%0 Journal Article %J Quarterly Journal of Economics %D Forthcoming %T Productivity and Misallocation in General Equilibrium %A David Baqaee %A Emmanuel Farhi %X This paper develops a general theory of aggregation in inefficient economies. We provide non-parametric formulas for aggregating microeconomic shocks in economies with distortions such as taxes, markups, frictions to resource reallocation, financial frictions, and nominal rigidities. We allow for arbitrary elasticities of substitution, returns to scale, factor mobility, and input-output network linkages. We show how to separately measure changes in technical and allocative efficiency. We also show how to compute the social cost of distortions. We pursue applications focusing on firm-level markups in the U.S. We find that improvement in allocative efficiency, due to the reallocation over time of market share to high-markup firms, accounts for about half of aggregate TFP growth over the period 1997-2015. We also find that eliminating the misallocation resulting from the large and dispersed markups estimated in the data would raise aggregate TFP by about 20%, increasing the economy-wide cost of monopoly distortions by two orders of magnitude compared to the famous 0.1% estimate by Harberger (1954). These exact numbers should be interpreted with care since the data is imperfect and requires substantial imputation. %B Quarterly Journal of Economics %G eng %0 Journal Article %J Journal of the European Economic Association %D Forthcoming %T The Microeconomic Foundations of Aggregate Production Functions %A David Baqaee %A Emmanuel Farhi %X Aggregate production functions are reduced-form relationships that emerge endogenously from input-output interactions between heterogeneous producers and factors in general equilibrium. We provide a general methodology for analyzing such aggregate production functions by deriving their first- and second-order properties. Our aggregation formulas provide non-parameteric characterizations of the macro elasticities of substitution between factors and of the macro bias of technical change in terms of micro sufficient statistics. They allow us to generalize existing aggregation theorems and to derive new ones. We relate our results to the famous Cambridge-Cambridge controversy. %B Journal of the European Economic Association %G eng %0 Journal Article %J American Economic Review %D Forthcoming %T Monetary Policy, Bounded Rationality, and Incomplete Markets %A Emmanuel Farhi %A Ivan Werning %X
%B American Economic Review %8 2017 %G eng %0 Journal Article %J American Economic Review %D Forthcoming %T Optimal Taxation with Behavioral Agents %A Emmanuel Farhi %A Xavier Gabaix %X
This paper develops a theory of optimal taxation with behavioral agents. We use a general behavioral framework that encompasses a wide range of behavioral biases such as misperceptions, internalities and mental accounting. We revisit the three pillars of optimal taxation: Ramsey (linear commodity taxation to raise revenues and redistribute), Pigou (linear commodity taxation to correct externalities) and Mirrlees (nonlinear income taxation). We show how the canonical optimal tax formulas are modified and lead to a rich set of novel economic insights. We also show how to incorporate nudges in the optimal taxation frameworks, and jointly characterize optimal taxes and nudges. We explore the Diamond-Mirrlees productive efficiency result and the Atkinson-Stiglitz uniform commodity taxation proposition, and find that they are more likely to fail with behavioral agents.
%B American Economic Review %G eng %0 Journal Article %J American Economic Review, Papers and Proceedings %D 2019 %T China vs. U.S.: IMS Meets IPS %A Emmanuel Farhi %A Matteo Maggiori %X Currently both the International Monetary System (IMS) and the International Price Systems (IPS) are dominated by the U.S. The emergence of China, both as reserve currency and as a currency of invoicing, is likely to disrupt this status quo. We provide a framework to understand the forces that will shape this transition and identify sources of instability. We highlight the risk of an abrupt shift triggered by a run on the dollar. %B American Economic Review, Papers and Proceedings %V 109 %P 476-481 %G eng %N May %0 Journal Article %J Econometrica %D 2019 %T The Macroeconomic Impact of Microeconomic Shocks: Beyond Hulten's Theorem %A David Baqaee %A Emmanuel Farhi %XWe provide a nonlinear characterization of the macroeconomic impact of microeconomic productivity shocks in terms of reduced-form non-parametric elasticities for efficient economies. We also show how structural microeconomic parameters are mapped to these reduced-form general equilibrium elasticities. In this sense, we extend the foundational theorem of Hulten (1978) beyond first-order terms to capture nonlinearities. Key features ignored by first-order approximations that play a crucial role are: structural elasticities of substitution, network linkages, structural returns to scale, and the extent of factor reallocation. In a business-cycle calibration with sectoral shocks, nonlinearities magnify negative shocks and attenuate positive shocks, resulting in an aggregate output distribution that is asymmetric (negative skewness), fat-tailed (excess kurtosis), and has a lower mean, even when shocks are symmetric and thin-tailed. Average output losses due to short-run sectoral shocks are an order of magnitude larger than the welfare cost of business cycles calculated by Lucas1(987). Nonlinearities can also cause shocks to critical sectors to have disproportionate macroeconomic effects, almost tripling the estimated impact of the 1970s oil shocks on world aggregate output. Finally, in a long-run growth context, nonlinearities, which underpin Baumol's cost disease, account for a 20 percentage point reduction in aggregate TFP growth over the period 1948-2017 in the US.
