Working Papers

This paper proposes a theory of external debt sustainability based on the government’s motive for redistribution. I study a small open economy model in which taxes are distortionary and the government has a redistributive concern and faces endogenous borrowing constraints due to its lack of commitment. Given these borrowing constraints, the value of financial autarky determines the sustainable level of debt. Financial autarky is endogenously costly because, in this case, redistribution requires high labor taxes, which distort labor supply and reduce the economy's efficiency. Having access to external financing allows the government to have more redistribution, measured as the differences in individual utilities, than in financial autarky at the same level of efficiency cost. Quantitatively, the theory can account 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. In response to a negative productivity shock, the optimal austerity policies are increasing external borrowing and redistribution while reducing redistribution to repay debt in the future. The magnitude of these responses varies with the underlying wage inequality.

This paper studies optimal taxation under the government's motive for redistribution and limited borrowing. The model is a small open economy in which agents are heterogeneous in labor productivity and the government faces self-enforcing debt constraints that arise endogenously from its limited commitment. Redistributive policies are proportional taxes on labor and domestic saving. The standard Ramsey results of labor tax smoothing and a zero capital tax in the limit no longer hold. Instead, optimal labor taxes decrease over time and eventually converge to a non-zero limit, and the optimal capital tax is positive in the limit. The trade-off between redistribution and efficiency influences both the initial and long-run optimal tax levels, while the binding debt constraints alter the optimal tax dynamics. The numerical analysis demonstrates that a stronger redistributive motive requires greater tax distortions at the beginning of time and a higher external debt level in the long run.

Sovereign Default and Inequality

Draft in progress

This paper examines how income inequality affects the sovereign default risk. I study fiscal policies in a sovereign default model with heterogeneous agents and distortionary taxation. I quantify the model in the case of Spain and find that inequality worsens the debt crisis by increasing the government's incentive to default. This mechanism is quantitatively consistent with the positive correlation between income inequality and sovereign spread across countries.

Work in Progress

Optimal Redistribution in A Sudden-Stop Prone Economy (with Fernando Arce)

We explore the implications of household heterogeneity on the design and implementation of optimal macroprudential policies. We document that countries with higher levels of inequality exhibit higher levels of private borrowing and more recurrent sudden stop crisis. We develop a production economy where households are heterogeneous in their labor productivity and have access to international credit markets subject to a collateral constraint that depends on their market income. As a result, high income households also have a higher borrowing capacity. We study the implications of this mechanism for the choice of labor and borrowing taxes for a government who faces a trade-off between decreasing the probability of a sudden stop and redistributive concerns.

A Theoretical Approach to Child Care Subsidies (with Emily G. Moschini)

Pre-PhD Publication

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.