WORKING PAPERS

World Commodity Prices, Money, and Foreign Exchange in Emerging Markets (with Shuang Feng) (Draft Coming Soon)

Most emerging countries are traditional economies relying heavily on the export of raw commodities and hold high volumes of the external debt denominated in foreign currencies. They are vulnerable to global shocks, such as shocks to world commodity prices. In this paper, we provide new evidence on how emerging countries respond with two monetary policy tools, i.e., the change of broad money and the choice of the exchange rate regimes, to the foreign revenue reduction caused by the fluctuation in world commodity prices. The estimated results show that declines in commodity prices significantly increase the ratio of broad money-to-GDP and the magnitude of this effect of commodity prices on the broad money is generally increasing with respect to the degree of the exchange rate regime flexibility. The estimated results also show that those emerging countries, when experiencing a long-term depression of commodity prices, prefer to adopt a more flexible exchange rate regime: Compared with increasing world commodity prices, decreasing commodity prices have three to four percent lower probability of seeing the peg or currency union while have approximately eight percent higher probability of seeing freely falling.

Wage, Wealth, and Income Inequality from Automation (with Morgan Holland and Jonathan Kreamer) (Draft Coming Soon)

Changes in income inequality from advanced automation may stem from two sources. Wages may become more unequal as lower skill tasks that are currently performed by workers are done in the future by computerized capital. With higher relative wage income, high-skill workers will be able to afford investments in capital that are out of reach for low-skill workers, exacerbating income inequality further. Using a general equilibrium model of task-based production, we disentangle the impacts of automation on wage, wealth, and income inequality. Next, using this framework, we develop a political economy framework to discuss the optimal taxing of capital in the context of increasing automation. We find that capital taxes may be optimal when they are used as a way to indirectly tax high-skill labor income.

Sovereign Debt: A Quantitative Comparative Investigation of the Partial Default Mechanism (with Shuang Feng) (Revised: October, 2023)

Sovereign defaults are partial. In this paper, we quantitatively explore the implications of the partial default mechanism for the dynamics of sovereign debt and default in a small open economy. The model features endogenous partial default and recovery on the defaulted amount with direct utility cost of default, instead of the loss of output and the exclusion from international markets which is the traditional setup in sovereign default models. The model is calibrated to Argentina and compared to the traditional full default models. We show that with our partial default framework, (1) the model with endowment not only matches the mean spread on debt and the debt-to-output ratio, like the traditional models, but also matches both the default frequency and the default rate; (2) the model with production, with investment as another margin to smooth consumption, improves the fit with data for the volatilities of consumption and spread on debt; and (3) furthermore, the non-exclusion from international markets provides a more realistic pattern of the impulse responses of various macro variables to economic shocks, which gives a better understanding of the propagation mechanism of partial default.

The Role of Demographic Change in Explaining Declining Labor Force Participation (with John Gibson and Felix Rioja) (Revised: June, 2023)

The labor force participation rate has been declining in the United States since the late 1990s. Decomposing the aggregate labor force participation rate by age reveals that this decline is being driven by reduced participation among relatively young in- dividuals, those aged 16 to 24. In fact, participation among older individuals, age 55 and above, has been increasing. In this paper, we develop a model in which individual decisions regarding schooling and retirement, in view of empirically observed changes in mortality, can simultaneously explain these three labor force participation trends. Furthermore, a counterfactual scenario that accounts for the observed demographic trends but does not account for agents’ endogenous schooling and retirement response is found to contradict the observed trends.

