Research Database

This paper analyzes the effects of money injections on interest rates and exchange rates in a model in which agents must pay a Baumol-Tobin style fixed cost to exchange bonds and money. Asset markets are endogenously segmented because this fixed cost leads agents to trade bonds and money only infrequently. When the government injects money through an open market operation, only those agents that are currently trading absorb these injections. Through their impact on these agents’ consumption, these money injections affect real interest rates and real exchange rates. We show that the model generates the observed negative relation between expected inflation and real interest rates. With moderate amounts of segmentation, the model also generates other observed features of the data: persistent liquidity effects in interest rates and volatile and persistent exchange rates. A standard model with no fixed costs can produce none of these features.

No abstract available.

An examination of the behavior of stock returns around quarterly earnings announcement dates finds a seasonal pattern: small firms show large positive abnormal returns and a sizable increase in the variability of returns around these dates. Only part of the large abnormal returns can be accounted for by the fact that firms with good news tend to announce early. Large firms show no abnormal returns around announcement dates and a much smaller increase in variability.

This paper presents a simple model of government reputation which captures two characteristics of policy outcomes in less developed countries: governments which betray public trust do so erratically, and, after a betrayal, public trust is regained only gradually.

Between the sixties and the late eighties the percentages of low-saving single-parent households and people living alone have grown dramatically at the expense of high-saving married households, while the household saving rate has declined equally dramatically. A preliminary analysis of population composition and savings by household type seems to indicate that about half of the decline in savings is due to demographic change. We construct a model with agents changing marital status, but where the saving behavior of the households can adjust to the properties of the demographic process. We find that the demographic changes that reduce the number of married households (mainly higher divorce and higher illegitimacy) induce all household types to save more and that the effect on the aggregate saving rate is minuscule. We conclude that the drop in savings since the sixties is not due to changes in household composition.

The paper compares implications of three kinds of models of households’ consumption behavior: the basic permanent-income model, several models of liquidity-constrained households, and a model of an informationally-constrained efficient contract. These models are distinguished in terms of implications regarding the present discounted values of net trades to households at various levels of temporary income, and the households’ marginal rates of substitution. Martingale consumption is studied as an approximation to the predicted consumption process of the efficient-contract model.

We extend the baseline Susceptible-Exposed-Infectious-Recovered (SEIR) infectious disease epidemiology model to understand the role of testing and case-dependent quarantine. Our model nests the SEIR model. During a period of asymptomatic infection, testing can reveal infection that otherwise would only be revealed later when symptoms develop. Along with those displaying symptoms, such individuals are deemed known positive cases. Quarantine policy is case-dependent in that it can depend on whether a case is unknown, known positive, known negative, or recovered. Testing therefore makes possible the identification and quarantine of infected individuals and release of non-infected individuals. We fix a quarantine technology - a parameter determining the differential rate of transmission in quarantine - and compare simple testing and quarantine policies. We start with a baseline quarantine-only policy that replicates the rate at which individuals are entering quarantine in the US in March, 2020. We show that the total deaths that occur under this policy can be achieved under looser quarantine measures and a substantial increase in random testing of asymptomatic individuals. Testing at a higher rate in conjunction with targeted quarantine policies can (i) dampen the economic impact of the coronavirus and (ii) reduce peak symptomatic infections - relevant for hospital capacity constraints. Our model can be plugged into richer quantitative extensions of the SEIR model of the kind currently being used to forecast the effects of public health and economic policies.

This paper presents a continuous-time model of sovereign debt. In it, a relatively impatient sovereign government’s hidden type switches back and forth between a commitment type, which cannot default, and an optimizing type, which can default on the country’s debt at any time, and assume outside lenders have particular beliefs regarding how a commitment type should borrow for any given level of debt and bond price. We show that if these beliefs satisfy reasonable assumptions, in any Markov equilibrium, the optimizing type mimics the commitment type when borrowing, revealing its type only by defaulting on its debt at random times. Further, in such Markov equilibria (the solution to a simple pair of ordinary differential equations), there are positive gross issuances at all dates, constant net imports as long as there is a positive equilibrium probability that the government is the optimizing type, and net debt repayment only by the commitment type. For countries that have recently defaulted, the interest rate the country pays on its debt is a decreasing function of the amount of time since its last default, and its total debt is an increasing function of the amount of time since its last default. For countries that have not recently defaulted, interest rates are constant.

