deposit insurance and external finance i introduction capital markets serve an essential purpose in the growth and development of modern economies they provide for the efficient channeling of funds from savers to investors there are two basic methods for financing capital investment primary issuance of equity or bonds and securing of bank loans looking around the world we see that countries differ substantially in the relative importance of banks and capital markets in providing investment financing equity market capitalization currently ranges from close to zero in countries like austria argentina and greece to nearly two times gross domestic product gdp in the united kingdom south africa and malaysia the importance of bank loan financing is essentially the mirror image of this what accounts for the cross country differences in the importance of banks and capital market financing of investment the purpose of this article is to address this question directly we contend that much of the variation across countries in the depth and breadth of capital markets can be explained by a combination of the existence of deposit insurance and the extent to which a country s banking system is state owned because of the importance of financial intermediation and the difficulties associated with potential bank failures governments in most countries have established a set of institutional structures to ensure the stability of their banking systems primary among these is the creation of deposit insurance by insuring deposits banks liability holders are significantly less likely to request the return of callable deposits reducing the chances of bank runs but at the same time deposit insurance subsidizes bank risk taking activities and allows the payment of lower interest rates to depositors 1 this channels money through banks and away from financial markets direct state bank ownership has a similar impact see barth et al 2001 la porta et al 2000 we present a simple three sector model in which the economy is composed of firms banks and households the firms require operating capital and can obtain it either through equity issuance or from bank loans banks take deposits from households and make loans to firms while households both allocate their wealth and purchase the firms output the model allows us to show how increases in deposit insurance or the percentage of the banking system that is state owned both reduces the size of the capital market and shrinks the amount of bank credit to the private sector and may decrease the number of firms seeking equity financing to examine the predictions of the model we study a data set composed of 49 countries of these 33 currently have explicit deposit insurance and 42 have some state ownership of banks ranging from less than 2 to almost 90 the data confirm the predictions of the model an increase in either state bank ownership or presence of deposit insurance both decreases the size of capital markets and the extent of bank lending for example we would predict that decreasing the percentage of the banking system that is state owned from 36 as it is in italy to zero would increase in the size of the capital market from less than 10 to over 30 of gdp and a raise in the level of bank lending from 57 to close to 90 of gdp our conclusions are in contrast with those in la porta et al 1997 who study the relationship between law and finance la porta et al note the importance of the countries legal system in determining the structure of the financial system in particular they point out that investors provide capital to firms only if they believe they will get their money back for equity holders this means that they must be able to vote out directors and managers who do not pay them for creditors and holders of bonds this means that they must have authority to repossess collateral furthermore these nominal legal rights must be accompanied by confidence that the laws will be enforced

energy disruptions interfirm price effects and the aggregate economy in an economy with many imperfect competitors monopolistic competition firms that pass through higher oil prices during a disruption will affect the demand for firms in other industries firms that charge higher prices for their final product will include the effect on their own final product in their private decisions but will exclude the effect on the final products of other firms although a pecuniary externality these actions will reduce society s welfare unlike the case of a perfectly competitive market this situation creates a societal risk that is much wider than an externality in any single market policy interest shifts from one of punishing persian gulf oil producers to one of cushioning an industrialized economy from sudden disruptions caused by political and military conflicts although the value of reducing oil use depends upon a number of unknown parameters with wide distributions a representative numerical example suggests that it may approach 5 per barrel

optimal state dependent rules credibility and inflation inertia abstract we use a state dependent model where pricing rules are optimal to examine the costs of a money based disinflation under various assumptions about the credibility of the policy change our analysis allows us to relate actual credibility and future inflation inertia to the asymmetry of the price deviation distribution an important implication of our state dependent setting is that disinflation can be attained without substantial cost even in a situation of low credibility provided that a mechanism of price alignment eliminates the asymmetry of the price deviation distribution we also develop an analytical framework for analyzing intermediate imperfect credibility cases

imperfect competition multiple equilibria and unemployment policy this paper takes a simple imperfectly competitive macro model with increasing returns and shows how it can lead to nonexistence or multiplicity of equilibria the consequences for government policy toward unemployment are explored and shown to be very different from the traditional model it is argued that a multiple equilibrium model is an attractive possible explanation of the behavior of u k unemployment in the 1980s copyright 1990 by royal economic society

adapting prices or quantities in the presence of adjustment costs it is often hypothesized that costs of adjusting both price and quantities may have important implications for the macroeconomic adjustment process not least to nominal shocks we analyse this in an explicit intertemporal general equilibrium model considering the empirically relevant case of fixed costs of adjusting prices and fixed and variable costs of adjusting quantities we find that the presence of both price and quantity adjustment costs changes the response to shocks significantly it is an implication that small shocks do not support the menu cost case but rather both fixed prices and quantities rationing a numerical analysis based on available evidence on adjustment costs is used to illustrate the likelihood that the various adjustment patterns actually arise

the inexorable and mysterious tradeoff between inflation and unemployment this paper discusses the short run tradeoff between inflation and unemployment although this tradeoff remains a necessary building block of business cycle theory economists have yet to provide a completely satisfactory explanation for it according to the consensus view among central bankers and monetary economists a contractionary monetary shock raises unemployment at least temporarily and leads to a delayed and gradual fall in inflation standard dynamic models of price adjustment however cannot explain this pattern of responses reconciling the consensus view about the effects of monetary policy with models of price adjustment remains an outstanding puzzle for business cycle theorists several years ago i gave myself a peculiar assignment i decided to try to summarise all of economics in ten simply stated principles the purpose of this task was to introduce students to the economic way of thinking in the first chapter of my textbook principles of economics i figured if god could boil all of moral philosophy down to ten commandments i should be able to do much the same with economic science most of the ten principles i chose were microeconomic and hard to argue with they involved the importance of tradeoffs marginal analysis the benefits of trade market efficiency market failure and so on i allocated the last three principles to macroeconomics the first of these was a country s standard of living depends on its ability to produce goods and services which i viewed as the foundation of all growth theory the second was prices rise when the government prints too much money which i took to be the essence of classical monetary theory the last of my ten principles is the subject of today s lecture society faces a short run tradeoff between inflation and unemployment perhaps not surprisingly this statement turned out to be controversial when my publisher sent out the manuscript for review a few readers objected

innovations prices and employment research firms are motivated by the prospect of monopoly rents that can be captured when a successful innovation is patented but those rents will be destroyed by the next innovation 1

