Working Papers:

Efficiency, Insurance, and Redistribution Effects of Government Policies (joint with Anmol Bhandari, Mikhail Golosov and Thomas Sargent) R&R JPE

We decompose welfare effects of switching from government policy A to policy B into three components: gains in aggregate efficiency from changes in total resources; gains in redistribution from altered consumption shares that ex-ante heterogeneous agents can expect to receive; and gains in insurance from changes in individuals’ consumption risks. Our decomposition applies to a broad class of multi-person, multi-good, multi-period economies with diverse specifications of preferences, shocks, and sources of heterogeneity. It has several desirable properties. For example, it attributes to the insurance component all welfare effects that arise purely from mean preserving spreads in consumption. We compare our decomposition to earlier ones developed by Benabou (2002) and Floden (2001) and show that those approaches attribute welfare effects from such spreads to insurance only under special conditions.

Managing Public Portfolios (joint with Anmol Bhandari, Mikhail Golosov and Thomas Sargent) R&R JPE

We develop a unified framework for optimal management of public portfolios for a general class of macro-finance models imposing very few restrictions on households’ risk and liquidity preferences or market structure for financial assets. Small-noise expansions to first-order conditions for a Ramsey plan can be reorganized into a formula for an optimal portfolio of government financial assets that isolates four motives balanced at an optimum: (1) hedging interest rate risk, (2) hedging primary deficit risk, (3) supplying liquid assets, and (4) internalizing equilibrium effects of public policies on financial asset prices. We directly calibrate quantitative measures of these four motives. Hedging interest rate risk plays a dominant role in shaping an optimal portfolio of financial assets for the U.S. federal government.

Optimal Taxation with Persistent Idiosyncratic Investment Risk

We study the role of capital taxation in a general equilibrium heterogeneous agent economy with uninsurable investment risk characterized by persistent productivity shocks to the firms privately owned by the entrepreneurs.  In contrast to models with i.i.d. investment risk, the inclusion of persistent investment risk does not allow for easy aggregation.  Instead, in solving this model we use a novel application of perturbation theory to economies with heterogeneous agents.  This application exploits a symmetry that reduces the computational burden of approximating policy rules via a truncated Taylor expansion, allowing us to change the point of approximation to be the closest non-degenerate steady state to the current state of the planner’s problem as the economy evolves.  The presence of idiosyncratic investment risk leads to an under-accumulation of capital, which leads the Ramsey planner to have two conflicting motives in setting the capital tax.  On the one hand, the planner wishes to correct the under-accumulation of capital by subsidizing saving.  On the other hand, the planner wants to use capital taxes to redistribute from agents whose investments paid off to those whose investments did not perform well.  In the presence of i.i.d. productivity shocks the first motive dominates and the planner moves to correct the savings decisions of the agents, but we find that with persistent shocks the motive for redistribution dominates, leading the government to tax capital.  This result is robust to the inclusion of financial frictions.

Published Papers

Locally Rational Agents (with Alex Li and Bruce McGough) Journal of Economy Behavior and Organization

A new behavioral concept, local rationality, is developed within the context of a simple heterogeneous-agent model with incomplete markets. To make savings decisions, agents fore- cast the shadow price of asset holdings. Absent aggregate uncertainty, locally rational agents forecast shadow prices rationally, and thereby make optimal state-contingent decisions. They use adaptive learning to extend their forecasts to accommodate aggregate uncertainty. Over time the state evolves to an ergodic distribution near the economy’s restricted perceptions equi- librium. In a partial equilibrium environment we develop intuition for locally rational decision making, documenting an important hysteresis effect. General equilibrium dynamics are ex- amined via a calibration exercise. Calibrated representative-agent RBC models induce low consumption volatility relative to the data. Extending the model by either incorporating adap- tive learning or heterogeneous agents fails to alter this conclusion. Via the hysteresis effect, local rationality, which interacts heterogeneity and adaptive learning, significantly improves the model’s fit along this dimension.