According to the folklore of economics, game theory has failed. This paper argues that that is an incorrect interpretation of the game theory literature. When faced with a well-posed problem, game theory provides a solution. When faced with an ill-posed problem, game theory fails to provide a solution. This is, indeed, the best one can hope for from a method of analysis! Further, some suggestions are made for facing game theory with well-posed economic problems.

What is the force of attraction of cities? Leading explanations include the advantages of a concentrated market and knowledge spillovers. This paper develops a model of firm location decisions in which it is possible to distinguish the importance of the concentrated-market motive from other motives, including knowledge spillovers. A key aspect of the model is that it allows for the firm to choose multiple locations. The theory is applied to study the placement of manufacturing sales offices. The implications of the concentrated-market motive are found to be a salient feature of U.S. Census micro data. The structural parameters of the model are estimated. The concentrated-market motive is found to account for approximately half of the concentration of sales offices in large cities.

We consider an environment in which individuals receive income shocks that are unobservable to others and can privately store resources. We provide a simple characterization of the efficient allocation in cases in which the rate of return on storage is sufficiently high or, alternatively, in which the worst possible outcome is sufficiently dire. We show that, unlike in environments without unobservable storage, the symmetric efficient allocation is decentralizable through a competitive asset market in which individuals trade risk-free bonds among themselves.

In this paper we present a consistent estimator for a linear filter (distributed lag) when the independent variable is subject to observational error. Unlike the standard errors-in-variables estimator which uses instrumental variables, our estimator works directly with observed data. It is based on the Hilbert transform relationship between the phase and the log gain of a minimum phase-lag linear filter. The results of using our method to estimate a known filter and to estimate the relationship between consumption and income demonstrate that the method performs quite well even when the noise-to-signal ratio for the observed independent variable is large. We also develop a criterion for determining whether an estimated phase function is minimum phase-lag.

In high-tech industries, one important method of diffusion is through employee mobility: many of the entering firms are started by employees from incumbent firms using some of their former employers’ technological know-how. This paper explores the effect of incorporating this mechanism in a general industry framework by allowing employees to imitate their employers’ know-how. The equilibrium is Pareto optimal since the employees “pay” for the possibility of learning their employers’ know-how. The model’s implications are consistent with data from the rigid disk drive industry. These implications concern the effects of know-how on firm formation and survival.

This paper presents a two-country overlapping generations model in which financial intermediation arises endogenously as an incentive-compatible means of economizing on monitoring costs. Because of the existence of transactions costs, money markets in the two countries are segmented and investors have differential access to international credit markets. The model is used to generate predictions about the role of international intermediation in economic development and to examine the nature of business cycle phenomena across alternative exchange rate regimes. Disturbances are propagated by a credit allocation mechanism, which also lends a novel flavor to the model’s long-run properties.

Will an industry with no antitrust policy converge to monopoly, competition or somewhere in between? We analyze this question using a dynamic dominant firm model with rational agents, endogenous mergers and constant returns to scale production. We find that perfect competition and monopoly are always steady states of this model and that there may be other steady states with a dominant firm and a fringe co-existing. Mergers are likely only when supply is inelastic or demand is elastic, suggesting that the ability of a dominant firm to raise price through monopolization is limited. Additionally, as the discount rate increases, it becomes harder to monopolize the industry, because the dominant firm cannot commit to not raising prices in the future.

