This research is part of an on-going upheaval in economic theory caused by the use of contract theory as a foundation for understanding economic behavior. This project continues work on two strands of economic theory - search models of macroeconomics and a model of taxation under global uncertainty. Trade coordination difficulties appear to be an important cause of macroeconomic problems in the US economy. In part, trade coordination difficulties come from the fact that economic decisions are made at many points of time. Search theoretic equilibrium models have explored the implications for resource allocation of decentralized and staggered economic transactions and decisions. This extension of the research approach will focus on credit; including the role of credit in enhancing the efficiency of transactions, the determinants of the equilibrium terms of credit; and the effects of credit on the presence of multiple equilibria. Optimal tax theory is one approach to thinking systematically about how the government should set taxes and the levels of public expenditure. Most work on optimal taxation has assumed either certainty or individual uncertainty with no aggregate uncertainty. This project explores the implication for optimal taxation of uncertainties which are large for the economy as a whole. Attention is paid particularly to the implications of limited markets for insuring these uncertainties. These two strands of research are considered by many economic theorists as two of the most important and promising current lines of research. Work on the coordination difficulties could provide a synthesis of microeconomic and macroeconomic theories of the economy. The specific work in this project should provide insights into the way banks and other financial intermediaries influence the overall economy. Research on this topic is very timely given concerns about the fragility of US financial institutions and the possibility that bank runs could cause a depression. The other line of research is also important because it addresses a major weakness in the tax theory used by analysts in policy debates about tax reform. The weakness is that optimal tax theory does not rigorously incorporate the uncertainty that pervades the economy. Tax theory is forced to assume away the uncertainty because of the lack of a good theory of the behavior of the firm in the presence of uncertainty, missing markets, and many owners. The investigator proposes to develop just such a theory of the firm that will be tractable for optimal tax questions. Preliminary work by the investigator suggests that many of the results of optimal tax theory change once uncertainty is introduced into the analysis.
