capital taxation and accumulation in a life cycle growth model almost all of the serious economic work on savings decisions within the past decade has relied on some variant of the life cycle hypothesis in which savings arise out of individual choices of an optimum lifetime consumption path this paper reexamines the incidence and welfare consequences of capital income taxes within a realistic life cycle model the results suggest that the elimination of capital income taxation would have very substantial economic effects for example a complete shift to consumption taxation might raise steady state output by as much as 18 percent and consumption by 16 percent the long run welfare gain from such a shift would for plausible parameter values exceed 150 billion annually stated somewhat differently shifting to consumption taxation would raise the lifetime utility of the representative consumer by the equivalent of about six years income in the new steady state these estimates dwarf estimates of the static welfare cost of taxation and significantly exceed even extreme previous estimates of the dynamic loss this study departs from earlier analyses of the effects of taxes on capital income in several respects probably the most important difference between this treatment and most preceding ones lies in the assumptions about the interest elasticity of saving it is shown below that the common two period formulation of saving decisions yields quite misleading results a more realistic model of life cycle savings demonstrates that for a wide variety of plausible parameter values savings are very interest elastic this implies that shifting away from capital income taxation would significantly increase capital formation making possible long run increases in consumption many studies of the welfare effects of capital income taxation have ignored the general equilibrium effects of increased capital formation in an economy with life cycle savings there is no presumption that the undistorted growth path corresponds to any sort of social optimum as peter diamond has shown life cycle savings can lead to a steady state capital intensity either greater or less than the golden rule level more generally it is clear that there is no reason to believe that a life cycle economy will maximize any particular intertemporal social welfare function a fundamental tenet of welfare evaluation is that preexisting distortions must be considered in evaluating the consequences of tax changes the results presented in this paper take explicit account of the nonoptimal character of the no tax steady state this explains in large part why such a sizeable welfare effect of capital taxes is found in an economy far from the golden rule level of capital intensity there are substantial gains in steady state consumption achievable through increased capital formation section i of the paper examines the aggregate savings function in a continuous time life cycle framework the second section clarifies the differences between wage and consumption taxes an aggregate production function is added to complete the model in the third section the effects of changes in capital taxes on both steady state incidence and welfare are considered within a general equilibrium framework the final section of the paper discusses some implications of the results and suggests areas which appear to warrant further study assistant professor of economics massachusetts institute of technology and research analyst national bureau of economic research i am grateful to alan auerbach martin feldstein laurence kotlikoff to the participants in the nber workshop on business taxation and to the harvard public finance seminar for useful discussions james poterba and james buchal performed the numerical calculations

elasticities of substitution in real business cycle models with home production this paper constructs a simple model of home production that demonstrates the connection between the intertemporal elasticity of substitution in market consumption ies and the static elasticity of substitution between home and market consumption ses understanding this connection is important because there is a large body of empirical evidence suggesting that the ies is small but little evidence on the size of the ses we use our framework to shed light on the properties of a home production model with a low ies we find that such a model must have three fundamental properties in order to match key aspects of aggregate u s data first the steady state growth rate of technology must be the same across sectors second shocks to technology must be sufficiently positively correlated across sectors third capital must be used more intensively in the market sector than in the home sector a home production model with these three properties can be surprisingly successful at reconciling the rbc paradigm with evidence for a low ies

precautionary saving of chinese and u s households we employ a model of precautionary saving to study why household saving rates are high in china and low in the united states the use of recursive preferences gives a convenient decomposition of saving into precautionary and nonprecautionary components over 80 of china s saving rate and nearly all u s saving arises from the precautionary motive the difference between u s and chinese household income growth rates is vastly more important than income risk for explaining the saving rates the key mechanism is that precautionary savers have target wealth to income ratios and rapid income growth necessitates high saving rates to maintain the ratio

self enforcing employment contracts and business cycle fluctuations abstract this paper incorporates risk sharing employment contracts into an economy in which matching frictions characterize the labour market and in which agents cannot commit in equilibrium the terms of ongoing contracts are affected by those being negotiated in the job market because contracts must be self enforcing in this context risk sharing implies that hours worked and wages are negatively related while enforcement considerations imply the converse overall the sign of this relationship is ambiguous therefore the existence of such contracts may explain why movements in hours worked appear weakly related to those in real wages in u s aggregate data

