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Money and Taxes Implement Dynamic Optimal Mechanisms

Author

Listed:
  • Biais, Bruno

    (HEC Paris)

  • Gersbach, Hans

    (ETH Zurich - CER-ETH -Center of Economic Research; IZA Institute of Labor Economics; CESifo (Center for Economic Studies and Ifo Institute); Centre for Economic Policy Research (CEPR))

  • Rochet, Jean Charles

    (University of Geneva)

  • von Thadden, Ernst-Ludwig

    (Universitaet Mannheim; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI))

  • Villeneuve, Stéphane

    (University of Toulouse 1)

Abstract

We analyze dynamic capital allocation and risk sharing between a principal and many agents, who privately observe their output. Incentive compatibility requires that agents bear part of their idiosyncratic risk. The larger the agents' risk exposure, the larger the rents the principal can extract from them. The optimal mechanism can be implemented as the equilibrium of a market where agents exchange goods for money, needed to pay taxes. Inflation affects agents' portfolio choice between risky capital and safe money. To implement the optimal mechanism, the principal targets an inflation rate such that agents' risk exposure is the same in equilibrium and in the mechanism.

Suggested Citation

  • Biais, Bruno & Gersbach, Hans & Rochet, Jean Charles & von Thadden, Ernst-Ludwig & Villeneuve, Stéphane, 2023. "Money and Taxes Implement Dynamic Optimal Mechanisms," HEC Research Papers Series 1490, HEC Paris.
    • Handle: RePEc:ebg:heccah:1490
    DOI: 10.2139/ssrn.4571768
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    Keywords

    Money; Taxes; Mechanism Design; Incentive Compatibility; Inflation;
    All these keywords.

    JEL classification:

    • D50 - Microeconomics - - General Equilibrium and Disequilibrium - - - General
    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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