A New General Equilibrium Welfare Measure, with Application to Labor Income Taxes

In this paper we extend the Hicksian compensating variation welfare measure in two directions. First, we adjust the size of the compensating variation in order to account for the fact that the compensating transfers will result in changes in output, as well as in prices, because labor and, in dynamic models, capital will adjust in response to these transfers. Second, we extend the measure to a dynamic setting with possibly time non-separable preferences. We find that these considerations become more significant for the welfare cost of higher labor income taxes as one moves from static to dynamic models, to models with time non-separable preferences, and finally to models with uncertainty.

Nonlinear Unemployment Effects of the Inflation Tax

We argue that long-run inflation has nonlinear and state-dependent effects on unemployment, output, and welfare. Using panel data from the OECD, we document three correlations. First, there is a positive long-run relationship between anticipated inflation and unemployment. Second, there is also a positive correlation between anticipated inflation and unemployment volatility. Third, the long-run inflation-unemployment relationship is not only positive, but also stronger when unemployment is higher. We show that these correlations arise in a standard monetary search model with two shocks – productivity and monetary – and frictions in labor and goods markets. Inflation lowers the surplus from a worker-firm match, in turn making it sensitive to productivity shocks or to further increases in inflation. We calibrate the model to match the U.S. postwar labor market and monetary data, and show that it is consistent with observed cross-country correlations. The model implies that the welfare cost of inflation is nonlinear in the level of inflation and is amplified by the presence of aggregate shocks.

Assessing the Cost of Populism to Global Trade

This chapter assesses the cost of populist protectionism, beginning with the traditional measures of welfare cost from trade restrictions, as well as the institutional disruption it often entails, which amplifies these costs. One distinctive impact of Trump’s trade policies as well as from Brexit, for example, is the uncertainty it creates in the business environment, which itself tends to diminish business investment and trade. Populist protectionism, by flouting established rules, also tends to provoke retaliation, further compounding its cost. The systemic cost of eroding long-standing trade practices and norms also diminishes trust between populist governments and other countries, which may move global trade toward discriminatory, defensive trade blocs. Reduced trust may spill over into nontrade issues in which cooperation is required to solve cross-border or global problems, such as with the coronavirus crisis. Populist restrictions on immigration also have negative trade effects in terms of inefficient labor allocation, reduced output, and diminished trade opportunities.

Should monetary policy lean against the wind in a small-open economy? Revisiting the Tinbergen rule

It has been debated whether monetary policy should lean against the wind, i.e., if central banks should also respond to the build-up of financial imbalances. I contribute to the debate by showing that targeting the two policy objectives with a single instrument is more costly for a small-open economy than for a closed one. To this end, I develop a small-open economy DSGE model with the Bernanke-Gertler-Gilchrist financial accelerator that features financial frictions and monopolistic competition in goods markets. I then estimate this model for Mexico to explore the policy regimes yielding the lowest welfare cost. My main finding is that the Tinbergen rule is alive and well. In addition, my model is useful to gauge macroprudential measures effectiveness when discriminating against foreign liabilities.