In an economy with distortionary taxes on labour, can subsidies on day care, financed by increased taxes, raise welfare by encouraging women with small children to work? We show, within a stylized life-cycle framework, that the Ramsey optimal policy consists in equalizing consumption/leisure wedges over the life cycle. A simple way to implement this is to make day care expenses tax deductible. Modifying and calibrating our model to fit some key facts about labour supply in Germany, we find that the reform that maximizes a distribution-neutral social welfare function involves subsidizing day care at a rate of 50% and leads to a near doubling of labour supply for mothers with small children. The overall welfare gain from this reform corresponds to a 0.4 percent increase in consumption.

We solve a multi-period model of strategic trading with long-lived information in multiple assets with correlated innovations in fundamental values. Market makers in each asset can only condition their pricing functions on trading in each asset. Using daily non-public data from the New York Stock Exchange, we test the model's predictions on the conditional and unconditional lead–lag relations of institutional order flow and returns within portfolios. We find support for the model prediction of positive autocorrelations in portfolio returns as well as the predictions for how informed order flow positively predicts future returns and future informed order flow. We show that these relations strengthen for portfolios formed from assets within the same industry, which likely have higher correlation of fundamental values. Furthermore, we discuss issues that arise when testing implications of strategic models with imperfect proxies for the underlying strategic behaviour.

Voters often dismantle constitutional checks and balances on the executive. If such checks and balances limit presidential abuses of power and rents, why do voters support their removal? We argue that by reducing politician rents, checks and balances also make it cheaper to bribe or influence politicians through non-electoral means. In weakly institutionalized polities where such non-electoral influences, particularly by the better organized elite, are a major concern, voters may prefer a political system without checks and balances as a way of insulating politicians from these influences. When they do so, they are effectively accepting a certain amount of politician (presidential) rents in return for redistribution. We show that checks and balances are less likely to emerge when the elite is better organized and is more likely to be able to influence or bribe politicians, and when inequality and potential taxes are high (which makes redistribution more valuable to the majority). We also provide case study evidence from Bolivia, Ecuador, and Venezuela consistent with the model.

We construct a theory of persistent civil conflicts, where persistence is driven by the endogenous dynamics of inter-ethnic trust and trade. In times of peace, agents belonging to two groups are randomly matched to trade bilaterally. Trade hinges on trust and cooperation. The onset of conflict signals that the aggressor has a low propensity to cooperate, harming future trust and trade. Agents observe the history of conflicts and update their beliefs over time. The theory predicts that civil wars are persistent. Moreover, even accidental con.icts that do not reflect economic fundamentals erode trust, and can plunge a society into a vicious cycle of recurrent conflicts (a war trap). The incidence of conflict can be reduced by policies abating cultural barriers, fostering inter-ethnic trade and human capital, and shifting beliefs. Coercive peace policies such as peacekeeping forces or externally imposed regime changes have instead no persistent effects.

Sacrifice is widely believed to enhance cooperation in churches, communes, gangs, clans, military units, and many other groups. We find that sacrifice can also work in the lab, apart from special ideologies, identities, or interactions. Our subjects play a modified VCM game—one in which they can voluntarily join groups that provide reduced rates of return on private investment. This leads to both endogenous sorting (because free-riders tend to reject the reduced-rate option) and substitution (because reduced private productivity favours increased club involvement). Seemingly unproductive costs thus serve to screen out free-riders, attract conditional cooperators, boost club production, and increase member welfare. The sacrifice mechanism is simple and particularly useful where monitoring difficulties impede punishment, exclusion, fees, and other more standard solutions.

We develop a numerical procedure that facilitates efficient likelihood evaluation in applications involving non-linear and non-Gaussian state-space models. The procedure employs continuous approximations of filtering densities, and delivers unconditionally optimal global approximations of targeted integrands to achieve likelihood approximation. Optimized approximations of targeted integrands are constructed via efficient importance sampling. Resulting likelihood approximations are continuous functions of model parameters, greatly enhancing parameter estimation. We illustrate our procedure in applications to dynamic stochastic general equilibrium models.