Research Database

Optimal control theory can be combined with the probability structure of a vector autoregression to investigate the tradeoffs available to policymakers. Such an approach obtains results based on a minimal set of assumptions about the economy and the structure of policy actions. This paper takes this approach to analyze the potential effectiveness of countercyclical monetary policy.

U.S. stock prices have increased much faster than gross domestic product GDP) in the postwar period. Between 1962 and 2000, corporate equity value relative to GDP nearly doubled. In this paper, we determine what standard growth theory says the equity value should be in 1962 and 2000, the two years for which our steady-state assumption is a reasonable one. We find that the actual valuations were close to the theoretical predictions in both years. The reason for the large run-up in equity value relative to GDP is that the average tax rate on dividends fell dramatically between 1962 and 2000. We also find that, given legal constraints that effectively prohibited the holding of stocks as reserves for pension plans, there is no equity premium puzzle in the postwar period. The average returns on debt and equity are as theory predicts.

I develop an idea flows theory of firm and worker dynamics in order to assess the consequences of population aging. Older people are less likely to attempt entrepreneurship and switch employers because they have found better jobs. Consequently, aging reduces entry and worker mobility through a composition effect. In equilibrium, the lower entry rate implies fewer new, better job opportunities for workers, while the better matched labor market dissuades job creation and entry. Aging accounts for a large share of substantial declines in firm and worker dynamics since the 1980s, primarily due to equilibrium forces. Cross-state evidence supports these predictions.

In aggregate unadjusted data, measured Solow residuals exhibit large seasonal variations. Total Factor Productivity grows rapidly in the fourth quarter at an annual rate of 16 percent and regresses sharply in the first quarter at an annual rate of –24 percent. This paper considers two potential explanations for the measured seasonal variation in the Solow residual: labor hoarding and increasing returns to scale. Using a specification that allows for no exogenous seasonal variation in technology and a single seasonal demand shift in the fourth quarter, we ask the following question: How much of the total seasonal variation in the measured Solow residual can be explained by Christmas? The answer to this question is surprising. With increasing returns and time varying labor effort, Christmas is sufficient to explain the seasonal variation in the Solow residual, consumption, average productivity, and output in all four quarters. Our analysis of seasonally unadjusted data uncovers important roles for labor hoarding and increasing returns which are difficult to identify in adjusted data.

The sectoral composition of global saving changed dramatically during the last three decades. Whereas in the early 1980s most of global investment was funded by household saving, nowadays nearly two-thirds of global investment is funded by corporate saving. This shift in the sectoral composition of saving was not accompanied by changes in the sectoral composition of investment, implying an improvement in the corporate net lending position. We characterize the behavior of corporate saving using both national income accounts and firm-level data and clarify its relationship with the global decline in labor share, the accumulation of corporate cash stocks, and the greater propensity for equity buybacks. We develop a general equilibrium model with product and capital market imperfections to explore quantitatively the determination of the flow of funds across sectors. Changes including declines in the real interest rate, the price of investment, and corporate income taxes generate increases in corporate profits and shifts in the supply of sectoral saving that are of similar magnitude to those observed in the data.

Herd behavior is argued by many to be present in many markets. Existing models of such behavior have been subjected to two apparently devastating critiques. The continuous investment critique is that in the basic model herds disappear if simple zero-one investment decisions are replaced by the more appealing assumption that investment decisions are continuous. The price critique is that herds disappear if, as seems natural, other investors can observe asset market prices. We argue that neither critique is devastating. We show that once we replace the unappealing exogenous timing assumption of the early models that investors move in a pre-specified order by a more appealing endogenous timing assumption that investors can move whenever they choose then herds reappear.

We develop a model which accounts for the observed equity premium and average risk-free rate, without implying counterfactually high risk aversion. The model also does well in accounting for business-cycle phenomena. With respect to the conventional measures of business-cycle volatility and comovement with output, the model does roughly as well as the standard business-cycle model. On two other dimensions, the model’s business-cycle implications are actually improved. Its enhanced internal propagation allows it to account for the fact that there is positive persistence in output growth, and the model also provides a resolution to the “excess sensitivity puzzle” for consumption and income. Two key features of the model are habit persistence preferences and a multisector technology with limited intersectoral mobility of factors of production.

In "Liquidity Preference as Behavior Towards Risk," Tobin suggests that risk aversion and expected utility maximization can provide a rigorous foundation for an equilibrium demand for money. In Tobin's model, money plays a risk reducing role in individual portfolios. This note considers whether a general equilibrium stochastic model can produce equilibrium yield distributions that allow money to play that role if money does not appear directly as an argument in the utility or production functions of the economy. The model examined, a stochastic production variant of Samuelson's model of overlapping generations, cannot produce such yield distributions.

This paper examines two different clearing arrangements for bank liabilities. One was a profit-maximizing private entity, the Suffolk Banking System. It cleared notes for New England banks between 1827 and 1858. The other was a nonprofit collective, the clearinghouses organized in many cities beginning in 1853. The paper examines how well these arrangements prevented bank failures and acted as lenders of last resort. It finds the Suffolk system had fewer failures but acted less like a lender of last resort. It argues that these differences can be explained by the different incentives facing the Suffolk Bank and the members of clearinghouses.

Banks have historically provided mutual insurance against asset risk, where the insurance arrangement itself was characterized by limited enforcement. This paper shows that a non-trivial interaction between asset and liquidity risk plays a crucial role in shaping optimal banking arrangements in the presence of limited enforcement. We find that liquidity shocks are essential for the provision of insurance against asset shocks, as they mitigate interbank enforcement problems. These enforcement problems generate endogenous aggregate uncertainty as investment allocations depend upon the joint distribution of shocks. Paradoxically, a negative correlation between liquidity and asset shocks ameliorates enforcement limitations and facilitates interbank cooperation.

Bimetallism has been the subject of considerable debate: Was it a viable monetary system? Was it a desirable system? In our model, the (exogenous and stochastic) amount of each metal can be split between monetary uses to satisfy a cash-in-advance constraint, and nonmonetary uses in which the stock of uncoined metal yields utility. The ratio of the monies in the cash-in-advance constraint is endogenous. Bimetallism is feasible: we find a continuum of steady states (in the certainty case) indexed by the constant exchange rate of the monies; we also prove existence for a range of fixed exchange rates in the stochastic version. Bimetallism does not appear desirable on a welfare basis: among steady states, we prove that welfare under monometallism is higher than under any bimetallic equilibrium. We compute welfare and the variance of the price level under a variety of regimes (bimetallism, monometallism with and without trade money) and find that bimetallism can significantly stabilize the price level, depending on the covariance between the shocks to the supplies of metals.