We develop a theory of endogenous and stochastic fluctuations in economic activity. Individual firms choose to randomize over firing or keeping workers who performed poorly in the past to give them an ex-ante incentive to exert effort. Different firms choose to correlate the outcome of their...

Economic disruptions generally create winners and losers. The compensation problem consists of designing a reform of the existing income tax system that offsets the welfare losses of the latter by redistributing the gains of the former. We derive a formula for the compensating tax reform and its...