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

fixed production capacity menu cost and the output inflation relationship this paper analyses the impact of inflation when firms face frictions in both price and quantity adjustments a vast literature examines the consequences of price adjustment costs assuming frictionless quantity adjustments however temporary quantity adjustments may be expensive for example because continual adjustments of the optimal production plant are impossible moreover recent findings suggest that frictions in quantity adjustment may remove the linkage between output and inflation in this paper we show that this is not the case when inflation is anticipated on the contrary a predetermined production capacity may significantly amplify the consequences of price adjustment costs

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

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

protecting endangered species when are shoot on sight policies the only viable option to stop poaching abstract protecting endangered species that offer poachers from low income countries high economic benefits remains a policy challenge a broadly applicable economic model of poaching shows why cites international bans have not always been successful especially in situations where black markets exist and nonpoaching wages are low in these situations poachers may have nothing left to lose since low nonpoaching wages impose a practical cap on the potential economic costs of fines and imprisonment thus the model suggests shoot on sight policies as the only viable option trends in animal populations appear to support the efficacy of the shoot on sight policies which also suggests an inherent value of life traditionally not captured in value of a statistical life estimates

a hedonic travel cost analysis for valuation of multiple components of site quality the recreation value of forest management abstract one benefit of managing forests is that one can alter the qualities of sites the value of changing site qualities however is generally not known this paper develops a formal hedonic travel cost model which can be used to estimate the value of both marginal and non marginal changes to sites the approach accommodates multiple simultaneous changes in site characteristics estimating this model using a set of permits from wilderness areas leads to revealed preference estimates of the recreational value of clear cuts old growth and nine other wilderness attributes

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

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

optimal disinflationary paths abstract this paper characterizes optimal monetary policy in the context of a general equilibrium model with optimizing agents and staggered price setting starting from a steady state with positive inflation a rapid disinflation is desirable when announcements of future monetary policy are fully credible disinflationary policy yields substantial losses in output and employment when the monetary authority lacks credibility nevertheless the benefits of disinflation still exceed the costs disinflation often fails to be welfare improving however when lost seignorage revenues must be replaced using other distortionary taxes

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

permanent effects of monetary policy in a dynamic menu cost model abstract this paper investigates whether a systematic monetary policy can affect output in a dynamic menu cost model that results in s s price rules it will be shown that monetary policy potentially can affect output not only in the short run but also with regard to long run average output even though the policy rule is fully known by the rational firm perfectly anticipated monetary policy intervention may have a permanent real effect in the long run

the impact of imperfect credibility in a transition to price stability in this paper we study the impact of a temporary lack of credibility in a transition to price stability we quantify the effects of a period of disinflation on temporary output losses and the impact of the lack of credibility on the optimal speed of disinflation we demonstrate that the disinflationary booms found by ball 1994 and ireland 1997 may or may not disappear in an environment with imperfect credibility depending on the speed of learning relative to the speed of disinflation finally we enquire whether the speed of the volcker disinflation was excessive or not

the characteristics model hedonic prices and the clientele effect in this paper the characteristics model of lancaster is reconsidered it is shown by example that equilibrium prices need not be linearly decomposable it does follow that equilibrium prices must be a convex function of characteristics however further it is shown that this fact holds independent of the form of firm competition e g perfect or monopolistic finally the predictions of the theory are discussed in the context of two empirical examples

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

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

external cost of coal based electricity generation a tale of ahmedabad city abstract electricity production causes unintended impacts their exclusion by the market leads to suboptimal resource allocations monetizing and internalizing of external costs though challenging and debatable leads to a better allocation of economic resources and welfare in this paper a life cycle analysis lca on the production of electricity from conventional coal based electricity generation system has been performed in order to examine the environmental impacts of coal based electricity generating systems in the twin city of ahmedabad and gandhinagar in western india by using dose response functions we make an attempt to estimate the damages to human health crops and building materials resulting from the operation of coal power plants and its associated mines further we use geographic information system to account for spatially dependent data finally monetary values have been assigned to estimate the damage to human health crops and building materials this study reveals that the health as well as on non health impacts of air pollution resulting from coal based electricity generation may not be ignored both in absolute as well as economic value terms