%B Econometrica %V 87 %P 1155-1203 %8 2019 %G eng %N 4 %0 Journal Article %J Brookings Papers on Economic Activity %D 2018 %T Accounting for Macro-Finance Trends: Market Power, Intangibles, and Risk Premia %A Emmanuel Farhi %A Francois Gourio %B Brookings Papers on Economic Activity %V Fall %P 147-250 %G eng %0 Journal Article %J NBER Macroeconomics Annual %D 2018 %T The Macroeconomics of Border Taxes %A Omar Barbiero %A Emmanuel Farhi %A Gita Gopinath %A Oleg Itskkoki %B NBER Macroeconomics Annual %V 33 %P 395-457 %G eng %0 Journal Article %J Quarterly Journal of Economics %D 2018 %T A Model of the International Monetary System %A Emmanuel Farhi %A Matteo Maggiori %XWe propose a simple model of the international monetary system. We study the world supply and demand for reserve assets denominated in different currencies under a variety of scenarios: a Hegemon vs. a multipolar world; abundant vs. scarce reserve assets; a gold exchange standard vs. a floating rate system. We rationalize the Triffin dilemma, which posits the fundamental instability of the system, as well as the common prediction regarding the natural and beneficial emergence of a multipolar world, the Nurkse warning that a multipolar world is more unstable than a Hegemon world, and the Keynesian argument that a scarcity of reserve assets under a gold standard or at the zero lower bound is recessive. Our analysis is both positive and normative.
%B Quarterly Journal of Economics %V 133 %P 295-355 %G eng %N 1 %0 Journal Article %J Review of Economic Studies %D 2018 %T Deadly Embrace: Sovereign and Financial Balance Sheets Doom Loops %A Emmanuel Farhi %A Jean Tirole %X
The recent unravelling of the Eurozone's financial integration raised concerns about feedback loops between sovereign and banking insolvency. This paper provides a theory of the feedback loop that allows for both domestic bailouts of the banking system and sovereign debt forgiveness by international creditors or solidarity by other countries. Our theory has important implications for the re-nationalization of sovereign debt and the rationale for banking unions.
%B Review of Economic Studies %V 85 %P 1781-1823 %G eng %N 3 %0 Journal Article %J Journal of Economic Perspectives %D 2017 %T The Safe Asset Shortage Conundrum %A Ricardo J. Caballero %A Emmanuel Farhi %A Pierre-Olivier Gourinchas %X A safe asset is a simple debt instrument that is expected to preserve its value during adverse systemic events. The supply of safe assets, private and public, has historically been concentrated in a small number of advanced economies, most prominently the United States. Over the last few decades, with minor cyclical interruptions, the supply of safe assets has not kept up with global demand. The reason is straightforward: the collective growth rate of the advanced economies that produce safe assets has been lower than the world's growth rate, which has been driven disproportionately by the high growth rate of high-saving emerging economies such as China. The signature of this growing shortage is a steady increase in the price of safe assets; equivalently, global safe interest rates must decline, as has been the case since the 1980s. The early literature, brought to light by Ben Bernanke's famous "savings glut" speech of 2005, focused on a general shortage of assets without isolating its safe asset component. The distinction, however, has become increasingly important over time, particularly in the aftermath of the subprime mortgage crisis and its sequels. We begin by describing the main facts and macroeconomic implications of safe asset shortages. Faced with such a structural conundrum, what are the likely short- to medium-term escape valves? We analyze four of them, each with its own macroeconomic and financial trade-offs. %B Journal of Economic Perspectives %V 31 %P 29-46 %G eng %N 3 %0 Journal Article %J American Economic Review, Papers and Proceedings %D 2017 %T Rents, Technical Change, and Risk Premia: Accounting for Secular Changes in Interest Rates, Returns to Capital, Earnings Yields, and Factor Shares %A Ricardo J. Caballero %A Emmanuel Farhi %A Pierre-Olivier Gourinchas %X
The secular decline in safe interest rates since the early 1980s has been the subject of considerable attention. In this short paper, we argue that it is important to consider the evolution of safe real rates in conjunction with three other first-order macroeconomic stylized facts: the relative constancy of the real return to productive capital, the decline in the labor share, and the decline and subsequent stabilization of the earnings yield. Through the lens of a simple accounting framework, these four facts offer insights into the economic forces that might be at work.