market structure and fiscal policy effectiveness in a monopolistic competition macromodel with endogenous market structure the fiscal multiplier is shown to consist of two components the first depicts the response of output to a fiscal expansion through the conventional channels that disregard the role of market imperfections the second component captures the effects of firms market power as well as the policy induced change in market structure the latter effect which has not been taken into account in existing studies is shown to be quite significant in raising the fiscal multiplier even above unity and in improving consumers welfare when the labour market is competitive

the development of nominal wage rigidity in the late 19th century wage price and output indexes suitable for comparing cyclical movements across decades show a decrease in nominal wage flexibility the change in wage inflation associated with output fluctuations after the 1880s following an increase in strike frequency linked to the spread of large scale manufacturing cross sectional data show that firms in industries experiencing more strikes in the 1880s were less likely to cut nominal wages in the depression of 1893 this and other evidence suggests that the nineteenth century decrease in wage flexibility was caused by an increase in workers bargaining power in the absence of binding wage contracts copyright 1993 by american economic association

inflation costly price and quantity adjustments and time spent in the keynesian regime abstract this paper considers a menu cost firm under inflation due to costly quantity adjustments the firm is sometimes in a keynesian regime where sales are demand determined with a positive real interest rate the proportion of time in the keynesian regime is less than the inverse of the absolute value of the average elasticity of demand in that regime

the shifting drivers of global liquidity abstract the sensitivities of the main global liquidity components international loan and bond flows to global factors varied considerably over the past decade the estimated sensitivity to us monetary policy rose substantially in the immediate aftermath of the global financial crisis peaked around the time of the 2013 fed taper tantrum and then reverted towards pre crisis levels conversely the responsiveness of international bank lending to global risk conditions declined steadily throughout the post crisis period we show that the main driver of the fluctuations in the estimated sensitivities to us monetary policy was the degree of convergence among advanced economy monetary policies meanwhile the post crisis fall in the sensitivity of international bank lending to global risk was mainly driven by increases in the lending shares of better capitalized banking systems

adjustment costs inventories and output this paper analyzes the optimal adjustment strategy of an inventory holding firm facing price and quantity adjustment costs in an inflationary environment the model nests both the original menu cost model that allows production to be costlessly adjusted and the later model that includes price and quantity adjustment costs but rules out inventory holdings it is shown that the firm s optimal adjustment strategy may involve stockouts at low inflation rates output is inversely related to the inflation rate and the length of time demand is satisfied increases with the demand elasticity but decreases with the storage cost and the real interest rate

can more frequent price changes lead to price inertia nonneutralities in a state dependent pricing context the authors present a generalized s s state dependent pricing model in which menus are changed not just in response to price misalignment but also in response to factors such as changing product mix their model generates aggregate price inertia and so reverses an important earlier result on neutrality in state dependent pricing contexts in more general settings than previous modifications it also provides a compromise between state and time dependent rules gives a glimpse at the dynamic implications of menu cost models and reproduces two recent results one on phillips curve slopes and one on asymmetric fluctuations copyright 1997 by economics department of the university of pennsylvania and the osaka university institute of social and economic research association

deposit insurance and money market freezes in the presence of deposit insurance a rise in counterparty risk may cause a freeze in interbank money markets we show this in a general equilibrium model with regionally segmented bank based retail financial markets in which money markets facilitate the reallocation of funds across banks from different regions counterparty risk creates an asymmetry between banks in savings rich regions which remain marginally financed by the abundant regional insured deposits and in savings poor regions which have to pay large spreads in money markets this asymmetry distorts the aggregate allocation of credit and in the presence of demand externalities can cause large output losses

elusive persistence wage and price rigidities the new keynesian phillips curve and inflation dynamics abstract we review the main new keynesian inflation equations that have arisen as a result of aggregation from individual firms price rigidities we find that on the whole they cannot account for inflation persistence a key feature of the empirical dynamics of inflation and with important policy implications the only exceptions seem to be when indexation is allowed in price setting or when price stickiness is combined with wage rigidity and staggering

reward structures and the allocation of talent as relative rewards that different professions receive are a key factor in the allocation of talent what determines the reward structure of a society is an important question this paper develops an equilibrium model of the allocation of talent between productive and unproductive activities such as rent seeking the existence of rent seeking creates a negative externality on productive agents and implies that relative rewards are endogenously determined the same externality can also lead to the existence of multiple equilibria each with different reward structures in a dynamic setting allocations of past generations as well as expectations of future allocations influence current rewards and the society may get trapped in a rent seeking steady state equilibrium the paper also discusses how the non pecuniary reward structure can be influenced by equilibrium selection and a historical example that suggests the presence of a causal link from the allocation of talent to non pecuniary rewards

imperfectly credible disinflation under endogenous time dependent pricing the real effects of an imperfectly credible disinfl ation depend critically on the extent of price rigidity therefore the study of how policymakers credibility affects the outcome of an announced disinflation should not be dissociated from the analysis of the determinants of the frequency of price adjustments in this paper we examine how the policymaker s credibility affects the outcome of an announced disinflation in a model with endogenous time dependent pricing rules both the initial degree of price ridigity calculated optimally and more notably the changes in contract length during disinflation play an important role in the explanation of the effects of imperfect credibility we initially evalute the costs of disinfl ation in as etup where credibility is exogenous and then allow agents to update beliefs about the type of monetary authority that they face we show that in both cases the interaction between the endogeneity of time dependent rules and imperfect credibility increases the output costs of disinflation

stabilising properties of discretionary monetary policies in a small open economy this article sets out a simple new keynesian open economy model and shows that the conduct of discretionary monetary policy in an open economy differs substantially from the closedeconomy framework the article shows analytically that the existence of the direct exchange rate channel in the open economy phillips curve impairs the perfect stabilising property of monetary policy in the face of demand side disturbances under domestic inflation targeting if cpi inflation is instead the target then the perfect stabilising property of monetary policy breaks down even in the absence of the direct exchange rate channel in the phillips curve

currency areas and voluntary transfers this paper discusses the relationship between the formation of a currency area and the use of voluntary fiscal transfers between countries we show that there is a trade off between the benefits of flexible exchange rates and the additional risk sharing benefits of voluntary transfers that can be sustained in a currency area we show that whether a currency area is beneficial or not will depend on the magnitude of economic parameter values in particular we show that in a simple two country model and for a plausible set of economic parameter values a currency area is optimal

