Research Database

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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.

This paper derives a variance bounds test for a broad class of linear rational expectations models. According to this test, if observed data accord with the model, then a weighted sum of auto-covariances of the covariance-stationary components of the endogenous state variables should be nonnegative. The new test reinterprets West’s (1986) variance bounds test and extends its applicability by not requiring observable exogenous state variables, covariance-stationary exogenous or endogenous state variables, or a zero initial value for the endogenous state variable. The paper also discusses the possibility of the new test’s application to nonlinear models.

We show that some classes of sterilized interventions have no effect on equilibrium prices and quantities. The proof does not require complete markets, Ricardian equivalence, monetary neutrality, or the law of one price. Moreover, regressions of exchange rates or interest differentials on variables measuring debt’s currency composition contain no information about the effectiveness of such interventions. Other interventions require changes in monetary and fiscal policy; their effects depend, generally, on the influence of these changes on the economy and not on the intervention alone. In short, sterilized intervention is not, as the portfolio balance approach indicates, an extra policy instrument.

This paper considers whether short-period deterministic cycles can exist in a class of stationary overlapping generations models with long- (but finite-) lived agents. It shows that if agents discount the future positively, then as life spans get large, nonmonetary cycles will disappear. Further, neither constant monetary steady states nor stationary monetary cycles can exist. It also shows that if agents discount the future negatively, then there are robust examples in which constant monetary steady states as well as stationary monetary cycles (with undiminished amplitude) can occur no matter how long agents live.

We show that some classes of sterilized interventions have no effect on equilibrium prices or quantities. The proof does not depend on complete markets, infinitely-lived agents, Ricardian equivalence, monetary neutrality, or the law of one price. Moreover, regressions of exchange rates or interest differentials on variables measuring the currency composition of the debt may contain no information, in our theoretical economy, about the effectiveness of such interventions. Another class of interventions requires simultaneous changes in monetary and fiscal policy; their effects depend, generally, on the influence of tax distortions, government spending, and money supplies on economic behavior. We suggest that in applying the portfolio balance approach to the study of intervention, lack 01 explicit modeling of these features is a serious flaw.

We analyze the incentive for a government to default on its debts in a variant of the Lucas and Stokey (1983) model of optimal taxation. Optimal fiscal policy requires the use of debt to smooth tax distortions over time. Dynamic consistency requires that governments not have an incentive to default on the inherited debt. We consider policy and allocation rules which map the history of the economy into current decisions. A sustainable equilibrium is a sequence of history-contingent functions which satisfy sequential rationality for the government and for private agents. We characterize sustainable equilibrium outcomes when the horizon in finite. We show that, under plausible assumptions, the loss in welfare due to the absence of a commitment technology to honor debts is small.

This paper examines the limiting behavior of cooperative and noncooperative fiscal policies as countries market power goes to zero. In the first part we provide sufficient conditions for these policies to converge. In the second part we provide examples where these policies diverge. Briefly, we show that if there are unremovable domestic distortions then there can be gains to coordination between countries even when countries have no ability to affect world prices. These results are at variance with the received wisdom in the optimal tariff literature. The key distinction is that we model explicitly the spending decisions of the government while the optimal tariff literature does not.

A model with private information is constructed that supports conventional arguments for a government monopoly in supplying circulating media of exchange. The model also yields predictions, including rate-of-return dominance of circulating media of exchange, that are consistent with observations from free banking regimes and fiat money regimes. In a laissez faire banking equilibrium, fiat money is not valued, and the resulting allocation is not Pareto optimal. However, if private agents are restricted from issuing circulating notes, there exists an equilibrium with valued fiat money that Pareto dominates the laissez faire equilibrium and is constrained Pareto optimal.