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

menu costs and the neutrality of money a model of endogenous price adjustment under money growth is presented firms follow s s pricing policies and price revisions are imperfectly synchronized in the aggregate price stickiness disappears and money is neutral the connection between firm price adjustment and relative price variability in the presence of monetary growth is also investigated the results contrast with those obtained in models with exogenous fixed timing of price adjustment

valuations of life and injury risks a research on valuing risks to life and health in thecontext of a developing country is practicallynon existent this study provides the first estimatedvalues of life and health using data from india these values can aid policy makers internationalagencies and researchers in evaluating health projectsin developing nations they can also be used to carryout comparisons with values obtained for developedcountries

costs of price adjustment and the welfare economics of inflation and disinflation this paper studies the welfare consequences of inflation and disinflation in a model in which monopol istic firms incur a fixed cost of price adjustment it is shown that a moderately increasing price level is associated with higher social welfare than a perfectly stable price level and the model therefore provides theoretical support for the widespread belief that a little bit of inflation is good for the economy nevertheless it is also tr ue that the eradication of a moderate inflation leads to an increase in social welfare copyright 1988 by american economic association

valuing bundled attributes a latent characteristics approach lancaster wrote that attributes of goods may combine to produce characteristics that are the primary units of consumption 1966 often the attributes of goods are bundled and cannot be separated we show that if attributes are technically bundled then valuation analyses that treat these attributes as independent will be wrong we show that a latent characteristics ap proach improves upon other methods by incorpo rating more information about attributes than standard methods and by directly modeling the linkages among attributes for the case of wilder ness hiking the latent approach provides a statis tically better model of site choice than other stan dard methods jel q20 q26

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

mixed monetary and non monetary valuation of attractive urban green space a case study using amsterdam house prices abstract this paper offers new insight into the monetary value of green space at the intra urban level to this end an established monetary valuation method hedonic price analysis is integrated with a relatively novel non monetary valuation method in specific online value mapping based survey data n 723 are used to inform hedonic models of the preferences that potential home buyers may have for nearby attractive green spaces the estimation uses data on 35 298 home transactions in the amsterdam agglomeration s urban core homes nearby attractive green space are found to sell at a price premium which decays with distance and becomes negligible after one kilometer the estimated price effect varies from 7 1 9 3 for houses within 0 25 km from the nearest attractive green space to 1 7 2 3 for houses located at 0 75 1 0 km away depending on the scale at which omitted spatial variables are controlled for adding to the discussion of spatial controls in this type of analysis the controls are evaluated at multiple scales and a metric that simplifies the interpretation of the scale of spatial controls the mean equalized diameter is introduced this study s findings may inform policymakers who seek to maximize the well being of urban citizens through public investments in attractive amenities

stopping inflations big and small previous studies of disinflation work with models in which firms use time dependent strategies changing nominal prices at intervals of fixed length these models may be criticized for failing to allow pricing behavior to adjust after a large shift in policy regime consequently this paper develops a model that permits firms to adopt strategies that are partially state dependent changing nominal prices whenever they depart sufficiently from their target values the paper uses this model to examine how the welfare costs and benefits of disinflation vary with the initial inflation rate and the speed of disinflation copyright 1997 by ohio state university press

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

perceptions versus objective measures of environmental quality in combined revealed and stated preference models of environmental valuation abstract this study examines perceptions and objective attribute measures in discrete choice models of recreation site choice behavior these forms of attribute measurement are examined in individual and combined revealed preference stated preference models our results suggest that the model based on perceptions slightly outperforms the models based on objective attribute measures however issues such as the definition of the choice set and the measurement of welfare present significant challenges when using perceptions data