a cross country panel analysis of currency substitution and trade attention that has been directed toward the effect of trade on foreigner s holdings of domestic currency comes exclusiely from time series eidence here we extend a model of currency substitution that incorporates a trade motie for foreigners to hold domestic currency it uses time series and cross sectional information for a panel of 17 industrialized countries testing two way fixed effects models against pooled and random effects alternaties the cross sectional information is significant reealing that pooling of data could result in misleading inferences since country specific effects regional group effects and distance are all important determinants of

historical frontiers and the rise of inequality the case of the frontier of granada the authors acknowledge financial support from the spanish ministry of science and technology grant eco2009 13357 the spanish ministry of economics and competitiveness grant eco2012 35430 and the andalusian council of innovation and science excellence project sej 4546

do actions speak louder than words household expectations of inflation based on micro consumption data survey data on household expectations of inflation are routinely used in economic analysis yet it is not clear how accurately households are able to articulate their expectations in survey interviews we propose an alternative approach to recovering households expectations of inflation from their consumption expenditures we show that these expectations measures have predictive power for consumer price index cpi inflation they are better predictors of cpi inflation than household survey responses and more highly correlated with professional inflation forecasts except for highly educated consumers consistent with the view that more educated consumers are better able to articulate their expectations we also document that households inflation expectations respond to inflation news as measured by the unpredictable component of inflation predictions in the survey of professional forecasters the response to inflation news tends to increase with households level of education consistent with the existence of constraints on household s ability to process this information

variation in the real exchange rate as a source of currency substitution abstract this paper presents a shopping cost money service model in which it is shown that the real exchange rate influences the desired ratio of domestic to foreign currency bank deposits empirically it is found that if the real exchange rate value of the canadian dollar falls then us dollar deposits of canadians rise relative to canadian m2 this relationship is found to be cointegrated dynamic adjustment analyzed using an error correction model indicates a cyclical adjustment the results provide evidence that variation in the real exchange rate is a source of currency substitution and reinforces the argument that demand side factors influence the money stock jel e41

intertemporal and intratemporal substitution and the speed of convergence in the neoclassical growth model abstract this paper re examines the speed of convergence in a one sector growth model under fairly general conditions with respect to both production and preferences we investigate the response of the rate of convergence to the intratemporal elasticity of substitution in production and to the intertemporal and intratemporal elasticities of substitution in consumption the speed of convergence is highly sensitive to the first two elasticities but not to the third which is reflected primarily in the agent s labor leisure choice small deviations in the elasticities from standard benchmark parameters can lead to significant variations in the rate of convergence encompassing the range of typical empirical estimates

the later you pay the higher the k this paper shows the importance of the age path life cycle timing of any tax for the accumulation of capital in the economy income consumption and wage taxes differ in their age paths as well as their incentive effects this paper studies how the differing age path of each tax affects the capital accumulation of the economy in an empirically calibrated life cycle model we investigate lump sum age taxes and find in every case that the later the person pays tax the higher the k of the economy to analyze the life cycle timing effect of conventional transactions based taxes income consumption and wage we replace each tax with a lump sum age tax that has the identical age path of tax payments over the life cycle we find that the timing effect is quantitatively important and often causes the impact of a tax on capital accumulation to be very different from what would be predicted from the incentive effect

the role of consumption substitutability in the international transmission of monetary shocks abstract this paper develops a general framework to analyze the impact of monetary shocks in an open economy focusing on the role of the degree of substitutability between goods produced in different countries we extend the contributions by obstfeld and rogoff obstfeld m rogoff k 1995 exchange rate dynamics redux journal of political economy 103 624 659 and corsetti and pesenti corsetti g pesenti p 1997 welfare and macroeconomic interdependence nber working paper 6307 to show that the welfare impact differs across countries when the degree of substitutability between goods produced in different countries is different from the degree of substitutability between goods produced in the same country a shock that would be beneficial in a closed economy can have an adverse beggar thyself effect in the country where it takes place or an adverse beggar thy neighbor effect on its neighbor

