Research

Optimal Redistribution with A Shadow Economy  (Joint with Paweł Doligalski) (Theoretical Economics 18 (2023), 749–791).

We extend the theory of optimal redistributive taxation to economies with an informal labor market. The optimal tax formula contains two novel terms capturing reported income responses of informal workers on an intensive and an extensive margin. Both terms decrease the optimal tax rates. We estimate the model with Colombian data and show that the reduction of tax rates relative to the best-performing standard tax formula can be quantitatively large, reaching 25 pp and leading to a 1.9\% welfare gain. We also provide a novel decomposition of the welfare impact of the shadow economy into an efficiency and a redistribution components. Conditional on the optimal tax policy, the Colombian shadow economy benefits efficiency at the expense of redistribution. Consequently, the presence of the informal sector reduces welfare only when preferences for redistribution are strong.

M&A and early investment decisions in digital platforms (Joint with Zelda Brutti)

(Journal of Industrial and Business Economics 49 (2022), 509-543)

We propose an original theoretical framework that models early investment decisions of digital platform startups and use it to study how merger and acquisition policy affects consumer welfare by shaping such decisions. We formalize the investment options faced by digital platforms into a dual margin: investment in `customer engagement technology', directed towards expanding the user base and in `intermediation technology', directed towards lowering operational costs. Sinergies through technological transfer and increased investment incentives in customer engagement explain consumer welfare improvements in the case of M&As occurring between platforms with disjoint user bases. On the other hand, lower competition erodes consumer welfare in the case of allowing M&As between platforms with overlapping user bases. We conclude that M&A policy guidance should depend on the relationship between the incumbent's and startup's target users and on the ability of the startup to catch up with the incumbent.

The Bright Side of the Doom Loop: Banks Exposure and Default Incentives (Joint with Dominik Thaler) (R&R at the European Economic Review)

Latest version (2024) June 2024 revised version!

The feedback loop between sovereign and financial sector insolvency, termed the “doom loop”, was a key driver of the European debt crisis and motivated an array of policy proposals. This paper revisits the “doom loop” focusing on governments’ incentives to default. We introduce a 3-period model with strategic sovereign default, where debt is held by both domestic banks and foreign investors. The government maximizes domestic welfare; thus, the temptation to default increases with externally-held debt. Importantly, the cost of default arises endogenously from the damage that default causes to domestic banks’ balance sheets. Domestically-held debt thus serves as a commitment device for the government. We show that two prominent policy prescriptions – lower exposure of domestic banks to domestic sovereign debt or a commitment not to bailout banks – can backfire, since default incentives depend not only on the quantity of debt, but also on who holds it. Conversely, allowing domestic banks to buy additional domestic sovereign debt during times of sovereign distress can avert the doom loop. In the context of a monetary union similar unintended negative consequences may arise from a backstop by the central bank (e.g., the ECB’s Transmission Protection Instrument) if imprecisely calibrated or the pooling of debt (e.g., European safe bond, also known as ESBies).

Optimal Taxation, Informality and Welfare: Redistribution Costs and Efficiency Gains ((Joint with Paweł Doligalski) (R&R at the CESifo Economic Studies)

We characterize the welfare effects of the informal sector by proposing a decomposition into efficiency and redistribution components. We focus on an economy where a planner wants to redistribute income with taxation and sets the optimal tax scheme. Since the informal sector can limit the taxation possibilities for the government but at the same time provide a shelter against tax distortions for individuals we show that the net welfare effect can be positive or negative. We show that the relative advantage between informal and formal employment across different income levels is the key dimension that shapes the welfare costs of the informal sector. Using the model estimated with Colombian microdata, we show that, conditional on the optimal tax policy, the Colombian shadow economy benefits efficiency at the expense of redistribution. Consequently, the presence of the informal sector reduces welfare only when preferences for redistribution are strong.

Optimal Disinflation with Delegation and Limited Credibility (Joint with Mridula Duggal)

BSE working paper 1401 (2023 version)

We examine the challenge faced by a government aiming to implement a gradual reduction in inflation by entrusting monetary policy to an independent central bank with limited credibility. Expanding upon the framework established by Barro (1983) , we demonstrate that an optimal policy for minimizing the sacrifice ratio of disinflation involves a gradual disinflationary process coupled with the announcement of intermediate targets. The speed at which disinflation occurs strikes a balance between the objective of enhancing credibility and the associated costs of unexpected inflation. Our theoretical framework provides an explanation for the disinflationary experiences observed in Chile and Colombia during the 1990s, wherein these countries established new monetary institutions and steadily achieved single-digit inflation levels through the annual announcement of decreasing inflation targets. We argue that the use of intermediate targets played a pivotal role in their design, facilitating the establishment of credibility with lower output costs.

Expectations Formation and Investment During Recessions 

A standard assumption in macroeconomic modeling is that economic agents may have limited information but perfect market knowledge. In an environment where firms do not have perfect market knowledge and form expectations with a simplified model of the economy, I show that during recessions firms tend to delay investment due to "pessimism": their subjective beliefs underestimate the potential gains of the investment project. The mechanism proposed helps to explain a stylized fact highlighted in this paper: After recessions, investment is slower in recovering than GDP. Since the pessimism induces an inefficient delay of investment I study the potential gains of an investment subsidy and a counter-cyclical corporate tax policy. If the government cannot distinguish between a lack of investment driven by pessimism and one by high technological risk, a counter-cyclical corporate tax policy can screen pessimistic firms and provide incentives to invest. On the other hand, an investment subsidy would push firms to invest in both cases, leading to excessive risk taking.

Learning in Sovereign Debt Markets

A default episode is typically followed by 1) a raise in spreads and 2) a positive surplus for the lenders. In this paper I show that this fact can be reconciled with a model of creditors learning about the default probability of a sovereign. Existing sovereign debt models are instead unable to accommodate these aspects of the data, as they portray mappings from economy fundamentals to spreads which are not affected by default history. The theory also implies that full repayment of debt can lead to a drop in spreads, providing the incentives to the sovereign for higher debt exposure and consequently a negative surplus for the lenders. Furthermore, if creditors learn about multiple countries, I show that clusters of default emerge as a side effect of the beliefs formation process, and can occur even if there is no trade or capital market link between countries.