new keynesian macroeconomics and the term structure this article complements the structural new keynesian macro framework with a no arbitrage affine term structure model whereas our methodology is general we focus on an extended macro model with an unobservable time varying inflation target and the natural rate of output which are filtered from macro and term structure data we obtain large and significant estimates of the phillips curve and real interest rate response parameters our model also delivers strong contemporaneous responses of the entire term structure to various macroeconomic shocks the inflation target dominates the variation in the level factor whereas the monetary policy shocks dominate the variation in the slope and curvature factors

sticky wage or sticky price analysis of the cyclical behavior of the real wage the study of business cycles has been at the heart of macroeconomic theory for decades theoretical efforts have focused on providing an adequate explanation for sources of economic fluctuations new keynesian explanations have emphasized rigidity that interferes with market forces increasing the effect of demand shocks on the output produced the form of rigidity is in sharp contrast between sticky wage and sticky price models the former imposes rigidity on the shortrun adjustment of wages to demand shocks 20 47 the latter in contrast imposes rigidity on the short run price adjustment to demand shocks 2 34 40 9 43 4 the theoretical plausibility of competing explanations of business cycles has stimulated interest to establish their empirical validity 32 28 1 8 11 23 21 26 these efforts have focused attention on cyclical fluctuations of the real wage in response to demand shocks the real wage may move procyclically or countercyclically according to the relative adjustment of wages and prices the interest in studying the cyclical behavior of the real wage relates to its implications to the real effects of aggregate demand shocks in the context of sticky wage models nominal wage rigidity reinforces the countercyclical response of the real wage to demand shocks and the real effect of these shocks on output growth sticky price models in contrast advocate that price rigidity increases the procyclical response of the real wage to demand shocks and their real effect on output growth the results of earlier investigations of the cyclical behavior of the real wage appear conflicting and therefore do not lend support to a given explanation 2 the present investigation seeks to contribute to this literature unlike previous empirical research on the subject the objective of this investigation is to study the cyclical behavior of the real wage and the relative flexibility of the nominal wage and the price level that determines this behavior in response to demand shocks using data for the united states in the preand post world war ii sample periods the cyclical

low inflation pass through and the pricing power of firms abstract recently there has been a significant decline in the degree to which firms pass through changes in costs to prices a decline that is frequently characterized as a reduction in the pricing power of firms the decline appears to be associated with the decline in inflation in many countries the decline has important implications for monetary policy because it affects both forecasts of inflation and the effects of changes in monetary policy on inflation some have argued that the decline in pricing power helped to keep inflation low in the face of apparently strong demand pressures in the united states in the late 1990s this paper puts forth the view that the decline in pass through or pricing power is due to the low inflation environment that has recently been achieved in many countries first a microeconomic model of price setting is used to show that lower pass through is caused by lower perceived persistence of cost changes evidence is then presented showing that inflation is positively correlated with persistence of inflation suggesting that the low inflation itself has caused the low pass through an economy wide model consistent with the micromodel is then presented to illustrate how such changes in pricing power affect output and inflation dynamics in favorable ways but can disappear quickly if monetary policy and expectations change

capital distribution and macroeconomics core beliefs and theoretical foundations the paper suggests an alternative benchmark model or microfoundations for theorising about macroeconomic phenomena in the case of competitive equilibria this alternative reflects a classical sraffian explanation of relative prices this approach also provides a coherent framework for the analysis of the choice of technique in a multi commodity setting in turn it leads to results which throw into question a number of key propositions of conventional macro theory including the notion of a long run self correcting mechanism for involuntary unemployment in the presence of wage and price flexibility the paper argues that a classical sraffian approach provides a means of reconciling keynesian results with competitive outcomes copyright 2004 oxford university press

sticky prices as coordination failure this paper links the coordination failure and menu cost approaches to the microeconomic foundations of keynesian macroeconomics if a firm s desired price is increasing in others prices then the gain from price adjustment after a nominal shock is greater if others adjust this strategic complementarity leads to multiple equilibria in the degree of rigidity welfare may be much higher in the equilibria with less rigidity thus nominal rigidity arises from a failure to coordinate price changes jel e12 e30 keynesian macroeconomics waned in the 1970 s because economists grew disenchanted with its weak microeconomic foundations the central difficulty was that keynesian models were based on ad hoc rigidities in nominal wages and prices the 1980 s produced two approaches to reviving keynesian theory the menu cost literature n gregory mankiw 1985 george akerlof and janet yellen 1985 seeks to provide rigorous explanations for nominal rigidities these papers argue that small frictions in price setting are enough to produce large nominal rigidities in contrast the coordination failure literature russell cooper and andrew john 1988 abandons nominal rigidities and seeks alternative foundations for keynesian models the central idea is that many economic activities such as production e g john bryant 1983 trade e g peter diamond 1982 and investment e g nobuhiro kiyotaki 1988 exhibit synergism or strategic complementarity one agent s optimal level of activity depends positively on others activity strategic complementarity can lead to multiple equilibria with high activity equilibria superior to low activity equilibria thus an economy may be stuck in an underemployment equilibrium even though a superior equilibrium exists models with nominal rigidities and models with coordination failures are often presented as competing paradigms 1 this paper shows that this view is incorrect we take a step toward unifying the foundations of keynesian economics by showing that the two sets of ideas are highly complementary nominal rigidity arises from a failure to coordinate price changes this failure has the essential features of coordination failures in previous models flexibility in one firm s price increases the incentives for other firms to make their prices flexible this strategic complementarity leads to multiple equilibria in the degree of nominal rigidity equilibria with less rigidity more active price adjustment are often pareto superior to equilibria with more rigidity these results contribute to our understanding both of coordination failure and of nominal rigidity the range of keynesian phenomena explained by coordination failures is greatly expanded previous coordination failure models contain only real variables and thus ascribe no role to monetary policy or other determinants of nominal spending our results suggest that coordination failure is at the root of inefficient nonneutralities of money theories of nominal rigidities gain new empirical and policy im

an interview with edmond malinvaud this article contains an interview with edmond malinvaud professor malinvaud describes the origins of his interest in economics teachers who had a major influence on his development as an economist his visit to the cowles commission in 1950 the substance of his research and the contributions he made as a policy maker among the interesting tidbits in the interview is that professor malinvaud s popular textbooks in microeconomic theory macroeconomics and econometrics were a direct outgrowth of courses he taught at insee i am not good at speaking he said when not constrained by a written text