the after tax rate of return affects private savings level of savings and the rate of capital formation are of central concern to both economists and policymakers although the welfare effects of tax reforms do not directly depend on their impact on savings the effects of taxes on savings is crucial to considerations of tax incidence and equity and to the issue of long run growth the impact of the rate of return on consumption and savings decisions also bears on questions regarding the appropriate government discount rate the short run crowding out effects of fiscal policy and the effects of public indebtedness on capital intensity the traditional view among economists is that changes in the rate of return are likely to have only a small effect on the savings rate this consensus is supported by theoretical arguments pointing to the opposing income and substitution effects associated with changes in the rate of return the ambiguous implications of theory are matched by empirical studies which yield conflicting estimates as to the size of the impact of changes in the rate of return the polar empirical estimate is michael boskin s 1978 suggestion that the interest elasticity of savings is 4 this estimate is widely regarded as too high

equilibrium consumption and precautionary savings in a stochastically growing economy abstract the derivation of a closed form solution for consumption based on the constant elasticity utility function in the presence of stochastic labor income has proved to be intractable this paper derives a closed form equilibrium relationship between consumption and wealth one that holds along a balanced growth path in a stochastic romer endogenous growth model by employing more general recursive preferences we can disentangle the coefficient of relative risk aversion from the intertemporal elasticity of substitution the effects of key structural parameters on equilibrium consumption and its tradeoff with leisure are analyzed a significant aspect of our analysis concerns the extent to which current risk in the economy is shared between labor and capital this plays an important role in determining the impact of risk on the economy in general and on consumption in particular formal analysis is supplemented with extensive numerical simulations

international currency substitution and the income velocity of money abstract this paper presents new empirical evidence on the degree to which international currency substitution destabilizes domestic money demand it also provides an explanation of some apparent discrepancies among previous empirical studies of currency substitution this explanation hinges on the distinction between the elasticity of currency substitution and the cross elasticity of money demand a large small value of one elasticity does not imply a large small value of the other a large cross elasticity is required for currency substitution to destabilize domestic money demand the empirical evidence presented here is consistent with the view that these cross elasticities are typically small

currency substitution in turkey although currency substitution is a widely observed phenomenon in both developed and developing counries most of the studies on currency substitutioin in small open economies have focused on high inflatin south american countries this paper extends the previous analysis to a newly industrializing high inflation economy namely turkey a vector autoregression model has beeb estimated employing the certain policy variables to investigate the dynamics of currency substitution in the economy dynamic impulse responses show that the residents have a preference for substitutiong foregn currencies for domestic currency because of reawl exchange rate depreciations the results suggest that to stop or to reverse the on going currency substition process a plicy aiming to increase the expected real return on domestic assets should be adopted

what are the headwaters of formal savings experimental evidence from sri lanka the world s poor are seeing a rapid expansion in access to formal savings accounts what is the source of savings when households are connected to a formal account we combine a high frequency panel survey spanning two and a half years with an experiment in which a sri lankan bank used mobile point of service pos terminals to collect deposits directly from households each week we find that the headwaters of formal savings lie in sacrificed leisure time households work more and improved savings options generate an increase in labour effort in both self employment and in the wage market the results suggest that the labour allocation channel is an important mechanism linking savings opportunities to income

who is credit constrained in the u s economy an important assumption of the life cycle model of consumption is the postulate of perfect capital markets this hypothesis has recently been challenged by substantial empirical evidence hall and mishkin 1982 using the panel study of income dynamics estimate that 20 percent of united states families are liquidity constrained mariger 1986 derives a life cycle model with endogenous liquidity constraints and using a cross section estimates this fraction to be 19 4 percent hubbard and judd 1986 simulate a model with a constraint on net worth which shows that with reasonable assumptions about preferences 19 0 percent of united states consumers are liquidity constrained the emerging consensus points therefore to a fraction of approximately 20 percent of the population behaving in a manner that is inconsistent with the pure life cycle model in addition hayashi 1985 and zeldes 1989 investigate the correlation among consumption wealth and income for various population groups and infer that liquidity constraints are more important for younger families with low levels of wealth and saving the main limitation of these studies is that in their data sets constrained consumers are not observable and have to be identified via indirect evidence thus there is as yet little firm evidence about the characteristics of the consumers who are likely to be credit constrained this paper adopts an approach that differs from previous tests for liquidity constraints because it makes use of data where constrained consumers are observable and explicitly links their existence to credit market imperfections and personal characteristics the data drawn from the 1983 survey of consumer finances scf and described in section ii provide information on individuals whose request for credit has been rejected by financial intermediaries in section iii a model is developed in which consumers and lenders behavior jointly determines the probability that a consumer is rationed in the credit market this probability is then