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

output and welfare effects of inflation with costly price and quantity adjustments there exists by now a burgeoning literature concerned with the consequences of a fixed cost of price adjustment due to this cost a monopolistic firm does not necessarily adjust its price even though the current price deviates from the price that would maximize the firm s current profit as a result the production generally differs from what it would be in the absence of a menu cost with the effect of inflation on the average output and welfare under monopolistic competition being ambiguous and depending in a complicated way on the profit and demand functions 1 however one strong result holds unambiguously for all profit and demand functions at low inflation rates the average output and welfare are above their levels at full price stability where firms charge the static monopoly price 2 the driving force is that discounting makes a firm more concerned with its real profits earlier in a period with a constant nominal price than with its real profits later in the period in fact as the inflation rate approaches zero the firm s initial real price converges to the profit maximizing real price while the terminal real price converges to a smaller real price at low inflation rates therefore a firm s price is most of the time below the price that would maximize the current profit since output and welfare under monopolistic competition are inversely related to price average output and welfare are higher than under full price stability the inevitable conclusion is that the economy benefits from a little bit of inflation a critical assumption underlying this result is that firms can continuously adjust their production to satisfy demand so while the menu cost literature explicitly assumes that there is a small fixed cost incurred at each price adjustment it also implicitly assumes that it is costless to continuously adjust the quantity of output 3 this is however a questionable assumption there is some empirical evidence indicating the existence of a cost of quantity adjustment part of which is fixed in that it does not depend on the size of the adjustment 4 the cost of quantity adjustment stems from the need to rearrange and reorganize the factor inputs for the new level of production and includes managerial time and effort a fixed cost of quantity adjustment rules out any continuous adjustment of the production to satisfy the increasing demand that results from a decreasing real price within a period with a constant nominal price under the reasonable assumption that the menu cost does not exceed the fixed cost of quantity adjustment 5 in an inflationary environment a firm chooses to adjust its nomi

a near rational model of the business cycle with wage and price inertia this paper presents a model in which insignificantly suboptimal behavior causes aggregate demand shocks to have significant real effects the individual loss to agents with inertial price wage behavior is second order in terms of the parameter describing the shock while the effect on real economic variables is first order thus significant changes in business activity can be generated by anticipated money supply changes provided that some agents are willing to engage in nonmaximizing behavior which results in small losses

the output inflation trade off when prices are costly to change the output inflation trade off is investigated in a rational expectations equilibrium economy in which costly price setting makes it inefficient for agents to vary their prices at every instant it is shown that sticky prices are not some exogenous source of output fluctuation but result from the monetary policy process an economy with slow and counterinflationary money growth exhibits staggered changes in sticky prices as assumed in some new keynesian analyses an economy with fast money growth and a high degree of monetary accommodation exhibits either flexible prices or bunched frequently changing sticky prices