the role of product market regulations in the process of structural change abstract the sectoral allocation of labor differs considerably across developed economies even in the presence of similar patterns of structural change a general equilibrium model that captures the stylized facts of structural change is presented in this framework economy wide product market regulations hinder the development of dynamic sectors such as service industries this is consistent with the negative cross country relationship between product market regulations and the service employment share discussed in the paper additionally the model suggests that higher service prices and rents in regulated economies reduce labor supply providing a rationale for the negative association between product market regulations and the employment rate previously found in the literature

stabilisation policy targets and unemployment in imperfectly competitive economies this paper argues that the rate of equilibrium unemployment depends on the objectives of the central bank in a model where the central bank uses monetary policy to stabilise the economy we show that unemployment and inflation will be lower with an inflation target than with targets for output money or nominal gdp the intuition for this is that the elasticities of demand in both the product and the labour markets are greater when there is an inflation target we show that this leads to a lower mark up of price over marginal cost and makes wages more sensitive to unemployment

nominal rigidity and monetary uncertainty abstract a stochastic macromodel with dynamically optimising wage setting households is used to examine the effect on current macroeconomic variables of an anticipated increase in variability of the money stock there is a nominal rigidity in the form of a money wage set one period in advance in whose absence monetary uncertainty has no effect on current variables we show that for plausible parameterisations monetary uncertainty combined with nominal rigidity raises the nominal interest rate depressing aggregate demand and hence current price and output it also causes the wage to be set higher increasing the natural rate of unemployment

european monetary union adjustment and exchange rate variability abstract this paper uses a three country three good factor specific model of trade with wage rigidities to investigate how european monetary union is likely to affect exchange rate variability focusing on international macroeconomic adjustment under both exogenous and optimizing monetary policies it shows that the relative variability against external currencies of the euro and a basket of predecessor currencies depends on the relative sizes and specialization patterns of countries and the relative importance of different shocks monetary union is likely to decrease increase aggregate european exchange rate variability for shocks to industries in which large small euro area countries specialize

endogenous market structures and the business cycle we propose a flexible prices model where endogenous market structures and search and matching frictions in the labor market interact endogenously the interplay between firms endogenous entry strategic interactions among producers and labor market frictions represents a strong amplification channel of technology shocks on labor market variables and helps addressing the unemployment volatility puzzle consistently with u s evidence new firms create a large fraction of new jobs and grow faster than more mature firms net firms entry is procyclical and the price mark up is countercyclical

comment on theoretical analysis regarding a zero lower bound on nominal interest rates the sharp decline in interest rates in the past two decades has shifted attention to a new policy question do low interest rates interfere with the ability of a central bank to do its job some say the answer is yes according to them with rates low the central bank has lost the option to cut them further in the event of a bad economic shock 1 according to mccallum the right answer is no he asserts that the central bank has a second tool for stabilizing the economy the exchange rate he maintains that the central bank can stabilize the economy by exploiting its control over the exchange rate even if it cannot cut the interest rate because it is stuck on its zero lower bound according to mccallum s model exchange rate policy can even lift the economy out of the worst case scenario this occurs when the nominal rate of interest is zero and the expected future price level and exchange rate are sxed because the public srmly believes the central bank is committed to a price level target in this scenario a standard prescription for stimulating the economy reduce the real interest 1ate by committing to loose money in the future is ineffective according to mccallum s model this worst case scenario is not as big a problem as it might seem the central bank can still stimulate the economy by depreciating the currency through purchases of foreign exchange in my comment i make two points

a quantized approach to rational inattention abstract in this paper i propose a model of rational inattention where the choice variable is a deterministic function of the exogenous variables and still only a finite amount of information is being used this holds provided the choice variable is discrete rather than continuous that is the mapping from the realization of the exogenous variables to the endogenous ones is piece wise constant thus limited information is now a source of lumpiness in behavior rather than a source of noise the approach is applied to a simple static model of price setting where individual price setters face aggregate monetary shocks and idiosyncratic productivity shocks the effect of aggregate money shocks on output and prices is studied it is shown that as the variance of idiosyncratic shocks become large the aggregate log price level converges to a linear function of the aggregate money shock with a coefficient which is strictly between 0 and 1 consequently unanticipated aggregate money shocks have real effects on output in contrast to the sticky price model of caplin and spulber 1987 but these effects are smaller than in standard rational inattention models or in the lucas 1972 misperception model

inflation and productive activity in a multiple matching model of money abstract this paper investigates the relationship between money growth inflation and productive activity in a dynamic general equilibrium multiple matching framework where trade frictions are manifested by limited consumption variety productive activity and matching in the goods market are endogenized by a time allocation decision of work and search effort we find that a high degree of complementarity between participation in the labor and goods markets creates a channel by which inflation can positively influence production and output this feature arises when household preferences for consumption variety is sufficiently large and it can also lead to the multiplicity of monetary equilibria

living in an imaginary world that looks real abstract in the paper we show using standard approaches general equilibrium modeling and the assumption of complete rationality that the macroeconomic environment is endogenous and is indeterminate specifically it is argued without resorting to sunspot type arguments that microeconomic fundamentals do not suffice to characterize the economy at the macro level in particular we show how perceptions of rational agents of the workings of the economy a shape the environment b affect the environment sufficiently to ensure that rational economic agents find the observed environment consistent with their beliefs even though it is not as a by product we illustrate that endogenous macro uncertainty can arise as an outcome if rational economic agents whose expectations are anchored on endogenous variables expect them to arise finally we show that systematic errors can persist indefinitely under rationality

interactions of commitment and discretion in monetary and fiscal policies we consider monetary scal interactions when the monetary authority is more conservative than the scal with both policies discretionary 1 nash equilibrium yields lower output and higher price than the ideal points of both authorities 2 of the two leadership possibilities scal leadership is generally better with scal discretion monetary commitment yields the same outcome as discretionary monetary leadership for all realizations of shocks but scal commitment is not similarly negated by monetary discretion second best outcomes require either joint commitment or identical targets for both authorities output socially optimal and price level appropriately conservative or complete separation of tasks jel e61 e63