is it really good to annuitize although rational consumers without bequest motives are better off investing exclusively with annuitized instruments in partial equilibrium we demonstrate the welfare effect of annuitization is ambiguous in general equilibrium on account of pecuniary externalities absent institutional constraints like prices and budgets the optimal consumption rule would have marginal utility increase at the preferential discount rate in a rational competitive equilibrium where households fully annuitize the growth rate of marginal utility will be the discount rate minus the interest rate resulting in a consumption profile that is too flat accidental bequests transfer wealth from the old to the young steepening the consumption profile and yielding a better equilibrium if households are restricted to keynesian consumption functions the optimal irrational equilibrium with standard preferences can replicate observed consumption and macroeconomic behavior and the equilibrium without annuities delivers higher utility than the equilibrium with annuities whereas preceding papers have merely hypothesized that households might engage in socially optimal yet irrational behavior the failure of households to annuitize is a real world example of this policymakers should not take steps to encourage more annuitization by the public

current accounts in the euro area an intertemporal approach abstract current accounts have diverged substantially among euro area countries since the creation of the euro this divergence has raised concerns about the sustainability of some member countries external indebtedness this paper uses an intertemporal model of the current account to analyze the fluctuations in current account balances experienced by euro area countries over the last three decades and to disentangle its determinants we find that the model is not rejected for six of the ten euro area countries examined belgium france italy netherlands portugal and spain although it tends to underestimate their current account volatility for these countries we derive the expectations about future income and relative prices which according to the model underlie their current account balances expectations about future growth increased in all southern european countries at the creation of the euro but they diverged considerably by 2005 while in portugal these expectations were below its historical mean by then in spain they were at an historical high

does buffer stock saving explain the smoothness and excess sensitivity of consumption one of the lasting contributions to modernday consumer theory is the idea that consumption is determined by the expected value of lifetime resources or permanent income the modern day specification of this concept is typically presented as a special case of intertemporalchoice theory where felicity functions are quadratic labor income is stochastic there are no restrictions on borrowing consumers have infinite horizons and expectations are formed rationally we refer to this model as the permanentincome hypothesis pih although the pih has considerable intuitive appeal a series of influential papers published after its inception revealed two notable discrepancies between the model s predictions and aggregate data first the model predicts that consumption growth should be more volatile than income growth if aggregate income growth has positive serial correlation as the quarterly data suggest it does yet aggregate consumption growth is in fact much smoother than aggregate income growth angus deaton 1987 john y campbell and deaton 1989 jordi gali 1991 second the pih predicts that consumption changes should be orthogonal to predictable or lagged income changes yet the coffelation between consumption growth and lagged income growth has been found to be one of the most robust features of aggregate data for example marjorie a flavin 1981 alan s blinder and deaton 1985 campbell and n gregory mankiw 1989 orazio p attanasio and guglielmo weber 1993 thus aggregate consumption growth has been described as exhibiting two puzzles it is both excessively smooth relative to current labor income growth and excessively sensitive to lagged labor income growth 2 in response to these and other empirical anomalies researchers have recently sought out modifications of the pih framework chief ludvigson federal reserve bank of new york 33 liberty street new york ny 10045 michaelides university of cyprus p o box 20537 1678 nicosia cyprus a previous version of this paper appeared under the title can we explain the consumption excesses yet aggregate consumption implications of buffer stock saving behavior for many helpful comments we thank orazio attanasio dave backus ben bernanke john y campbell christopher carroll todd clark angus deaton pierreolivier gourinchas bo honore james kahn martin lettau costas meghir christina paxson steve pischke andrew samwick christopher sims mark watson guglielmo weber michael woodford steve zeldes and two anonymous referees conference participants at the national bureau of economic research summer workshop on the aggregate implications of microeconomic consumption behavior july 1998 the tmr workshop on saving and pensions center tilburg university march 1999 and the new york area macroeconomics workshop october 1998 seminar participants at columbia university insead the new york federal reserve university college london london business school city university business school university of cyprus tel aviv university and jeffrey brown for excellent research assistance the views expressed are those of the authors and do not necessarily reflect those of the federal reserve bank of new york or the federal reserve system any errors or omissions are the responsibility of the authors 1 note that the important insight of danny quah 1990 that individuals may be better able than econometricians to distinguish short run from long run innovations to their income cannot resolve the excess smoothness puzzle laid out in campbell and deaton 1989 these authors show that in the context of the pih excess sensitivity and excess smoothness are the same phenomena in addition campbell 1987 demonstrates that superior information of the type emphasized by quah will show up in households saving behavior and using this information allows the econometrician to control for the agent s private information when predicting income since excess sensitivity is well established and controlling for saving does not eliminate it see campbell and deaton 1989 the observed smoothness of consumption cannot be explained by superior information on the part of permanent income consumers see deaton 1992 for further discussion 2 philippe bacchetta and stefan gerlach 1997 and ludvigson 1999 document another kind of excess sensitivity the correlation between consumption growth and predictable changes in consumer credit although we do not explore these findings here ludvigson finds that a bufferstock model with time varying liquidity constraints can replicate such a correlation