[Please note that the following Greek lettering is improperly transcribed.] If [0,1] is a measure space of agents and X---- a collection of pairwise uncorrelated random variables with common finite mean U and variance a , one would like to establish a law of large numbers () Xdl = U. In this paper we propose to interpret () as a Pettis integral. Using the corresponding Riemann-type version of this integral, we establish (*) and interpret it as an L2-law of large numbers. Intuitively, the main idea is to integrate before drawing an W, thus avoiding well-know measurability problems. We discuss distributional properties of i.i.d. random shocks across the population. We given examples for the economic interpretability of our definition. Finally, we establish a vector-valued version of the law of large numbers for economies.

A model is constructed where banks provide access to a communication technology which facilitates trade. Bank liabilities may coexist with alternative means of payment in equilibrium, and there exist regions of the parameter space where banking dominates the payments system and where physical exchange media dominate. The model is consistent with some observations concerning the role of the banking system in economic development, and with characteristics of banking crises. In particular, in early stages of economic development: 1) rapid output growth is accompanied by an increasing share of banking in transactions activity and 2) there are recurrent banking "panics" where reductions in measured aggregate output coincide with increases in the use of alternative means of payment relative to bank liabilities. In later stages of development, growth slackens off, the share of banking in the payments system stabilizes and the economy is less likely to be subject to banking panics.

Three economic environments are reviewed, and in each organizations play an essential role. For an adverse selection insurance economy, we find that when mutual insurance arrangements are permitted an equilibrium necessarily exists and is optimal. This example, and the two others, illustrate the problems that may result from imposing organizational structure on an environment rather than permitting the structure to be determined endogenously.

Doan, Litterman, and Sims have described a method for estimating Bayesian vector autoregressive (BVAR) forecasting models. The method has been successfully applied to the U.S. macroeconomic dataset, which is relatively long and stable. Despite the brevity and volatility of the post-1976 Chilean macroeconomic dataset, this paper shows that a straightforward application of the DLS method to this dataset, with simple modifications to allow for delays in the release of data, also appears to satisfy at least one criterion of relative forecasting accuracy suggested by Doan, Litterman, and Sims. However, the forecast errors of the Chilean BVARs are still large in absolute terms.Also, the model's coefficients change sharply in periods marked by policy shifts, such as the floating of the peso in 1982.

We consider a production economy with a finite number of heterogeneous, infinitely lived consumers. We show that, if the economy is smooth enough, equilibria are locally unique for almost all endowments. We do so by converting the infinite dimensional fixed point problem stated in terms of prices and commodities into a finite dimensional Negishi problem involving individual weights in a social value function. By adding a set of artificial fixed factors to utility and production functions, we can write the equilibrium conditions equating spending and income for each consumer entirely in terms of time zero factor endowments and derivatives of the social value function.

This paper shows that bank runs can be modeled as an equilibrium phenomenon. We demonstrate that some aspects of the intuitive “story” that bank runs start with fears of insolvency of banks can be rigorously modeled. If individuals observe long “lines” at the bank, they correctly infer that there is a possibility that the bank is about to fail and precipitate a bank run. However, bank runs occur even when no one has any adverse information. Extra market constraints such as suspension of convertibility can prevent bank runs and result in superior allocations.

In a monetary model, it is shown that if there is a unique Pareto inefficient barter equilibrium, then a monetary equilibrium exists when traders are sufficiently patient.

Forecasts are routinely revised, and these revisions are often the subject of informal analysis and discussion. This paper argues 1) that forecast revisions are analyzed because they help forecasters and forecast users to evaluate forecasts and forecasting procedures, and 2) that these analyses can be sharpened by using the forecasting model to systematically express its forecast revision as the sum of components identified with specific data revisions and forecast errors. An algorithm for this purpose is explained and illustrated.

Previous authors have argued that the optimal monetary policy is contractionary. If buyers value consumption substantially more than sellers, there is some randomness and informational constraints make asset trading useful, we show that there is an incentive compatible expansionary policy that dominates all incentive compatible contractionary policies.

