This paper studies the evolution of wealth inequality in an economy with endogenous borrowing constraints. In the model economy, young agents need to borrow to finance human capital investments but cannot commit to repaying their loans. Creditors can punish defaulters by banishing them permanently from the credit market. At equilibrium, loan default is prevented by imposing a borrowing limit tied to the borrower's inheritance. The heterogeneity in inheritances translates into heterogeneity in borrowing limits: endogenously, some borrowers face a zero borrowing limit, and some are partly constrained, whereas others are unconstrained. Depending on the initial distribution of inheritances, it is possible that all lineages are attracted either to the zero-borrowing-limit steady state or to the unconstrained-borrowing steady state—long-run equality. It is also possible that some lineages end up in one steady state and the rest in the other—complete polarization.

This study provides an infinite-horizon model of rational bubbles in a production economy. A bubble can arise when the pursuit of status is modeled explicitly, capturing the notion of “the spirit of capitalism.” Using a parameterized model, I demonstrate the specific conditions for the existence of bubbles and their implications. Bubbles crowd out investment, stimulate consumption, and slow economic growth. I also discuss a stochastic bubble that bursts with an exogenous probability. I show that there could be multiple stochastic bubbly equilibria. Moreover, I suggest that taxing wealth properly can eliminate bubbles and achieve the social optimum.

This paper documents a puzzling fact, namely that there is a significant negative relation between employment protection legislation and the usage of the intensive margin of labor market adjustments. I make use of a real business cycle model and introduce search and matching frictions as well as adjustment costs along the extensive and the intensive labor market margins. I show that the model is able to replicate the observed patterns of cyclicality, volatility, and especially the behavior of extensive and intensive margins if we assume low firing costs and relatively high hours adjustment costs.

We use the returns on lottery-like stocks and a dynamic factor model to construct a novel index of investor sentiment. This new measure is highly correlated with other behavioral indicators, but more closely tracks speculative episodes. Our main new finding is that the effects of sentiment are asymmetric: During peak-to-trough periods of investor sentiment (sentiment contractions), high sentiment predicts low future returns for the cross section of speculative stocks and for the market overall, whereas the relationship between sentiment and future returns is positive but relatively weak during trough-to-peak episodes (sentiment expansions). Overall, these results match theories and anecdotal accounts of investor sentiment.

We use robust control to study how a central bank in an economy with imperfect interest rate pass-through conducts monetary policy if it fears that its model could be misspecified. We find that, first, whether robust optimal monetary policy under commitment responds more cautiously or more aggressively depends crucially on the source of shock. Imperfect pass-through amplifies the robust policy. Second, if the central bank is concerned about uncertainty, it dampens volatility in the inflation rate preemptively but accepts higher volatility in the output gap and loan rate. However, for highly sticky loan rates, insurance against model misspecification becomes particularly pricy. Third, if the central bank fears uncertainty only in the IS equation or the loan rate equation, the robust policy shifts its concern for stabilization away from inflation.

This paper presents a simple model of an economy with heterogeneous agents to show that the redistribution of wealth among such agents can play a significant role in the propagation mechanism of financial crises. In an economy where firms with heterogeneous productivity operate under borrowing constraints, the redistribution reproduces hump-shaped responses for output and labor and procyclicality in observed productivity. In this model, a financial shock generates a persistent and hump-shaped response, whereas a productivity shock does not. Further, the redistribution of wealth significantly amplifies the persistence and hump shape of these responses following a financial shock. This model suggests that redistribution may thus be a key driving force behind the transmission of financial crises.

This paper investigates patterns of variation in economic growth across and within countries using a time-varying transition matrix Markov-switching approach. The model developed here explains the dynamics of growth based on a collection of different states that countries pass into and out of over time; in addition, these states are characterized by their own submodels and growth patterns. The transition matrix among the different states varies over time—depending on the conditioning variables of each country—with a linear dynamic for each state. We develop a generalization of Diebold's EM algorithm and estimate a sample model in a panel with a transition matrix conditioned on institutional quality and the investment level. We find three states of growth: stable growth, miraculous growth, and stagnation. The results show that institutional quality is an important determinant of long-term growth, whereas the investment level plays a variety of roles: it contributes positively in countries with high-quality institutions but is of little relevance in countries with medium- or low-quality institutions.