The prevailing neo-Wicksellian view holds that the central bank's objective is to track the natural rate of interest (r *), which itself is largely exogenous to monetary policy. We challenge this view using a fixed-cost model of durable consumption demand, in which expansionary monetary policy prompts households to accelerate purchases of durable goods. This yields an intertemporal trade-off in aggregate demand as encouraging households to increase durable holdings today leaves fewer households acquiring durables going forward. Interest rates must be kept low to support demand going forward, so accommodative monetary policy today reduces r * in the future. We show that this mechanism is quantitatively important in explaining the persistently low level of real interest rates and r * after the Great Recession.

The direct benefits of infrastructure in developing countries can be large, but if new infrastructure induces in-migration, congestion of other local publicly provided goods may offset the direct benefits. Using the example of rural household electrification in South Africa, we demonstrate the importance of accounting for migration when evaluating welfare gains of spatial programs. We also provide a practical approach to computing welfare gains that does not rely on land prices. We develop a location choice model that incorporates missing land markets and allows for congestion in local land. Using this model, we construct welfare bounds as a function of the income and population effects of the new electricity infrastructure. A novel prediction from the model is that migration elasticities and congestion effects are especially large when land markets are missing. We empirically estimate these welfare bounds for rural electrification in South Africa and show that congestion externalities from program-induced migration reduced local welfare gains by about 40%.

No abstract available.

An alternative solution concept is recommended for noncooperative games with multiple equilibra. Players maximize security level in a contracted game. Examples in economics are given in which this solution concept yields a unique solution: a fiat money model, the capital overaccumulation problem, and multiple rational expectations equilibria generally.

We report on experiments that tested the predictions of competing theories of learning in games. Experimental subjects played a version of the three-person matching-pennies game. The unique mixed-strategy Nash equilibrium of this game is locally unstable under naive Bayesian learning. Sophisticated Bayesian learning predicts that expectations will converge to Nash equilibrium if players observe the entire history of play. Neither theory requires payoffs to be common knowledge. We develop maximum-likelihood tests for the independence conditions implied by the mixed-strategy Nash equilibrium. We find that perfect monitoring was sufficient and complete payoff information was unnecessary for average play to be consistent with the equilibrium (as is predicted by sophisticated Bayesian learning). When subjects had imperfect monitoring and incomplete payoff information, average play was inconsistent with the equilibrium.

This paper quantitatively evaluates the hypothesis that deflation can account for much of the Great Depression (1929–33). We examine two popular explanations of the Depression: (1) The “high wage” story, according to which deflation, combined with imperfectly flexible wages, raised real wages and reduced employment and output. (2) The “bank failure” story, according to which deflationary money shocks contributed to bank failures and to a reduction in the efficiency of financial intermediation, which in turn reduced lending and output. We evaluate these stories using general equilibrium business cycle models, and find that wage shocks and banking shocks account for a small fraction of the Great Depression. We also find that some other predictions of the theories are at variance with the data.

We present a class of convex endogenous growth models and analyze their performance in terms of both growth and business cycle criteria. The models we study have close analogs in the real business cycle literature. We interpret the exogenous growth rate of productivity as an endogenous growth rate of human capital. This perspective allows us to compare the strengths of the two classes of models.

To highlight the mechanism that gives endogenous growth models the ability to improve upon their exogenous growth relatives, we study models that are symmetric in terms of human and physical capital formation—our two engines of growth. More precisely, we analyze models in which the technology used to produce human capital is identical to the technologies used to produce consumption and investment goods and in which the technology shocks in the two sectors are perfectly correlated.

We develop a positive theory of the adoption of child labor laws. Workers who compete with children in the labor market support the introduction of a child labor ban, unless their own working children provide a large fraction of family income. Since child labor income depends on family size, fertility decisions lock agents into specific political preferences, and multiple steady states can arise. The introduction of child labor laws can be triggered by skill-biased technological change that induces parents to choose smaller families. The model replicates features of the history of the U.K. in the nineteenth century, when regulations were introduced after a period of rising wage inequality, and coincided with rapidly declining fertility rates.

