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State Finance in History

Articles 

The mechanism by which aggregate supply creates the income that generates its matching demand (called Say's law), may not work in a general equilibrium with decentralized markets and savings in bonds or money. Full employment is an equilibrium, but convergence to that state is slow. A self-fulfilling precautionary motive to accumulate  bonds (with a zero aggregate supply)  can set the economy on an equilibrium  path with a fast convergence towards a steady state with unemployment that may be an absorbing state from which no equilibrium path emerges to restore full employment. 

Under Philip II, Castile was the first country with a large nation-wide domestic public debt. A new view of that fiscal system is presented that is potentially relevant for other fiscal systems in Europe before 1800. The credibility of the debt, mostly in perpetual redeemable annuities, was enhanced by decentralized funding through taxes administered by cities making up the Realm in the Cortes. The accumulation of shortterm debt depended on the refinancing through long-term debt. Financial crises in the short-term debt occurred when the service of the long-term debt reached the revenues of its servicing taxes. They were not caused by liquidity crises and were resolved after protracted negotiations in the Cortes by tax increases and interest rate reductions.

Documents   

Sales of juros at 5% in 1568: transcript, (copy of original available).
Sales of juros at 5% in 1572: transcript, (copy of original available). 

Under Philip II, Castile was the first country with a large nation-wide domestic public debt. A new view of that fiscal system is presented that is potentially relevant for other fiscal systems in Europe before 1800. The credibility of the debt, mostly in perpetual redeemable annuities, was enhanced by decentralized funding through taxes administered by cities making up the Realm in the Cortes. The accumulation of shortterm debt depended on the refinancing through long-term debt. Financial crises in the short-term debt occurred when the service of the long-term debt reached the revenues of its servicing taxes. They were not caused by liquidity crises and were resolved after protracted negotiations in the Cortes by tax increases and interest rate reductions.

We compare basic economic models on social behavior with with similar sensor fusion problems studied in information theory and in signal processing, where the limitations in the learning performance are the consequence of physical constraints in communicating, rather than self-interest. We discuss a more general information sharing model, where agents are allowed to have interactions over an arbitrary network and studies on network diffusion algorithms in signal processing. The analysis of network formation under strategic models motivatesthe emergence of communication graph between self-interested individuals with specific payoffs on sharing information with others.

The coordination of saving and investment is analyzed in a general equilibrium model with rational expectations and no forward market. Shocks affect preferences for future consumption. A paradox of thrift is proven within a general equilibrium model. The model formalizes an argument in the General Theory of Keynes but the equilibrium is a constrained Pareto optimum. Textbook fiscal policies are neutral at best, or inefficient.

A model of lending is presented where loans are established in matches between banks (lenders) and entrepreneurs (borrowers) who meet in a search process. Projects turn out randomly a quick payoff or a long-term payoff that requires a rollover of the loan. The model generates, under proper parameter conditions, two steady states without or with rollover, and rollover is socially inefficient. Under imperfect information, the standard debt contract is privately efficient. However, it extends the domains of equilibria with socially inefficient rollover. The global dynamics displays a continuum of equilibrium paths that each exhibits sudden discontinuities - crises - in which the mass of outstanding loans is reduced by a quantum amount of terminations. Crises have a cleansing effect. 

In the 1730s and 1750s the English government proposed to refinance the redemable debt by “lowering the interest rate”. In the ensuing coordination game among creditors, large investors like the Bank of England could block the policy change by demanding cash. Using 4 percent and 3 percent annuties prices to analyze market expectations, this article studies two refinancing episodes with very different fates. Lord Barnard failed in 1737 because his terms were too strict and financial agents induced a temporary market crash. Lord Pelham succeeded in 1750 because his better terms fit market prices, and interest rates had fallen much faster than expected.

Debt forgiveness for Greece should have come much earlier. Subsequent events have shown that view to be correct.

In a simple model of a frictionless financial market with rational agents,  the value of private information increases when large discrete  shocks independently affect the fundamental value of the asset and the exogenous trading. The complementarity in information gathering generates multiple equilibria.

In a financial market where agents trade for short-term profit and where news can increase the uncertainty of the public belief, there are strategic complementarities in the acquisition of private information, and if the cost of information is sufficiently small, is a continuum of equilibrium strategies. Imperfect observation of past prices reduces the continuum of Nash-equilibria to a Strongly Rational-Expectations Equilibrium. In that equilibrium, there are two sharply different regimes for the evolution of price, the volume trade and the information acquisition.

The general model of social learning with irreversible investment and endogenous timing is analyzed for any distribution of private informations. Strategic complementarities and multiple equilibria appear which are generated solely by information externalities. Different equilibria generate strikingly different amounts of information. The impacts of various assumptions (bounded beliefs, large number of agents, discrete time and short periods) are examined carefully. The properties are robust to the introduction of observation noise with a continuum of agents.

This paper presents a model of rational Bayesian agents with speculative attacks in a regime of exchange rate which is pegged within a band. Speculators learn from the observation of the exchange rate within the band whether their mass is sufficiently large for a successful attack. Multiple periods are necessary for the existence of speculative attacks. Various defense policies are analyzed. A trading policy by the central bank may defend the peg if it is unbobserved and diminishes sthe market's information for the coordination of speculators.

The canonical model of strategic complementarities between individual actions, which exhibits multiple equilibria under perfect information, is extended with heterogeneous agents and imperfect information. Agents observe their own cost of action and the history of the levels of aggregate activity. The distribution of individual characteristics evolves through a random process, and individuals are rational Bayesians. Under plausible conditions, there is a unique equilibrium with phases of high and low activity and random switches. Applications may be found in macroeconomics and revolutions.

 

Chapters in books and other journals

  • Sovereign bailouts and senior loans (Spring 2013), with Brian Pinto, International Seminar on Macroeconomics, Giavazzi and West (eds), NBER International Seminar on Macroeconomics.

Institutional lending in crisis is evaluated from a theoretical point of view. First, the share of senior loans in new loans is irrelevant under a given probability distribution of the country's resources. Second, seniority may partially alleviate the inefficiency of debt contracts when the distribution of resources is endogenous to the country's physical investment. Third, with multiple lending rate equilibria, institutional lending may induce a switch to a lower private loan rate if it can be done in suciently large amount. Fourth, conditions are analyzed under which debt forgiveness is ecient under a nancial shock.