%B American Economic Review, Papers and Proceedings %V 107 %P 614-620 %G eng %N 5 %0 Journal Article %J Review of Economic Studies %D 2017 %T The Safety Trap %A Ricardo J Caballero %A Emmanuel Farhi %XIn this paper we provide a model of the macroeconomic implications of safe
asset shortages. In particular, we discuss the emergence of a deflationary
safety trap equilibrium with endogenous risk premia. It is an acute
form of a liquidity trap, in which the shortage of a specific form of
assets, safe assets, as opposed to a general shortage of assets, is the
fundamental driving force. At the ZLB, our model has a Keynesian cross
representation, in which net safe asset supply plays the role of an
aggregate demand shifter. Essentially, safety traps correspond to liquidity
traps in which the emergence of an endogenous risk premium significantly
alters the connection between macroeconomic policy and economic activity.
``Helicopter drops'' of money, safe public debt issuances, swaps of private
risky assets for safe public debt, or increases in the inflation target,
stimulate aggregate demand and output, while forward guidance is less
effective. The safety trap can be arbitrarily persistent, as in the secular
stagnation hypothesis, despite the existence of infinitely lived assets.
We study cross-country risk sharing as a second-best problem for members of a currency union using an open economy model with nominal rigidities and provide two key results. First, we show that, if financial markets are incomplete, the value of gaining access to any given level of aggregate risk sharing is greater for countries that are members of a currency union. Second, we show that, even if financial markets are complete, privately optimal risk sharing is constrained inefficient. A role emerges for government intervention in risk sharing to both guarantee its existence and to influence its operation. The constrained efficient risk sharing arrangement can be implemented by contingent transfers within a fiscal union. The benefits of such a fiscal union are larger, the bigger the asymmetric shocks affecting the members of the currency union, the more persistent these shocks, and the less open the member economies.
%B American Economic Review %V 107 %P 3788-3834 %G eng %N 12 %0 Journal Article %J Handbook of Macroeconomics %D 2017 %T Fiscal Multipliers: Liquidity Traps and Currency Unions %A Emmanuel Farhi %A Ivan Werning %XWe provide explicit solutions for government spending multipliers during a liquidity trap and within a fixed exchange regime using standard closed and open-economy New Keynesian models. We confirm the potential for large multipliers during liquidity traps. For a currency union, we show that self-financed multipliers are small, always below unity, unless the accompanying tax adjustments involve substantial static redistribution from low to high marginal propensity to consume agents, or dynamic redistribu- tion from future to present non-Ricardian agents. But outside-financed multipliers which require no domestic tax adjustment can be large, especially when the average marginal propensity to consume on domestic goods is high or when government spending shocks are very persistent. Our solutions are relevant for local and national multipliers, providing insight into the economic mechanisms at work as well as the testable implications of these models.