This paper examines the long-run relationship between trade openness and government size in a two-country dynamic general equilibrium model. We analytically show that different factor intensities in the production of tradable and nontradable sectors affect the government's response to changes in trade openness. Specifically, if the production of the nontradable sector is more capital-intensive, a positive relationship between trade openness and government size will be observed. In contrast, if the production of the tradable sector is more capital-intensive, a negative correlation between trade openness and government size will arise. This theoretical prediction is robust to both utility-enhancing and productive government expenditures. The differentiated factor intensities therefore provide a potential explanation to the mixed empirical findings in the literature about the long-run relation of trade openness and government size.

This paper applies smooth transition regressions to incorporate nonlinearity into the impact of trading volume on exchange rate volatility, the so-called mixture distribution hypothesis (MDH). Linking this analysis to the Tobin tax debate, we provide the first empirical corroboration that such a tax may be effective in limiting speculation and reducing exchange rate volatility, especially in turbulent times. Our study points to two main results. First, we show that nonlinearities should be taken into account to explain the MDH. When volatility, spreads, and volume are simultaneously high, the relationship between trading volume and volatility tends to grow stronger and thus the MDH holds in turbulent periods. Second, on the assumption of constant trading volume elasticity, a Tobin tax would have been stabilizing and effective in the 2008 crisis.

Traditional regression models have reported conflicting results on the effectiveness of tax incentives in stimulating business investment. This study investigates the effects of the Bush tax cuts on U.S. investment using intervention analysis in conjunction with regression analysis that controls for relevant variables. Although intervention analysis has the advantage of allowing the behavior of investment to be influenced only by the time path of exogenous shocks such as tax reforms, control variables can test for the robustness of the results. We have found that the two tax reforms enacted in 2001 and 2003 had little impact on marginal investment incentives. The intervention analysis results are further reinforced by the evidence provided by alternative regression models that control for a host of variables. The failure of the tax reforms to stimulate investment spending may be attributable to several factors, such as a global savings glut, cheap global money, inappropriate designs for tax incentives, and budget deficits.

This paper develops an overlapping-generations model to study the growth-maximizing level of public debt under conditions of demograhic change. It is shown that the optimal debt level depends on a positive marginal productivity of public capital. In general, it also depends on the demographic parameters, but not if the government is not allowed to borrow to cover revenue shortfalls for current age-related spending. In that context, balanced budget rules are not an approriate form of fiscal rule. The implication is that a government facing demograhic change or demands for more welfare spending will have to adjust its fiscal plans to accommodate those changes, most likely downward, if growth is to be preserved. An advantage of this model is that it allows us to determine in advance the way in which fiscal policies need to adjust as demographic parameters change.

In this paper we investigate the growth effect of environmental taxes when time preference is endogenously determined by environmental quality. We find that if people become more patient because of a cleaner environment, raising the environmental tax may reduce pollution and stimulate growth. Moreover, the Pigouvian principle may be inefficient in the presence of endogenous time preference.

This paper examines the dynamic and desirable properties of monetary regimes in a remittances recipient economy, with emphasis on the effect on sectoral output and nontradable inflation dynamics. The findings indicate that under a fixed exchange rate regime, an increase in remittances creates increased demand for nontradable goods, and hence a rise in nontradable inflation, as well as expansion in output of nontradables. Under a nontradable inflation targeting regime, however, a decrease in nontradable inflation and an expansion in tradable goods production are observed following an increase in remittances. A near-zero nontradable inflation rate and managed variability in the nominal exchange rate typify the optimal monetary policy, suggesting that an inflation targeting regime is preferable to a fixed exchange regime under such a scenario. A VAR analysis shows that the dynamics of inflation in El Salvador and the Philippines is in consonance with those observed in the model under the fixed exchange rate and nontradable inflation targeting regimes, respectively.