This paper examines the validity of one very special version of Coase's Theorem. The version we examine is that in any economy in which the property rights are fully allocated, competition will lead to efficient allocations. One repercussion of this result is that one way to "solve" the public goods problem would be to allocate property rights fully, transforming the economy to a private goods one and let markets do their work. This is particularly appealing due to its decentralized nature, but one must question the claim that the market will lead to efficient outcomes in this case. That is, the privatized economy created above is of a very special type which, as it turns out is highly susceptible to strategic behavior. We show that the "mechanism" suggested above is not likely to work well in economies with either pure public goods or "global" externalities. Basically, the free-rider problem manifests itself as one of monopoly power in this private goods setting. On the other hand, if the public goods or externalities are "local" in nature, there is reason to hope that this (and perhaps other) mechanism(s) will work well. The work is related to the recent literature on the foundations of Walrasian Equilibrium in that it points up a relationship between the appropriateness of Walrasian equilibrium as a solution concept, the incentives for strategic play, the aggregate level of complementarities in the economy and the problem of coordinating economic activity.

This study estimates the effects of allowing bank holding companies (BHCs) to enter several lines of financial business not now permitted. A simulation technique is used to estimate the risk and return of hypothetical financial corporations after merger between a BHC and a large firm in each of these industries: securities, real estate, life insurance, property and casualty insurance, and insurance agencies. The study concludes that a merger between a BHC and a life insurance company may decrease the probability of bankruptcy for the merged firm relative to the BHC alone. This result does not hold true, however, for BHC mergers with firms in the other industries. In particular, BHC mergers with securities or real estate firms are found to increase the probability of bankruptcy.

Stochastic inflation affects the risk characteristics, measured by the equity premium and the correlation of the equity’s return with consumption, in a fundamental way. The riskiness of a dollar-denominated asset depends on two conditional covariances: the covariance of the marginal rate of substitution (MRS) with the equity price and the covariance of the MRS with the rate of appreciation in the purchasing power of money. The second covariance may take either sign which becomes significant when the risk characteristics of the dollar-denominated asset are compared with the risk characteristics of an indexed asset constructed in a real version of the model.

The effects of stochastic inflation on the assets’ risk characteristics are studied in a parameterized version of a cash-in-advance asset-pricing model. The growth rates of the endowment and monetary transfer evolve according to a VAR. The equity price is a geometric distributed lead of log–normally distributed random variables; an algorithm to express the price as an explicit function of the state variables is described.

This paper examines several grounds for doubting the value of much of the special attention recently devoted to unit root econometrics. Unit root hypotheses are less well connected to economic theory than is often suggested or assumed; distribution theory for tests of other hypotheses in models containing unit roots are less often affected by the presence of unit roots than has been widely recognized; and the Bayesian inferential theory for dynamic models is largely unaffected by the presence of unit roots. The paper displays an example to show that when Bayesian probability statements and classical marginal significance levels diverge as they do for unit root models, the marginal significance levels are misleading. The paper shows how to carry out Bayesian inference when discrete weight is given to the unit root null hypothesis in a univariate model.

For the first-order univariate autoregression without constant term, the joint p.d.f (corresponding to a flat prior) for the true coeffecient p and the least squares estimate p-hat is estimated by Monte Carlo and graphically displayed. The graphs show how the symmetric distribution of p|p-hat coexists with the assymetric distribution of p-hat|p. Treating tail areas of the p-hat|p distribution as if they summarized evidence in the data about the location of p amounts to ignoring the shrinkage in the variance of p-hat|p as p approaches one. Prior p.d.f.'s implicit in treating classical significance levels as if they were Bayesian conditional probabilities are calculated. They are shown to depend sensitively on p-hat and to put substantial probability on p's above one.

Leamer (1983) suggested to study the range of estimators β˅0 in the model y=Xβ + δ when imposing linear constraints of the form M (Cβ - c) = 0 where only C and c are fixed. However the extremes may come from models with a bad R^2, say. In this paper we give the exact bounds when only considering models with R^2 ≥ (1 - δ) R^2 max + δR^2 min. These exact bounds can be found from calculating only two regressions. We apply our techniques to study the velocity of money.