Richard G. Harris

Computing optimal tax equilibria

Abstract This paper proposes a technique for computing optimal taxes in a full general equilibrium model. It is based upon a fixed point algorithm of the type that is widely used to solve Walrasian general equilibrium models. Computing an optimal tax equilibrium is more difficult than solving a general equilibrium model only to the extent that the derivatives of the social welfare function and of the consumer demand functions must be calculated in the former case. Solutions to several sample problems are provided to demonstrate the technique. They suggest that optimal tax rates are exceedingly sensitive to the specification of the model used to derive them.

Ex-Post Efficiency and Resource Allocation under Uncertainty

This paper considers two resource allocation mechanisms which operated in an ex ante exchange environment and have the properties that: 1) equilibrium allocations are ex post efficient; 2) ex post efficient allocations can be attained as equilibrium of the mechanisms. With the possibility of production ex post efficiency is inadequate as a partial ordering of resource allocations and an alternative efficiency notion is introduced.

A characterization of piecemeal second best policy

This paper derives conditions under which prices may be set proportional to margin cost in some sectors of the economy when fixed distortions exist in other sectors. Two simple neo-classical economies are considered -- one with fixed producer prices and one with variable producer prices. In the former case, necessary and sufficient conditions are derived for piecemeal policy in terms of properties of derivatives of the demand functions. These conditions are interpreted in terms of separability properties of utility functions. In the latter case, sufficient conditions are derived which involve both demand and supply derivatives. We use a dual formulation to the problem, where conditions in terms of demand and supply derivatives are observable, and explicitly take into consideration the budgetary constraint of the government. In general, complete laissez-faire is not optimal.

Efficient Commodity Taxation

Abstract Necessary and sufficient conditions for a set of commodity taxes to be Pareto efficient are derived. Unlike the literature on optimal taxation these conditions are derived without reference to a social welfare function. One of the necessary conditions derived by a revealed preference argument is particularly useful. It is shown to yield the Ramsey rule for single-person economies and some alternative rules for many-person economies. These rules have the desirable feature that they depend only upon the properties of the aggregate household demand functions and aggregate technology.

Optimal Capital Policy with Bounded Investment Plans

The neoclassical theory of optimal capital accumulation commonly employs the assumption that the level of investment by the firm is bounded neither above nor below.2 Arrow [2] has considered irreversible investment in which case the investment plan is bounded below by zero and he provided a characterization of the optimal capital policy on both those intervals of time where the bound was effective and on those intervals where the bound was not effective. In this paper we consider the optimal capital policy of a firm maximizing its present value over an infinite horizon under perfect certainty, when the investment plan is bounded both above and below. The upper bound is such that the amount invested by the firm at any moment of time is limited by current profits. It turns out that this bound has some interesting implications in terms of a comparison with the traditional case of unbounded investment plans. The interest in investment plans which are bounded above stems from the observation that a number of capital market imperfections lead precisely to such bounds.3 In particular we show that situations in which either the firm faces a non-price capital rationing constraint or the absence of a capital market in which firms may borrow there exists an upper bound on investment plans equivalent to the one mentioned above. Capital market imperfections such as these are not uncommon. Credit rationing, for example, was found to be an empirically significant phenomenon by Jaffee and Modigliani [4] and has often beeni noted as one of the more common forms of capital market imperfections facing firms. It is perhaps not insignificant then that in the applied business finance literature the investment problem is often treated as allocating a fixed amount of investment funds among various projects. In order to provide a characterization of the optimal capital policy of the firm with bounded investment plans, we use as reference a firm identical in all other respects, but whose investment plans are not constrained as in the case of a perfect capital market. Now it is not immediately obvious in a dynamic model how one should go about comparing two investment plans. The question we wish to address is whether the bound on investment plans imposed by the capital market

Incomplete information and the equilibrium determination of the forward exchange rate

Abstract In the present paper we embed the forward exchange rate in an equilibrium macroeconomic model incorporating rational expectations and portfolio balance, and in which the spot exchange rate, the forward exchange rate, the expected future spot rate, and the domestic interest rate are determined simultaneously. The purpose is to examine the impact of alternative macroeconomic disturbances on the spot and forward exchange rates and on the bias in the forward rate as a predictor of future spot rates. The rational expectations hypothesis plays a key role in the analysis; alternative assumptions made about the information available to agents in the economy are shown to have rather dramatic consequences on the answers obtained.

A General Equilibrium Analysis of the Capital Asset Pricing Model

The mean-variance portfolio model of Markowitz and Tobin has been the most substantive contribution to the theory of individual asset demand under uncertainty, in terms of comparative static results and testable implications. Although subject to a number of criticisms at the axiomatic level, it still stands as the classic portfolio model. The general equilibrium extension of the Tobin-Markowitz model due to Sharpe [14], Lintner [9], and Mossin [11] has led to important propositions about the nature of risk in general equilibrium and its effect on the pricing of assets, and the model has subsequently been subjected to extensive empirical testing. It has been used for a variety of purposes in areas ranging from corporate-finance theory to the debate on the social discount rate.

The NAMU Debate

In my comments I want to emphasize the major problems with flexible exchange rates in light of the longer term resource allocation effects on the economy of the exchange rate regime. These are undoubtedly one of the major considerations driving the Canadian interest in the North American monetary union (NAMU), and exchange rate stability in North America more generally. It is worth emphasizing that the Canadian-US situation is much different than for many other small, open economies. Canada not only has a high degree of openness, but it trades predominantly with a single country. Moreover, as Tom Courchene has emphasized, this integration is very much a north-south regional integration which reflects the peculiar geography of Canada relative to virtually all other countries. The fact of this integration coupled with the shift in the wealth-generation process within Canada toward human-capital-intensive activities has considerably raised the benefit-cost ratio of exchange rate fixity. Let me elaborate on these themes.