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Working Paper
Are Government Bonds Net Wealth or a Liability? ---Optimal Debt and Taxes in an OLG Model with Uninsurable Income Risk
The rapidly growing national debt in the U.S. since the 1970s has alarmed and intrigued the academic world. Consequently, the concept of dynamic (in)efficiency in an overlapping generations (OLG) world and the importance of the heterogeneous-agents and incomplete markets (HAIM) hypothesis to justify a high debt-to-GDP ratio have been extensively studied. Two important consensus emerge from this literature: (i) The optimal quantity of public debt is positive—due to insufficient private liquidity to support private saving and investment (see, e.g., Barro (1974), Woodford (1990), and Aiyagari ...
Working Paper
The Determination of Public Debt under both Aggregate and Idiosyncratic Uncertainty
We use an analytically tractable model to show that the Ramsey planner's decisions to finance stochastic public expenditures under uninsurable idiosyncratic risk implies a departure from tax smoothing. In the absence of state-contingent bonds the government's attempt to balance the competing incentives between tax smoothing and individual consumption smoothing---even at the cost of extra tax distortion---implies a bounded stochastic unit root component in optimal taxes. Nonetheless, a sufficiently high average level of public debt to support individuals’ self-insurance position is welfare ...
Working Paper
Are Unconditional Lump-sum Transfers a Good Idea?
The role of unconditional lump-sum transfers in improving social welfare in heterogenous agent models has not been thoroughly understood in the literature. We adopt an analytically tractable Aiyagari-type model to study the distinctive role of unconditional lump-sum transfers in reducing consumption inequality due to ex-post uninsurable income risk. Our results show that in the presence of ex-post heterogeneity and in the absence of wealth inequality, unconditional lump-sum transfers are not a desirable tool for reducing consumption inequality—the Ramsey planner opts to rely solely on ...
Working Paper
The Determination of Public Debt under both Aggregate and Idiosyncratic Uncertainty
We use an analytically tractable model to show that the Ramsey planner's decisions to finance stochastic public expenditures under uninsurable idiosyncratic risk implies a departure from tax smoothing. In the absence of state-contingent bonds the government's attempt to balance the competing incentives between tax smoothing and individual consumption smoothing---even at the cost of extra tax distortion---implies a bounded stochastic unit root component in optimal taxes. Nonetheless, a sufficiently high average level of public debt to support individuals’ self-insurance position is welfare ...
Working Paper
The Ramsey Steady-State Conundrum in Heterogeneous-Agent Economies
In infinite horizon, heterogeneous-agent and incomplete-market models, the existence of an interior Ramsey steady state is often assumed instead of proven. This paper makes two fundamental contributions: (i) We prove that the interior Ramsey steady state assumed by Aiyagari (1995) does not exist in the standard Aiyagari model. Specifically, a steady state featuring the modified golden rule and a positive capital tax is feasible but not optimal. (ii) We design a modified, analytically tractable version of the standard Aiyagari model to unveil the necessary and/or sufficient conditions for the ...
Working Paper
Designing Unemployment Insurance for Developing Countries
The high incidence of informality in the labor markets of middle-income economies challenges the provision of unemployment protection. We show that, despite informational frictions, introducing an unemployment insurance savings account (UISA) system may provide substantial benefits. This system improves welfare by providing insurance to the unemployed and creating incentives to work in the formal sector. The optimal scheme generates a reduction in unemployment (from 4 to 3 percent), an increase in formality (from 68 to 72 percent), and a rise in total output (by 4 percent). Overall, ...
Working Paper
Time-Inconsistent Optimal Quantity of Debt
A key property of the Aiyagari-type heterogeneous-agent models is that the equilibrium interest rate of public debt lies below the time discount rate. This fundamental property, however, implies that the Ramsey planner’s fiscal policy may be time-inconsistent because the forward-looking planner would have a dominant incentive to issue plenty of debt such that all households are fully self-insured against idiosyncratic risk. But such a full self-insurance allocation may be paradoxical because, to achieve it, the optimal labor tax rate may approach 100% and aggregate consumption may approach ...
Working Paper
Time-Inconsistent Optimal Quantity of Debt
A key property of the Aiyagari-type heterogeneous-agent models is that the equilibrium interest rate of public debt lies below the time discount rate. This fundamental property, however, implies that the Ramsey planner's fiscal policy may be time-inconsistent because the forward-looking planner would have a dominate incentive to issue plenty of debt, such that all households are fully self-insured against idiosyncratic risk whenever the interest rate of government borrowing is lower than the household time discount rate. But such a full self-insurance allocation may be paradoxical because, to ...
Working Paper
Assessing Bankruptcy Reform in a Model with Temptation and Equilibrium Default
A life-cycle model with equilibrium default in which agents with and without temptation coexist is constructed to evaluate the 2005 bankruptcy law reform. The calibrated model indicates that the 2005 reform reduces bankruptcies, as seen in the data, and improves welfare, as lower default premia allows better consumption smoothing. A counterfactual reform of changing income garnishment rate is also investigated. Interesting contrasting welfare effects between two types of agents emerge. Agents with temptation prefer a lower garnishment rate as tighter borrowing constraint prevents them from ...
Working Paper
A Racial Inequality Trap
Why has the U.S. black/white earnings gap remained around 40 percent for nearly 40 years? This paper''s answer consists of a model of skill accumulation and neighborhood formation featuring a trap: Initial racial inequality and racial preferences induce racial segregation and asymmetric skill accumulation choices that perpetuate racial inequality. Calibrated to match the U.S. distribution of race, house prices and earnings across neighborhoods, the model produces one-half of the observed racial earnings gap. Moving the economy from the trap to a racially integrated steady state implies a 15.6 ...