Latest version: April 2022. R&R at Journal of International Economics.
How should governments with a preference for redistribution design tax policies when facing limited borrowing? This paper studies optimal taxation in a small open economy with heterogeneous agents and endogenous debt constraints arising from the government's limited commitment to fiscal policies. The optimal labor tax decreases over time and is non-zero in the limit, and the optimal capital and domestic borrowing taxes are positive in the limit, deviating from the standard Ramsey tax results. The government’s redistributive motive directly affects optimal tax levels, whereas binding debt constraints influence optimal tax dynamics. In the numerical analysis, a stronger redistributive preference requires greater initial tax distortions and a higher external debt level in the long run.
This paper proposes a theory of sovereign debt sustainability based on the government’s motive for redistribution. I study a small open economy model with income inequality, distortionary taxes, and endogenous borrowing constraints because the government lacks commitment. Having access to external financing allows the government to reduce the distortionary cost of redistribution by redistributing via domestic financial markets. Therefore, default is endogenously costly in the presence of inequality. Quantitatively, the theory accounts for the external debt’s recent buildup in Italy and is consistent with the positive correlation between pre-tax income inequality and external debt across countries. The optimal austerity policies are increasing external borrowing and redistribution in the short run while reducing redistribution to repay debt in the long run.
Work in Progress
Sudden stops are often accompanied by high income inequality and increases in consumption inequality during crises. We rationalize this fact in a sudden stop model of collateral constraints by incorporating income inequality and nonhomothetic preferences. Nontradable goods are more income-elastic than tradable goods. Borrowings of high income households have a stronger effect on future real exchange rates than low-income households. Excessive international debt accumulation by high income households increases the frequency and severity of sudden stop crises. On the other hand, low income households underborrow from a social perspective. Both income inequality and nonhomotheticity of preferences amplify the inefficiency of the pecuniary externality. Therefore, macroprudential policies are more welfare improving than in standard models.
Undergraduate Economic Review, 2014.
The recent decrease in U.S. money velocity raises debates about its unit root behavior. This paper revisited the random walk hypothesis (RWH) of the U.S. money velocity in 1960-2010 and two sub-periods 1960-85 and 1986-2010 by applying the Variance Ratio methodologies, including new nonparametric tests by Wright (2000) and Belaire-Franch and Contreras (2004). The results suggested that the velocity would likely increase, and the U.S. monetary policy will soon stimulate GDP and employment. Furthermore, past velocity is important to predict the future outcomes, and changes in financial structural could alter the empirical characteristics of the velocity series.