• Policy Announcements and Welfare (pdf), with Christian Stoltenberg (job market paper) (2007)
  • Abstract: In this paper we show that policy announcements can be detrimental to welfare. We consider an economy in which agents face idiosyncratic and aggregate risk. The policy maker learns about the aggregate shock before it directly impacts on the allocation, and can decide to announce that information early. Agents engage in risk-sharing contracts consistent with voluntary participation incentives. By early announcements the policy maker distorts agents' insurance possibilities, thereby increasing the variance of the optimal consumption allocation and worsening welfare ex-ante. As a particular application, we consider the problem of a monetary authority, which has the option of announcing shifts in the inflation target early. In this economy, monetary policy has real effects captured by a cash-in advance constraint. A fraction of firms need to set prices one period in advance, so that a late announcement of inflation target shifts results in welfare-reducing distortions of relative prices, if no idiosyncratic risk is present. However, with idiosyncratic risk of households -- modeled as employment opportunities -- we show that it may be better for the central bank to remain secretive. We characterize the parameters for which this is so.

 

• Government Investment and the European Stability and Growth Pact (pdf), with Marco Bassetto (2007)
  • Abstract: We consider the effect of excluding government investment from the deficit subject to the limits of the European Stability and Growth Pact. In the model we consider, residents of a given country discount future costs and benefits of government spending more than efficiency would dictate, because they fail to take into account the portion that will accrue to people that have not yet been born or immigrated into the country. It is thus in principle desirable to design budget rules that favor long term investment (by allowing more borrowing) over other government spending that only carries short term benefits. However, given the low rates of population growth, mortality, and mobility across European countries, we find that the distortions arising from treating all government spending equally are likely to be modest. We also show that these modest distortions can be alleviated only if net government investment is excluded from the deficit computation; excluding gross investment may even be counterproductive, as it promotes overspending in government capital.

 

• Time Consistency Problem in a Monetary Union (pdf) (2006)
  • Abstract: We study a monetary union with a monetary authority that lacks commitment and adopts monetary decisions collectively. The lack of commitment implies that the governments of the union countries tend to overissue the nominal debt knowing that the monetary authority would inflate the debt. We show that under the majority rule there are multiple noncooperative equilibria. In all of the equilibria only the majority of the union countries takes directly into account the actions of the noncommitted monetary authority. The minority free rides on the majority and obtains higher welfare. Remarkably, the best noncooperative majority equilibrium provides higher welfare than a symmetric cooperative equilibrium. Fiscal constraints, if binding, shrink the set of the noncooperative equilibria, which calls into question the desirability of the fiscal constraints as a tool to combat the lack of commitment.