theoretical developments in the light of macroeconomic policy and empirical research macroeconomics is surveyed with emphasis on the implications of the new classical and rational expectations critiques for the keynesian paradigm and the role of macro policies at the background are the main macro developments of the 1 970s and 1 980s as well as the specific lessons of recent high chronic inflation processes a synthesis is emerging in which the basic keynesian view of the existence of market and price coordination failures as well as room for pareto improving policy intervention are maintained at the same time the theoretical underpinnings are undergoing substantial change mainly due to a rational expectations reformulation

corporate debt overhang and macroeconomic expectations one way in which corporate financial structure affects macroeconomic performance is by creating debt overhang debt overhang occurs when existing debt deters new investment because the benefits from new investment will go to the existing creditors not to the new investors if the economy is booming debt overhang will not bind because the returns to investing are high if the economy is stagnant debt overhang will bind because the returns to investing are low as a result high levels of debt can create multiple expectational equilibria in which animal spirits determine economy activity copyright 1995 by american economic association

asymmetric effects of money supply shocks and trend inflation in recent years a number of empirical studies have presented evidence that money supply shocks have asymmetric effects that is unexpected negative changes in the money supply slow the economy more than unexpected positive changes accelerate the economy evidence of asymmetry was documented by cover 1992 for the postwar u s economy and his finding was confirmed by de long and summers 1988 morgan 1993 rhee and rich 1995 and karras 1996a b stimulated by these empirical works several attempts have been made to provide microeconomic foundations for the asymmetric effects of money supply shocks 1 among those theories this paper examines the one that focuses on asymmetric price adjustment and let us call it a sticky price theory money supply shocks will have asymmetric effects on real output if prices are less flexible downward than upward this sticky price theory was proposed by tsiddon 1993 ball and mankiw 1994 and caballero and engel 1992 by employing a menu cost model the above researchers show that positive trend inflation can produce the asymmetric effects of money supply shocks the logic of their theory is the following along with price adjustment costs positive trend infla

nominal disturbances wage flexibility and shifting resources in a two sector economy the recent behaviour of european unemployment rates has sparked considerable interest in the connection between wage flexibility and unemployment see for example bruno and sachs i985 and the papers in the i986 supplement to economica much of the empirical work finds that economies adjust more rapidly and with less inflation when wages and prices are very responsive to unemployment this finding supports the belief that greater wage and price flexibility leads to greater macroeconomic stability in fact one can view martin weitzman s i 983 i 984 and i 985 share system as an institutional change aimed at providing sufficient wage and price flexibility to avoid unemployment it is hard to imagine how wage and price flexibility could increase in all sectors of the economy simultaneously instead greater aggregate wage and price flexibility is likely to result from increased wage and price flexibility at particular firms in particular sectors as a result realistic proposals for share systems involve some time perhaps forever when share firms and wage firms would coexist during this period an increase in aggregate flexibility will be associated with an increase in the difference in wage and price flexibility between sectors this paper analyses allocational issues raised by such an uneven increase in aggregate wage and price flexibility the analysis is done explicitly in terms of a short run two sector model where the first sector is a fixed wage sector and the second sector is a share sector the model is short run because both the number of firms in each sector and the pay parameters at all firms are fixed while the explicit analysis is done in terms of share firms in the second sector the model is more general the second sector can be thought of as the flexible sector where wage and price flexibility maintain full employment an important new phenomenon occurs in the mixed system relative prices change in response to nominal disturbances in particular the relative price of the flexible sector falls in response to a decrease in nominal aggregate demand as a result of the change in relative prices both the utilisation of labour and the mix of consumption shift to the more flexible sector in addition the opposite shifting of resources and consumption occurs in response to an increase

modeling the demand for alcoholic beverages and advertising specifications in this paper the demand for beer wine spirits and soft drinks in ontario is modeled in two parts an equation is specified to endogenize group expenditures and a demand system is set up to allocate budgeted group expenditures across types of beverages advertising is allowed to influence both the level of group expenditures and its allocation three popular advertising specifications are compared using the j test and the likelihood dominance criterion even though all three specifications fitted well according to standard criteria the calculated expenditure price and advertising elasticities were sensitive to the manner with which advertising is specified this clearly highlights the need to rely on a sound criterion to identify a dominant specification from the identified dominant specification we found that advertising has very subtle effects on expenditures on alcoholic beverages group and individual beverages thus advertising is not effective in enlarging markets and this suggests that firms especially breweries use advertising to compete in zero sum market share games from a public policy perspective our results are comforting but future research should investigate whether the neutral effect of advertising on aggregated expenditures hide substantial offsetting changes in the drinking habits of individuals 2000 elsevier science b v all rights reserved

aggregate pattern of time dependent adjustment rules ii strategic complementarity and endogenous nonsynchronization abstract this paper provides an explanation for an important institutional feature of staggered time dependent adjustment rules assumed in a number of macroeconomic models it identifies strategic complementarity as the crucial factor leading to nonsynchronized decisions in a game theoretic framework the paper first shows that nonsynchronization is the equilibrium outcome in an infinite horizon game in which strategic complementarity is present whether the players choose predetermined or fixed actions by pursuing the interpretation of a nonsynchronized move dynamic game as a series of games with symmetric stackelberg leadership it is further suggested that the relationship between strategic complementarity and the benefit to the stackelberg follower provides the insight to the game theoretic explanation of nonsynchronization the results of this paper reveal a link between strategic complementarity and nonsynchronization two important macroeconomic features journal of economic literature classification numbers e30 l16

some evolutionary foundations for price level rigidity this paper shows that price rigidity evolves in an economy populated by imperfectly rational agents who experiment with alternative rules of thumb in the model firms must set their prices in face of aggregate demand shocks their payoff depends on the level of aggregate demand as well as on their own price and their neighbor s price the latter assumption captures local interactions despite the fact that the rational expectations equilibrium ree is characterized by a simple pricing rule that firms can easily adopt the economy does not converge to the ree for all parameter values when the volatility of monetary innovations is low and interactions among firms are high the aggregate price level exhibits rigidity in that it does not fully react to contemporaneous aggregate demand shocks we discuss the role of the nature of experimentation and of path dependence driven by interactions in explaining these results

monopolistic competition and the effects of aggregate demand how important is monopolistic competition to an understanding of the effects of aggregate demand on output we ask the question at three levels can monopolistic competition by itself explain why aggregate demand movements affect output can it together with other imperfections generate effects of aggregate demand in a way that perfect competition cannot if so can it give an accurate account of the response of the economy to aggregate demand movements the answers are no yes and yes

