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Generalized compensation principle

  • Tsyvinski, Aleh
  • Werquin, Nicolas
We generalize the classic concept of compensating variation and the welfare compensation principle to a general equilibrium environment with distortionary taxes. We derive in closed-form the solution to the problem of designing a tax reform that compensates the welfare gains and losses induced by an arbitrary economic disruption. In partial equilibrium, average taxes simply increase or decrease to counteract the revenue gains or losses caused by the disruption. In general equilibrium, the compensation features three elements that depart from this benchmark and respectively account for (i) the incidence of the initial exogenous shock, and the fact that the tax reform itself induces indirect welfare effects caused by (ii) the non-constant marginal product of labor and (iii) the skill complementarities in production. This leads to a progressive compensating tax reform, with average tax rates increasing at a rate given by the ratio of the elasticity of labor demand and the elasticity of labor supply net of the rate of progressivity of the pre-existing tax code. We also derive a closed form formula for the fiscal surplus of the wage disruption and the compensation, thus generalizing the traditional Kaldor-Hicks criterion. Finally, we apply our formula to the compensation of automation: in the U.S., one additional robot per thousand workers requires a reduction (resp., increase) in the average tax rate at the 10th (resp., 90th) percentile of the income distribution equal to 2 percentage points (resp., 0.5 pp)., The ADEMU Working Paper Series is being supported by the European Commission Horizon 2020 European Union funding for Research & Innovation, grant agreement No 649396.
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Introducing an Austrian backpack in Spain

  • Brogueira de Sousa, João
  • Díaz-Saavedra, Julián
  • Marimon, Ramon
In an overlapping generations economy with incomplete insurance markets, the introduction of an employment fund (akin to the one introduced in Austria in 2003, also known as `Austrian backpack') can enhance production effciency and social welfare, if it complements, and in part substitutes, the two classical systems of public insurance: pay-as-you-go pensions and unemployment insurance (UI). We show this in a calibrated dynamic general equilibrium model with heterogeneous agents of the Spanish economy (2014). A `backpack' (BP) employment fund is an individual (across jobs) transferable fund, which earns the economy interest rate as a return and is financed with a small payroll tax (a BP tax). The worker can use the fund if he or she becomes unemployed or retires. To complement the existing Spanish pension and UI systems with a 2% BP tax would be preferred to the status quo by more than 90% of the households of the calibrated economy, a percentage that can be higher with a more substantial BP (i.e. higher BP tax). Our model also provides a framework where other reforms (e.g. a partial, or complete, substitution of current unsustainable pension systems) can be quantitatively assessed., The ADEMU Working Paper Series is being supported by the European Commission Horizon 2020 European Union funding for Research & Innovation, grant agreement No 649396.
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The effects of inflation target changes in an open economy with heterogeneous households

  • Adão, Bernardino
  • Correia, Isabel
When discussing the level for the target inflation in a Monetary Union typically questions of efficacy of stabilization of monetary policy or conditions for the fulfilment of an optimal monetary currency are in the forefront. Even when inequality is a well- ocumented fact as well as di¤erent degrees of inequality across economies this is not brought forward to the discussion. We show here that this is a consideration of first order. We build a model where this is the only fundamental that distinguishes countries in the area and find that these different degrees of inequality determine that different economies will be affected differently by a change in the target for inflation. We show how the transmission mechanism can in this case amplify the effects obtained when heterogeneity is not considered. Moreover, we show that the effects over the different agents depend on their particular characteristics and on the economy where they live in. We also obtain that a redistribution of wealth in a given country increases efficiency and equality in all countries., The ADEMU Working Paper Series is being supported by the European Commission Horizon 2020 European Union funding for Research & Innovation, grant agreement No 649396.
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Bank funding and risk taking

  • Ferrari, Alessandro
  • Garcia Galindo, Carmen
  • Petricek, Matic
  • Winkler, Andreas
In this paper we use a novel approach to address issues of endogeneity in estimating a causal effect of leverage on risk taking by banks. Using data on local bank office deposits and local unemployment we construct an instrument to use in a regression of leverage on a measure of risk taking constructed from new issuance of loans. The results (i.) confirm that due to limited liability banks increase their risk taking after an exogenous increase in leverage, and (ii.) that an increase in deposit supply has a direct positive effect on risk taking by banks., The ADEMU Working Paper Series is being supported by the European Commission Horizon 2020 European Union funding for Research & Innovation, grant agreement No 649396.
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Debt dilution and debt overhang

