Search Results
Discussion Paper
Introducing a Series on Large and Complex Banks
The chorus of criticism levied against mega-banks has, in some cases, outrun the research needed to back the criticism. To help the research catch up with the rhetoric, financial economists here at the New York Fed have engaged in a systematic study of the economics of large and complex banks and their resolution in the event of failure. The result of those efforts is a collection of eleven papers, each of which was subject to review (internal and external). The papers are now online in our Economic Policy Review. Today, we begin a two-week series of posts that present the key findings of ...
Working Paper
Markov-Perfect Risk Sharing, Moral Hazard and Limited Commitment
We define, characterize and compute Markov-perfect risk-sharing contracts in a dynamic stochastic economy with endogenous asset accumulation and simultaneous limited commitment and moral hazard frictions. We prove that Markov-perfect insurance contracts preserve standard properties of optimal insurance with private information and are not more restrictive than a long-term contract with one-sided commitment. Markov-perfect contracts imply a determinate asset time-path and a non-degenerate long-run stationary wealth distribution. We show numerically that Markov-perfect contracts provide sizably ...
Speech
Discussion of “Evaluating Monetary Policy Operational Frameworks” by Ulrich Bindseil: remarks at the 2016 Economic Policy Symposium at Jackson Hole, Wyoming
Remarks at the 2016 Economic Policy Symposium at Jackson Hole, Wyoming.
Briefing
When Should Employees Be Suspended Instead of Fired?
The economic theory of incentives explains why a worker who consistently underperforms must be fired. To respond to incentives, the worker must maintain a stake in the relationship with the employer. When the worker's stake runs out, the relationship must terminate. This article reviews recent research showing that this explanation is oversimplified. A temporary suspension of the worker is usually sufficient to rebuild the worker's stake, which allows the productive relationship to resume without terminating. The costs and benefits of suspending the worker, however, can be highly sensitive to ...
Working Paper
The Optimal Taxation of Business Owners
Business owners in the United States are disproportionately represented among the wealthy and are exposed to substantial idiosyncratic risk. Further, recent evidence indicates that business income primarily reflects returns to the human capital of the owner. Motivated by these facts, this paper characterizes stationary efficient allocations and optimal linear taxes on income and wealth when business income depends on innate ability, luck, and the past effort of the owner. I first show that in stationary efficient allocations, more productive entrepreneurs typically bear more risk and the ...
Working Paper
On the Optimality of Differential Asset Taxation
In this paper I study the optimality of differential asset taxation in an environment with entrepreneurs and workers in which output is stochastic and entrepreneurs can misreport profits and abscond with capital. I show that a stationary efficient allocation may be implemented as an equilibrium with endogenous collateral constraints, transfers to newborns, and linear taxes on profits, investment, and interest. Further, these taxes differ from one another and serve distinct purposes. The profits tax shares risk and depends solely on the severity of the misreporting friction, while the ...
Working Paper
On the Optimality of Differential Asset Taxation
How should a government balance risk-sharing and redistributive concerns with the need to provide incentives for investment? Should they tax firm profits or individual savings, or simply levy lump-sum transfers? I address these questions in an environment with entrepreneurs and workers in which output is subject to privately observed shocks and firm owners can both misreport profits and abscond with a fraction of assets. When frictions in financial markets restrict private risk-sharing, the stationary efficient allocation may be implemented in a competitive equilibrium with collateral ...
Working Paper
Optimal Long-Term Contracting with Learning
We introduce uncertainty into Holmstrom and Milgrom (1987) to study optimal long-term contracting with learning. In a dynamic relationship, the agent's shirking not only reduces current performance but also increases the agent's information rent due to the persistent belief manipulation effect. We characterize the optimal contract using the dynamic programming technique in which information rent is the unique state variable. In the optimal contract, the optimal effort is front-loaded and decreases stochastically over time. Furthermore, the optimal contract exhibits an option-like feature in ...
Discussion Paper
What Millions of Homeowner’s Insurance Contracts Reveal About Risk Sharing
Housing is the largest component of assets held by households in the United States, totaling $48 trillion in 2025. When natural disasters strike, the resulting damage to homes can be large relative to households’ liquid savings. Homeowner’s insurance is the primary financial tool households use to protect themselves against property risk. Despite the economic importance of homeowner’s insurance, we know surprisingly little about how insurance contracts are actually designed with respect to property risk. In this post, which is based on our new paper, “Economics of Property ...
Working Paper
Modeling the Revolving Revolution: The Debt Collection Channel
We investigate the role of information technology (IT) in the collection of delinquent consumer debt. We argue that the widespread adoption of IT by the debt collection industry in the 1990s contributed to the observed expansion of unsecured risky lending such as credit cards. Our model stresses the importance of delinquency and private information about borrower solvency. The prevalence of delinquency implies that the costs of debt collection must be borne by lenders to sustain incentives to repay debt. IT mitigates informational asymmetries, allowing lenders to concentrate collection ...