optimal random monetary policy with nominal rigidity abstract this paper studies a money in the utility function model with imperfect competition and one period ahead nominal price setting under standard assumptions on preferences friedman s rule setting the money growth rate equal to the household time discount factor generates an equilibrium that is optimal within the class of deterministic policies we then provide conditions under which a random monetary policy increases ex ante expected welfare relative to friedman s rule the result obtains because random policy can reduce the distortion associated with imperfect competition our result exhibits original features relative to existing cases of welfare improving random monetary policy such as polemarchakis and weiss j econom theory 15 1977 345

price formation in an open economy theory and evidence for the united kingdom 1951 1991 price formation is an increasingly important part of modern macroeconomics however the empirical literature on price setting is diverse and confused this paper uses cointegration techniques to test theories of price setting on uk aggregate data for 1951 91 we find i domestic prices are determined by both domestic costs and world prices and ii at the macroeconomic level prices are related to marginal cost rather than average or normal cost

relative price changes as aggregate supply shocks this paper proposes a theory of supply shocks or shifts in the short run phillips curve based on relative price changes and frictions in nominal price adjustment when price adjustment is costly firms adjust to large shocks but not to small shocks and so large shocks have disproportionate effects on the price level therefore aggregate inflation depends on the distribution of relative price changes inflation rises when the distribution is skewed to the right and falls when the distribution is skewed to the left we show that this theoretical result explains a large fraction of movements in postwar u s inflation moreover our model suggests measures of supply shocks that perform better than traditional measures such as the relative prices of food and energy

in search of the liquidity effect in a modern monetary model abstract this paper examines the impact of a monetary policy shock in a dynamic stochastic general equilibrium model with sticky prices and financial market frictions first we examine the shortcomings of monetary models emphasizing these frictions individually the model then is specified to limit the response of prices and savings to a current period monetary disturbance our results show that this model can account for the following key responses to an expansionary monetary policy shock a fall in the nominal interest rate a rise in output consumption and investment and a gradual increase in the price level finally a detailed sensitivity analysis shows the model s results depend on the parameters assigned to critical structural features

the magnitude of menu costs direct evidence from large u s supermarket chains we use store level data to document the exact process of changing prices and to directly measure menu costs at five multistore supermarket chains we show that changing prices in these establishments is a complex process requiring dozens of steps and a nontrivial amount of resources the menu costs average 105 887 year per store comprising 0 70 percent of revenues 35 2 percent of net margins and 0 52 price change these menu costs may be forming a barrier to price changes specifically 1 a supermarket chain facing higher menu costs due to item pricing laws that require a separate price tag on each item changes prices two and one half times less frequently than the other four chains 2 within this chain the prices of products exempt from the law are changed over three times more frequently than the products subject to the law in principle fixed costs of changing prices can be observed and measured in practice such costs take disparate forms in different firms and we have no data on their magnitude so the theory can be tested at best indirectly at worst not at all alan blinder 1991 p 90

do central banks act asymmetrically empirical evidence from the ecb and the bank of england the paper attempts to exploit whether monetary authorities have a different behaviour during recession and expansion to this end a multivariate extension of hamilton markov switching model is adopted first regime dependent taylor type rules are estimated for the euro area and the united kingdom in order to capture the systematic behaviour of central banks then impulse response functions that account for the different phases of the business cycle are analysed in addition a comparative analysis concerning the estimated rules as well as the different reaction of real economy to monetary shocks is implemented the study strongly suggests that central banks cannot neglect the regime where the monetary action takes place it follows that the phase of business cycle is an important matter in monetary policy decision process

shopping externalities and self fulfilling unemployment fluctuations we propose a novel theory of self fulfilling fluctuations in the labor market a firm employing an additional worker generates positive externalities on other firms because employed workers have more income to spend and have less time to shop for low prices than unemployed workers we quantify these shopping externalities and show that they are sufficiently strong to create s complementarities in the employment decisions of different firms and to generate multiple rational expectations equilibria equilibria differ with respect to agents rational expectations about future unemployment we show that negative shocks to agents expectations lead to fluctuations in vacancies unemployment labor productivity and the stock market that closely resemble those observed in the us during the great recession

imperfect competition and the suboptimality of rational expectations abstract this paper investigates whether nonrational expectations can lead to outcomes which other things being equal pareto dominate rational expectations outcomes in order to carry out this investigation we construct an intertemporal micro based macroeconomic model with the two following strong points a it accommodates both rational and non rational expectations b both prices and quantities are determined by optimizing agents in particular prices are determined by explicit price setters using objective demand curves in this model the first theorem of welfare holds so that the walrasian equilibrium with rational expectations cannot be pareto dominated this conclusion is extremely fragile however and we show that as soon as some degree of imperfect competition is present rational expectations are suboptimal in the sense that they are dominated by irrational expectations

fiscal policy multipliers the role of monopolistic competition scale economies and intertemporal substitution in labour supply a dynamic macroeconomic model of monopolistic competition is developed for the closed economy forward looking consumers demand differentiated goods supply labour and save part of their income in the form of shares producers manufacture the differentiated goods by using labour and capital we study the short run transition and long run effects of fiscal policy comparisons with the new classical case of perfect competition are made simple expressions far multipliers are derived the sensitivity of the multipliers for diversity preference and ethier productivity effects intratemporal and intertemporal substitution effects and markup effects under free and restricted entry are also studied

real exchange rates and the pattern of trade comparative dynamics for north and south abstract using a two country model of imperfect competition this paper examines cross sectional implications for the time series behavior of real exchange rates across different patterns of trade under intersectoral trade price setters display less interaction in their pricing decisions across national boundaries allowing for greater deviation and weaker mean reversion in relative prices conversely with intra industry trade greater price linkages between similar countries trading in similar goods generate lower pass through and less real exchange rate persistence the pattern of trade is shown to essentially alter the degree of domestic price stickiness which in turn affects the self correcting mechanism of an open economy

product market reforms labour market institutions and unemployment we analyze the impact of product market competition on unemployment and wages and how this depends on labour market institutions we use differential changes in regulations across oecd countries over the 1980s and 1990s to identify the effects of competition we find that increased product market competition reduces unemployment and that it does so more in countries with labour market institutions that increase worker bargaining power the theoretical intuition is that both firms with market power and unions with bargaining power are constrained in their behaviour by the elasticity of demand in the product market we also find that the effect of increased competition on real wages is beneficial to workers but less so when they have high bargaining power intuitively real wages increase through a drop in the general price level but workers with bargaining power lose out somewhat from a reduction in the rents that they had previously captured

