Essays in macroeconomics : liquidity and taxation

Abstract

This thesis consists of three independent chapters on the Macroeconomics of Liquidity and Taxation. The first chapter studies how concerns about future funding difficulties and liquidity dry ups influence investment decisions. In an environment with financial frictions, investors need to take liquidity management into account when deciding between different investment alternatives and when designing financial arrangements with other fund providers. Their decisions affect both idiosyncratic and aggregate exposure to shocks and fluctuations. When shocks occur to external liquidity sources, such as changes in the cash-flows that support mortgage-backed securities or other non-corporate assets, these are transmitted through financial arrangements towards the real sector. The anticipation of these shocks and its reflection in asset prices influence project selection and change the pattern of fluctuations, creating additional comovement across sectors of economy and different assets. Likewise, the anticipation of variations in the internal liquidity of firms, resulting from shocks to their productivity, changes their choice of projects. For moderate liquidity scarcity, the effect through project choice is shown to lead to the dampening of these underlying productivity shocks; while for more severe shortages, amplification emerges. Despite the possibility of excess exposure to risk being generated endogenously, equilibrium allocations are constrained efficient. Policy implications are then discussed in light of this result. The second chapter focuses on the auxiliary role of taxes in helping smooth income fluctuations. From a mechanism design perspective, it studies the characterization of the constrained optimal allocation in an economy with endowment fluctuations which are private information, where agents are also able to trade assets unobservably. In this environment, production and aggregate savings can be manipulated by a planner through the use of capital taxation. Using this instrument, the planner is capable of affecting prices on the unobservable trades. In this environment, the constrained optimal allocation can be implemented in a simple decentralized way, which takes the form of a bond market economy with capital taxes. The chapter provides conditions ensuring that an untaxed economy would fail to achieve an efficient allocation. The essential element for a possible Pareto improvement is a wedge which is introduced between the returns on capital and the market return on bonds. Around the undistorted economy the sign of a welfare improving wedge depends centrally on the covariance of asset holdings and marginal utility in the cross-section of the population. The covariance term represents the redistributive impact of a combination of price changes and lump-sum revenue rebates: a bond price increase affects agents negatively in proportion to their asset holdings, while the rebate increases their individual welfare in proportion to average savings. A necessary condition for the optimal tax is also presented. This condition takes that redistributive effect into account, in addition to the combined consequences that each price change has on revenues across periods. The third paper is product of joint work with Plamen T. Nenov. Its central concern are the effects of increased uncertainty on financial stability. By studying a debt roll-over coordination game with dispersed information and a market-determined liquidity scenario, it describes conditions under which an improvement in the precision of individual information about financial institutions' fundamentals leads to greater financial stability. For the limiting case of arbitrarily precise private information, that condition obtains a simple form in terms of payoff elasticities. Conversely, we characterize when an increase in uncertainty leads to a higher frequency of debt runs and show how this deleterious effect is amplified through the deterioration of prices for liquidated assets.