Minimum consumptions requirements: theoretical and quantitative implications for growth and distribution

The authors study the impact of a minimum consumption requirement on the rate of economic growth and the evolution of wealth distribution. The requirement introduces a positive dependence between the intertemporal elasticity of substitution and household wealth. This dependence implies a transition phase during which the growth rate of per-capita quantities rise toward their steady-state values and the distributions of wealth, consumption, and permanent income become more unequal. The authors calibrate the minimum consumption requirement to match estimates available for a sample of Indian villagers and find that these transitional effects are quantitatively significant and depend importantly on the economy's steady-state growth rate. NOTE: This paper refers to figures not currently available with this electronic version. For a hard copy of the figures, call the Research Department's Publications Desk at 215-574-6428 and ask for Working Paper 97-15.Consumption (Economics) ; Wealth

Costly technology adoption and capital accumulation

The authors develop a model of costly technology adoption where the cost is irrecoverable and fixed. Households must decide when to switch from an existing technology to a new, more productive technology. Using a recursive approach, the authors show that there is a unique threshold level of wealth above which households will adopt the new technology and below which they will not. This threshold is independent of preference parameters and depends only on technology parameters. Prior to adoption, households invest at increasing rates, but consumption growth is constant. The authors also show that richer households adopt sooner and that income inequality increases over time. Both these results are consistent with the evidence from the Green Revolution.Technology ; Wealth

Search Frictions and Asset Price Volatility

We examine the quantitative effect of search frictions in product markets on asset price volatility. We combine several features from Shi (1997) and Lagos and Wright (2002) in a model without money. Households prefer special goods and general goods. Special goods can be obtained only via a search in decentralized markets. General goods can be obtained via trade in centralized competitive markets and via ownership of an asset. There is only one asset in our model that yields general goods. The asset is also used as a medium of exchange in the decentralized market to obtain the special goods. The value of the asset in facilitating transactions in the decentralized market is determined endogenously. This transaction role makes the asset pricing implications of our model different from those in the standard asset pricing model. Our model not only delivers the observed average rate of return on equity and the volatility of the equity price, but also accounts for most of the spectral characteristics of the equity price.Financial markets; Market structure and pricing

Optimal auditing and insurance in a dynamic model of tax compliance

We study the optimal auditing of a taxpayer's income in a dynamic principal-agent model of hidden income. Taxpayers in our model initially have low income and stochastically transit to high income that is an absorbing state. A low-income taxpayer who transits to high income can under-report his true income and evade his taxes. With a constant absolute risk-aversion utility function and a costly auditing technology, we show that the optimal auditing mechanism in our model consists of cycles. Within each cycle, a low-income taxpayer is initially unaudited, but if the duration of low-income report exceeds a threshold, then the auditing probability becomes positive. That is, the tax authority guarantees that the taxpayer will not be audited until the threshold duration is reached. We also find that auditing becomes less frequent if the auditing cost is higher or if the variance of income is lower.Tax compliance, tax auditing, stochastic costly state verification

From Cronies to Professionals: The Evolution of Family Firms

We develop a dynamic model where each generation in a family firm can continue operating its inherited production technology or it could hire a professional to do the same. Though the professional is more qualified, his interests are not aligned with the interests of the family. In the context of an overlapping generations framework, we analyze how this tradeoff affects the evolution of the family firm. We find that family firms initially grow in size by accumulating capital and later professionalize their management after reaching a critical size.Family firms; Cronies; Moral Hazard;

Costly Technology Adoption and Capital Accumulation

We develop a model of costly technology adoption where the cost is irrecoverable and fixed. Households must decide when to switch from an existing technology to a new, more productive technology. Using a recursive approach, we show that there is a unique threshold level of wealth above which a household will adopt the new technology and below which it will not. This threshold is independent of preference parameters, and depends only on technological parameters. Prior to adoption, households invest at increasing rates but consumption growth is constant. We also show that richer households adopt sooner which is consistent with the evidence from the Green Revolution. Our results are robust to households having access to loans.

Search Frictions and Asset Price Volatility

Excess volatility, liquidity

Optimal auditing and insurance in a dynamic model of tax compliance

We study the optimal auditing of a taxpayer’s income in a dynamic principal- agent model of hidden income. Taxpayers in our model initially have low income and stochastically transit to high income that is an absorbing state. A low-income taxpayer who transits to high income can underreport his true income and evade his taxes. With a constant absolute risk-aversion utility function and a costly and imperfect auditing technology, we show that the optimal auditing mechanism in our model consists of cycles. Within each cycle, a low-income taxpayer is initially unaudited, but if the duration of low-income reports exceeds a threshold, then the auditing probability becomes positive. That is, the tax authority guarantees that the taxpayer will not be audited until the threshold duration is reached. We also find that auditing becomes less frequent if the auditing cost is higher or if the variance of income is lower.Tax auditing ; Taxation

Growth and Risk-Sharing with Private Information

We examine the impact of incomplete risk-sharing on growth and welfare. The source of market incompleteness in our economy is private information: a household's idiosyncratic productivity shock is not observable by others. Risk-sharing between households occurs through long-term contracts with intermediaries. We find that incomplete risk- sharing tends to reduce the rate of growth relative to the complete risk sharing benchmark. Numerical examples indicate the contracts are relatively efficient and that the growth effects of private information are small.growth, long-term contracts, risk-sharing

The Return to Capital and the Business Cycle

A widely cited failing of real business cycle models is their inability to account for the cyclical patterns of financial variables. Perhaps less well known is the fact that the return to capital and equity are identical in the neoclassical growth model. This paper constructs a measure of the return to business capital for the U.S. The S&P 500 return is roughly six times more volatile than the return to business capital. Owing to the equivalence between the returns to capital and equity in the neoclassical growth model, papers in the real business cycle literature that successfully account for the time series variation in the S&P 500 return must fail to account for the time series properties of the return to capital. A fairly basic real business cycle model captures most of the observed variability in the return to capital. What is needed is a theory of the stock market that breaks the equivalence between the returns to equity and capital. Forthcoming, Review of Economic Dynamicsreturn to capital, business cycles, asset returns