Fiscal Hedging and the Yield Curve

We identify a novel, fiscal hedging motive that helps to explain why governments issue more expensive, long-term debt. We analyze optimal fiscal policy in an economy with distortionary labor income taxes, nominal rigidities and nominal debt of various maturities. The government in our model can smooth labor tax rates by changing the real return it pays on its outstanding liabilities. These changes require state contingent inflation or adjustments in the nominal term structure. In the presence of nominal pricing rigidities and a cash in advance constraint, these changes are themselves distortionary. We show that long term nominal debt can help a government hedge fiscal shocks by spreading out and delaying the distortions associated with increases in nominal interest rates over the maturity of the outstanding long-term debt. After a positive spending shock, the government raises the yield curve and steepens it.

How does the U.S. government finance fiscal shocks?

We develop a method for identifying and quantifying the fiscal channels that help finance government spending shocks. We define fiscal shocks as surprises in defense spending and show that they are more precisely identified when defense stock data are used in addition to aggregate macroeconomic data. Our results show that in the postwar period, about 9% of the U.S. government’s unantic- ipated spending needs were financed by a reduction in the market value of debt and more than 70% by an increase in primary sur- pluses. Additionally, we find that long-term debt is more effective at absorbing fiscal risk than short-term debt.

Optimal Rules for Patent Races

There are two important rules in a patent race: what an innovator must accomplish to receive the patent and the allocation of the benefits that flow from the innovation. Most patent races end before R&D is completed and the prize to the innovator is often less than the social benefit of the innovation. We study the optimal combination of prize and minimal accomplishment necessary to obtain a patent in a dynamic multistage innovation race. A planner, who cannot distinguish between competing firms, chooses the innovation stage at which the patent is awarded and the magnitude of the prize to the winner. We examine both social surplus and consumer surplus maximizing patent race rules. We show that a key consideration is the efficiency costs of transfers and of monopoly power to the patentholder. We show that races are undesirable only when efficiency costs are low, firms have similar technologies, and the planner maximizes social surplus. However, in all other circumstances, the optimal policy spurs innovative effort through a race of nontrivial duration. Races are also used to filter out inferior innovators.

Fiscal Hedging with Nominal Assets

We analyze optimal fiscal and monetary policy in an economy with distortionary labor income taxes, nominal rigidities and nominal debt of various maturities. Optimal policy prescribes the exclusive use of long term debt. Such debt mitigates the distortions associated with hedging fiscal shocks by allowing the government to allocate them efficiently across states and periods.

On the Approximation of Value Correspondences

Recursive game theory provides theoretical procedures for computing the equilibrium payoff sets of repeated games and the equilibrium payoff correspondences of dynamic games. In this paper, we propose and implement outer and inner approximation methods for value correspondences that naturally occur in the analysis of dynamic games.The procedure utilizes set-valued step functions. We provide an application to a bilateral insurance game with storage.

Factor Price Equalization in Heckscher-Ohlin Model

This paper investigates the likelihood of factor-price equalization under the simple assumptions of Heckscher-Ohlin Theory. Factor-price equalization is also directly related to whether countries specialize or not in the global market. A full-equilibrium in the world requires not only the equilibrium in the production side of the economy, but also the supply-demand equality in the world. However, once we obtain an equilibrium in the production side of the economy, it is always possible to define demand in a way to get supply-demand equality at any production side equilibrium amounts. Therefore, it is not possible to talk about factor-price equalization without specifying demand in the economy. Using L-P diagrams, the paper demonstrates how both factor-price equalization and non-equalization cases are possible when we look at only the production side of the economy. It is also demonstrated that the equilibrium possibilities will be much larger for factor-price equalization case if the number of commodities is more than the number of factors of production. However, the larger possibilities do not refer to different real equilibria, but only to indeterminacy in production. When demand is introduced in the economy and supply-demand equality constraints are respected, we see that factor-prices might or might not be equalized depending on factor endowments, production functions and demand. The paper demonstrates this by introducing a model with 2 countries, 2 factors of production, 3 goods and CES utility function. Finally, using comparative statistics on this simple model, the conditions under which the likelihood of factor-price equalization increases are determined.

How Does the U.S. Government Finance Fiscal Shocks?

We develop a method for identifying and quantifying the fiscal channels that help finance government spending shocks. We define fiscal shocks as surprises in defense spending and show that they are more precisely identified when defense stock data are used in addition to aggregate macroeconomic data. Our results show that in the postwar period, over 9% of the U.S. government's unanticipated spending needs were financed by a reduction in the market value of debt and more than 73% by an increase in primary surpluses. Additionally, we find that long-term debt is more effective at absorbing fiscal risk than short-term debt.

Non-linear Capital Taxation Without Commitment

We study efficient non-linear taxation of labour and capital in a dynamic Mirrleesian model incorporating political economy constraints. Policies are chosen sequentially over time, without commitment. Our main result is that the marginal tax on capital income is progressive, in the sense that richer agents face higher marginal tax rates

Dynamic Principal-Multiple Agent Contracts

I explore the nature of optimal static and dynamic contracts in an environment with moral hazard, where individuals contracting with the same principal receive correlated productivity shocks. The environment resembles the one considered in relative compensation theory ( i.e tournament theory), but extends this theory by solving for the optimal static and dynamic contracts in this setting. I compute and analyze \emph{independent} (each worker's compensation depends only on her output) and relative contracts (each worker's compensation depends on the xoutputs of all workers contracting with the same principal). Results imply that the optimal static relative contract is not substantially different from the optimal static independent contracts. However, the dynamic relative contract displays a strong a tournament feature; the contract gives the highest compensation to the worker who produces more than her counterparts and the lowest compensation to the least productive worker. I also characterize the stochastic processes for consumption and effort implied by dynamic contracts, and study the age-earnings profiles of the workers.dynamic contracts, mechanism design, tournaments, lotteries