There are two striking aspects of the recovery from the Great Depression in the United States: the recovery was very weak and real wages in several sectors rose significantly above trend. These data contrast sharply with neoclassical theory, which predicts a strong recovery with low real wages. We evaluate whether New Deal cartelization policies designed to limit competition among firms and increase labor bargaining power can account for the persistence of the Depression. We develop a model of the intraindustry bargaining process between labor and firms that occurred with these policies, and embed that model within a multi-sector dynamic general equilibrium model. We find that New Deal cartelization policies are an important factor in accounting for the post-1933 Depression. We also find that the key depressing element of New Deal policies was not collusion per se, but rather the link between paying high wages and collusion.
In this paper we make the following three claims. (1), in contradiction with the conventional view according to which the French depression was very different to that observed in the US, we argue that there are more similarities than differences between the French and U.S. experiences and therefore a common explanation should be sought. (2), poor growth in technological opportunities appear neither necessary nor sufficient to account for the French depression. (3), changes in institutional and market regulation appear necessary to account for the overall changes observed over the period. Moreover, we show that the size of these institutional changes may by themselves be enough to quantatively explain the French depression. However, at this time, we have no theory to explain the size or the timing of these changes.
This paper investigates the optimal tax structure in an overlapping generations model in which individuals face idiosyncratic income risk, borrowing constraints and lifetime uncertainty. The calibrated model economy produces some quantitative results that differ significantly from the findings of the previous research. The main finding in this imperfect insurance setup is that moving away from capital income taxation toward higher labor income taxation yields a (steady-state) welfare benefit of 1% of aggregate consumption compared with the 6% figure Lucas (1990) finds in an infinite-horizon, complete markets model. This is because replacing the tax on capital income with a higher tax on labor income redistributes resources away from the young working years during which borrowing constraints are more likely to bind. Furthermore, when the individuals have access to a private annuity market to insure against uncertain lifetimes, it becomes optimal to tax capital. When a consumption tax is made available, it is optimal to switch to consumption taxation. The welfare benefit from implementing this optimal plan is on the order of 1.5-3.2% of GNP.
This paper is part of a project to model the interaction between heterogeneous agents in intertemporal stochastic models and to develop numerical algorithms to solve these kind of models. It is well-known that solving dynamic heterogeneous agent models is a challenging problem, since in these models the distribution of wealth and other characteristics evolve endogenously over time. Existing dynamic models in the literature contain therefore just two agents or other simplifying assumptions to limit the heterogeneity.
This paper considers the unobserved endowment economy of Green (1987) with a restriction that agents can walk away from insurance contracts at the beginning of any period and contract with another insurer (one-sided commitment). An equilibrium is derived characterized by a unique, market determined insurance contract with the property that agents never want to walk away from it. I show that trade (or insurance) still occurs and that a non-degenerate long-ran distribution of consumption exists.
The objective of this paper is to investigate whether, in a Sidrauski type model with uncertainty, welfare maximization calls for following the famous "Chicago Rule". This question will be answered in the affirmative in this paper, i.e. social welfare optimization calls for a zero nominal interest rate on one-period bonds. The zero nominal interest rate, however, does not imply in an uncertain world that there is no systematic difference between the expected rate of deflation and the rate of time preference in an economy without growth. The magnitude of this difference turns out to be small, however. Numerical welfare comparisons are made between the optimal policy and policies in which the growth rate of money is fixed. The optimal policy requires that the monetary authorities react every period to the available information and they choose a growth level of the money stock that will set the interest rate equal to zero. If we compare the time paths of the real variables under the optimal policy with the time paths if the money supply decreases at a rate equal to the rate of time preference, then we see hardly any differences. The price dynamics can be very different, however. The paper also investigates the issue of superneutrality and finds that the quantitative deviations from superneutrality are substantial if a model with a shopping time technology is used. The neo-classical models in this paper are solved numerically using a technique developed in Marcet (1988).
This paper develops a new method for approximating dynamic competitive equilibria in economies in which competitive equilibrium is not necessarily Pareto optimal. The method involves finding approximate equilibrium policy functions by iterating on the stochastic Euler equations which characterize the economy's equilibrium. Two applications are presented: the stochastic growth model of Brock and Mirman (1971) modified to allow distortionary taxation, and a model of inflation and capital accumulation based on Stockman (1981). The computational speed and accuracy of this approach suggests that it may be a feasible method for studying suboptimal economies with large state spaces.