measuring global money market interrelationships an investigation of five major world currencies abstract this paper extends the study of global money market integration in two primary directions first a technique which combines stationarity and cointegration tests as a basis for constructing an error correction model is applied to assess the existence of long run equilibrium relationships between money market series second analysis for the increasingly significant asian offshore markets of singapore and hong kong is added to traditional european and national markets analysis major findings are 1 the error correction model is an appropriate technique for identifying causality relationships and 2 major domestic markets and included offshore markets are partially segmented

the analytics of technology news shocks abstract this paper constructs several models in which unlike the standard neoclassical growth model positive news about future technology generates an increase in current consumption hours and investment these models are said to exhibit procyclical news shocks we find that all models that exhibit procyclical news shocks in our paper have two commonalities there are mechanisms to ensure that i consumption does not crowd out investment or vice versa ii the benefit of forgoing leisure in response to news shocks outweighs the cost among the models we consider we believe one model holds the greatest potential for explaining procyclical news shocks its critical assumption is that news of the future technology also illuminates the nature of this technology this illumination in turn permits economic actors to invest in capital that is forward compatible i e adapted to the new technology on the technical side our paper reintroduces the laplace transform as a tool for studying dynamic economies analytically using laplace transforms we are able to study and prove results about the full dynamics of the model in response to news shocks

cointegration how short is the long run abstract when testing for cointegration and faced with short sample periods it is common for researchers to turn to more frequently sampled observations that is to move from annual to quarterly or monthly data in order to increase the number of observations we argue that such a gain in the degrees of freedom is more apparent than real essentially cointegration is a long run concept and hence requires long spans of data to give tests for cointegration much power rather than merely large numbers of observations using monte carlo simulations we demonstrate this for four popular tests for cointegration

myopia liquidity constraints and aggregate consumption a simple test this note conducts a simple test for myopia and liquidity constraints in aggregate u s consumption the test exploits the fact that under myopia consumption should be equally sensitive to predictable income declines and increases while under liquidity constraints consumption should be more sensitive to predictable income increases than to declines using quarterly postwar data the author shows that aggregate consumption is in fact more sensitive to predictable income declines than increases this perverse asymmetry is inconsistent with both myopia and liquidity constraints but is qualitatively consistent with recent theoretical work incorporating loss aversion into intertemporal preferences

currency substitution and monetary autonomy the foreign demand for us demand deposits abstract this paper presents new evidence of currency substitution using the two step estimator of cointegrated systems developed by engle and granger 1987 we estimate and find cointegration among variables suggested by the money services model of currency substitution following engle et al 1989 we estimate an error correction model for each of five countries allowing isolation of long term from short term influences on the foreign demand for us demand deposits our results suggest that currency substitution is a potentially significant phenomenon influencing long term monetary policy independence