  • Jungherr, Joachim
  • Schot, Immo
We introduce long-term debt (and a maturity choice) into a standard model of firm financing and investment. This allows us to study two distortions of investment: (1.) Debt dilution distorts firms’ choice of debt which has an indirect effect on investment; (2.) Debt overhang directly distorts investment. In a dynamic model of investment, leverage, and debt maturity, we show that the two frictions interact to reduce investment, increase leverage, and increase the default rate. We provide empirical evidence from U.S. firms that is consistent with the model predictions. Using our model, we isolate and quantify the effect of debt dilution and debt overhang. Debt dilution is more important for firm value than debt overhang. Debt overhang can actually increase firm value by reducing debt dilution. The negative effect of debt dilution on investment is about half as strong as that of debt overhang. Eliminating the two distortions leads to an increase in investment equivalent to a reduction in the corporate income tax of 3.5 percentage points., The ADEMU Working Paper Series is being supported by the European Commission Horizon 2020 European Union funding for Research & Innovation, grant agreement No 649396.
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Downward wage rigidity and wage restraint

  • Wolf, Martin
The combination of downward nominal wage rigidity and pegged exchange rate creates an externality which leads to excessive wage inflation (Schmitt-Groh_e and Uribe, 2016). This paper re-examines this result assuming that wage setters are forward looking, hence endogenously restrain wage increases facing downward wage rigidity, as in Elsby (2009). In this case, wage inflation is either excessively high or excessively low compared to the social optimum: while wages increase too strongly following demand shocks, they rise by too little following Balassa-Samuelson-type technology shocks. Applying the model to euro area countries, I document excessively high wage inflation rates in the euro periphery, but excessively low rates in the euro core, in the pre-crisis period., The ADEMU Working Paper Series is being supported by the European Commission Horizon 2020 European Union funding for Research & Innovation, grant agreement No 649396.
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The maturity structure of sovereign debts within a solidarity zone

  • Soyres, Constance de
This paper characterizes the optimal bailout maturity structure for a sovereign on the verge of a default. I find that buying back long-term debt is strictly optimal when it can prevent a default today and in the future. Otherwise, buying back short-term debt is optimal and can prevent a default only today. The paper also investigates the choice of debt maturity structure of the sovereign in the presence of bailouts. I find that potential bailouts extend the sovereign’s borrowing capacity and make it rely more on debt with shorter maturities on average. As short-term debt is vulnerable to rollover crises, it generates more default risk. Eventually, the paper analyses how potential bailouts affect ex post welfare and studies ex ante welfare-improving policies., The ADEMU Working Paper Series is being supported by the European Commission Horizon 2020 European Union funding for Research & Innovation, grant agreement No 649396.
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Which ladder to climb? : wages of workers by job, plant, and education

  • Bayer, Christian
  • Kuhn, Moritz
How much does your wage depend on what you learned, for whom you work, or what job you do? Using largely unexplored administrative data from Germany allows us to relate 80% of wage variation to observable characteristics of jobs, firms, and workers. One wage determinant stands out: the hierarchy level of a job, summarizing its responsibility, complexity, and required independence. This variable is typically absent in other data sources. Climbing the hierarchy ladder explains almost all of the rise in wage dispersion and half of the wage growth by age. It also is key to explaining gender wage differences., The ADEMU Working Paper Series is being supported by the European Commission Horizon 2020 European Union funding for Research & Innovation, grant agreement No 649396.
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Optimal government policies in models with heterogeneous agents

  • Bohácek, Radim
  • Kejak, Michal
In this paper we develop a new approach for funding optimal government policies in economies with heterogeneous agents. Using the calculus of variations, we present three classes of equilibrium conditions from government's and individual agent's optimization problems: 1) the first order conditions: the government's Lagrange-Euler equation and the individual agent's Euler equation; 2) the stationarity condition on the distribution function; and, 3) the aggregate market clearing conditions. These conditions form a system of functional equations which we solve numerically. The solution takes into account simultaneously the e_ect of the government policy on individual allocations, the resulting optimal distribution of agents in the steady state and, therefore, equilibrium prices. We illustrate the methodology on a Ramsey problem with heterogeneous agents, finding the optimal limiting tax on total income., The ADEMU Working Paper Series is being supported by the European Commission Horizon 2020 European Union funding for Research & Innovation, grant agreement No 649396.
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The sociology of power applied to Saudi Arabia’s elites and its impact on foreign policy. The case of the military intervention in Yemen (2015-2018)

  • Dorsch, Leonie
In March 2015, the Kingdom of Saudi Arabia launched a military campaign against the Houthi rebels who have seized power in Yemen. Since then a devastating armed conflict is ongoing being one of the biggest humanitarian crisis ever since. This paper assesses why the Kingdom of Saudi Arabia opted for a military intervention as foreign policy response to the developments in Yemen. The Saudi Kingdom’s power structure in which foreign policy decisions are made is analysed, examining the different actors, interests and resources that play a role in the intervention. The analysis is based on the field of Foreign Policy Analysis applying the bureaucratic process model which is then supplemented by the Sociology of Power. Such combination is a new approach and shall generate a comprehensive theoretical framework. In the case of the Saudi military intervention in Yemen, the foreign policy decision to carry out the intervention results to have been taken in a complex power structure, in which the Saudi elites have faced competition with different actors regarding military resources, political influence in Yemen, as well as geopolitical and religious leadership in the region. The case study demonstrates that the Sociology of Power contributes the field of foreign policy analysis and should be applied to further investigations.
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