A cash-in-advance constraint on consumption is incorporated into a standard model of consumption and capital accumulation. Monetary policy consists of lump-sum cash transfers. Methods are developed for establishing the existence and uniqueness of an equilibrium. and for explicitly constructing this equilibrium. The model economy's dependence on monetary policy is explored.
Also published in the International Finance Discussion Paper series, number 323.
In a world with two similar, developed economies, economic integration can cause a permanent increase in the worldwide rate of growth. Starting from a position of isolations, closer integration can be achieved by increasing trade in goods or by increasing flows of ideas. We consider two models with different specifications of the research and development sector that is the source of growth. Either form of integration can increase the long-run rate of growth if it encourages the worldwide exploitation of increasing returns to scale in the research and development sector.
Elasticities of substitutions between U.S. imports from Mexico, Canada, the rest of the world, and competing domestic production are estimated for 128 mining and manufacturing sectors, based on quarterly data for 1980-88. Results will be useful for subsequent computable general equilibrium (CGE) model simulations of North American trade, including the proposed free trade area between Mexico and the United States.
The process by which per capita income in the South converged to northern levels is intimately related to the structural transformation of the U.S. economy. We find that empirically most of the southern gains are attributable to the nation-wide convergence of agricultural wages to non-agricultural wages, and the faster rate of transition of the Southern labor force from agricultural to non-agricultural jobs. Similar results describe the Mid-West's catch up to the North-East (but not the relative experience of the West). To explain these observations, we construct a model in which the South (Mid-West) has a comparative advantage in producing unskilled-labor intensive agricultural goods. Thus, it starts with a disproportionate share of the unskilled labor force and lower per capita incomes. Over time, declining education/training costs induce an increasing proportion of the labor force to move out of the (unskilled) agricultural sector and into the (skilled) non-agricultural sector. The decline in the agricultural labor force leads to an increase in relative agricultural wages. Both effects benefit the South (Mid-West) disproportionately since it has more agricultural workers. The model successfully matches the quantitative features of the U.S. structural transformation and regional convergence, as well as several other stylized facts on U.S. economic growth in the last century. The model does not rely on frictions on factor mobility, since in our empirical work we find this channel to be less important than the compositional effects the model emphasizes.
This paper develops a unified model of growth, population, and technological progress that is consistent with long-term historical evidence. The economy endogenously evolves through three phases. In the Malthusian regime, population growth is positively related to the level of income per capita. Technological progress is slow and is matched by proportional increases in population, so that output per capita is stable around a constant level. In the post-Malthusian regime, the growth rates of technology and total output increase. Population growth absorbs much of the growth of output, but income per capita does rise slowly. The economy endogenously undergoes a demographic transition in which the traditionally positive relationship between income per capita and population growth is reversed. In the Modern Growth regime, population growth is moderate or even negative, and income per capita rises rapidly. Two forces drive the transitions between regimes: First, technological progress is driven both by increases in the size of the population and by increases in the average level of education. Second, technological progress creates a state of disequilibrium, which raises the return to human capital and induces parents to substitute child quality for quantity.
A number of theoretical models of technology adoption have been proposed that emphasize technological switching, loss of expertise and subsequent technology-specific learning. These models imply that measured productivity may initially fall and then later rise after the adoption of a new technology. This paper investigates whether or not this implication is a feature of plant-level data from the Colombian manufacturing sector. We regress measures of productivity growth at the plant level on a plant-specific measure of technology adoption and its lagged values. We find that...
How much technological progress has there been in structures? An attempt is made to measure this using panel data on the age and rents for buildings. This data is interpreted through the eyes of a vintage capital model where buildings are replaced at some chosen periodicity. There appears to have been significant technological advance in structures that accounts for a major part of economic growth.
This paper presents a model in which a country's average propensity to save tends to rise endogenously over time. The paper uses a two-sector neoclassical framework to model the transition from agriculture to manufacturing which typically accompanies economic development. Key assumptions are that only the agricultural sector uses land and a simple version of Engel's law. When a country's income per capita is low, agricultural consumption is important; consequently, land is valuable and capital gains on it may account for most wealth accumulation, making the NIPA APS appear low. If exogenous technological progress raises incomes over time, Engel's law shifts demand to manufactured goods. Then land's importance in portfolios relative to reproducible capital diminishes and the measured average propensity to save can rise.