Growth, Income Distribution and Policy Implications of Automation (with Morgan Holland and Jonathan Kreamer) (Revised: January, 2023)

Motivated by recent discussions about the distributional implications of automation and the possibility of a “universal basic income” (UBI) program to address them, we analyze the distributional and political economy implications of automation in a task- based model of production. We conceptualize automation as a shift in the relative productivity of capital at certain tasks that reduces the set of tasks done by labor. We capture distributional concerns by including two kinds of agents — workers, who supply labor, and entrepreneurs, who own capital. After characterizing the equilibrium with fixed tax rates, we endogenize policy variables by computing the political economy equilibrium under majority voting, where policymakers have access to a capital tax and a transfer to workers (a “universal basic income”). We quantitatively study an episode of automation in a calibrated model, and find that workers prefer higher capital taxes in the long run, but lower capital taxes during the transition. Interestingly, this results in larger welfare gains for entrepreneurs than for workers relative to a constant tax regime, suggesting that capital owners stand to benefit from the institution of a UBI in a policy regime that maximizes worker welfare. In other results, we derive conditions under which the economy experiences full automation, characterize comparative statics of traditional technical progress vs. automation, give a condition under which automation may lower long-term wages, and show that all kinds of capital should be taxed at the same rate (i.e. no “robot taxes”).

Testing for Spurious Dynamics in Structural Models with Applications to Monetary Policy (with Mikhail Dmitriev) (Revised: August, 2021)

We propose a universal and straightforward test for validating assumptions in the structural models. Structural models impose a causal structure, take data as an input, and then produce exact structural parameters. We simulate the new data while breaking the original causal structure. We then feed the model the simulated data and then see whether it produces different results. If its conclusions are the same, then the models’ implications are not sensitive to the underlying data, and the model fails the test. We then apply our test to the models analyzing monetary policy. We find out that simple SVARs successfully pass the test and can be used to identify monetary policy effects. On the other hand, DSGE models estimated via full-information methods such as Smets and Wouters (2007) fail the test and potentially force their conclusions on the data.

Tax Evasion in an Overlapping Generations Model with Public Investment (Revised: August, 2009)

The current analysis of the impact of stricter enforcement of tax laws on tax evasion ignores the most policy revelant case where it has effects running from public revenue to public expenditure. The paper shows that existing results in the literature apply to this policy relevant case under certain restrictions on government policy. Using a dynamic general equilibrium model, it shows that the benefits of stricter enforcement are realized immediately but these immediate effects are slightly smaller than the long-run effects derived in literature. When stricter enforcement is used as a tool to raise revenue for public investment, the positive impact on growth from increased public investment is tempered by the negative general equilibrium effect on private capital accumulation.

Long-Run Growth and Welfare: The Importance of Transitional Dynamics When Assessing Alternative Fiscal Policies (with Bassam Awad and Milton H. Marquis) (Revised: July, 2009)

This paper analyzes the effects of distortionary taxes on growth and welfare in an endogenous growth model with a public capital externality. The model is calibrated to the U.S. economy, and experiments are run under which the tax regime is shifted from the current mix of capital income, labor income, and consumption taxes to a fiscal policy regime with complete reliance on a single source of taxation, including lump-sum tax. We find that tax policy changes that induce higher growth rate do not necessarily result in higher welfare due to different transitory effects. In fact, a shift to capital income tax while delivering highest long-run growth results in lowest welfare. Furthermore, long-run gains take many years - a generation - to start getting realized. Among different sources of taxation, we find that, in the long run, complete reliance on a consumption tax dominates the current tax regime; however, the current tax regime dominates an exclusive labor income tax, which in turn is less welfare-reducing than an exclusive capital income tax. These results are due to the fact that taxes on labor income and capital income distort investment decisions in reproducible capital, i.e., human capital and physical capital, and therefore have cumulative effects that do not result from a tax on consumption. Unlike previous studies, we account for the welfare effects of transition using optimal decision rules all along the transition path.

Productivity-Enhancing Reforms, Private Capital Inflows and Real Interest Rates in Africa (Revised: December, 2008)

The rise in economic growth in some countries of Africa over past two decades, powered mainly by productivity boom, has been associated with large private capital inflows despite poor integration of the African countries with the world capital markets. While these countries lack access to world capital markets, they are nonetheless highly dollarized and allowing for this fact can explain large private capital inflows and other stylized macroeconomic facts associated with the productivity-enhancing reforms in Africa. With a number of African economies poised to reap gains in productivity, as they return to stable and sound political and economic environment, the paper suggests the framework that can be used to understand the macroeconomic implications of and suggest appropriate policy responses to such gains in productivity.