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Working Paper
The Politics of Flat Taxes
We study the determination of flat tax systems using a workhorse macroeconomic model of inequality. Our first result is that, despite the multidimensional policy space, equilibrium policies are typically unique (up to a fine grid numerical approximation). The majority voting outcome features (i) zero labor income taxation, (ii) simultaneous use of capital income and consumption taxation, and (iii) generally low transfers. We discuss the role of three factors?the initial heterogeneity in sources of income, the mobility of income and wealth, and the forward-looking aspect of voting?in ...
Working Paper
A tale of two commitments: equilibrium default and temptation
I construct the life-cycle model with equilibrium default and preferences featuring temptation and self-control. The model provides quantitatively similar answers to positive questions such as the causes of the observed rise in debt and bankruptcies and macroeconomic implications of the 2005 bankruptcy reform, as the standard model without temptation. However, the temptation model provides contrasting welfare implications, because of overborrowing when the borrowing constraint is relaxed. Specifically, the 2005 bankruptcy reform has an overall negative welfare effect, according to the ...
Working Paper
Majority Voting: A Quantitative Investigation
We study the tax systems that arise in a once-and-for-all majority voting equilibrium embedded within a macroeconomic model of inequality. We find that majority voting delivers (i) a small set of outcomes, (ii) zero labor income taxation, and (iii) nearly zero transfers. We find that majority voting, contrary to the literature developed in models without idiosyncratic risk, is quite powerful at restricting outcomes; however, it also delivers predictions inconsistent with observed tax systems.
Working Paper
Long and Plosser Meet Bewley and Lucas
We develop a N-sector business cycle network model a la Long and Plosser (1983), featuring heterogenous money demand a la Bewley (1980) and Lucas (1980). Despite incomplete markets and a well-defined distribution of real money balances across heterogeneous households, the enriched N-sector network model remains analytically tractable with closed-form solutions up to the aggregate level. Relying on the tractability, we establish several important results: (i) The economy's input-output network linkages become endogenously time-varying over the business cycle?thanks to the influence of the ...
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
Closing Large Open Economy Models
A large class of international business cycle models admits multiple locally isolated deterministic steady states, if the elasticity of substitution between traded goods is sufficiently low. I explore the conditions under which such multiplicity occurs and characterize the dynamic properties in the neighborhood of each steady state. Models with standard incomplete markets, portfolio costs, a debt-elastic interest rate, or an overlapping generations framework allow for multiple steady states, if the model features multiple steady states under financial autarchy. If the excess demand for the ...
Working Paper
Optimal Fiscal Policies under Market Failures
The aggregate capital stock in a nation can be overaccumulated for many different reasons. This paper studies which policy or policy mix is more effective in achieving the socially optimal (modified golden rule) level of aggregate capital stock in an infinite-horizon heterogeneous-agents incomplete-markets economy where capital may be over-accumulated for two distinct reasons: (i) precautionary savings and (ii) production externalities. By solving the Ramsey problem analytically along the entire transitional path, we show that public debt and capital taxation play very distinct roles in ...
Working Paper
Low Risk Sharing with Many Assets
Classical contributions in international macroeconomics rely on goods-market mechanisms to reconcile the cyclicality of real exchange rates when financial markets are incomplete. However, cross-border trade in one domestic and one foreign-currency-denominated risk-free asset prohibits these mechanisms from breaking the pattern consistent with complete markets. In this paper, we characterize how goods markets drive exchange rate cyclicality, taking into account trade in risk-free and/or risky assets. We show that goods-market mechanisms come back into play, even when there is cross-border ...
Report
The cost of business cycles for unskilled workers
This paper reconsiders the cost of business cycles under incomplete markets. Primarily, we focus on the heterogeneity in the cost of business cycles among agents with different skill levels. Unskilled workers are subject to a much larger risk of unemployment during recessions than are skilled workers. Moreover, unskilled workers earn less income, which limits their ability to self-insure. We examine how this heterogeneity in unemployment risk and income translates into heterogeneity in the cost of business cycles. We set up a dynamic general equilibrium model with incomplete markets, in which ...
Working Paper
The Determination of Public Debt under both Aggregate and Idiosyncratic Uncertainty
We analyze the Ramsey planner's decisions to finance stochastic public expenditures under incomplete insurance markets for idiosyncratic risk. We show analytically that whenever the market interest rate lies below the time discount rate, the Ramsey planner has a dominant incentive to increase debt to meet the private sector's demand for full self-insurance regardless of the relative size of aggregate shocks---suggesting a departure from tax smoothing. However, if a full self-insurance Ramsey allocation is infeasible in the absence of a government debt limit, an interior or bounded Ramsey ...