There were three important changes in the United States economy during the 1980s. First, from 1982-90, the decade featured the longest consecutive stretch of positive quarterly output growth in United States history. Second, wage inequality expanded greatly as the wages of highly skilled workers grew markedly faster than the wages of less skilled workers (Katz and Murphy (1992)). Finally, consumption inequality also expanded as the consumption of highly skilled workers grew faster than that of less skilled workers (Attanasio and Davis (1994)). This paper argues that these three aspects of the United States economic experience can be interpreted as being part of an efficient response to a macroeconomic shock given the existence of a particular technological impediment to full insurance. I examine the properties of efficient allocations of risk in an economic environment in which the outside enforcement of risksharing arrangements is infinitely costly. In these allocations, relative productivity movements have effects on both the current and future distribution of consumption across individuals. If preferences over consumption and leisure are nonhomothetic, these changes in the allocation of consumption will generate persistent cycles in aggregate output that do not occur in efficient allocations when enforcement is costless.
I show that a simple sticky price model based on Rotemberg (1982) is consistent with a variety of facts concerning the correlation of prices, hours and output. In particular, I show that it is consistent with a negative correlation between the detrended levels of output and prices when the Beveridge-Nelson method is used to detrend both the price and output data. Such a correlation, i.e.,a negative correlation between the predictable movements in output and the predictable movements in prices is present (and very strong) in U.S. data. Consistent with the model, this correlation is stronger than correlations between prices and hours of work. I also study the size of the predictable price movements that are associated with predictable output movements as well as the degree to which there are predictable movements in monetary aggregates associated with predictable movements in output. These facts are used to shed light on the degree to which the Federal Reserve has pursued a policy designed to stabilize expected inflation.
We introduce, into a version of the Real Business Cycle model, mild increasing returns-to-scale. These increasing returns-to-scale occur as a consequence of sector specific externalities, that is externalities where the output of the consumption and investment sectors have external effects on the output of firms within their own sector. Keeping the production technologies for both sectors identical for expositional simplicity, we show that indeterminacy can easily occur for parameter values typically used in the real business cycle literature, and in contrast to some earlier literature on indeterminacies, for externalities mild enough so that labor demand curves are downward sloping.
We propose a model in which an unanticipated reduction in the money supply leads to a contemporaneous increase in inventories followed by periods with lower output. This persistent real effect does not require price-rigidity or real shocks and confusion. It is obtained in a model in which markets are cleared and agents are price-takers.
A cash-in-advance model with sequential markets is constructed, where unanticipated monetary injections are nonneutral and can potentially produce large liquidity effects. However, if the monetary authority adheres to an optimal money rule, money should not respond to unanticipated shocks, so that a Friedman rule is suboptimal and the monetary authority does not exploit the liquidity effect. Quantitatively, the model can generate variability in money and nominal interest rates close to what is observed, and can produce data with no obvious evidence of the existence of liquidity effects.
Procedures for computing the parameters of a broad class of multifactor continuous time models of the term structure based on indirect estimation methods are proposed. The approach consists of simulating the unknown factors from a set of stochastic differential equations which are used to compute synthetic bond yields. The bond yields are calibrated with actual bond yields via an auxiliary model. The approach circumvents many of the difficulties associated with direct estimation of this class of models using maximum likelihood. In particular, the paper addresses the identification issues arising from singularities in the yields and spreads which tend not to be recognised in existing estimation procedures and thereby overcome potential misspecification problems inherrent in direct methods. Indirect estimates of single and multifactor models are computed and compared with the estimates based on existing estimation procedures.
This paper is interested in the small sample properties of the indirect inference procedure which has been previously studied only from an asymptotic point of view. First, we highlight the fact that the Andrews (1993) median-bias correction procedure for the autoregressive parameter of an AR(1) process is closely related to indirect inference; we prove that the counterpart of the median-bias correction for indirect inference estimator is an exact bias correction in the sense of a generalized mean. Next, assuming that the auxiliary estimator admits an Edgeworth expansion, we prove that indirect inference operates automatically a second order bias correction. The latter is a well known property of the Bootstrap estimator; we therefore provide a precise comparison between these two simulation based estimators.
The possibility of exact maximum likelihood estimation of many observation-driven models remains an open question. Often only approximate maximum likelihood estimation is attempted, because the unconditional density needed for exact estimation is not known in closed form. Using simulation and nonparametric density estimation techniques that facilitate empirical likelihood evaluation, we develop an exact maximum likelihood procedure. We provide an illustrative application to the estimation of ARCH models, in which we compare the sampling properties of the exact estimator to those of several competitors. We find that, especially in situations of small samples and high persistence, efficiency gains are obtained.
