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We analyze a dynamic stochastic general-equilibrium (DSGE) model with an externality—through climate change—from using fossil energy. Our central result is a simple formula for the marginal externality damage of emissions (or, equivalently, for the optimal carbon tax). This formula, which holds under quite plausible assumptions, reveals that the damage is proportional to current GDP, with the proportion depending only on three factors: (i) discounting, (ii) the expected damage elasticity (how many percent of the output flow is lost from an extra unit of carbon in the atmosphere), and (iii) the structure of carbon depreciation in the atmosphere. Thus, the stochastic values of future output, consumption, and the atmospheric CO 2 concentration, as well as the paths of technology (whether endogenous or exogenous) and population, and so on, all disappear from the formula. We find that the optimal tax should be a bit higher than the median, or most well-known, estimates in the literature. We also formulate a parsimonious yet comprehensive and easily solved model allowing us to compute the optimal and market paths for the use of different sources of energy and the corresponding climate change. We find coal—rather than oil—to be the main threat to economic welfare, largely due to its abundance. We also find that the costs of inaction are particularly sensitive to the assumptions regarding the substitutability of different energy sources and technological progress.

We study optimal redistribution and insurance in a life-cycle economy with private idiosyncratic shocks. We characterize Pareto optima, show the forces determining optimal labor distortions, and derive closed form expressions for their limiting behavior. The labor distortions for high-productivity shocks are determined by the labor elasticity and the higher moments of the shock process; the labor distortions for low-productivity shocks are determined by the autocorrelation of the shock process, redistributive objectives, and past distortions. In a model calibrated using newly available estimates of idiosyncratic shocks, the labor distortions are U-shaped and the savings distortions generally increase in current earnings.

This paper reviews recent advances in the theory of optimal policy in a dynamic Mirrlees setting, and contrasts this approach to the one based on the representative-agent Ramsey framework. We revisit three classical issues and focus on insights and results that contrast with those from the Ramsey approach. In particular, we illustrate, using a simple two period economy, the implications for capital taxation, tax smoothing, and time inconsistency.

We study optimal monetary and fiscal policies in a New Keynesian model with heterogeneous agents, incomplete markets, and nominal rigidities. Our approach uses small-noise expansions and Fréchet derivatives to approximate equilibria quickly and efficiently. Responses of optimal policies to aggregate shocks differ qualitatively from what they would be in a corresponding representative agent economy and are an order of magnitude larger. A motive to provide insurance that arises from heterogeneity and incomplete markets outweighs price stabilization motives.

This paper studies a Diamond-Dybvig model of providing insurance against unobservable liquidity shocks in the presence of unobservable trades. We show that competitive equilibria are inefficient. A social planner finds it beneficial to introduce a wedge between the interest rate implicit in optimal allocations and the economy's marginal rate of transformation. This improves risk sharing by reducing the attractiveness of joint deviations where agents simultaneously misrepresent their type and engage in trades on private markets. We propose a simple implementation of the optimum that imposes a constraint on the portfolio share that financial intermediaries invest in short-term assets.

The paper studies how asset prices are determined in a decentralized market with asymmetric information about asset values. We consider an economy in which a large number of agents trade two assets in bilateral meetings. A fraction of the agents has private information about the asset values. We show that, over time, uninformed agents can elicit information from their trading partners by making small offers. This form of experimentation allows the uninformed agents to acquire information as long as there are potential gains from trade in the economy. As a consequence, the economy converges to a Pareto efficient allocation.

This article studies the structural transformation of Russia in 1885-1940 from an agrarian to an industrial economy through the lens of a two-sector neoclassical growth model. We construct a data set that covers Tsarist Russia during 1885-1913 and Soviet Union during 1928-1940. We develop a methodology that allows us to identify the types of frictions and economic mechanisms that had the largest quantitative impact on Russian economic development. We find that entry barriers and monopoly power in the nonagricultural sector were the most important reason for Tsarist Russia's failure to industrialize before World War I. Soviet industrial transformation after 1928 was achieved primarily by reducing such frictions, albeit coinciding with a significantly lower performance of productivity in both agricultural and nonagricultural sectors. We find no evidence that Tsarist agricultural institutions were a significant barrier to labour reallocation to manufacturing, or that \"Big Push\" mechanisms were a major driver of Soviet growth.

We develop a theory of endogenous and stochastic fluctuations in economic activity. Individual firms choose to randomize over firing or keeping workers who performed poorly in the past to give them an ex-ante incentive to exert effort. Different firms choose to correlate the outcome of their randomization to reduce the probability with which they fire non-performing workers. Correlated randomization leads to aggregate fluctuations. Aggregate fluctuations are endogenous---they emerge because firms choose to randomize and they choose to randomize in a correlated fashion---and they are stochastic---they are the manifestation of a randomization process. The hallmark of a theory of endogenous and stochastic fluctuations is that the stochastic process for aggregate \"shocks\" is an equilibrium object.

A Ramsey planner chooses a distorting tax on labor and manages a portfolio of securities in an economy with incomplete markets. We develop a method that uses second order approximations of Ramsey policies to obtain formulas for conditional and unconditional moments of government debt and taxes that include means and variances of the invariant distribution as well as speeds of mean reversion. The asymptotic mean of the planner’s portfolio minimizes a measure of fiscal risk. We obtain analytic expressions that approximate moments of the invariant distribution and apply them to data on a primary government deficit, aggregate consumption, and returns on traded securities. For U.S. data, we find that the optimal target debt level is negative but close to zero, the invariant distribution of debt is very dispersed, and mean reversion is slow.

This paper studies the optimal redistribution of income inequality caused by the presence of search and matching frictions in the labor market. We study this problem in the context of a directed search model of the labor market populated by homogeneous workers and heterogeneous firms. The optimal redistribution can be attained using a positive unemployment benefit and an increasing and regressive labor income tax. The positive unemployment benefit serves the purpose of lowering the search risk faced by workers. The increasing and regressive labor tax serves the purpose of aligning the cost to the firm of attracting an additional applicant with the value of an application to society.