Modern business cycle theory focuses on the study of dynamic stochastic general equilibrium models that generate aggregate fluctuations similar to those experienced by actual economies. We discuss how this theory has evolved from its roots in the early real business cycle models of the late 1970s through the turmoil of the Great Recession four decades later. We document the strikingly different pattern of comovements of macro aggregates during the Great Recession compared to other postwar recessions, especially the 1982 recession. We then show how two versions of the latest generation of real business cycle models can account, respectively, for the aggregate and the cross-regional fluctuations observed in the Great Recession in the United States.

We study the effect of culture on important economic outcomes by using the 1970 census to examine the work and fertility behavior of women born in the U.S. but whose parents were born elsewhere. We use past female labor force participation and total fertility rates from the country of ancestry as our cultural proxies. These variables should capture, in addition to past economic and institutional conditions, the beliefs commonly held about the role of women in society (i.e., culture). Given the different time and place, only the beliefs embodied in the cultural proxies should be potentially relevant. We show that these cultural proxies have positive and significant explanatory power for individual work and fertility outcomes, even after controlling for possible indirect effects of culture. We examine alternative hypotheses for these positive correlations and show that neither unobserved human capital nor networks are likely to be responsible.

This paper illustrates the application of observable index models to the problem of macroeconomic forecasting. In this context, a Bayesian prior is used to describe a class of models which impose the index structure with more or less weight. An out-of-sample forecasting experiment is used to measure the possible benefits of this approach. In addition, impulse response functions and the decomposition of forecast variance are analyzed to suggest a possible separation of real and nominal shocks into separate channels.

Why are methods of production used in an area when more “efficient” methods are available? This paper explores a “resistance to technology” explanation. In particular, the paper attempts to understand why some industries, like the construction industry, have had continued success in blocking new methods, while others have met failure, like the dairy industry's recent attempt to block bST. We develop a model which shows that how easily goods move between areas determines in part the extent of resistance to new methods in an area.

In this paper, I provide a possible explanation of why nominally risk-free bonds are essential in monetary economies. I argue that the role of nominal bonds is to serve as record-keeping devices in intertemporal exchanges of money. I show that bonds can only serve this role if they are illiquid (costly to exchange for goods). Finally, I show that in economies in which nominal bonds are essential, welfare and nominal interest rates are both positively associated with the supply of illiquid bonds (if that supply is small).

We interpret observed gender differences in education as the equilibrium outcome of a two-sex overlapping generations model where men and women of each generation bargain over consumption, number of children, and investment in education of their children conditional on gender. This model represents a new framework for the analysis of the process of intrahousehold decision making in an intergenerational setting.

We highlight an example of considerable bias in officially published input-output data (factor-income shares) by an LDC (Turkey), which many researchers use without question. We make use of an intertemporal general equilibrium model of trade and production to evaluate the dynamic gains for Turkey from currently debated trade policy options and compare the predictions using conservatively adjusted, rather than official, data on factor shares. We show that the predicted welfare gains are not only of a different order of magnitude, but in some cases, of a different sign, hence, suggesting contradictory policy recommendations.

We estimate a dynamic general equilibrium model of the U.S. economy that includes an explicit household production sector and stochastic fiscal variables. We use our estimates to investigate two issues. First, we analyze how well the model accounts for aggregate fluctuations. We find that household production has a significant impact and reject a nested specification in which changes in the home production technology do not matter for market variables. Second, we study the effects of some simple fiscal policy experiments and show that the model generates different predictions for the effects of tax changes than similar models without home production.

We find conditions for the Friedman rule to be optimal in three standard models of money. These conditions are homotheticity and separability assumptions on preferences similar to those in the public finance literature on optimal uniform commodity taxation. We show that there is no connection between our results and the result in the standard public finance literature that intermediate goods should not be taxed.