"Sudden Stops " experienced during emerging markets crises are characterized by large reversals of capital inflows and the current account, deep recessions, and collapses in asset prices. This paper proposes an open-economy equilibrium asset pricing model in which financial frictions cause Sudden Stops. Margin requirements impose a collateral constraint on foreign borrowing by domestic agents and trading costs distort asset trading by foreign securities firms. At equilibrium, margin constraints may or may not bind depending on portfolio decisions and equilibrium asset prices. If margin constraints do not bind, productivity shocks cause a moderate fall in consumption and a widening current account deficit. If debt is high relative to asset holdings, the same productivity shocks trigger margin calls forcing domestic agents to fire-sell equity to foreign traders. This sets off a Fisherian asset-price deflation and subsequent rounds of margin calls. A current account reversal and a collapse in consumption occur when equity sales cannot prevent a sharp rise in net foreign assets.
In this paper we will consider a simple small open economy with three assets - domestic capital, foreign securities and public debt - to study the government's incentives to devalue and to repay or default the debt. We show that the announcement of a devaluation is anticipated by domestic agents who reduce domestic investments and increase foreign holdings. Once a government devalues, the expectations vanish and the economy recovers its past levels of investment and GDP. However, in a country with international debt denominated in US dollars if a government devalues it requires a higher fraction of GDP to repay its external debt. In consequence, there exists a trade-off between recovering the economy and increasing the future cost of repaying the debt. Our main result is to show that, as devaluation beliefs exists, a devaluation increase government incentives to default and devalue. We calibrate our model to match the decrease in investment of domestic capital, the reduction in production, the increase in trade balance surplus, and the increase in debt levels observed throughout 2001 in Argentina. We show that for a probability of devaluation consistent with the risk premium of the Argentinian Government bonds nominated in dollars issued on April 2001 the external debt of Argentina was in a crisis zone were the government find optimal to default and to devalue.
We estimate the effects of policy distortions on aggregate productivity. Based on a model of plant production and productivity uncertainty and heterogeneity, and using Chilean manufacturing data, we focus on the effect of taxation on the exit behavior of plants. We find that taxes do distort the liquidation decisions of firms, suggesting that policy distortions reduce the extent to which factors are reallocated towards the most productive plants. Our results have important consequences for growth and development, as policies that alter the measure of plants that operate in equilibrium change the short-run response of output to exogenous shocks and the long run level of aggregate TFP. In particular, we find that the amount of productivity lost due to excessive plant shutdowns are very large.
In most developed countries, housing receives preferential tax treatment relative to other assets. In particular (i) the housing services provided by owner-occupied housing (generally referred to as imputed rents) are untaxed and (ii) mortgage interest payments reduce taxable income. The potential economic distortions resulting from the unique treatment of housing may be substantial, especially in light of the fact that residential capital accounts for more than half of the assets in the U.S. In particular, this tax treatment distorts the households' portfolio composition, their saving rates and their tenure choice. In this paper we build a general equilibrium model populated by heterogeneous agents subject to idiosyncratic risk. We use this framework to quantitatively assess the macroeconomic and distributional distortions introduced by this preferential tax treatment. We also study the effects of alternative tax schemes which could correct the current system's bias.
This paper proposes a model of diversifiable uncertainty, irreversible investment decisions, and endogenous growth. The detailed microeconomic structure of the model makes it possible to study the. general equilibrium effects of obstacles to labor mobility, due to institutional as well as technological features of the economy. Labor mobility costs reduce private returns to investment, and the resulting slower rate of endogenous growth unambiguously lowers a representative individual's welfare. Turnover costs can have positive effects on full employment equilibrium wages when all external effects are disregarded: this may help explain why policy and institutions often tend to decrease labor mobility in reality, rather than to enhance it. Lower flexibility, however, reduces the growth rate of wages in endogenous growth equilibrium, with negative welfare effects even for agents who own only labor.
We explain how a long period of slow pre-industrial development triggers an Industrial Revolution that leads to modern balanced growth. Development in the preindustrial period is driven by increasing returns to specialization made possible by a growing population. Increasing access to specialized intermediate goods eventually makes fundamental technological innovation possible. Innovation initiates the Industrial Revolution, after which productivity grows endogenously regardless of population growth. Industrialization reconciles the crucial role of population early on with its weak relation to per capita product in developed economies. Faster population growth speeds early development, though if it results from a highly productive primitive technology, the consequences for development are ambiguous.
