David M. Arseneau

Optimal Fiscal and Monetary Policy With Costly Wage Bargaining

Costly nominal wage adjustment has received renewed attention in the design of optimal policy. In this paper, we embed costly nominal wage adjustment into the modern theory of frictional labor markets to study optimal fiscal and monetary policy. Our main result is that the optimal rate of price inflation is highly volatile over time despite the presence of sticky nominal wages. This finding contrasts with results obtained using standard sticky-wage models, which employ Walrasian labor markets at their core. The presence of shared rents associated with the formation of long-term employment relationships sets our model apart from previous work on this topic. The existence of rents implies that the optimal policy is willing to tolerate large fluctuations in real wages that would otherwise not be tolerated in a standard model with Walrasian labor markets; as a result, any concern for stabilizing nominal wages does not translate into a concern for stabilizing nominal prices. Our model also predicts that smoothing of labor tax rates over time is a much less quantitatively-important goal of policy than standard models predict. Our results demonstrate that the level at which nominal wage rigidity is modeled -- whether simply lain on top of a Walrasian market or articulated in the context of an explicit relationship between workers and firms -- can matter a great deal for policy recommendations.

Tax Smoothing in Frictional Labor Markets

We re-examine the optimality of tax smoothing from the point of view of frictional labor markets. Our central result is that whether or not this cornerstone optimal scal policy pre

Optimal Fiscal and Monetary Policy in Customer Markets

A growing body of evidence suggests that ongoing relationships between consumers and firms may be important for understanding price dynamics. We investigate whether the existence of such customer relationships has important consequences for the conduct of both long-run and short-run policy. Our central result is that when consumers and firms are engaged in long-term relationships, the optimal rate of price inflation volatility is very low even though all prices are completely flexible. This finding is in contrast to those obtained in first-generation Ramsey models of optimal fiscal and monetary policy, which are based on Walrasian markets. Echoing the basic intuition of models based on sticky prices, unanticipated inflation in our environment causes a type of relative price distortion across markets. Such distortions stem from fundamental trading frictions that give rise to long-lived customer relationships and makes pursuing inflation stability optimal.

The Welfare Costs of Skill-Mismatch Employment

Skill-mismatch employment occurs when high-skilled individuals accept employment in jobs for which they are over-qualified. These employment relationships can be beneficial because they allow high-skilled individuals to more rapidly transition out of unemployment. They come at the cost, however, in the form of lower wage compensation. Moreover, an externality arises as high-skilled individuals do not take into account the effect that their search activity in the market for low-tech jobs has on low-skilled individuals. This paper presents a tractable general equilibrium model featuring mismatch employment and on-the-job search to articulate these tradeoffs. We derive a set of efficiency conditions that describe the labor market distortions associated with these two model features and illustrate how they alter the standard notion of the labor wedges inherent in general equilibrium search models. Finally, we calibrate the model to U.S. data and show that the distortions associated with mismatch employment are largely distributional and can be quantitatively large.

Offshoring, Mismatch, and Labor Market Outcomes

We study the role of labor market mismatch in the adjustment to a trade liberalization that results in the offshoring of high-tech production. Our model features two-sided heterogeneity in the labor market: high- and low-skilled workers are matched in a frictional labor market with high- and low-tech frms. Mismatch employment occurs when high-skilled workers choose to accept a less desirable job in the low-tech industry. The main result is that this type of job displacement is actually benefcial for the labor market in the country doing the o¤shoring. The reason is that mismatch allows this economy to reallocate domestic high-skilled labor across both high- and low-tech industries. In doing so, this reallocation dampens both the increase in the aggregate unemployment rate and the decline in aggregate wages that come as a consequence of shifting domestic production abroad. From a policy perspective, this result is perhaps counter-intuitive because it suggests that some degree of job dislocation is actually desirable as it helps facilitate adjustment in the labor market following a trade liberalization.

Explaining the energy consumption portfolio in a cross-section of countries: are the BRICs different?

This paper uses disaggregated data from a broad cross-section of countries to empirically assess differences in energy consumption profiles across countries. We find empirical support for the energy ladder hypothesis, which contends that as an economy develops it transits away from a heavier reliance on traditional fuel sources towards an increase in the use of modern commercial energy sources. We also find empirical support for the hypothesis that structural transformation--the idea that as an economy matures, it transforms away from agriculture-based activity into industrial activity and, finally, fully matures into a service-oriented economy--is an important driver for the distribution of end-use energy consumption. However, even when these two hypotheses are taken into account, we continue to find evidence suggesting that the patterns of energy consumption in the BRIC economies are importantly different from those of other economies.

Competitive Search Equilibrium in a DSGE Model

We show how to implement a competitive search equilibrium in a fully-specified DSGE environment. Competitive search, an equilibrium concept well-understood in labor market theory, offers an alternative to the commonly-used Nash bargaining in search-based macro models. Our simulation-based results show that business cycle fluctuations under competitive search equilibrium are virtually identical to those under Nash bargaining for a broad range of calibrations of Nash bargaining power. We also prove that business cycle fluctuations under competitive search equilibrium are exactly identical to those under Nash bargaining restricted to the popularly-used Hosios condition for search efficiency. This latter result extends the efficiency properties of competitive search equilibrium to a DSGE environment. Our results thus provide a foundation for researchers interested in studying business cycle fluctuations using search-based environments to claim that the sometimes-awkward assumption of bargaining per se does not obscure interpretation of results.

Optimal Inflation in an Open Economy with Imperfect Competition

This paper uses a two-country, monetary general equilibrium model with imperfect competition to study the optimal rate of inflation in an open economy. In contrast with the closed economy literature, when policy is set non-cooperatively in the open economy, the optimality of the Friedman rule is not a general result. Monetary authorities face an incentive to use the inflation tax to gain a beggar-thy-neighbor advantage over the terms of trade. Strategic use of the inflation tax, however, results in coordination failure. International monetary cooperation helps to mitigate this coordination failure and, as a result, can lead to more efficient equilibria. Monetary union ensures the maximum gain from cooperation by restoring the optimality of the global Friedman rule, placing the world economy at the Pareto frontier.

Private and Public Liquidity Provision in Over-the-Counter Markets

We show that trade frictions in OTC markets result in inefficient private liquidity provision. We develop a dynamic model of market-based financial intermediation with a two-way interaction between primary credit markets and secondary OTC markets. Private allocations are generically inefficient because investors and firms fail to internalize how their actions affect liquidity in secondary markets. This inefficiency can lead to liquidity that is suboptimally low or high compared to the second best. Our analysis provides a rationale for the regulation and public provision of liquidity and the effect of quantitative easing or tightening on capital markets and investment.

How Would Us Banks Fare in a Negative Interest Rate Environment

This paper uses a unique new data set to empirically examine bank-level expectations regarding the impact of negative short-term interest rates on bank profitability through net interest margins. The results show that banks differ significantly in their views regarding how profits might be affected in a negative interest rate environment and that much of this heterogeneity can be explained by cross-bank differences in the provision of liquidity services. We find that those banks that are more active in providing liquidity to borrowers anticipate suffering reduced profitability through declines in interest income on short-duration assets. The opposite is true of banks that are more active in providing liquidity to depositors as these banks expect to benefit from lower short-term funding costs. However, we find that these distributional effects wash out at the aggregate level, as liquidity provision is sufficiently well diversified across all banks.