Recent critiques have demonstrated that existing attempts to account for the unemployment volatility puzzle of search models are inconsistent with the procylicality of the opportunity cost of employment, the cyclicality of wages, and the volatility of risk-free rates. We propose a model that is immune to these critiques and solves this puzzle by allowing for preferences that generate time-varying risk over the cycle, and so account for observed asset pricing fluctuations, and for human capital accumulation on the job, consistent with existing estimates of returns to labor market experience. Our model reproduces the observed fluctuations in unemployment because hiring a worker is a risky investment with long-duration surplus flows. Intuitively, since the price of risk in our model sharply increases in recessions as observed in the data, the benefit from creating new matches greatly drops, leading to a large decline in job vacancies and an increase in unemployment of the same magnitude as in the data.

This paper uses an estimated structural model to argue that the option to move in and out of the parental home is an important insurance channel against labor market risk for youths who do not attend college. Using data from the NLSY97, I construct a new monthly panel of parent-youth coresidence outcomes and use it to document an empirical relationship between these movements and individual labor market events. The data is then used to estimate the parameters of a dynamic game between youths and their altruistic parents, featuring coresidence, labor supply and savings decisions. Parents can provide both monetary support through explicit financial transfers, and non-monetary support in the form of shared residence. To account for the data, two types of exogenous shocks are needed. Preference shocks are found to explain most of the cross-section of living arrangements, while labor market shocks account for individual movements in and out of the parental home. I use the model to show that coresidence is a valuable form of insurance, particularly for youths from poorer families. The option to live at home also helps to explain features of aggregate data for low-skilled young workers: their low savings rates and their relatively small consumption responses to labor market shocks. An important implication is that movements in and out of home can reduce the consumption smoothing benefits of social insurance programs.

No abstract available.

No abstract available.

Long-term contracts are explained as equilibrium strategies of supergames. In the specific coherent general equilibrium model provided, limited mobility of labor, in the form of a fixed cost of moving, generates long-term contracts.

The consequences of a straightforward monetary targeting scheme are examined for a simple dynamic macro model. The notion of “targeting” used is the strategic one introduced by Rogoff (1985). Numerical calculations are used to demonstrate that for the model under consideration, monetary targeting is likely to lead to a deterioration of policy performance. These examples cast doubt upon the general efficacy of simple targeting schemes in dynamic rational expectations models.

We use balance sheet data and stock market data for the major U.S. banking institutions during and after the 2007-8 financial crisis to estimate the magnitude of the losses experienced by these institutions because of the crisis. We then use these estimates to assess the impact of the crisis under alternative, and higher, capital requirements. We find that substantially higher capital requirements (in the 20% to 30% range) would have substantially reduced the vulnerability of these financial institutions, and consequently they would have significantly reduced the need of a public bailout.

Deaton (1986) has noted that if income is a first-order autoregressive process in first differences, then a simple version of Friedman’s permanent income hypothesis (SPIH) implies that measured U.S. consumption is insufficiently sensitive to innovations in income. This paper argues that this implication of the SPIH is a consequence of the fact that it ignores the role of the substitution effect in the consumption decision. Using a parametric version of the standard model of economic growth, the paper shows that very small movements in interest rates are sufficient to induce an empirically plausible amount of consumption smoothing. Since an overall evaluation of the model’s explanation for the observed smoothness of consumption requires examining its implications for other aspects of the data, the paper also explores some of these.

This paper reexamines U.S. postwar data to investigate if the observed comovements between money, interest rates, inflation, and output are compatible with the money to real interest to output links suggested by existing monetary theories of the business cycle, which include both Keynesian and equilibrium models. We find these theories are incompatible with the data, and in light of these results, we propose an alternative structural model which can account for the major dynamic interactions among the variables. This model has two central features: (i) output is unaffected by the money supply; and (ii) the money supply process is influenced by policies designed to achieve short-run price stability.

The desirability of fiscal constraints in monetary unions depends critically on whether the monetary authority can commit to follow its policies. If it can commit, then debt constraints can only impose costs. If it cannot commit, then fiscal policy has a free-rider problem, and debt constraints may be desirable. This type of free-rider problem is new and arises only because of a time inconsistency problem.