This paper develops a dynamic general equilibrium model of economic growth. The model has a steady state equilibrium in which some firms devote resources to discovering qualitatively improved products and other firms devote resources to copying these products. Rates of both innovation and imitation are endogenously determined based on the outcomes of R&D races between firms. Innovation subsidies are shown to unambiguously promote economic growth. Welfare is only enhanced however if the steady state intensity of innovative effort exceeds a critical level.
The paper proposes a theory of ambiguous financial contracts. Leaving contractual contingencies unspecified may be optimal, even when stipulating them is costless. We show that an ambiguous contract has two advantages. First, it permits the guarantor to sacrifice reputational capital in order to preserve financial capital as well as information reusability in states where such tradeoff is optimal. Second, it fosters the development of reputation. This theory is then used to explain ambiguity in mutual fund contracts, bank loan commitments, bank holding company relationships, the investment banker's "highly confident" letter, non-recourse debt contracts in project financing, and other financial contracts.
Technology change is modeled as the result of decisions of individuals and groups of individuals to adopt more advanced technologies. The structure is calibrated to the U.S. and postwar Japan growth experiences. Using this calibrated structure we explore how large the disparity in the effective tax rates on the returns to adopting technologies must be to account for the huge observed disparity in per capita income across countries. We find that this disparity is not implausibly large.
In this paper we study the relationship between wealth, income distribution and growth in a game-theoretic context in which property rights are not completely enforcable. We consider equilibrium paths of accumulation which yield players utilities that are at least as high as those that they could obtain by appropriating higher consumption at the present and suffering retaliation later on. We focus on those subgame perfect equilibria which are constrained Pareto-efficient (second best). In this set of equilibria we study how the level of wealth affects growth. In particular we consider cases which produce classical traps (with standard concave technologies): growth may not be possible from low levels of wealth because of incentive constraints while policies (sometimes even first-best policies) that lead to growth are sustainable as equilibria from high levels of wealth. We also study cases which we classify as the "Mancur Olson" type: first best policies are used at low levels of wealth along these constrained Pareto efficient equilibria, but first best policies are not sustainable at higher levels of wealth where growth slows down. We also consider the unequal weighting of players to ace the subgame perfect equiliria on the constrained Pareto frontier. We explore the relation between sustainable growth rates and the level of inequality in the distribution of income.
Results in Lucas (1987) suggest that if public policy can affect the growth rate of the economy, the welfare implications of alternative policies will be large. In this paper, a stochastic, dynamic general equilibrium model with endogenous growth and money is examined. In this setting, inflation lowers growth through its effect on the return to work. However, the welfare costs of higher inflation are extremely modest.
This paper studies efficient insurance arrangements in village economies when there is complete information but limited commitment. Commitment is limited because only limited penalties can be imposed on households which renege on their promises. Any efficient insurance arrangement must therefore take into account the fact that households will renege if the benefits from doing so outweigh the costs. We study a general model which admits aggregate and idiosyncratic risk as well as serial correlation of incomes. It is shown that in the case of two households and no storage the efficient insurance arrangement is characterized by a simple updating rule. An example illustrates the similarity of the efficient arrangement to a simple debt contract with occasional debt forgiveness. The model is then extended to multiple households and a simple storage technology. We use data from the ICRISAT survey of three villages in southern India to test the theory against three alternative models: autarky, full insurance, and a static model of limited commitment due to Coate and Ravallion (1993). Overall, the model we develop does a significantly better job of explaining the data than does any of these alternatives.
We study the asset pricing implications of a multi-agent endowment economy where agents can default on debt. We build on the environment studied by Kocherlakota (1995) and Kehoe and Levine (1993). We present an equilibrium concept for an economy with complete markets and with endogenous solvency constraints. These solvency constraints prevent default, but at the cost of reduced risk sharing. We show that versions of the classical welfare theorems hold for this equilibrium definition. We characterize the pricing kernel, and compare it to the one for economies without participation constraints: interest rates are lower and risk premia depend on the covariance of the idiosyncratic and aggregate shocks.
As a network, a payment system is likely to exhibit network externalities and perhaps some public good characteristics. Such properties may be more pronounced in an electronic payment system, because of its greater reliance on communication infrastructures with high fixed and low variable costs, for instance. This paper presents the basic economics of network externalities and reviews some basic principles regarding public goods. It then asks what these phenomena imply about the role of the Federal Reserve in emerging payment systems. The general conclusion is that there is reason to be skeptical that network externalities and public goods will be significant sources of market failure in electronic payment systems. These phenomena, by themselves, give rise to no particular, essential central bank role in these markets.