Learning from Prices: Public Communication and Welfare. 

(joint with Pierre Olivier Weill, UCLA)

We present an economy where agents are uncertain about two shocks: an aggregate productivity shock and an aggregate monetary shock. We show that when agents learn from the distribution of prices, a release of public information about either one of the two shocks (as a consequence, for example, of publishing an economic aggregate) can reduce the informational efficiency of the nominal price system and reduce welfare. In some cases, public information releases can create or eliminate multiple equilibria. PDF.

Investment Cycles and Sovereign Debt Overhang. 

(joint with Mark Aguiar, Rochester and Gita Gopinath, Harvard)

Review of Economic Studies, forthcoming

We characterize optimal taxation of foreign capital and optimal sovereign debt policy in a small open economy where the government cannot commit to policy and seeks to insure a risk averse domestic constituency. The expected tax on capital is shown to vary with the state of the economy, generating cyclicality in investment and debt in an environment where the first best capital stock is a constant. The government's lack of commitment induces a negative correlation between investment and the stock of government debt, a ``debt overhang'' effect. If the government discounts the future at a rate higher than the market, then capital oscillates indefinitely at a level strictly below the first best. Debt relief is never Pareto improving and cannot affect the long-run level of investment. Further, restricting the government to a balanced budget can eliminate the cyclical distortion of investment. PDF.

Learning from Private and Public Observations of others actions. 

(joint with Pierre Olivier Weill, UCLA)

We study the diffusion of dispersed private information in a large economy. We assume that agents learn from the actions of others through both a private channel, which represents learning from local interactions, and a public channel, which represents learning from prices. We show that the private and public channels of information diffusion generate different learning dynamics and welfare implications. In particular, while public information always increases welfare when agents learn only from a public channel, it can reduce it when a private learning channel is present. PDF.

Link to a much older version in discrete time: old PDF.

Efficient Expropiation: Sustainable Fiscal Policy in a Small Open Economy

(joint with Mark Aguiar, Rochester and Gita Gopinath, Harvard)

We study optimal fiscal policy in a small open economy characterized by two main frictions -- incomplete financial markets and an inability of the government to commit to policy. Our main contribution is to show that in this environment, the best sustainable policy can amplify and prolong shocks to output. In particular, the government's credibility not to expropriate foreign capital endogenously varies with the state of the economy and may be "scarcest" during recessions. This increased threat of expropriation depresses investment and prolongs downturns. PDF

Commitment versus Flexibility

(joint with G.Angeletos, MIT and I.Werning, MIT)

Econometrica March 2006 - 74(2) - p. 365-396

This paper studies the optimal trade-off between commitment and flexibility in an intertemporal consumption/savings choice model. Individuals expect to receive relevant information regarding their own situation and tastes - generating a value for flexibility -- but also expect to suffer from temptations with or without self-control -- generating a value for commitment. The model combines the representations of preferences for flexibility introduced by Kreps (1979) with its recent antithesis for commitment proposed by Gul and Pesendorfer (2001), or alternatively, the hyperbolic discounting model. We set up and solve a mechanism design problem that optimizes over the set of consumption/saving options available to the individual each period. We characterize the conditions under which the solution takes a simple threshold form where minimum savings policies are optimal. We also show that in these cases the optimal commitment device can be implemented sequentially by allowing the agent to manage a portfolio of liquid and illiquid assets. PDF. Supplementary material .

Link to older NBER version

A Political Model of Sovereign Debt Repayment

Bulow and Rogoff (1989) show that a country that has access to a sufficiently rich asset market cannot commit to repay its debts and therefore should be unable to borrow. This is because for any debt contract, there exists a time at which the country is made better off by defaulting and replicating the payoffs of the debt contract through savings in the asset market. This paper provides an answer to this paradox based on a political economy model of debt. It shows that the presence of political uncertainty reduces the ability of a country to save, and hence to replicate the original debt contract after default. In a model where different parties alternate in power, an incumbent party with a low probability of remaining in power has a high short-term discount rate and is therefore unwilling to save. The current incumbent party realizes that in the future whoever achieves power will be impatient as well, making the accumulation of assets unsustainable. This time-inconsistency is shown to be equivalent to the problem faced by a hyperbolic consumer. Because of their inability tosave, politicians demand debt ex-post and the desire to borrow again in the future enforces repayment today.PDF

Savings under Political Compromise.

In this paper, I present a political economy model of government savings. Two political parties alternate in power every period. The party in power controls the government and decides how to allocate spending this period and how much to save for the future. No party has the ability to commit and at any point in time a party can spend all the income of the government in her own consumption and save nothing for the future. If both parties behave as previously described, then these strategies are the worst subgame perfect equilibria. However, parties are long run players in this political game, and they might be expected to coordinate and play more efficiently. I characterize the set of efficient subgame perfect equilibria. PDF

Entrepreneurial Pressure and Innovation

(joint with Augustin Landier, NYU Stern)

Ideas occur to managers who envision projects that can possibly improve on existing technologies. Such projects can be implemented either inside existing firms or be financed outside with venture capital. The willingness of an incumbent firm to implement a new idea depends on the price that the firm has to pay the manager to do it inside relative to the threat that the project constitutes if successfully implemented outside. This price depends in turn on the expected payoff that the manager can get by implementing the project outside. Therefore, the venture capital market affects the innovation policy of established companies by affecting both the set of projects that can be implemented outside and the payoffs required to acquire new ideas. Which projects are done inside vs. outside depends on the balance between two comparative advantages: the incumbent firm can use existing assets while the venture capitalist can write contracts contingent on the project's outcome. In the presence of behavioral or informational frictions, the most innovative projects are implemented in new ventures and more focused firms innovate more. If the marginal innovation is done under pressure from outside, a better VC market increases the innovation rate. If the marginal innovation would have been implemented without outside pressure, a better VC market, by decreasing the rents of being the incumbent firm, decreases the rate of innovation. Therefore, in equilibrium, the relation between innovation and the efficiency of external capital markets is non-monotonic. PDF