Knowledge that Transforms

This paper addresses two long‐standing positive questions in public finance: (i) Why is the property tax, despite widespread popular complaints against its fairness, the almost exclusive tax instrument used by local governments, and (ii) why do we consistently observe higher levels of governments (states) undermining local property tax systems through income tax‐funded grants and state‐imposed caps on local property tax rates? A new intuitive argument to explain question is presented and tested in simulations using a computable general equilibrium model with parameters set to be consistent with New Jersey data. Both the intuitive argument and the simulation results indicate that setting local income tax rates to zero is a dominant strategy for community planners. When faced with popular sentiment against the property tax, community planners can collude and introduce local income taxes simultaneously to prevent adverse general equilibrium migration and price changes. Since zero income tax rates are dominant strategies, however, such an agreement is enforceable only if an outsider such as

We test whether the time-series positive correlation of inflation and intermarket relative price variability is also present in a cross section of U.S. cities. We find this correlation to be a robust empirical regularity: cities that have higher than average inflation also have higher than average relative price dispersion, ceteris paribus. This result holds for different periods of time, for different classes of goods, and across different time horizons. Our results suggest that at least part of the relationship between inflation and relative price variability cannot be explained by monetary factors.

In an overlapping generations economy with (incomplete) financial markets but no intermediaries, there is underinvestment in safe assets. In an economy with intermediaries and no financial markets, accumulating reserves of save assets allows returns to be smoothed, nondiversifiable risk to be eliminated, and an ex ante Pareto improvement compared to the allocation in the market equilibrium to be achieved. In a mixed financial system, however, competition from financial markets constrains intermediaries so that they perform no better than markets alone.

Hypothetical referenda have been proposed as an incentive‐compatible mechanism that can be used to obtain social valuations of environmental resources. We employ experimental methods to test the hypothesis that such referenda are indeed incentive compatible. Our results lead us to reject that hypothesis.

Why are contracts not fully indexed? In a setting in which fully indexed contracts are feasible, we find that when price‐level data are gathered with delay, these contracts are not renegotiation‐proof. The contracts that replace them entail a lower level of welfare for the parties to that contract. They also imply that real variables respond to nominal shocks.

The authors construct a model of a dynamic economy in which lenders cannot force borrowers to repay their debts unless the debts are secured. In such an economy, durable assets play a dual role: not only are they factors of production but they also serve as collateral for loans. The dynamic interaction between credit limits and asset prices turns out to be a powerful transmission mechanism by which the effects of shocks persist, amplify, and spill over to other sectors. The authors show that small, temporary shocks to technology or income distribution can generate large, persistent fluctuations in output and asset prices.

A model of global warming with endogenous substitution of energy resources and multiple energy demands is developed. It suggests that, if historical rates of cost reduction in the production of solar energy are maintained, most of the world's coal will never be used. The world will move from oil and natural gas use to solar energy. Temperatures will rise by only about 1.5-2.0 degrees centigrade by the middle of the twenty-first century and then decline to preindustrial levels. These results are significantly lower than those predicted by the Intergovernmental Panel on Climate Change and suggest that the case for global warming may be seriously overstated.

Corrupt agents (officials or gangsters) exact money from firms. Corruption affects the number of firms in a free‐entry equilibrium. The degree of deep competition in the economy increases with lower overhead costs relative to profits and with a tendency toward similar cost structures. Increases in competition may not lower corruption. The model explains why a rational corrupt agent may extinguish the source of his bribe income by causing a firm to exit. Assessing the welfare effect of corruption is complicated by the fact that exit caused by corruption does not necessarily reduce social welfare.