Research

This paper studies the relationship between fiscal rules and intergovernmental transfers within a federation. We analyze an environment where present-biased governments must insure against future shocks. The present bias generates a reason for fiscal rules to exist, while risk sharing motives bring out the need for transfers. A central authority designs the optimal combination of state contingent transfers and fiscal rules that maximize the federation’s welfare. We show that independently of the present bias, it is optimal to achieve the first-best pattern of aggregate spending. However, how it is implemented depends on the intensity of the bias. When the bias is mild, a mechanism akin to an emergency fund with tight fiscal rules arises, while when the bias is severe, it is optimal to provide loans with contingent payments and to loosen up fiscal rules. Moreover, there is always a degree of bias for which a fiscal union is not optimal.

When resources are limited, information about the environment becomes critically important. This paper introduces a stylized dynamic model to illustrate how the challenge of audit agents—who may engage in activities such as tax evasion, crime, or other undesirable behaviors—is shaped by the need to gather information for future use. Our analysis reveals that monitors might choose to forgo immediate preventive actions in favor of collecting valuable information. This strategic decision allows them to better identify and target high-risk agents in the future. The extent to which monitors prioritize learning over deterrence depends on how valuable is learning. We discuss two key factors that affect the value of acquiring information: heterogeneity in agents' characteristics and level of penalties. We also show that an information acquisition rationale arises even in a static model with delegated enforcement.

This paper examines the role of random audits in tax enforcement as an information acquisition tool. Random audits provide an unbiased view of the taxpayer population but are less cost-effective than risk-based audits. We develop a dynamic model in which the Tax Agency learns about the income-generating process from past audits and uses this information to improve future audit targeting. We show that random audits create an informational trade-off: they improve estimation precision by increasing sample representativeness, but reduce the informativeness of risk-based audits due to budget constraints. We characterize conditions under which a share of random audits increase total information and derive a necessary and sufficient condition for when they are revenue-maximizing. Our results provide a theoretical foundation for incorporating random audits into optimal audit design and suggest that their informational value may justify their use as part of an effective enforcement strategy.

Recent evidence in the finance literature indicates that safe sovereign bonds issued by different governments are highly substitutable. Consequently, a country’s decision on bond issuance generates two distinct spillovers. First, a price externality arises, whereby issuance by one country influences not only the price of its domestic bonds but also that of foreign bonds with similar safety profiles. Second, a convenience externality occurs, as the provision of safe assets by one country confers benefits on international investors. We examine these spillover effects within a two country Ramsey model, wherein governments simultaneously choose distortionary taxes and debt levels. Our analysis reveals inefficiencies both in the short run and at the steady state. Depending on relative spending needs and the convenience yield of bonds in each state, the model generates either an overprovision or underprovision of safe assets. Moreover, the absence of coordination induces a compositional inefficiency, leading to a public debt distribution across countries that deviates from the allocation recommended by a central planner.

Many advanced-economy governments have been selling sovereign bonds at a yield below the risk-free rate, benefiting from a “safe asset premium” (or “convenience yield”). This premium reflects a special demand for safe sovereign bonds which typically appreciate during recessions, thereby providing investors with a hedge against aggregate risk (good friend analogy). In this paper, we argue that sovereign bonds provide a hedge only against demand (disinflationary) recessions. In supply (inflationary) recessions, however, sovereign bonds are no longer a hedge as their value depreciates in real terms. We demonstrate in a stylized model that bond-safe asset premia fall when the composition of shocks shifts from demand to supply. We confirm in daily financial data that an increase in the expected share of supply shocks, reflected in a higher inflation risk premium, indeed is associated with lower safe asset premia for low-risk European countries. Our evidence points to a novel reason for the recent decline in “convenience yields”: the resurgence of supply shocks.