Research

Publications


  •  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.


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.


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.


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.


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.

 


Working Papers


 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.


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.


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



Work in progress