what differentiates industrial business cycles a cross country investigation theoretical explanations appear in sharp contrast concerning the determinants of demand driven industrial business cycles aggregate factors are likely to differentiate cyclical fluctuations for a given industry across countries industry specific factors are likely to differentiate cyclical fluctuations across industries of a given economy the differences are evaluated using data for industries producing private domestic output across a group of major industrial countries aggregate factors dominate industryspecific factors in explaining industrial cyclical fluctuations in response to aggregate demand shifts consistent with the various explanations higher variability of aggregate demand moderates the response of industrial output to aggregate demand shifts across countries contrary to the implications of the new classical imperfect information model cyclical fluctuations in industrial output appear also smaller in response to higher trend price inflation across countries business cycles appear the

coordination through social learning in a general equilibrium model this paper analyses coordination through social learning in a general equilibrium model we use a fully decentralized economy in which households and firms exchange labour and consumption goods in the corresponding markets with potential rationing their strategies are updated through an evolutionary learning process based on imitation and random experimenting this learning process induces substantial coordination failures especially between firms which lead almost systematically to below equilibrium output levels and social welfare losses the main underlying mechanism is a self reinforcing uneven distribution of households income which results in a lack of aggregate demand

aggregation and optimization with state dependent pricing the literature on the aggregation of s s policies has ignored the impact of aggregate behavior on the individual s optimization problem in the case of pricing the feedback effects are clear not only do pricing strategies determine the evolution of the price level but the evolution of the price level also influences the optimal pricing strategies in this paper we provide a consistent treatment of aggregation and optimization we use this model to analyze three issues in the menu cost pricing literature the relationship between strategic complementarity and the real effects of money the relationship between the variance of the money supply and the correlation between money and output and the relationship between the cost of price adjustment and the size of price adjustment questions concerning the dynamics of aggregate variables such as prices employment investment and consumption represent the core of business cycle analysis one striking feature of these variables is the radical difference between properties of these aggregates and the nature of the individual behavior that underlies them the behavior of a firm s prices investment and employment and the behavior of an individual s consumption all involve frictional elements that lead to discrete adjustment at the microeconomic level heterogeneity among individuals however tends to smooth the behavior of the corresponding aggregates in recent years a large body of research has developed to examine the manner in which microeconomic frictions influence aggregate dynamics one of the centerpieces of this research has been the s s model developed by arrow harris and marschak 1951 the key element of this model is the state dependence of individual decisions agents act when a state variable crosses some critical threshold which balances the cost and benefits of adjustment the aggregate implications of this form of microeconomic behavior have been analyzed by blinder 1981 caplin 1985 and mosser 1991 in the context of inventory dynamics by caplin and spulber 1987 caballero and engel 1991 1993 and caplin and leahy 1991 in the context of prices and by bertola and caballero 1990 caballero 1993 and eberly 1994 in the context of con sumer durables one of the most limiting aspects of these models is that they focus exclusively on the impact that microeconomic inertia has on aggregate dynamics they 1we would like to thank michael harrison loannis karatzas john leahy sr andreu mas colell a co editor and four anonymous referees for helpful discussions and comments and the national science foundation and the sloan foundation for financial support

the new open economy macroeconomics a survey since the 1995 publication of obsteld and rogoff s redux model there has been an outpouring of research on open economy dynamic general equilibrium models that incorporate imperfect competition and nominal rigidities this paper offers an interim survey of this recent literature 2001 elsevier science b v all rights reserved

imperfect common knowledge staggered price setting and the effects of monetary policy this paper studies the consequences of a lack of common knowledge in the transmission of monetary policy by integrating the woodford 2003a imperfect common knowledge model with taylor calvo staggered price setting models the average price set by monopolistically competitive firms depends on their higher order expectations about not only the current state of the economy but also about the states in the future periods in which prices are to be fixed this integrated model provides a plausible explanation for the observed effects of monetary policy it shows analytically how price adjustments are delayed and how the response of output to monetary disturbances is amplified

imperfect competition and crowding out abstract this paper applies the central feature of imperfect competition in the goods market to examine the validity of the standard belief in international macroeconomics namely that policy effects in a small open economy are less effective than in a closed economy it is shown that the profit margin in imperfect competition and marginal propensity to leisure are the key factors in determining whether this standard belief is valid

firm entry excess capacity and endogenous productivity abstract we show that sluggish firm entry causes productivity to vary endogenously in response to technology shocks the endogenous productivity effect is caused by incumbent firms utilizing excess capacity as entry adjusts we develop a nonparametric model of endogenous sunk costs and monopolistic competition to show that imperfect competition and dynamic entry are necessary and jointly sufficient conditions for endogenous productivity fluctuations quantitatively we show the endogenous productivity effect is as large as that from a traditional capital utilization effect

what determines aggregate returns to scale abstract this paper develops a unified framework that incorporates four features important in existing models with increasing returns fixed costs decreasing marginal costs product variety and market power when fixed costs are not allowed to vary and profits are imposed to be zero in every period only the degree of returns to variety determines the degree of aggregate increasing returns to scale when fixed costs respond to changes in aggregate activity or the zero profit condition does not hold in the short run aggregate returns depend not only on product variety but also on diminishing marginal costs or market power the degree of market power however does not affect input prices which are critical to determine the uniqueness of equilibrium

price rigidities and market structure conventional wisdom has it that a large part of the explanation of keynesian unemployment is the observed rigidities of wages and prices what has been lacking however is a satisfactory theory or conjunction of theories which explains how wages and prices can be at non market clearing levels the objective of this paper is to sketch out several alternative theoretical explanations of this phenomenon each in contrast with keynesian theory is consistent with the observation that as the economy goes into a recession real product wages do not increase and may in fact decrease all of the theories assume rational profit maximizing firms and all entail some important departure from the standard competitive paradigm the first three explanations represent minor adaptations of standard models

