Essays in macroeconomics and political economy

Abstract

Chapter 1: This chapter provides an answer to the Bulow and Rogoff (1989) sovereign debt paradox based on a political economy model of debt. It shows that the presence of political uncertainty reduces the ability of a country to save, and hence to replicate the debt contract after default. In a model where different parties alternate in power, an incumbent party with a low probability of remaining in power has a high short-term discount rate and is therefore unwilling to save. The current incumbent party realizes that in the future whoever achieves power will be impatient as well, making the accumulation of assets unsustainable. Because of their inability to save, politicians demand debt ex-post and the desire to borrow again in the future enforces repayment today. Chapter 2: In this chapter, I present a political economy model of government savings. Two political parties alternate in power every period. The party in power controls the government and decides how to allocate spending this period and how much to save for the future. No party has the ability to commit and at any point in time a party can spend all the income of the government in her own consumption and save nothing for the future. If both parties behave as previously described, then these strategies are the worst subgame perfect equilibria. However, parties are long run players in this political game, and they might be expected to coordinate and play more efficiently. I characterize the set of efficient subgame perfect equilibria. Chapter 3: This chapter studies the implementation of new ideas by managers who choose between contracts offered by an existing firm and a competitive venture capitalist.

(cont.) Relying on existing assets makes implementation cheaper. But it also reduces contractual flexibility which is valuable in the presence of behavioral or informational frictions. To implement an idea, the incumbent firm has to pay the manager an amount that depends on the venture capitalist offer. Venture capital affects the innovation policy of incumbents by changing both the threat of new ideas and their price. The value of an incumbent firm is endogenous and negatively related to the intensity of venture capital pressure. More innovative projects tend to be implemented in new ventures because of the importance of contractual flexibility.