Creator: Prescott, Edward C. and Wessel, Ryan Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 562 Abstract:
Businesses hold large quantities of cash reserves, which have average returns well below their investments in tangible capital. Businesses do this because these monetary assets provide services. One implication is that money services is a factor of production in capital theoretic valuation equilibrium models. Our aggregate production function is consistent with both the classical demand for money function relationship and with extended periods of near zero short-term nominal interest rates. In our model economy, there is a 100 percent reserve requirement on all demand deposits. Demand deposits are legal tender. We find (i) money services in the production function necessitates revisions in the national accounts; (ii) monetary and fiscal policy cannot be completely separated; (iii) for a given policy, equilibrium is either unique or does not exist; and (iv) Friedman’s monetary satiation is not optimal. We make quantitative comparisons between interest rate targeting regimes and between inflation rate targeting regimes. The best inflation rate target was 2 percent.
Keyword: Money in production function, Friedman monetary satiation, Interest rate targeting, Zero lower bound, Inflation rate targeting, and 100 percent reserve banking Subject (JEL): E00 - Macroeconomics and Monetary Economics: General, E60 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook: General, E50 - Monetary Policy, Central Banking, and the Supply of Money and Credit: General, and E40 - Money and Interest Rates: General
Creator: Prescott, Edward C. and Wessel, Ryan Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 530 Abstract:
We explore monetary policy in a world without currency. In our world, money is a form of government debt that bears interest, which can be negative as well as positive. Services of money are a factor of production. We show that the national accounts must be revised in this world. Using our baseline economy, we determine the balanced growth paths for a set of money interest rate target policy regimes. Besides this interest rate, the only policy variable that differs across regimes is either the labor income tax rate or the inflation rate. We find that Friedman monetary satiation without deflation is possible. We also examine a set of inflation rate targeting regimes. Here, the only other policy variable that differs across policy regimes is the tax rate. There is a sequence of markets with outcome in each market being a Debreu valuation equilibrium, which determines the vector of assets and liabilities households take into the subsequent period. Evaluating a policy regime is an advanced exercise in public finance. Monetary satiation is not optimal even though money is costless to produce. A preliminary version of this paper circulated under the title “Monetary Policy with 100 Percent Reserve Banking: An Exploration.”
Keyword: Inflation rate targeting, 100 percent reserve banking, Interest rate targeting, Money in production function, and Friedman monetary satiation Subject (JEL): E40 - Money and Interest Rates: General, E60 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook: General, E50 - Monetary Policy, Central Banking, and the Supply of Money and Credit: General, and E00 - Macroeconomics and Monetary Economics: General
Creator: McGrattan, Ellen R. and Prescott, Edward C. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 472 Abstract:
A problem that faces many countries including the United States is how to finance retirement consumption as the population ages. Proposals for switching to a saving-for-retirement system that do not rely on high payroll taxes have been challenged on the grounds that welfare would fall for some groups such as retirees or the working poor. We show how to devise a transition path from the current U.S. system to a saving-for-retirement system that increases the welfare of all current and future generations, with estimates of future gains higher than those found in typically used macroeconomic models. The gains are large because there is more productive capital than commonly assumed. Our quantitative results depend importantly on accounting for differences between actual government tax revenues and what revenues would be if all income were taxed at the income-weighted average marginal tax rates used in our analysis.
Keyword: Retirement, Medicare, Social Security, and Taxation Subject (JEL): H55 - Social Security and Public Pensions, I13 - Health Insurance, Public and Private, and E13 - General Aggregative Models: Neoclassical
Creator: Blandin, Adam, Boyd, John H., and Prescott, Edward C. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 717 Abstract:
We develop an equilibrium concept in the Debreu (1954) theory of value tradition for a class of adverse selection economies which includes the Spence (1973) signaling and Rothschild-Stiglitz (1976) insurance environments. The equilibrium exists and is optimal. Further, all equilibria have the same individual type utility vector. The economies are large with a finite number of types that maximize expected utility on an underlying commodity space. An implication of the analysis is that the invisible hand works for this class of adverse selection economies.
