Albert Marcet

Optimal taxation without state-contingent debt

In an economy studied by Lucas and Stokey, tax rates inherit the serial correlation structure of government expenditures, belying Barros earlier result that taxes should be a random walk for any stochastic process of government expenditures. To recover a version of Barros random walk tax-smoothing outcome, we modify Lucas and Stokeys economy to permit only risk-free debt. Having only risk-free debt confronts the Ramsey planner with additional constraints on equilibrium allocations beyond one imposed by Lucas and Stokeys assumption of complete markets. The Ramsey outcome blends features of Barros model with Lucas and Stokeys. In our model, the contemporaneous effects of exogenous government expenditures on the government deficit and taxes resemble those in Lucas and Stokeys model, but incomplete markets put a near-unit root component into government debt and taxes, an outcome like Barros. However, we show that without ad hoc limits on the governments asset holdings, outcomes can diverge in important ways from Barros. Our results use and extend recent advances in the consumption-smoothing literature.

Convergence of Least-Squares Learning in Environments with Hidden State Variables and Private Information

We study the convergence of recursive least-squares learning schemes in economic environments in which there is private information. The presence of private information leads to the presence of hidden state variables from the viewpoint of particular agents. By applying theorems of Ljung, we extend some of our earlier results to characterize conditions under which a system governed by least-squares learning will eventually converge to a rational expectations equilibrium. We apply insights from the learning results to formulate and compute the equilibrium of a version of Townsends model.

Recurrent hyperinflations and learning

This paper uses a model of boundedly rational learning to account for the observations of recurrent hyperinflations in the last decade. We study a standard monetary model where the fully rational expectations assumption is replaced by a formal definition of quasi-rational learning. The model under learning is able to match remarkably well some crucial stylized facts observed during the recurrent hyperinflations experienced by several countries in the 80s. We argue that, despite being a small departure from rational expectations, quasi-rational learning does not preclude falsifiability of the model and it does not violate reasonable rationality requirements.

Accuracy in Simulations

Since the actual solution to intertemporal rational expectations models is usually not known, it is useful to have criteria for judging the accuracy of a given numerical solution. In this paper we propose a test for accuracy that is easy to implement and can be applied to a wide class of models without knowledge of the exact solution. We discuss the power of the test by simulating several models with the linear-quadratic approximation and with the method of parameterized expectations. We conclude that the test is powerful.

Equilibrium asset prices and savings of heterogeneous agents in the presence of incomplete markets and portfolio constraints

We study the quantitative properties of a dynamic general equilibrium model in which agents face both idiosyncratic and aggregate income risk, state-dependent borrowing constraints that bind in some but not all periods and markets are incomplete. Optimal individual consumption -savings plans and equilibrium asset prices are computed under various assumptions about income uncertainty. Then we investigate whether our general equilibrium model with incomplete markets replicates two empirical observations: the high correlation between individual consumption and individual income, and the equity premium puzzle. We find that, when the driving processes are calibrated according to the data from wage income in different sectors of the US economy, the results move in the direction of explaining these observations, but the model falls short of explaining the observed correlations quantitatively. If the incomes of agents are assumed independent of each other, the observations can be explained quantitatively.

Supply Side Interventions and Redistribution

We evaluate the effect on welfare of shifting the burden of capital income taxes to labour taxes in a dynamic equilibrium model with heterogeneous agents and constant tax rates. We calibrate and simulate the economy; we find that lowering capital taxes has two effects: it increases efficiency in terms of aggregate production and it redistributes wealth in favour of those agents with a low wage/wealth ratio. When the parameters of the model are calibrated to match the distribution of income in terms of the wage/wealth ratio, the redistributive effect dominates, and agents with a high wage/wealth ratio would experience a large loss in utility if capital income taxes were eliminated.

Debt and Deficit Fluctuations and the Structure of Bond Markets

We analyse the implications of optimal taxation for the stochastic behaviour of debt. We show that when a government pursues an optimal fiscal policy under complete markets, the value of debt has the same or less persistence than other variables in the economy and it declines in response to shocks that cause the deficit to increase. By contrast, under incomplete markets debt shows more persistence than other variables and it increases in response to shocks that cause a higher deficit. Data for US government debt reveals diametrically opposite results from those of complete markets and is much more supportive of bond market incompleteness.

Fiscal Insurance and Debt Management in OECD Economies

Assuming the role of debt management is to provide hedging against fiscal shocks we consider: (i) what indicators can be used to assess the performance of debt management? (ii) how well historical debt management policies have performed (iii) how performance is affected by variations in debt issuance, using OECD data between 1970 and 2000. We propose performance indicators for debt management, which we evaluate using Monte Carlo analysis. Those based on the relative persistence of debt perform best. There is only limited evidence that debt management has helped insulate policy against unexpected fiscal shocks. The degree of fiscal insurance achieved is not well connected to cross-country variations in debt issuance patterns.

The Impact of Debt Levels and Debt Maturity on Inflation

In the context of a sticky price DSGE model subject to government expenditure and preference shocks where governments issue only nominal non-contingent bonds we examine the implications for optimal inflation of changes in the level and average maturity of government debt. We analyse these relationships under two different institutional settings. In one case government pursues optimal monetary and fiscal policy in a coordinated way whereas in the alternative we assume an independent monetary authority that sets interest rates according to a Taylor rule and where the fiscal authority treats bond prices as a given. We identify the main mechanisms through which inflation is affected by debt and debt maturity (a real balance effect and an implicit profit tax) and also study additional channels through which the government achieves fiscal sustainability (tax smoothing, interest rate twisting and endogenous fluctuations in bond prices). In the case of optimal coordinated monetary and fiscal policy we find that the persistence and volatility of inflation depends on the sign, size and maturity structure of government debt. High levels of government debt do lead to higher inflation and longer maturity debt leads to more persistent inflation. However even in the presence of modest price stickiness the role of inflation is minor with the majority of fiscal adjustment achieved through changes in taxes and the primary surplus. However in the case of an independent monetary authority where debt management, monetary policy and fiscal policy are not coordinated then inflation has a much more substantial and more persistent role to play. Inflation is higher, more volatile and more persistent especially in response to preference shocks and plays a major role in achieving fiscal solvency.

Optimal Policy with General Signal Extraction

This paper studies optimal policy with partial information in a general setup where observed signals are endogenous to policy. In this case, signal extraction about the state of the economy cannot be separated from the determination of the optimal policy. We derive a non-standard first order condition of optimality from first principles and we use it to find numerical solutions. We show how previous results based on linear methods, where separation or certainty equivalence obtains, arise as special cases. We use as an example a model of fiscal policy and show that optimal taxes are often a very non-linear function of observed hours, calling for tax smoothing in normal times, but for a strong fiscal reaction to output when a recession is quite certain and the economy is near the top of the Laffer curve or near a debt limit.