Modern Fiscal Policy

‘US Federal Debt 1776 – 1960: Quantities and Prices,’ Sargent, T. (with G. Hall and J. Payne), 2018.

This document describes Pandas DataFrames and the spreadsheets underlying them that contain prices, quantities, and descriptions of bonds and notes issued by the United States Federal government from 1776 to 1960. It contains directions to a public github repository at which DataFrames and other files can be downloaded..

‘Managing expectations and fiscal policy,’ Sargent, T. (with L.P. Hansen and A.G. Karantounias), 2009.

This paper studies an optimal fiscal policy problem of Lucas and Stokey (1983) but in a situation in which the representative agent’s distrust of the probability model for government expenditures puts model uncertainty premia into history-contingent prices. This gives rise to a motive for expectation management that is absent within rational expectations and a novel incentive for the planner to smooth the shadow value of the agent’s subjective beliefs in order to manipulate the equilibrium price of government debt. Unlike the Lucas and Stokey (1983) model, the optimal allocation, tax rate, and debt all become history dependent despite complete markets and Markov government expenditures.

‘Inequality, Business Cycles and Fiscal-Monetary Policy,’ Sargent, T. (with A. Bhandari, D. Evans and M. Golosov), 2018.

We study optimal monetary and fiscal policy in a model with heterogeneous agents, incomplete markets, and nominal rigidities. We develop numerical techniques to approximate Ramsey plans and apply them to a calibrated economy to compute optimal responses of nominal interest rates and labor tax rates to aggregate shocks. Responses dier qualitatively from those in a representative
agent economy and are an order of magnitude larger. Taylor rules poorly approximate the Ramsey optimal nominal interest rate. Conventional price stabilization motives are swamped by an across person insurance motive that arises from heterogeneity and incomplete markets.

‘Honoring public debts,’ Sargent, T., 2017.

‘Complications for the United States from International Credits: 1913-1940,’ Sargent, T. (with G. Hall), 2019.

The start of World War I in August 1914 brought investment decisions by private US citizens that influenced US foreign policy and then federal expenditure, monetary, debt management, and taxation policies in unintended and long-lasting ways. After the US entered the War in April 1917, the US Treasury borrowed $23 billion from US citizens and lent $12 billion to 20 foreign nations. What began as foreign loans during the war had by the early 1930s become subsidies.

‘Public Debt in economies with Heterogeneous Agents,’ Sargent, T. (with A. Bhandari, D. Evans and M. Golosov), 2017.

We study public debt in competitive equilibria in which a government chooses transfers and taxes optimally and in addition decides how thoroughly to enforce debt contracts. If the government enforces perfectly, asset inequality is determined in an optimum competitive equilibrium but the level of government debt is not. Welfare increases if private debt contracts are not enforced. Borrowing frictions let the government gather monopoly rents that come from issuing public debt without facing competing private borrowers. Regardless of whether the government chooses to enforce private debt contracts, the level of initial government debt does not affect an optimal allocation.

‘Fiscal Policy and Debt Management with Incomplete Markets,’ Sargent, T. (with A. Bhandari, D. Evans and M. Golosov), 2017.

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. Asymptotically the planner’s portfolio minimizes a measure of fiscal risk. Analytic expressions that approximate moments of the invariant distribution apply 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, that the invariant distribution of debt is very dispersed, and that mean reversion is slow.

‘A History of U.S. Debt Limits,’ Sargent, T. (with G. Hall), 2015.

Congress first imposed an aggregate debt limit in 1939 when it delegated decisions about designing US debt instruments to the Treasury. Before World War I, Congress designed each bond and specified a maximum amount of each bond that the Treasury could issue. It usually specified purposes for which proceeds could be spent. We construct and interpret a Federal debt limit before 1939..

‘Global Banks and Systemic Debt Crises,’ Perez, D. (with P. Ottonello, J. Morelli), 2019.

We study the role of global financial intermediaries in international lending. We construct a model of the world economy, where heterogeneous borrowers issue risky securities purchased by financial intermediaries. Aggregate shocks transmit internationally through financial intermediaries’ net worth. The strength of this transmission is governed by the degree of frictions intermediaries face financing their risky investments. We provide direct empirical evidence on this mechanism showing that, around Lehman Brothers’ collapse, emerging-market bonds held by more-distressed global banks experienced larger price contractions. A quantitative analysis of the model shows that global financial intermediaries play a relevant role driving borrowing-cost and consumption fluctuations in emerging-market economies, both during debt crises and in regular business cycles. The portfolio of financial intermediaries and the distribution of bond holdings in the world economy are key to determine aggregate dynamics.

‘Structured Uncertainty and Model Misspecification∗,’ Sargent, T. (with L.P. Hansen), 2019.