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

output effects of inflation with fixed price and quantity adjustment costs i introduction there is convincing evidence that fixed costs of price adjustment may be large levy et al 1997 found such costs to be 0 7 of a firm s revenue and zbaracki et al 2004 found them to be 1 22 in the presence of fixed costs of price adjustment a monopolistic firm does not adjust its nominal price continuously with the result that the real price and output generally deviate from their static monopoly level at low inflation rates the average output is higher than the static monopoly output if there is positive discounting danziger 1988 and depends on higher order derivatives of the profit and demand functions if there is no discounting benabou and konieczny 1994 1 most of the literature assumes that only price adjustments are costly while output can be continuously adjusted without cost however bresnahan and ramey 1994 document that there may be large fixed costs of quantity adjustments relatedly many publications show that adjusting labor and capital inputs involves significant fixed costs 2 such costs may derive from loss of organizational capital baily et al 2001 jovanovic and rousseau 2001 as well as from job protection rules severance pay and legal and administrative complications in a framework with both price and quantity adjustment costs andersen 1995 and andersen and toulemonde 2004 demonstrate that only intermediate size shock but not large or small shocks may affect output for a constant inflation rate danziger 2001 shows that a firm s permanent production decreases with inflation at low inflation rates if discounting is positive and danziger and kreiner 2002 that output capacity decreases with inflation if the elasticity of demand is constant and there is no discounting see also danziger 2003 the purpose of this article is to provide a simple general characterization of the output effects of a constant inflation rate if both price and quantity adjustments involve fixed costs it is assumed that quantity adjustments are at least as costly as price adjustments which implies that a firm s production is held constant at a permanent level 3 each firm then keeps its nominal price unchanged in periods of equal length and the nominal price is adjusted so that the initial real price is the same in each period thus a firm s optimal strategy consists of the initial real price the duration of the periods with unchanged nominal price and the permanent level of production the article shows that in the absence of discounting the effect of inflation on the aggregate production depends on how fast firms marginal real revenue decreases with demand and that this effect is fully determined by the elasticity of the marginal real revenue with respect to demand thus aggregate production decreases with inflation if the elasticity of the marginal real revenue always exceeds minus unity increases with inflation if the elasticity of the marginal real revenue is always less than minus unity and is invariant to inflation if the elasticity of the marginal real revenue always equals minus unity several studies have found that the comovement between output and prices is typically negative in the long run cooley and ohanian 1991 den haan 2000 den haan and sumner 2004 fiorito and kollintzas 1994 within the framework of the present model the negative comovement indicates that the empirically relevant situation is when the elasticity of the marginal real revenue always exceeds minus unity this will be the case among others if demand functions exhibit a constant price elasticity less than minus unity as assumed in danziger and kreiner 2002 ii the model consider an economy with a unit continuum of identical consumers and a unit continuum of monopolistic firms producing differentiated perishable products each firm and its product are indexed by i which is uniformly distributed on 0 1

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

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

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

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

price adjustment costs and the output inflation trade off when prices are costly to adjust there is a trade off between the rate of inflation and the firm s average level of output this trade off is the result of fully optimizing behaviour by the firm sufficient conditions are developed for inflation to have no effect on output however these conditions are unlikely to be met in practice this suggests that the superneutrality of money hypothesis is incompatible with the type of demand and cost curves normally encountered in economic theory if the discount rate is positive moderate rates of inflation will always lead to higher levels of output

a dynamic economy with costly price adjustments this paper studies a general equilibrium model of a dynamic economy with menu costs each firm s productivity is exposed to idiosyncratic and aggregate productivity shocks around a trend and the money supply to monetary shocks around a trend all consumption pricing and production decisions are based on optimizing behavior there exists a staggered markov perfect equilibrium with prices determined by a two sided s s markup strategy the paper analyzes the optimal markup strategy and investigates the dynamics of the price index and the aggregate output the welfare consequences of the uncertain aggregate productivity and money supply are also examined

endogenous time dependent rules and inflation inertia in this paper we endogenize fixed price time dependent rules to examine the output effects of monetary disinflation we derive the optimal rules in and out of inflationary steady states and develop a methodology to aggregate individual pricing rules which vary through time because of strategic complementarities we have to solve both problems simultaneously this allows us to reassess the output costs of monetary disinflations including aspects such as the roles of the initial level of inflation and of the degree of strategic complementarity in price finally we relax the strict assumption of pure time dependent rules by allowing price setters to re evaluate their rules at the time disinflation is announced

the equilibrium and optimal timing of price changes this paper studies the welfare properties of the equilibrium timing of price changes staggered price setting has the advantage that it permits rapid adjustment to firm specific shocks but the disadvantages that it causes unwanted fluctuations in relative prices and that by creating price level inertia it can increase aggregate fluctuations because each firm ignores its contribution to these problems staggering can be a stable equilibrium even if it is highly inefficient in addition there can be multiple equilibria in the timing of prices changes indeed whenever there is an inefficient staggered equilibrium there is also an efficient equilibrium with synchronized price setting

search price setting and inflation a model of monopolistic competition in an inflationary environment is developed which embodies optimal sequential search price dynamics and entry on the part of consumers and firms respectively equilibrium price strategies are s s these bounds increase continuously with consumer search costs and so does price dispersion indeed the whole equilibrium varies smoothly from the competitive bertrand to the monopolistic diamond 1971 end of the spectrum the latter s paradoxical result is explained as a limiting case where frictions on firms side of the market price adjustment costs but not on buyers search costs tend to zero a positive relationship between smooth and perfectly anticipated inflation and price dispersion or uncertainty is established