small menu costs and large business cycles a macroeconomic model of monopoly i introduction the conflict between modern neoclassical and traditional keynesian theories of the business cycle centers upon the pricing mechanism in neoclassical models prices are fully flexible they represent the continuous optimization of economic agents and the continuous intersection of supply and demand in keynesian models prices are often assumed to be sticky they do not necessarily equilibrate all markets at all times one of the reasons for the resurgence of the equilibrium approach to macroeconomics has been the absence of a theoretical underpinning for this keynesian price stickiness this note shows that sticky prices can be both privately efficient and socially inefficient the business cycle results from the suboptimal adjustment of prices in response to a demand shock to the extent that policy can stabilize aggregate demand it can mitigate the social loss due to this suboptimal adjustment in some keynesian models prices are simply exogenously fixed 2 in others agents must set their prices in advance of the transaction date the act of altering a posted price is certainly costly these costs include such items as printing new catalogs and informing salesmen of the new price yet these menu costs are small and therefore generally perceived as providing only a weak foundation for these fixed price models however this inference is flawed small menu costs can cause large welfare losses the claim that price adjustment costs are small does not rebut the claim that they are central to understanding economic fluctuations

increasing returns and the foundations of unemployment theory current approaches to macroeconomic theory divide roughly into two basic schools of thought one approach typically associated with rational expectations views the economy as basically at or near walrasian market clearing equilibrium in which case it becomes very difficult to explain away convincingly the undeniable persistence at times of involuntary unemployment another approach views the underemployed economy as being in a state of temporary fixed price disequilibrium in which case aside from having to repress suspicions that the essence of effective demand failure might not have to do with prices fixed at wrong values there is a lot of rationalising to be done about why profitable adjustments are so slow this paper argues that something like an internally consistent theory of steady state involuntary unemployment is possible and even plausible the cornerstone of this third approach is increasing returns to scale which blocks unemployed agents from breaking out of a low level equilibrium trap unless there is overall coordination or stimulation a simple model is presented which contains the basic ideas

firm dynamics and markup variations implications for sunspot equilibria and endogenous economic fluctuations this paper analyzes how the interaction between firms entry and exit decisions and variations in competition gives rise to self fulfilling expectation driven fluctuations in aggregate economic activity and in measured total factor productivity tfp the analysis is based on a dynamic general equilibrium model in which net business formation is endogenously procyclical and leads to endogenous countercyclical variations in markups this interaction leads to indeterminacy in which economic fluctuations occur as a result of self fulfilling shifts in the beliefs of rational forward looking agents when calibrated with empirically plausible parameter values and driven solely by self fulfilling shocks to expectations the model can quantitatively account for the main empirical regularities characterizing postwar u s business cycles and for 65 of the fluctuations in measured tfp

excess capacity in a fixed cost economy abstract this paper proposes a new mechanism that can explain persistent economic slack the theory shows that when producers face negligible marginal costs and desired spending is below the economy s capacity the economy features slack in equilibrium even when prices are flexible and there are no other frictions a heterogeneous household version of the model demonstrates how an economy can enter a capacity trap in response to a temporary negative demand shock when demand by some consumers falls temporarily other consumers permanent income and hence their desired consumption also falls since output is determined by demand the permanent fall in desired consumption causes a permanent state of excess capacity

magazine prices revisited this paper examines price adjustment behaviour in the magazine industry in a frequently cited study cecchetti 1986 constructs a reduced form s s model for firms cecchetti assumes that a firm s pricing rules are fixed for non overlapping three year intervals and estimates the model using a conditional logit specification from chamberlain 1980 the estimates are inconsistent however due to the duration dependent specification of the model two alternative specifications are used to obtain consistent estimation the consistent estimates continue to provide strong evidence in favour of state dependent pricing models but only weak evidence on the behaviour of price adjustment costs copyright 2006 john wiley sons ltd

state dependent pricing and the general equilibrium dynamics of money and output economists have long suggested that nominal product prices are changed infrequently because of fixed costs in such a setting optimal price adjustment should depend on the state of the economy yet while widely discussed statedependent pricing has proved difficult to incorporate into macroeconomic models this paper develops a new tractable theoretical state dependent pricing framework we use it to study how optimal pricing depends on the persistence of monetary shocks the elasticities of labor supply and goods demand and the interest sensitivity of money demand

optimal monetary policy under low trend inflation abstract in the monetary policy literature it is common to assume that trend inflation is zero despite overwhelming evidence that zero inflation is neither empirically relevant nor a practical objective for central bank policy we therefore extend the standard new keynesian model to allow for positive trend inflation showing that even low trend inflation has strong effects on optimal monetary policy and the dynamics of inflation output and interest rates under discretion the efficient policy deteriorates and there is no guarantee of determinacy even with commitment targeting non zero trend inflation leads to substantial welfare losses our results serve as a warning against indiscriminate use of models assuming zero trend inflation

wage setting and the tax system theory and evidence for the united kingdom abstract this paper analyses the effects of a non linear tax system on wage bargaining the main conclusions are an increase in the marginal income or payroll tax rate reduces the pre tax wage in the isoelastic case an increase in the average tax rate increases the pre tax wage by more than the tax increase and a measure of the progressivity of the tax system residual income progression is a sufficient measure of the effect of the tax system on wage pressure empirical evidence is presented to support these propositions and the predictions of the model regarding the effect of recent changes to the u k tax system on the distribution of earnings discussed

taxation unemployment and growth dynamic welfare effects of green policies abstract this paper analyzes the effects of environmental tax reforms on a small open economy the labor market is characterized by union wage setting the carbon tax acts as an implicit tariff which gives rise to terms of trade gains the terms of trade effect together with the union wage setting leads to a positive relationship between the capital labor ratio and net foreign wealth in the short run the disinvestments in real and financial capital give temporary room for higher consumption and instantaneous utility the long run effect on instantaneous utility is more uncertain a strong double dividend may exist

existence of competitive equilibrium under financial constraints and increasing returns abstract this paper studies a factor cost in advance model with increasing returns in production in the model both partial equilibrium and general equilibrium may exist since working capital of firms limit their input demand we provide a sufficient condition for the existence of partial equilibrium of a firm operating on a non convex choice set furthermore we establish the existence and uniqueness of competitive equilibrium in the special case of logarithmic utility

institutions and short run macroeconomic performance abstract this paper reviews the growing interest in institutions it argues that the explanation for this interest is a fresh awareness of how institutions affect economic performance this connection arises because many economic interaction take the form of one or other of three classic games prisoners dilemma coordination and chicken and the outcome in these games and hence performance of the economy is influenced by the institutional context of these interactions the paper provides a detailed illustration of this argument with a survey of the literature which relates unemployment performances to the institutions of wage setting in oecd countries