Research Database

Constant returns to scale is a central construct of neoclassical theory. Previous studies argued that one must adopt a specification of the production function with substantial unobserved service variation to reconcile constant returns with the data. Some economists have argued that this finding has not resolved the size of returns to scale, since factor service variation is unobserved, and there is no generally accepted theory to guide specification of this alternative framework. In this paper we show that the stochastic version of the neoclassical growth model delivers an orthogonality condition which can be used to estimate returns to scale. Rather than the standard finding of increasing returns, we show that standard theory and conventional measures of output and inputs yield estimates of constant returns to scale at the aggregate level. Our estimates also suggest that factor service variation is not an important determinant of output fluctuations.

We produce a theoretical framework that helps explain the co-evolution of the real and financial sectors of an economy in the growth process, as described by Gurley and Shaw. According to them, self-financed capital investment first gives way to debt finance and later to the emergence of equity as an additional instrument for raising funds externally. As the economy develops further, the aggregate ratio of debt to equity will generally fall. We analyze that portion of their account concerning the evolution of equity markets. We show that in an important sense, debt equity are complementary sources for the financing of capital investments.

A current U.S. policy is to introduce a new style of currency that is harder to counterfeit, but not immediately to withdraw from circulation all of the old-style currency. This policy is analyzed in a random-matching model of money, and its potential to decrease counterfeiting in the long run is shown. For various parameters of the model, three types of equilibria are found to occur. In only one does counterfeiting continue at its initial high level. In the other two, both genuine and counterfeit old-style money go out of circulation—immediately in one and gradually in the other. There are objectives and expectations that can reasonably be imputed to policymakers, under which the policy that they have chosen can make sense.

Using an existing random matching model of money, I show that a once-for-all change in the quantity of money has short-run effects that are predominantly real and long-run effects that are in the direction of being predominantly nominal provided (i) the quantity of money is random and (ii) people learn about what happened to it only with a lag. The change in the quantity of money comes about through a random process of discovery that does not permit anyone to deduce the aggregate amount discovered when the change actually occurs.

We consider an environment in which risk-neutral firms must obtain external finance. They have access to two kinds of linear, stochastic investment opportunities. For one, return realizations are costlessly observed by all agents. For the other, return realizations are costlessly observed only by the investing firm; however, they can be (privately) observed by outsiders who bear a fixed verification cost. Thus, the second investment opportunity is subject to a standard costly state verification (CSV) problem of the type considered by Townsend (1979), Gale and Hellwig (1985), or Williamson (1986, 1987).

We examine the optimal allocations of investment between the two kinds of projects, as well as the optimal contract used to finance it. We show that the optimal contractual outcome can be supported by having firms issue appropriate (and determinate) quantities of debt and equity securities to outside investors.

The optimal debt-equity ratio necessarily depends (in part) on the firm’s asset structure. Investments in projects subject to CSV problems are associated (in a sense to be made precise) with the use of debt—as might be expected from the existing CSV literature. Investments in projects with publicly observable returns are associated with the use of external equity.

We examine in detail the relationship between the optimal asset and liability structure of the firm. We also describe conditions under which an increase in the cost of state verification shifts the composition of investment towards projects with observable returns, and reduces the optimal debt-equity ratio. Interestingly, the optimal debt-equity ratio is also shown to depend on factors that are irrelevant to asset allocations.

Finally, a large part of the interest in CSV environments has been due to the fact that they may result in equilibrium credit rationing. Our analysis has strong implications for the possibility of equilibrium credit rationing in more general CSV models.

In a finite-trader version of the Diamond-Dybvig (1983) model, the symmetric, ex-ante efficient allocation is implementable by a direct mechanism (i.e., each trader announces the type of his own ex-post preference) in which truthful revelation is the strictly dominant strategy for each trader. When the model is modified by formalizing the sequential-service constraint (cf. Wallace, 1988), the truth-telling equilibrium implements the symmetric, ex-ante efficient allocation with respect to iterated elimination of strictly dominated strategies.

This paper is motivated by a variety of empirical observations on the comovements of currency velocity, inflation, and the relative size of the “credit services” sector. By the credit services sector we mean the part of banking and credit sector which provides alternative means of transactions to using currency as well as other services which help people economize on currency. We incorporate the credit services sector into a monetary growth model. Our model makes two specific and new contributions. The first is to show that direct quantitative evidence on the welfare cost of low inflation using measures of the relative size of an appropriately defined credit services sector for the U.S.—essentially the cost incurred by banks and credit unions in providing demand deposit and credit card services—is consistent with the welfare cost measured using an estimated money demand curve following the classic analysis of Bailey (1956) and the more recent analysis of Lucas (1993). Both of these measures amount to about 0.5 percent of GNP. The second contribution is in providing welfare cost of inflation estimates over a range of inflation rates which have some new features. We find that the total welfare cost of inflation remains bounded at about 5 percent of consumption.

In this paper we analyze the rate of convergence to a balanced path in a class of endogenous growth models with physical and human capital. We show that such rate depends locally on the technological parameters of the model, but does not depend on those parameters related to preferences. This result stands in sharp contrast with that of the one-sector neoclassical growth model, where both preferences and technologies determine the speed of convergence to a steady-state growth path.