Research
Publications
Doubts about the model and optimal policy, Journal of Economic Theory, Volume 210, June 2023.
- For an older version with an example of a large firm that acts as Stackelberg leader who faces a competitive fringe, see Atlanta Fed WP 20-12.
- See the Online Appendix for: a) a broader setup with forward-looking constraints that nests several policy settings, b) the details of the small-doubts approximation.
Abstract: This paper analyzes optimal policy in setups where both the policymaker and the private sector have doubts about the probability model of uncertainty and form endogenous worst-case beliefs. There are two forces that shape optimal policy results: a) the manipulation of the endogenous beliefs of the private sector so that the forward-looking constraints that the policymaker is facing are relaxed, b) the discrepancy (if any) in pessimistic beliefs between a paternalistic policymaker and the private sector, which captures ultimately differences in welfare evaluation. I illustrate the methodology in an optimal fiscal policy problem and show that manipulation of beliefs materializes as an effort to make government debt cheaper through the endogenous beliefs of the household. This force may lead to either mitigation or amplification of the household's pessimism, depending on the problem's parameters. The policymaker's relative pessimism determines whether paternalism reinforces or opposes the price manipulation incentives.
Overconfidence, subjective perception and pricing behavior (with Pierpaolo Benigno), publisher's link, Journal of Economic Behavior and Organization, Volume 164, August 2019, pp. 107-132.
Abstract: We study the implications of overconfidence for price setting in a monopolistic competition setup with incomplete information. Our price-setters overestimate their abilities to infer aggregate shocks from private signals. The fraction of uninformed firms is endogenous; firms can obtain information by paying a fixed cost. We find two results: i) overconfident firms are less inclined to acquire information relative to the rational benchmark; ii) prices might exhibit excess volatility driven by non-fundamental noise. We explore the empirical predictions of our model for idiosyncratic price volatility.
Fiscal austerity in ambiguous times (with Axelle Ferriere), Online Appendix, publisher's link, American Economic Journal: Macroeconomics, Volume 11, Issue 1, January 2019, pp. 89-131.
Abstract: This paper analyzes optimal fiscal policy with ambiguity aversion and endogenous government spending. We show that, without ambiguity, optimal surplus-to-output ratios are acyclical and that there is no rationale for either reduction or further accumulation of public debt. In contrast, ambiguity about the cycle can generate optimally policies that resemble ``austerity'' measures. Optimal policy prescribes higher taxes in adverse times and front-loaded fiscal consolidations that lead to a balanced primary budget in the long-run. This is the case when interest rates are sufficiently responsive to cyclical shocks, that is, when the intertemporal elasticity of substitution is sufficiently low.
Optimal fiscal policy with recursive preferences, Online Appendix, publisher's link, Review of Economic Studies, Volume 85, Issue 4, October 2018, pp. 2283-2317.
Abstract: I study the implications of recursive utility, a popular preference specification in macro-finance, for the design of optimal fiscal policy. Standard Ramsey tax-smoothing prescriptions are substantially altered. The planner over-insures by taxing less in bad times and more in good times, mitigating the effects of shocks. At the intertemporal margin, there is a novel incentive for introducing distortions that can lead to an ex-ante capital subsidy. Overall, optimal policy calls for a much stronger use of debt returns as a fiscal absorber, leading to the conclusion that actual fiscal policy is even worse than we thought.
Managing pessimistic expectations and fiscal policy, Theoretical Economics, Volume 8, Issue 1, January 2013, pp. 193-231.
Abstract: This paper studies the design of optimal fiscal policy when a government that fully trusts the probability model of government expenditures faces a fearful public that forms pessimistic expectations. We identify two forces that shape our results. On the one hand, the government has an incentive to concentrate tax distortions on events that it considers unlikely relative to the pessimistic public. On the other hand, the endogeneity of the public’s expectations gives rise to a novel motive for expectation management that aims toward the manipulation of equilibrium prices of government debt in a favorable way. These motives typically act in opposite directions and induce persistence to the optimal allocation and the tax rate.
Comment on The market price of fiscal uncertainty by Croce, Nguyen and Schmid, CRN Conference Series in Public Policy, Journal of Monetary Economics, Volume 59, Issue 5, July 2012, pp. 417-421.
Working Papers
A general theory of tax-smoothing,(updated October 2023), slides, mimeo.
Abstract: This paper organizes, reinterprets and extends the dynamic theory of optimal fiscal policy with a representative agent by using a generalized version of recursive preferences. I allow markets to be complete or incomplete and study a policymaker that acts under commitment or discretion. I highlight the underlying common principles that hide in each particular economic environment. The resulting theories are interpreted through the excess burden of taxation, a multiplier, whose evolution gives rise to different notions of ``tax-smoothing.'' Variants of a law of motion in terms of the inverse excess burden emerge in each environment when we allow for richer asset pricing implications through recursive preferences. The basic policy prescription is simple and intuitive and revolves around interest rate manipulation: issue new debt and tax more in the future if this can lead to lower interest rates today.
Greed versus fear: optimal time-consistent taxation with default, (updated April 2023) two-period economy, slides, Federal Reserve Bank of Atlanta WP 2017-12. (new version coming soon)
Abstract: This paper studies the optimal time-consistent distortionary taxation when the repayment of government debt is not enforceable. The government taxes labor income or issues non-contingent debt in order to finance an exogenous stochastic stream of fiscal shocks. Debt can be repudiated subject to some default costs. Optimal policy is characterized by two opposing incentives: an incentive to postpone taxes by issuing more debt for the future (``greed''), and an incentive to tax more currently in order to avoid punishing default premia (``fear''). A Generalized Euler Equation (GEE) captures these two effects and determines the optimal back-loading or front-loading of tax distortions. Even if default risk is small, tax-smoothing is severely limited. The same mechanisms operate also in environments with long-term debt.
A tax plan for endogenous innovation (with M.M. Croce, Steve Raymond and Lukas Schmid), Federal Reserve Bank of Atlanta WP 2017-13, Opportunity & Inclusive Growth Institute System WP 18-02.
Abstract: In times when elevated government debt raises concerns about dimmer global growth prospects, we ask: How can the government provide incentives for innovation in a fiscally sustainable way? We address this question by examining the Ramsey problem of finding optimal tax and subsidy schemes in a model in which growth is endogenously sustained by risky innovation. We characterize the shadow value of growth and entry in the innovation sector. We find that a profit tax is required to replicate the first-best in order to balance the externalities associated with innovative activity. At the second-best, the profit tax is designed to optimally respond to growth shocks above and beyond what is prescribed by the standard tax-smoothing incentives in economies with exogenous growth. The interplay of risk and innovation opens a new margin for optimal taxation.
Policy publications
Model uncertainty and policy design, Federal Reserve Bank of Atlanta’s Policy Hub, No. 17-2020.
Work in progress
"Optimal climate policy in a global economy."
"Optimal taxation and redistribution with uncertainty," (with Pei-Cheng Yu).
"Macroprudential policy: the value of commitment," (with Javier Bianchi and Enrique Mendoza).