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 value of statistical life and the economics of landmine clearance in developing countries this paper presents estimates of the value of statistical life vsl in rural thailand using the contingent valuation cv method these estimates are applied to an economic analysis of landmine clearance the estimated vsl of us 250 000 suggests that the value of lives saved from landmine clearance is at least an order of magnitude greater than the values used in existing studies

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

the rigidity of prices this paper uses evidence on individual transaction prices to analyze price behavior the evidence shows that for many transactions pricesremain rigid for periods exceeding one year the rigidity of price ispositively correlated with industry concentration for several productsthe correlation of price changes across buyers is low the paper alsoinvestigates the relationship between price rigidity price change andthe length of time a buyer and seller have been doing business together the author interprets the evidence as emphasizing the importance of nonprice rationing and the inadequacy of models in whichprice movements alone clear markets copyright 1986 by american economic association

modeling recreation demand in the presence of unobservable travel costs toward a travel price model an important issue in the application of travel cost models is the construction of a travel cost variable this paper develops an econometric approach that views travel costs as an unobserved latent variable the latent variable approach utilizes indicators to capture the role of individual travel costs in recreational demand models the latent variables approach has at least two advantages over conventional approaches one the indicators can include both traditional components such as time and distance and non traditional components such as the scenic beauty second the estimation procedure results in each indicator being valued in dollar terms

inflation and efficiency in search markets this paper examines how inflation affects efficiency and output in monopolistically competitive search markets it formalizes the conventional wisdom linking higher inflation price dispersion and increased resources devoted to search it also brings to light the induced exit of arms which reduces rent dissipation but the most important effect of inflation is how it alters the distribution of real transactions prices whether this reduces or promotes efficiency and output is shown to depend critically on preferences and market structure and especially on whether search costs are large or small relative to consumer surplus

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

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

staggered wages and output dynamics under disinflation we study the output costs of a reduction in monetary growth in a dynamic general equilibrium model with staggered wages the money wage is fixed for two periods and is chosen according to intertemporal optimisation agents have labour market monopoly power we show that the introduction of microfoundations helps to resolve the puzzle raised by directly postulated models namely that disinflation in staggered pricing models causes a boom in our model disinflation whether unanticipated or anticipated unambiguously causes a slump

valuing risk in the workplace market price willingness to pay and the optimal provision of safety the theory of compensating wage differentials attributable to adam smith suggests that jobs with disagreeable characteristics will command high wages ceteris paribus most empirical tests of this theory with hedonic wage equations implicitly assume that workers willingness to pay for risk reduction safety in the workplace through diminished wages and market valuations of the price of these reductions are equivalent it is shown that this is not the case within the manufacturing sector where willingness to pay exceeds the price cost of risk reduction at current levels of risk exposure implications for implied value of life estimates are also examined copyright 1990 by mit press

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

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

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

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

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

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

optimal price dynamics and speculation with a storable good this paper analyzes as a dynamic game the optimal price and storage strategies of respectively a the seller of a storable good who must keep pace with inflation but incurs a cost to changing his price b his customers who speculate on the timing of price adjustments to buy and store just before a unique markov perfect equilibrium is shown to exist and is fully characterized rt generally involves a phase of mixed strategies during which the seller tries to deter speculation by injecting uncertainty into its price dynamics while speculators store in increasing numbers with possibly a final run on the good the stochastic price policies of a large number of such firms are shown to aggregate back to a price index growing at the rate of general inflation in response to which they arose the model thus establishes that a a constant rate of aggregate inflation can at the same time generate and cover up significant uncertainty and social costs at the microeconomic level b speculation can be destabilizing and socially wasteful even in the absence of shocks and imperfect information most importantly they provide a theoretical foundation for the frequently encountered claim that inflation causes price uncertainty