibria are familiar and common to the environments where limits to money growth are not considered. However, new equilibria emerge, where money growth and inflation are higher. These equilibria involve a run on the central bank's interest target: households borrow as much as possible from the central bank, and the ...
Working Paper
Tax riots
This paper considers an optimal taxation environment where household income is private information, and the government randomly audits and punishes households found to be underreporting. We prove that the optimal mechanism derived using standard mechanism design techniques has a bad equilibrium (a tax riot) where households underreport their incomes, precisely because other households are expected to do so as well. We then consider three alternative approaches to designing a tax scheme when one is worried about bad equilibria.
Discussion Paper
On the Ethics of Redistribution
Analysts of optimal policy often advocate for redistributive policies within developed economies using a behind-the-veil-of-ignorance criterion. Such analyses almost invariably ignore the effects of these policies on the well-being of people in poor countries. We argue that this approach is fundamentally misguided because it violates the criterion itself.
Discussion Paper
The \\"banks\\" we do need
Banks are prone to panic-induced runs due to their traditional structure of short-term, unconditional liabilities and long-term, illiquid assets. To avoid systemic crises caused by such panics, governments tend to bail out failing banks. Traditional banking systems thus impose external costs. Three major theoretical benefits are often used to justify a banking system that relies on short-term debt despite these costs: (1) maturity transformation, (2) efficient monitoring of bank managers and (3) facilitation of financial transactions. In a previous paper, we argued that the first two ...
Discussion Paper
What assets should banks be allowed to hold?
Banks are vulnerable to self-fulfilling panics because their liabilities (such as demand deposits and certificates of deposit) are short term and unconditional, and their assets (such as mortgages and business loans) are long term and illiquid. To prevent wider financial fallout from such panics, governments have strong incentive to bail out bank debtholders. Paradoxically, expectations of such bailouts can lead financial systems to rely excessively?from a societal perspective?on short-term debt to fund long-term assets. Fragile banking systems thus impose external costs, and regulation may ...
Discussion Paper
Incentive compensation in the banking industry: insights from economic theory
How can banks and similar institutions design optimal compensation systems? Would such systems conflict with the goals of society? This paper considers a theoretical framework of how banks structure job contracts with their employees to explore three points: the structure of a socially optimal compensation system; the structure of a compensation system that is privately optimal, given the reality of government-guaranteed bank debt; and policy interventions that can lead from the second structure to the first. Analysis reveals a potential policy option: providing proper incentives to banks by ...
Discussion Paper
Too Correlated to Fail
In this paper, we argue that the anticipation of bailouts creates incentives for banks to herd in the sense of making similar investments. This herding behavior makes bailouts more likely and potential crises more severe. Analyses of bailouts and moral hazard problems that focus exclusively on bank size are therefore misguided in our view, and the policy conclusion that limits on bank size can effectively solve moral hazard problems is unwarranted.
Discussion Paper
Insuring Against Adverse Outcomes at Birth
To what extent should government policy try to equalize economic outcomes due to differences among individuals in their most basic, innate circumstances: the kind of family they?re born into, their level of intelligence, their marketable talents, their health? Should policy tilt economic resources away from ?genetic winners? and toward less fortunate newborns? {{p}} This paper points to the usefulness of considering different perspectives regarding at-birth risks. It argues that law and policy need to focus on allowing tools for parents to mitigate the real risk to themselves associated with ...
Discussion Paper
Should We Worry About Excess Reserves?
Banks in the United States have the potential to increase liquidity suddenly and significantly?from $12 trillion to $36 trillion in currency and easily accessed deposits?and could thereby cause sudden inflation. This is possible because the nation?s fractional banking system allows banks to convert excess reserves held at the Federal Reserve into bank loans at about a 10-to-1 ratio. Banks might engage in such conversion if they believe other banks are about to do so, in a manner similar to a bank run that generates a self-fulfilling prophecy. {{p}} Policymakers could guard against this ...
Journal Article
Inequality and fairness
This study uses John Rawls' behind-the-veil of ignorance device as a fairness criterion to evaluate social policies and applies it to a contracting model in which the terms equality of opportunity and equality of result are well defined. The results suggest that fairness and inequality-even extreme inequality-are compatible. In a static world, when incentives must be provided, fairness implies equality of opportunity, but inequality of result. In a dynamic world of long-lived individuals, fairness implies not only inequality of result, but also, eventually, infinite inequality of result. If ...