%B Handbook of Macroeconomics %V 2 %P 2417-2492 %G eng %0 Journal Article %J American Economic Review, Papers and Proceedings %D 2016 %T Safe Asset Scarcity and Aggregate Demand %A Ricardo Caballero %A Emmanuel Farhi %A Pierre-Olivier Gourinchas %B American Economic Review, Papers and Proceedings %V 106 %P 513-518 %G eng %N 5 %0 Journal Article %J Econometrica %D 2016 %T A Theory of Macroprudential Policies in the Presence of Nominal Rigidities %A Emmanuel Farhi %A Ivan Werning %XWe study fiscal and monetary policy in a monetary union with the potential for rollover crises in sovereign debt markets. Member-country fiscal authorities lack commitment to repay their debt and choose fiscal policy independently. A common monetary authority chooses inflation for the union, also without commitment. We first describe the existence of a fiscal externality that arises in the presence of limited commitment and leads countries to over borrow; this externality rationalizes the imposition of debt ceilings in a monetary union. We then investigate the impact of the composition of debt in a monetary union, that is the fraction of high-debt versus low-debt members, on the occurrence of self-fulfilling debt crises. We demonstrate that a high-debt country may be less vulnerable to crises and have higher welfare when it belongs to a union with an intermediate mix of high- and low-debt members, than one where all other members are low-debt. This contrasts with the conventional wisdom that all countries should prefer a union with low-debt members, as such a union can credibly deliver low inflation. These findings shed new light on the criteria for an optimal currency area in the presence of rollover crises.
Parties in financial markets, industries, compensation design or politics may negotiate on either a piecemeal or a bundled basis. Little is known about the desirability of bundling when values are common and/or information endogenous. The paper shows that bundling encourages information-equalizing investments, thereby facilitating trade. It accordingly revisits and qualifies existing knowledge on security design.
Though risk aversion and the elasticity of intertemporal substitution have been the subjects of careful scrutiny when calibrating preferences, the long-run risks literature as well as the broader literature using recursive utility to address asset pricing puzzles have ignored the full implications of their parameter specifications. Recursive utility implies that the temporal resolution of risk matters and a quantitative assessment of how much it matters should be part of the calibration process. This paper gives a sense of the magnitudes of implied timing premia. Its objective is to inject temporal resolution of risk into the discussion of the quantitative properties of long-run risks and related models.
%B American Economic Review %V 104 %P 2680-2697 %G eng %N 9 %0 Journal Article %J IMF Economic Review (Special Volume in Honor of Stanley Fischer) %D 2014 %T Dilemma not Trilemma? Capital Controls and Exchange Rates with Volatile Capital Flows %A Emmanuel Farhi %A Ivan Werning %XWe consider a standard New Keynesian model of a small open economy with nominal rigidities and study optimal capital controls. Consistent with the Mundellian view, we find that the exchange rate regime is key. However, in contrast with the Mundellian view, we find that capital controls are desirable even when the exchange rate is flexible. Optimal capital controls lean against the wind and help smooth out capital flows.
%B IMF Economic Review (Special Volume in Honor of Stanley Fischer) %V 62 %P 569-605 %G eng %0 Journal Article %J Review of Economic Studies %D 2014 %T Fiscal Devaluations %A Emmanuel Farhi %A Gita Gopinath %A Oleg Itskhoki %XWe show that even when the exchange rate cannot be devalued, a small set of conventional fiscal instruments can robustly replicate the real allocations attained under a nominal exchange rate devaluation in a dynamic New Keynesian open economy environment. We perform the analysis under alternative pricing assumptions—producer or local currency pricing, along with nominal wage stickiness; under arbitrary degrees of asset market completeness and for general stochastic sequences of devaluations. There are two types of fiscal policies equivalent to an exchange rate devaluation—one, a uniform increase in import tariff and export subsidy, and two, a value-added tax increase and a uniform payroll tax reduction. When the devaluations are anticipated, these policies need to be supplemented with a consumption tax reduction and an income tax increase. These policies are revenue neutral. In certain cases equivalence requires, in addition, a partial default on foreign bond holders. We discuss the issues of implementation of these policies, in particular, under the circumstances of a currency union.
%B Review of Economic Studies %V 81 %P 725-760 %G eng %N 2 %0 Journal Article %J Rand Journal of Economics %D 2013 %T Fear of Rejection? Tiered Certification and Transparency %A Emmanuel Farhi %A Josh Lerner %A Jean Tirole %B Rand Journal of Economics %V 44 %P 610–631 %G eng %N 4 %0 Journal Article %J Review of Economic Studies %D 2013 %T Insurance and Taxation over the Life Cycle %A Emmanuel Farhi %A Ivan Werning %XWe consider a dynamic Mirrlees economy in a life-cycle context and study the optimal insurance arrangement. Individual productivity evolves as a Markov process and is private information. We use a first-order approach in discrete and continuous time and obtain novel theoretical and numerical results. Our main contribution is a formula describing the dynamics for the labour-income tax rate. When productivity is an AR(1) our formula resembles an AR(1) with a trend where: (i) the auto-regressive coefficient equals that of productivity; (ii) the trend term equals the covariance productivity with consumption growth divided by the Frisch elasticity of labour; and (iii) the innovations in the tax rate are the negative of consumption growth. The last property implies a form of short-run regressivity. Our simulations illustrate these results and deliver some novel insights. The average labour tax rises from 0% to 37% over 40 years, whereas the average tax on savings falls from 12% to 0% at retirement. We compare the second best solution to simple history-independent tax systems, calibrated to mimic these average tax rates. We find that age-dependent taxes capture a sizable fraction of the welfare gains. In this way, our theoretical results provide insights into simple tax systems.