An ambiguity averse decision maker evaluates plans under a restricted family of structured models and unstructured alternatives that are statistically close to them. Structured models include parametric models in which parameter values vary over time in ways that the decision maker cannot describe probabilistically. Because he suspects that all parametric models are misspecified, the decision maker also evaluates plans under alternative probability distributions with much less structure.

‘A Case for Incomplete Markets,’ Cogley, T. and T. Sargent (with L.E. Blume, D.A. Easley, and V. Tsyrennikov), 2015.

We propose a new welfare criterion that allows us to rank alternative financial market structures in the presence of belief heterogeneity. We analyze economies with complete and incomplete financial markets and/or restricted trading possibilities in the form of borrowing limits or transaction costs. We describe circumstances under which variousrestrictions on financial markets are desirable according to our welfare criterion.

‘On Money as a medium of exchange in near-cashless credit economies,’ Lagos, R. (with S. Zhang), 2019.

We study the transmission of monetary policy in credit economies where money serves as a medium of exchange. We find that—in contrast to current conventional wisdom in policy-oriented research in monetary economics—the role of money in transactions can be a powerful conduit to asset prices and ultimately, aggregate consumption, investment, output, and welfare. Theoretically, we show that the cashless limit of the monetary equilibrium (as the cash-and-credit economy converges to a pure-credit economy) need not correspond to the equilibrium of the nonmonetary pure-credit economy. Quantitatively, we find that the magnitudes of the responses of prices and allocations to monetary policy in the monetary economy are sizeable—even in the cashless limit. Hence, as tools to assess the effects of monetary policy, monetary models without money are generically poor approximations—even to idealized highly developed credit economies that are able to accommodate a large volume of transactions with arbitrarily small aggregate real money balances.

‘An Empirical Study of Trade Dynamics in the Fed Funds Market,’ Lagos, R. (with G. Afonso), 2014.

We use minute-by-minute daily transaction-level payments data to document the cross-sectional and time-series behavior of the estimated prices and quantities negotiated by commercial banks in the fed funds market. We study the frequency and volume of trade, the size distribution of loans, the distribution of bilateral fed funds rates, and the intraday dynamics of the reserve balances held by commercial banks. We find evidence of the importance of the liquidity provision achieved by commercial banks that act as de facto intermediaries of fed funds.

‘Monetary Exchange in Over-the-Counter Markets: A Theory of Speculative Bubbles, the Fed Model, and Self-fulfilling Liquidity Crises,’ Lagos, R. (with S. Zhang), 2015.

We develop a model of monetary exchange in over-the-counter markets to study the effects of monetary policy on asset prices and standard measures of financial liquidity, such as bid-ask spreads, trade volume, and the incentives of dealers to supply immediacy, both by participating in the market-making activity and by holding asset inventories on their own account. The theory predicts that asset prices carry a speculative premium that reflects the asset’s marketability and depends on monetary policy as well as the microstructure of the market where it is traded. These liquidity considerations imply a positive correlation between the real yield on stocks and the nominal yield on Treasury bonds—an empirical observation long regarded anomalous. The theory also exhibits rational expectations equilibria with recurring belief driven events that resemble liquidity crises, i.e., times of sharp persistent declines in asset prices, trade volume, and dealer participation in market-making activity, accompanied by large increases in spreads and abnormally long trading delays.

‘Turnover Liquidity and the Transmission of Monetary Policy,’ Lagos, R. (with S. Zhang), 2018.

We study the severity of liquidity constraints in the U.S. housing market using a life-cycle model with uninsurable idiosyncratic risks in which houses are illiquid, but agents have the option to extract home equity by refinancing their long-term mortgages. The model implies that three quarters of homeowners are liquidity constrained and willing to pay an average of 5 cents to extract an additional dollar of liquidity from their home. Most homeowners value liquidity for precautionary reasons, anticipating the possibility of income declines and the need to make mortgage payments in future periods. Mortgage assistance policies structured as credit lines to homeowners who experience a shortfall in income greatly reduce the severity of liquidity constraints.

‘Stress Tests and Bank Portfolio Choice,’ Williams, B., 2017.

How informative should bank stress tests be? I use Bayesian persuasion to formalize stress tests and show that regulators can reduce the likelihood of a bank run by performing tests which are only partially informative. Optimal stress tests give just enough failing grades to keep passing grades credible enough to avoid runs. The worse the state of the banking system, the more stringent stress tests must be to prevent runs. I find that optimal stress tests, by reducing the probability of runs, reduce the optimal level of banks’ liquidity cushions. I also examine the impact of anticipated stress tests on banks’ ex ante incentive to invest in risky versus safe assets.