Labor Force Participation and General Equilibrium Efficiency in Search and Matching Models (with David M. Arseneau).
We provide a characterization of general-equilibrium efficiency in the standard labor search and matching framework. The efficiency condition builds on the well-known Hosios condition for labor-market efficiency, which is derived in partial-equilibrium models of the labor market. What makes our analysis general equilibrium is that we consider a labor force participation decision, a margin absent in many models of the labor market. The efficiency condition we develop has a simple interpretation in terms of marginal rates of substitution and marginal rates of transformation; it also provides a criterion by which general equilibrium search models can measure the attainment of efficiency, as well as provides a new basis for empirical tests of labor-market efficiency.
PDF file, March 2009 version
Optimal Capital Taxation in an Economy with Capital Allocation Frictions (with David M. Arseneau and Andre Kurmann).
We study optimal capital-income taxation in an economy in which search frictions in physical capital markets give rise to flows of economic profit. These profit flows are necessary compensation for sunk search costs of entry into the capital market. Viewed in this way, profits are quasi-rents. At any point in time, however, profit flows from existing matches can also be viewed as pure rents. Whether a Ramsey government considers profit flows as pure rents or as quasi-rents is crucial for whether and to what extent capital-income taxation should be used to tax profits. We prove that if the government treats profits as quasi-rents, the canonical long-run zero-capital-tax prescription arises. If profits are instead treated as pure rents, the long-run optimal capital-income tax is non-zero, with a calibrated version of this economy featuring a capital-income tax rate of over 30 percent. The sharply contrasting results are not due to any lack of commitment. Rather, because profit flows are explicitly linked to free-entry conditions, a Ramsey government has an economic basis for adopting either the pure-rent view or the quasi-rent view. In the long run, however, the quasi-rent equilibrium is welfare-superior.
PDF file, September 2008 version
Money and Optimal Capital Taxation (with S. Boragan Aruoba).
In existing models of jointly-optimal fiscal and monetary policy, the monetary aspects of the economic environment have little to do with capital taxation prescriptions. Instead, the capital-taxation prescriptions of the underlying purely real economy in such models carry over unchanged, qualitatively and very nearly quantitatively, to the monetary economy. In this paper, we employ a micro-founded model of money in order to more meaningfully connect optimal fiscal and monetary policy, with a particular focus on optimal capital taxation. Our main result is that deep-rooted frictions underlying monetary trade in and of themselves provide a rationale for nonzero capital taxation --- specifically, for capital subsidies. Optimal capital subsidies arise in versions of our model where monetary trades lead to capital holdup problems --- in which case the prescription to subsidize capital follows readily --- as well as versions of our model where holdup problems are absent. The latter result especially highlights the unique connection between fiscal and monetary policy our model articulates because the underlying purely real economy in our model features zero capital taxation. Connecting our results with some other recent advances in optimal capital taxation, we prove that for some versions of our environment, capital-income subsidies are consistent with zero intertemporal distortions. Our main conclusion is that capital-tax policy can fundamentally be driven by monetary issues.
PDF file, August 2008 version
Competitive Search Equilibrium in a DSGE Model (with David M. Arseneau).
We show how to implement the concept of competitive search equilibrium in a fully-specified DSGE environment. Competitive search equilibrium, an equilibrium concept well-understood in labor market theory, offers an alternative to the commonly-used Nash bargaining in search-based macro models. Our simulation-based results show that business cycle fluctuations under competitive search equilibrium are virtually identical to those under Nash bargaining for a broad range of calibrations of Nash bargaining power. We also prove that business cycle fluctuations under competitive search equilibrium are identical to those under Nash bargaining restricted to the popularly-used Hosios condition for search efficiency. This latter result extends the efficiency properties of competitive search equilibrium to a DSGE environment. Our results thus provide a foundation for researchers interested in studying business cycle fluctuations using search-based environments to claim that the sometimes-awkward assumption of bargaining per se does not obscure interpretation of results.
PDF file, February 2008 version
Bargaining, Fairness, amd Price Rigidity in a DSGE Environment (with David M. Arseneau).
A growing body of evidence suggests that an important reason why firms do not change prices nearly as much as standard theory predicts is out of concern for disrupting ongoing customer relationships because price changes may be viewed as "unfair." Existing models that try to capture this concern regarding price-setting are all based on goods markets that are fundamentally Walrasian. In Walrasian goods markets, transactions are spot, making the idea of ongoing customer relationships somewhat difficult to understand. We develop a simple dynamic general equilibrium model of a search-based goods market to make precise the notion of a customer as a repeat buyer at a particular location. In this environment, the transactions price plays a distributive role as well as an allocative role. We exploit this distributive role of prices to explore how concerns for fairness influence price dynamics. Using pricing schemes with bargaining-theoretic foundations, we show that the particular way in which a "fair" outcome is determined matters for price dynamics. The most stark result we find is that complete price stability can arise endogenously. These are issues about which models based on standard Walrasian goods markets are silent.
PDF file, June 2007 version
Ramsey Meets Hosios: The Optimal Capital Tax and Labor Market Efficiency (with David M. Arseneau).
This paper studies optimal capital income taxation in an economy where labor markets are subject to search and matching frictions. We prove that, provided the government is constrained to capital and labor income taxation, inefficienc labor force participation leads to a non-zero optimal capital tax in the long run. In a calibration version of the model, the optimal capital income tax is very sensitive to how far above or below the participation rate is from its efficient level. Thus, even seemingly small inefficiencies in participation may call for large capital income taxes (or subsidies).
PDF file, June 2009 version