We analyze economies with private information concerning the quality of commodities. Without private information there is a nonmonetary equilibrium with only high quality commodities produced, and money cannot improve welfare. With private information there can be equilibria with bad quality commodities produced, and sometimes only nonmonetary equilibrium is degenerate. The use of money can lead to active (i.e., nondegenerate) equilibria when no active nonmonetary equilibrium exists. Even when active nonmonetary equilibria exist, with private information money can increase welfare via its incentive effects: in monetary equilibrium, agents may adopt trading strategies that discourage production of low quality output.

This paper proposes a new way of modeling age, period, and cohort effects that improves substantively and methodologically on the conventional linear model. The linear model suffers from a well-known identification problem: If we assume an outcome of interest depends on the sum of an age effect, a period effect, and a cohort effect, then it is impossible to distinguish these three separate effects because, for any individual, birth year = current year – age. Less well appreciated is that the model also suffers from a conceptual problem: It assumes that the influence of age is the same in all time periods, the influence of present conditions is the same for people of all ages, and cohorts do not change over time. We argue that in many applications, these assumptions fail. We propose a more general model in which age profiles can change over time and period effects can have different influences on people of different ages. Our model defines cohort effects as an accumulation of age-by-period interactions. Although a long-standing literature on theories of social change conceptualizes cohort effects in exactly this way, we are the first to show how to statistically model this more complex form of cohort effects. We show that the additive model is a special case of our model and that, except in special cases, the parameters of the more general model are identified. We apply our model to analyze changes in age-specific mortality rates in Sweden over the past 150 years. Our model fits the data dramatically better than the additive model. The estimates show that the rate of increase of mortality with age among adults became more steep from 1881 to 1941, but since then the rate of increase has been roughly constant. The estimates also allow us to test whether early-life conditions have lasting impacts on mortality, as under the cohort morbidity phenotype hypothesis. The results give limited support to this hypothesis: The impact of early-life conditions lasts for several years but is unlikely to reach all the way to old age.

In this paper we propose and test a new explanation of bank behavior during the Free Banking Era, 1837–63. Arguing against the view that free bank failures were due to fraud, we claim that they were caused by exposure to term structure risk. Testing this new explanation with a new and extensive body of data, we find strong support for it: periods of falling bond prices correspond to the periods with most of the free bank failures. The new data do not support the view that fraud caused the failures.

In this paper, we show that ignoring corporate intangible investments gives a distorted picture of the post-1990 U.S. economy. In particular, ignoring intangible investments in the late 1990s leads one to conclude that productivity growth was modest, corporate profits were low, and corporate investment was at moderate levels. In fact, the late 1990s was a boom period for productivity growth, corporate profits, and corporate investment.

This paper describes interactions between monetary and fiscal policies that affect equilibrium price levels and interest rates by critically surveying theories about (a) optimal anticipated inflation, (b) optimal unanticipated inflation, and (c) conditions that secure a "nominal anchor" in the sense of a unique price level path. We contrast incomplete theories whose inputs are budget-feasible sequences of government issued bonds and money with complete theories whose inputs are bond-money strategies described as sequences of functions that map time t histories into time t government actions. We cite historical episodes that conform the theoretical insight that lines of authority between a Treasury and a Central Bank can be ambiguous, obscure, and fragile.

Applied general equilibrium (AGE) models, which feature multiple countries, multiple industries, and input-output linkages across industries, have been the dominant tool for evaluating the impact of trade reforms since the 1980s. We review how these models are used to perform policy analysis and document their shortcomings in predicting the industry-level effects of past trade reforms. We argue that, to improve their performance, AGE models need to incorporate product-level data on bilateral trade relations by industry and better model how trade reforms lower bilateral trade costs. We use the least traded products methodology of Kehoe et al. (2015) to provide guidance on how improvements can be made. We provide further suggestions on how AGE models can incorporate recent advances in quantitative trade theory to improve their predictive ability and better quantify the gains from trade liberalization.