%B Review of Economic Studies %V 810 %P 596–635 %G eng %N 2 %0 Journal Article %J American Economic Review, Papers and Proceedings %D 2013 %T Estate Taxation with Altruism Heterogeneity %A Emmanuel Farhi %A Ivan Werning %X We develop a theory of optimal estate taxation in a model where bequest inequality is driven by differences in parental altruism. We show that a wide range of results are possible, from positive taxes to subsidies, depending on redistributive objectives implicit in the cardinal specification of utility and social welfare functions. We propose a normalization that is helpful in classifying these different possibilities. We isolate cases where the optimal policy bans negative bequests and taxes positive bequests, features present in most advanced countries. %B American Economic Review, Papers and Proceedings %V 103 %G eng %N 3 %0 Journal Article %J American Economic Review %D 2013 %T Unconventional Fiscal Policy at the Zero Bound %A Emmanuel Farhi %A Isabel Correia %A Juan Pablo Nicolini %A Pedro Teles %X When the zero lower bound on nominal interest rates binds, monetary policy cannot provide appropriate stimulus. We show that, in the standard New Keynesian model, tax policy can deliver such stimulus at no cost and in a time-consistent manner. There is no need to use inefficient policies such as wasteful public spending or future commitments to low interest rates. %B American Economic Review %V 103 %P 1172-1211 %G eng %N 4 %0 Journal Article %J American Economic Review %D 2012 %T Collective Moral Hazard, Maturity Mismatch and Systemic Bailouts %A Emmanuel Farhi %A Jean Tirole %X The paper shows that time-consistent, imperfectly targeted support to distressed institutions makes private leverage choices strategic complements. When everyone engages in maturity mismatch, authorities have little choice but intervening, creating both current and deferred (sowing the seeds of the next crisis) social costs. In turn, it is profitable to adopt a risky balance sheet. These insights have important consequences, from banks choosing to correlate their risk exposures to the need for macro-prudential supervision. %B American Economic Review %V 102 %P 60-93 %G eng %U %N 1 %0 Journal Article %J Review of Economic Studies %D 2012 %T Nonlinear Capital Taxation without Commitment %A Emmanuel Farhi %A Chris Sleet %A Ivan Werning %A Sevin Yeltekin %X We study efficient non-linear taxation of labour and capital in a dynamic Mirrleesian model incorporating political economy constraints. Policies are chosen sequentially over time, without commitment. Our main result is that the marginal tax on capital income is progressive, in the sense that richer agents face higher marginal tax rates. %B Review of Economic Studies %V 79 %P 1469-1493 %G eng %N 4 %0 Journal Article %J Journal of Political Economy %D 2012 %T Capital Taxation: Quantitative Explorations of the Inverse Euler Equation %A Emmanuel Farhi %A Ivan Werning %X Economies with private information provide a rationale for capital taxation. In this paper we ask what the welfare gains from following this prescription are. We develop a method to answer this question in standard general equilibrium models with idiosyncratic uncertainty and incomplete markets. We find that general equilibrium forces are important and greatly reduce the welfare gains. Once these effects are taken into account, the gains are relatively small in our benchmark calibration. These results do not imply that dynamic aspects of social insurance design are unimportant, but they do suggest that capital taxation may play a modest role. %B Journal of Political Economy %V 120 %P 398-445 %G eng %N 3 %0 Journal Article %J Review of Economic Studies %D 2012 %T Bubbly Liquidity %A Emmanuel Farhi %A Jean Tirole %X This paper analyzes the possibility and the consequences of rational bubbles in a dynamic economy where financially constrained firms demand and supply liquidity. Bubbles are more likely to emerge, the scarcer the supply of outside liquidity and the more limited the pledgeability of corporate income; they crowd investment in (out) when liquidity is abundant (scarce). We analyze extensions with firm heterogeneity and stochastic bubbles. %B Review of Economic Studies %V 79 %P 678-706 %G eng %N 2 %0 Journal Article %J Quarterly Journal of Economics %D 2010 %T Progressive Estate Taxation %A Emmanuel Farhi %A Ivan Werning %X We present a model with altruistic parents and heterogeneous productivity. We derive two key properties for optimal estate taxation. First, the estate tax should be progressive, so that parents leaving a higher bequest face a lower net return on