We study optimal fiscal and redistributive policies in an open economy without commitment. Due to its redistributive motives, the government's incentive to default on its external debt is affected by inequality. We show that in equilibrium the economy endogenously fluctuates between two regimes. In the first regime, the government borrows from abroad, spends generously on transfers and keeps the inequality low. In the second regime, it implements austerity-like policies by cutting transfers, reducing foreign debt and increasing the inequality. The equilibrium dynamics resembles the populist cycles documented in many developing countries.

We incorporate a search-theoretic model of imperfect competition into an otherwise standard model of asymmetric information with unrestricted contracts. We develop a methodology that allows for a sharp analytical characterization of the unique equilibrium, and then use this characterization to explore the interaction between adverse selection, screening, and imperfect competition. We show how the structure of equilibrium contracts-and hence the relationship between an agent's type, the quantity he trades, and the corresponding price-is jointly determined by the severity of adverse selection and the concentration of market power. This suggests that quantifying the effects of adverse selection requires controlling for the market structure. We also show that increasing competition and reducing informational asymmetries can be detrimental to welfare. This suggests that recent attempts to increase competition and reduce opacity in markets that suffer from adverse selection could potentially have negative, unforeseen consequences.

We examine the quantitative importance of financial market shocks in accounting for business cycle fluctuations. We emphasize the role financial markets play in reallocating funds from cash-rich, low productivity firms to cash-poor, high productivity firms. Using evidence on financial flows at the firm level, we find that for publicly traded firms (in Compustat), almost all investment is financed internally. However, using an alternative data source (Amadeus), we find that most investment by privately held firms is financed through borrowing. Motivated by these observations, we build a quantitative model featuring publicly and privately held firms that face collateral constraints and idiosyncratic risk over productivity as well as non-financial linkages. In our calibrated model, we find that a shock to the collateral constraints which generates a one standard deviation decline in the debt-to-asset ratio leads to a 0.5% decline in aggregate output on impact, roughly comparable to the effect of a one standard deviation shock to aggregate productivity in a standard real business cycle model. In this sense, we find that disturbances in financial markets are a promising source of business cycle fluctuations when non-financial linkages across firms are sufficiently strong. * We are indebted to V.V. Chari and Larry Jones for valuable advice. We would also like to thank

The volume of new issuances in secondary loan markets fluctuates over time and falls when collateral values fall. We develop a model with adverse selection and reputation that is consistent with such fluctuations. Adverse selection ensures that the volume of trade falls when collateral values fall. Without reputation, the equilibrium has separation, adverse selection is quickly resolved and trade volume is independent of collateral value. With reputation, the equilibrium has pooling and adverse selection persists over time. The equilibrium is efficient unless collateral values are low and originators reputational levels are low. We describe policies that can implement efficient outcomes.

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