currency substitution under finance constraints the perfect foresight continuous time couterpart of lucas and stokey s cash in advance model is generalized to the case of two currencies the money demand function for eac currency has as arguments the endowments of goods associated with each denomination various monetary shocks are investigated including permanent and temporary changes in levels and growth rates it is shown that substitution can be an important factor in explaining the possible negative transmission of inflation the amount of volatility of exchange rates and the degree tp which exchange rate movements approximate a random walk

information quality and stock returns revisited this paper investigates the relation between information on the state of the economy and equity risk premium we use a setup where investors have epstein zin preferences and the economy randomly switches between booms and recessions we are able to establish 2 key results first investors with high elasticity of intertemporal substitution eis will require lower excess returns for holding stocks if they are provided with better information on the state of the economy second we find that this also holds for investors with moderate eis if they are sufficiently risk averse

a multi country real business cycle model with heterogeneous agents a multicountry real business cycle model is developed capturing two important aspects of heterogeneity found in household survey data only a small fraction of the population holds stock and a significant fraction of nonstockholders are borrowing constrained the model is applied to data for twenty oecd countries it generates cross country consumption correlations consistent with those observed in the data potential welfare gains from international portfolio diversification by stockholders are large leaving the observed home bias as a significant puzzle the model can also account for the finding in u s data that consumption of stockholders is more volatile than that of nonstockholders copyright 1996 by the editors of the scandinavian journal of economics

a direct test of the permanent income hypothesis with an application to the u s states this paper tests the prediction of the permanent income hypothesis pih that news about future income induce a revision in consumption equal to the revision in permanent income we use time series data from 48 contiguous u s states to perform the test the empirical results provide some support for the pih across states

evaluating the empirical evidence for currency substitution a case study of the demand for sterling in europe currency substitution has important implications for the cost of european monetary union if it is significant it will help to reduce costs of convergence to a single currency this paper informs the policy debate by testing for its existence on a consistent european database making use of cointegration methods the results demonstrate that in the two types of models tested there is no clear evidence of currency substitution in either the short or the long run and that therefore currency substitution between sterling and ec currencies cannot be relied upon as a mechanism or an aid to reduce the costs of monetary convergence copyright 1994 by royal economic society

the sensitivity of consumption to transitory income estimates from panel data on households we investigate the stochastic relation between income and consumption specifically consumption of food within a panel of about 2 000 households our major findings are 1 consumption responds much more strongly to permanent than to transitory movements of income 2 the response to transitory income is nonetheless clearly positive 3 a simple test independent of our model of consumption rejects a central implication of the pure life cycle permanent income hypothesis the observed covariation of income and consumption is compatible with pure life cycle permanent income behavior on the part of80 percent of families and simple proportionality of consumption and income among the remaining 20 percent as a general matter our findings support the view that families respond differently to different sources of income variations in particular temporary income tax policies have smaller effects on consumption than do other more permanent changes in income of the same magnitude this abstract was borrowed from another version of this item

the intertemporal elasticity of substitution an analysis based on japanese data this paper investigates whether the intertemporal elasticity of substitution ies for japan possesses similar properties to that found for the united states in the literature as the existing empirical findings are mixed there is no clear consensus this paper uses a model with both production and non separability between nondurables and durables in order to control for possible factors that cause a bias in the ies we present the empirical results demonstrating that the ies is quite similar between the two countries

contracting productivity growth in this paper we analyze the interactions between growth and the contracting environment in the production sector allowing incompleteness in contracting implies that viable production relationships for firms and workers and therefore the profitability of industries depend on the rates of innovation and growth the speed at which new innovations arrive in turn depends on the profitability of production for the usual reasons examined in the endogenous growth literature we show that these interactions can have important implications which are consistent with observed phenomena in both the micro and macro environment in particular we demonstrate that a technological shock increasing productivity of research can through this interaction lead to a productivity slowdown and a shift in labor market contracts away from firms providing implicit guarantees of lifetime employment and towards shorter term contractor type arrangements we show the consistency of an increase in the proportion of the labor force under short term employment increased relative returns of workers in high productivity sectors and increased income inequality with a productivity slowdown of finite duration