bequests. Second, marginal estate taxes should be negative, so that all parents face a marginal subsidy on bequests. Both properties can be implemented with a simple nonlinear tax on bequests, levied separately from the income tax. These results apply to other intergenerational transfers, such as educational investments, and are robust to endogenous fertility choices. Both estate or inheritance taxes can implement the optimal allocation, but we show that the inheritance tax has some advantages. Finally, when we impose an ad hoc constraint requiring marginal estate taxes to be nonnegative, the optimum features a zero tax up to an exception level, and a progressive tax thereafter. %B Quarterly Journal of Economics %V 125 %P 635-673 %G eng %N 2 %0 Journal Article %J Journal of Political Economy %D 2010 %T Capital Taxation and Ownership when Markets are Incomplete %A Emmanuel Farhi %X This paper is a normative investigation of the theoretical and quantitative properties of optimal capital taxation in the neoclassical growth model with aggregate shocks and incomplete markets. The model features a representative-agent economy with linear taxes on labor and capital. I first allow the government to trade only a real risk-free bond. Taxes on capital are set one period in advance, reflecting inertia in tax codes and preventing replication of the complete markets allocation. Optimal policy has the following features: labor taxes fluctuate very little; capital taxes are volatile and feature a positive (negative) spike after a negative (positive) shock to the government budget; and capital taxes average to roughly zero across periods. I then consider the implications of allowing the government to trade capital. Optimality calls for a large short position. %B Journal of Political Economy %V 118 %P 908-948 %G eng %U %N 5 %0 Journal Article %J American Economic Review, Papers and Proceedings %D 2009 %T Leverage and the Central Banker’s Put %A Emmanuel Farhi %A Jean Tirole %B American Economic Review, Papers and Proceedings %V 99 %P 589-593 %G eng %N 2 %0 Journal Article %J Review of Economic Studies %D 2009 %T A Theory of Liquidity and Regulation of Financial Intermediation %A Emmanuel Farhi %A Mike Golosov %A Aleh Tsyvinski %X This paper studies a Diamond-Dybvig model of financial intermediation providing insurance against unobservable liquidity shocks in the presence of unobservable trades on private markets. We show that in this case competitive equilibria are inefficient. A social planner fi nds it benefi cial 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 need to invest in short-term assets. In the case of Diamond-Dybvig preferences, the optimal allocation coincides with the unconstrained optimum. For more general preferences, the optimal allocation does not coincide with the unconstrained optimum, and the direction of the policy intervention depends on the nature of the shocks in a manner that we precisely characterize. %B Review of Economic Studies %V 76 %P 973-992 %G eng %N 3 %0 Journal Article %J Journal of Monetary Economics, Carnegie Rochester Series %D 2008 %T Optimal Savings Distortions with Recursive Preferences %A Emmanuel Farhi %A Ivan Werning %X This paper derives an intertemporal optimality condition for economies with private information, focusing on a class of recursive preferences. By comparing it to the situation where agents can freely save in a risk-free asset market, we derive the optimal savings distortions necessary for constrained optimality. Our recursive preferences are homogeneous and satisfy a balanced-growth condition, while allowing us to separate the role of risk aversion and intertemporal elasticity of substitution. We perform some quantitative exercises that disentangle the respective roles played by these two parameters in optimal distortions and the implied welfare gains. %B Journal of Monetary Economics, Carnegie Rochester Series %V 55 %P 21-42 %G eng %N 1 %0 Journal Article %J American Economic Review %D 2008 %T An Equilibrium Model of Global Imbalances and Low Interest Rates %A Emmanuel Farhi %A Ricardo Caballero %A Pierre-Olivier Gourinchas %X The sustained rise in US current account deficits, the stubborn decline in long-run real rates, and the rise in US assets in global portfolios appear as anomalies from the perspective of conventional models. This paper rationalizes these facts as an equilibrium outcome when different regions of the world differ in their capacity to generate financial assets from real investments. Extensions of the basic model generate exchange rate and foreign direct investment excess returns broadly consistent with the recent