Research Database

The key question asked by standard monetary models used for policy analysis is, How do changes in short-term interest rates affect the economy? All of the standard models imply that such changes in interest rates affect the economy by altering the conditional means of the macroeconomic aggregates and have no effect on the conditional variances of these aggregates. We argue that the data on exchange rates imply nearly the opposite: the observation that exchange rates are approximately random walks implies that fluctuations in interest rates are associated with nearly one-for-one changes in conditional variances and nearly no changes in conditional means. In this sense, standard monetary models capture essentially none of what is going on in the data. We thus argue that almost everything we say about monetary policy using these models is wrong.

In the data, a large fraction of price changes are temporary. We provide a simple menu cost model which explicitly includes a motive for temporary price changes. We show that this simple model can account for the main regularities concerning temporary and permanent price changes. We use the model as a benchmark to evaluate existing shortcuts that do not explicitly model temporary price changes. One shortcut is to take the temporary changes out of the data and fit a simple Calvo model to it. If we do so prices change only every 50 weeks and the Calvo model overestimates the real effects of monetary shocks by almost 70%. A second shortcut is to leave the temporary changes in the data. If we do so prices change every 3 weeks and the Calvo model produces only 1/9 of the real effects of money as in our benchmark. We show that a simple Calvo model can generate the same real effects as our benchmark model if we set parameters so that prices change every 17 weeks.

Over the period 1982–2006, the U.S. Bureau of Economic Analysis (BEA) estimates the return on investments of foreign subsidiaries of U.S. multinational companies averaged 9.4 percent per year after taxes while U.S. subsidiaries of foreign multinationals earned on average only 3.2 percent. We estimate the importance of two factors that 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. Technology capital used abroad generates profits for foreign subsidiaries with no foreign direct investment. Plant-specific intangible capital in foreign subsidiaries is expensed abroad, lowering current profits on foreign direct investment (FDI) and increasing future profits. We develop a multicountry general equilibrium model with an essential role for FDI and apply the same methodology as the BEA 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.

Given a common technology for replicating blueprints, high-quality blueprints will be replicated more quickly than low-quality blueprints. If quality begets quality, and firms are identified with collections of blueprints derived from the same initial blueprint, then, along a balanced growth path, Gibrat’s Law holds for every type of firm. A firm size distribution with the thick right tail observed in the data can then arise only when the number of blueprints in the economy grows over time, or else firms cannot grow at a positive rate on average. But when calibrated to match the observed firm entry rate and the right tail of the size distribution, this model implies that the median age among firms with more than 10,000 employees is about 750 years. The problem is Gibrat’s Law. If the relative quality of a firm’s blueprints depreciates as the firm ages, then the firm’s growth rate slows down over time. By allowing for rapid and noisy initial growth, this version of the model can explain high observed entry rates, a thick-tailed size distribution, and the relatively young age of large U.S. corporations.

This paper studies efficient allocation of resources in an economy in which agents are initially heterogeneous with regard to their wealth levels and whether they have ideas or not. An agent with an idea can start a business that generates random returns. Agents have private information about (1) their initial types, (2) how they allocate their resources, and (3) the realized returns. The unobservability of returns creates a novel motive for subsidizing agents who have ideas but lack resources to invest in them. To analyze this motive in isolation, the paper assumes that agents are risk-neutral and abstracts away from equality and insurance considerations. The unobservability of initial types and actions implies that the subsidy that poor agents with ideas receive is limited by incentive compatibility: the society should provide other agents with enough incentives so that they do not claim to be poor and have ideas. The paper then provides an implementation of the constrained-efficient allocation in an incomplete markets setup that is similar to the U.S. Small Business Administration’s Business Loan Program. Finally, the paper extends the model in several dimensions to show that the results are robust to these generalizations of the model.

No abstract available.

The United States is indisputably undergoing a financial crisis and is perhaps headed for a deep recession. Here we examine three claims about the way the financial crisis is affecting the economy as a whole and argue that all three claims are myths. We also present three underappreciated facts about how the financial system intermediates funds between households and corporate businesses. Conventional analyses of the financial crisis focus on interest rate spreads. We argue that such analyses may lead to mistaken inferences about the real costs of borrowing and argue that, during financial crises, variations in the levels of nominal interest rates might lead to better inferences about variations in the real costs of borrowing. Moreover, we argue that even if current increase in spreads indicate increases in the riskiness of the underlying projects, by itself, this increase does not necessarily indicate the need for massive government intervention. We call for policymakers to articulate the precise nature of the market failure they see, to present hard evidence that differentiates their view of the data from other views which would not require such intervention, and to share with the public the logic and evidence that burnishes the case that the particular intervention they are advocating will fix this market failure.

Innovative activities have public good characteristics in the sense that the cost of producing the innovation is high compared to the cost of producing subsequent units. Moreover, knowledge of how to produce subsequent units is widely known once the innovation has occurred and is, therefore, non-rivalrous. The main question of this paper is whether mechanisms can be found which exploit market information to provide appropriate incentives for innovation. The ability of the mechanism designer to exploit such information depends crucially on the ability of the innovator to manipulate market signals. We show that if the innovator cannot manipulate market signals, then the efficient levels of innovation can be implemented without deadweight losses–for example, by using appropriately designed prizes. If the innovator can use bribes, buybacks, or other ways of manipulating market signals, patents are necessary.

This article analyzes Keynes’s “Economic Possibilities for our Grandchildren”—an essay presenting Keynes’s views about economic growth into the 21st century—from the perspective of modern growth theory. I find that the implicit theoretical framework used by Keynes to form his expectations about the 21st-century world economy is remarkably close to modern growth models, featuring a stable steady-state growth path driven by technological progress. On the other hand, Keynes’s forecast of employment in the 21st century is far off the mark, reflecting a mistaken view that the income elasticity of leisure is much higher than that of consumption.