currency substitution capital mobility and money demand abstract this paper re examines the currency substitution cs issue by specifying a general portfolio balance pb model where domestic residents demand for foreign money is distinguished from their demands for foreign non monetary assets the latter possibility which reflects international capital mobility as opposed to cs per se is already a key feature in the open economy macro literature the inclusion of foreign money leaves the usual asset demand functions unchanged in the pb model that ignores cs at least as far as the appropriate rate of return arguments and their signs are concerned although this suggests that cs is of limited importance in macro modelling it implication for the estimation of money demand functions is pursued an initial attempt is made to empirically isolate the separate efects of high capital mobility and currency substitution for canada germany the united kingdom and the united states the results while not conclusive due to high multicollinearity problems bring into question the empirical as well as the theoretical relevance of currency substitution

another visit to the cagan model of money demand the latest russian experience abstract this paper investigates empirically the cagan style money demand function for russia during the recent hyperinflation era 1992 1994 using the johansen multivariate cointegration test results indicate that rate of change of exchange rate currency depreciation is required in the demand function for real m2 and real currency in order to obtain a stationary long run relationship error correction model results show that there exists a bidirectional causality between real money balances and determinants of real money demand including currency depreciation exchange rate sensitivity of the demand for money indicates currency substitution

the intertemporal elasticity of substitution an exploration using a us panel of state data this paper uses state level consumption data to estimate the intertemporal elasticity of substitution of consumption ies in contrast to the results of hall 1988 and campbell and mankiw 1989 we provide evidence indicating that the ies is significantly different from zero and probably close to one since inference about the ies in the context of the standard euler equation is problematic as a result of mis specification bias we cast most of our discussion in the context of the framework developed by campbell and mankiw this modifies the euler equation in that a fraction of agents simply consume their income the use of panel data to examine the relationship between interest rates and consumption growth has two advantages first we achieve a significant increase in precision which in particular allows us to rule out a zero ies second we can use the panel aspect of the data to bypass asset return measurement problems in particular we identify a common time component in expected consumption growth that is associated with movements in interest rates when the ies is positive

portfolio theory and currency substitution one of the major reasons friedman 1953 and johnson 1972 advocated flexible exchange rates was to eliminate supply side monetary substitutability which can incapacitate domestic monetary policy however contributors to the currency substitution literature including miles 1978 girton and roper 1981 and mckinnon 1982 have argued that when economic agents hold both domestic and foreign monies variations in foreign interest rates or expected future exchange rates can make domestic money demand functions unstable as economic agents shift resources in response to changes in prospective relative returns as a result they and others have claimed that flexible exchange rates may not secure domestic monetary autonomy l the major purpose of this paper is to demonstrate the conditions under which foreign and domestic monies are substitutes in demand when economic agents have motives to hold both and to contrast the determinants of currency substitutability with those of the more general concept of asset substitutability importantly it is demonstrated that the usual portfolio theoretic justification for including opportunity cost variables such as foreign interest rates foreign inflation rates or expected

animal spirits through creative destruction we show how a schumpeterian process of creative destruction can induce rational herd behavior by entrepreneurs across diverse sectors as if fueled by animal spirits consequently a multisector economy in which productivity improvements are made by independent profit seeking entrepreneurs exhibits regular booms slowdowns and downturns as part of the long run growth process our cyclical equilibrium has higher average growth but lower welfare than the corresponding acyclical one we show how a negative relationship can emerge between volatility and growth across cycling economies and assess the extent to which our model matches several features of actual business cycles

intertemporal substitution risk aversion and economic performance in a stochastically growing open economy abstract the constant elasticity utility function implies that the intertemporal elasticity of substitution is the inverse of the coefficient of relative risk aversion with empirical evidence suggesting that this relationship may or may not hold studies of risk and growth should decouple these two parameters this paper provides an analytical characterization and numerical simulations of the equilibrium of a stochastically growing small open economy under general recursive preferences we show that errors committed by using the constant elasticity utility function even for small violations of the compatibility condition can be substantial our results suggest that the constant elasticity utility function should be employed with caution