trends in these variables. The framework is flexible enough to shed light on a range of scenarios in a global equilibrium environment. %B American Economic Review %V 98 %P 358-393 %G eng %N 1 %0 Journal Article %J Brookings Paper on Economic Activity %D 2008 %T Financial Crash, Commodity Prices and Global Imbalances %A Emmanuel Farhi %A Ricardo Caballero %A Pierre-Olivier Gourinchas %B Brookings Paper on Economic Activity %V Fall %G eng %0 Journal Article %J Journal of Financial Economics %D 2007 %T Saving and Investing for Early Retirement: A Theoretical Analysis %A Emmanuel Farhi %A Stavros Panageas %X We study optimal consumption and portfolio choice in a framework where investors adjust their labor supply through an irreversible choice of their retirement time. We show that investing for early retirement tends to increase savings and reduce an agent’s effective relative risk aversion, thus increasing her stock market exposure. Contrary to common intuition, an investor might find it optimal to increase the proportion of financial wealth held in stocks as she ages and accumulates assets, even when her income and the investment opportunity set are constant. The model predicts a decrease in risk aversion following strong market gains like those observed in the nineties. %B Journal of Financial Economics %V 83 %P 87-121 %G eng %N 1 %0 Journal Article %J Journal of Political Economy %D 2007 %T Inequality and Social Discounting %A Emmanuel Farhi %A Ivan Werning %XWe explore steady-state inequality in an intergenerational model with altruistically linked individuals who experience privately observed taste shocks. When the welfare function depends only on the initial generation, efficiency requires immiseration: inequality grows without bound and everyone’s consumption converges to zero.We study other efficient allocations in which the welfare function values future generations directly, placing a positive but vanishing weight on their welfare. The social discount factor is then higher than the private one, and for any such difference we find that consumption exhibits mean reversion and that a steady-state, cross-sectional distribution for consumption and welfare exists, with no one trapped at misery.
%B Journal of Political Economy %V 115 %P 365-402 %G eng %N 3 %0 Journal Article %J American Economic Review %D 2006 %T Speculative Growth: Hints from the U.S. Economy %A Emmanuel Farhi %A Ricardo Caballero %A Mohamad Hammour %X We propose a framework for understanding episodes of vigorous economic expansion and extreme asset valuations. We interpret this phenomenon as a high-valuation equilibrium with a low cost of capital based on optimism about future funding. The key ingredient for such equilibrium is feedback from increased growth to a decline in the long-run cost of capital. This feedback arises when an expansion comes with technological progress in the capital sector, when fiscal rules generate procyclical fiscal surpluses, when the rest of the world has lower expansion potential or high saving needs, and when financial constraints are relaxed by the expansion itself. %B American Economic Review %V 96 %P 1159-1192 %G eng %N 4 %0 Journal Article %J Journal of the European Economic Association %D 2005 %T Certifying New Technologies %A Emmanuel Farhi %A Josh Lerner %A Jean Tirole %X We study the role of Standard Setting Organization (SSOs) in the adoption of standards. The way the SSO balances the interests of sponsor and users is key to its ability to certify the technology. Proximity to users builds trust in the endorsement, but may be unattractive to technology sponsors. In a static context, we show that the SSO is an effective certifier if and only if it puts enough weight on users' interests. We then tackle the more challenging problem of SSO certification in a dynamic setting in which new information will accrue in the futurea nd user choices are irreversible.T he SSO and the users must then both take a dynamic perspective and contemplate the possibility of a "second chance" that may arise for the standard. A key insight is the possibility of multiple self-fulfilling expectations. It is possible to have an equilibrium with no second chance, a lenient SSO endorsement policy and high stigma from early rejection. It is also possible to have an equilibrium with a second chance, a selective SSO endorsement policy and low stigma from early rejection. Finally, and in both the static and the dynamic setups, we ask whether the SSO is too inclined to turn down or to accept the standard from a social viewpoint %B Journal of the European Economic Association %V 3 %P 734-744 %G eng %N 2/3