The RPEs of RBCs and other DSGEs (with George Evans and Bruce McGough) Journal of Economic Dynamics and Control

In a broad class of non-linear representative agent models, represented by a system of difference equations, we replace rational expectations with linear forecast models conditioning on a predetermined set of regressors. Within this framework, a restricted perceptions equilibrium (RPE) corresponds to a forecast rule that is optimal within that class of models. Local uniqueness of a stationary rational expectations equilib- rium (REE) near the non-stochastic steady state is shown to guarantee the existence, uniqueness and E-stability of an RPE local to that steady state. A benchmark RBC model with government spending shocks illustrates the theoretical results.

Bounded Rationality and Unemployment Dynamics (with George Evans and Bruce McGough) Economics Letters

Using the bounded rationality implementation developed in Evans, Evans, and McGough (2021), we consider unemployment dynamics driven by aggregate productivity shocks within a McCall-type labor-search model. We find that bounded rationality magnifies the impact effect of a decline in productivity on unemployment. Over the course of a recession, bounded rationality induces excess pessimism, resulting in higher unemployment relative to the rational model.

Learning When to Say No (joint with George Evans and Bruce McGough) Journal of Economic Theory

We consider boundedly-rational agents in McCall’s model of intertemporal job search. Agents update over time their perception of the value of waiting for an additional job offer using value-function learning. A first-principles argument applied to a stationary environment demonstrates asymptotic convergence to fully optimal decision-making. In environments with actual or possible structural change our agents are assumed to discount past data. Using simulations, we consider a change in unemployment benefits, and study the effect of the associated learning dynamics on unemployment and its duration. Separately, in a calibrated exercise we show the potential of our model of bounded rationality to resolve a frictional wage dispersion puzzle.

Inequality, Business Cycles and Monetary-Fiscal- Policy (joint with Anmol Bhandari, Mikhail Golosov and Thomas Sargent), Econometrica

We study optimal monetary and fiscal policies in a New Keynesian model with heterogeneous agents, incomplete markets, and nominal rigidities. Our approach uses small-noise expansions and Fréchet derivatives to approximate equilibria quickly and efficiently. Responses of optimal policies to aggregate shocks differ qualitatively from what they would be in a corresponding representative agent economy and are an order of magnitude larger. A motive to provide insurance that arises from heterogeneity and incomplete markets outweighs price stabilization motives.

Public Debt in Economies with Heterogeneous Agents (joint with Anmol Bhandari, Mikhail Golosov and Thomas Sargent), Journal of Monetary Economics

We study public debt in competitive equilibria in which a government chooses transfers and taxes optimally and in addition decides how thoroughly to enforce debt contracts. If the government enforces perfectly, asset inequality is determined in an optimum competitive equilibrium but the level of government debt is not. Welfare increases if private debt contracts are not enforced. Borrowing frictions let the government gather monopoly rents that come from issuing public debt without facing competing private borrowers. Regardless of whether the government chooses to enforce private debt contracts, the level of initial government debt does not affect an optimal allocation.

Fiscal Policy and Debt Management with Incomplete Markets (with Anmol Bhandari, Mikhail Golosov, and Thomas Sargent), Quarterly Journal of Economics

A Ramsey planner chooses a distorting tax on labor and manages a portfolio of securities in an environment with incomplete markets. We develop a method that uses second order approximations of the policy functions to the planner’s Bellman equation to obtain expressions for the unconditional and conditional moments of debt and taxes in closed form such as the mean and variance of the invariant distribution as well as the speed of mean reversion. Using this, we establish that asymptotically the planner’s portfolio minimizes an appropriately defined measure of fiscal risk. Our analytic expressions that approximate moments of the invariant distribution can be readily applied to data recording the primary government deficit, aggregate consumption, and returns on traded securities. Applying our theory to U.S. data, we find that an optimal target debt level is negative but close to zero, that the invariant distribution of debt is very dispersed, and that mean reversion is slow.

Work In Progress

A Perturbational Approach for Approximating Heterogeneous-Agent Models (with Anmol Bhandari, Thomas Bourany, and Mikhail Golosov)

Perturbation Theory with Heterogeneous Agents: A Multi-Country Application.

Risk and Monetary Policy in a New Keynesian Model (with Anmol Bhandari and Mikhail Golosov)

Why Do Consumers Demand High-Cost Credit Products? (with David Low)

Optimal Taxation of Paid- and Self-Employment (with Anmol Bhandari, Ellen McGrattan and Yuki Yao)