Keyword: Insurance, Mutual organization, Adverse selection equilibrium, Theory of value, The core, and Signaling Subject (JEL): G22 - Insurance; Insurance Companies; Actuarial Studies, C62 - Existence and Stability Conditions of Equilibrium, G29 - Financial Institutions and Services: Other, D46 - Value Theory, and D82 - Asymmetric and Private Information; Mechanism Design
Creator: McGrattan, Ellen R. and Prescott, Edward C. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 494 Abstract:
During the downturn of 2008–2009, output and hours fell significantly while labor productivity rose. These facts have led many to conclude that there is a significant deviation between observations and current macrotheories that assume business cycles are driven, at least in part, by fluctuations in total factor productivities of firms. We show that once investment in intangible capital is included in the analysis, there is no inconsistency. Measured labor productivity rises if the fall in output is underestimated; this occurs when there are large unmeasured intangible investments. Microevidence suggests that these investments are large and cyclically important.
Keyword: Intangible capital, Productivity, and Business cycles Subject (JEL): E32 - Business Fluctuations; Cycles and E13 - General Aggregative Models: Neoclassical
Creator: McGrattan, Ellen R. and Prescott, Edward C. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 694 Abstract:
Prior to the mid-1980s, labor productivity growth was a useful barometer of the U.S. economy’s performance: it was low when the economy was depressed and high when it was booming. Since then, labor productivity has become significantly less procyclical. In the recent downturn of 2008–2009, labor productivity actually rose as GDP plummeted. These facts have motivated the development of new business cycle theories because the conventional view is that they are inconsistent with existing business cycle theory. In this paper, we analyze recent events with existing theory and find that the labor productivity puzzle is much less of a puzzle than previously thought. In light of these findings, we argue that policy agendas arising from new untested theories should be disregarded.
Keyword: Intangible capital, Nonneutral technology change, Labor productivity, Labor wedge, and RBC models Subject (JEL): E01 - Measurement and Data on National Income and Product Accounts and Wealth; Environmental Accounts, E13 - General Aggregative Models: Neoclassical, and E32 - Business Fluctuations; Cycles
Creator: Prescott, Edward C. and Wallenius, Johanna Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 457 Abstract:
There have been tremendous advances in macroeconomics, following the introduction of labor supply into the field. Today it is widely acknowledged that labor supply matters for many key economic issues, particularly for business cycles and tax policy analysis. However, the extent to which labor supply matters for such questions depends on the aggregate labor supply elasticity—that is, the sensitivity of the time allocation between market and non-market activities to changes in the effective wage. The magnitude of the aggregate labor supply elasticity has been the subject of much debate for several decades. In this paper we review this debate and conclude that the elasticity of labor supply of the aggregate household is much higher than the elasticity of the identical households being aggregated. The aggregate household utility function differs from individuals’ utility functions for the same reason the aggregate production function differs from individual firms’ production functions being aggregated. The differences in individual and aggregate supply elasticities are what aggregation theory predicts.
Creator: McGrattan, Ellen R. and Prescott, Edward C. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 369 Abstract:
For the 1990s, the basic neoclassical growth model predicts a depressed economy, when in fact the U.S. economy boomed. We extend the base model by introducing intangible investment and non-neutral technology change with respect to producing intangible investment goods and find that the 1990s are not puzzling in light of this new theory. There is micro and macro evidence motivating our extension, and the theory’s predictions are in conformity with U.S. national accounts and capital gains. We compare accounting measures with corresponding measures for our model economy. We find that standard accounting measures greatly understate the 1990s boom.
Keyword: Intangible Investment, Hours, and Productivity Subject (JEL): O47 - Empirical Studies of Economic Growth; Aggregate Productivity; Cross-Country Output Convergence, E23 - Macroeconomics: Production, O33 - Technological Change: Choices and Consequences; Diffusion Processes, and E22 - Investment; Capital; Intangible Capital; Capacity
Creator: McGrattan, Ellen R. and Prescott, Edward C. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 406 Abstract:
The U.S. Bureau of Economic Analysis (BEA) estimates the return on investments of foreign subsidiaries of U.S. multinational companies over the period 1982–2006 averaged 9.4 percent annually after taxes; U.S. subsidiaries of foreign multinationals averaged only 3.2 percent. Two factors distort BEA returns: technology capital and plant-specific intangible capital. Technology capital is accumulated know-how from intangible investments in R&D, brands, and organizations that can be used in foreign and domestic locations. Used abroad, it generates profits for foreign subsidiaries with no foreign direct investment (FDI). Plant-specific intangible capital in foreign subsidiaries is expensed abroad, lowering current profits on FDI and increasing future profits. We develop a multicountry general equilibrium model with an essential role for FDI and apply the BEA’s methodology to construct economic statistics for the model economy. We estimate that mismeasurement of intangible investments accounts for over 60 percent of the difference in BEA returns.
Subject (JEL): F32 - Current Account Adjustment; Short-term Capital Movements and F23 - Multinational Firms; International Business