real interest rates and endogenous growth in a monetary economy abstract in endogenous growth models where the engine of growth is human capital acquired via formal education inflation taxes may raise or lower real interest rates depending upon whether or not physical and or human capital are liquidity constrained cases are examined

inflation uncertainty and growth in a cash in advance economy abstract this paper analyzes the effects of inflation variability on economic growth in a model where money is introduced via a cash in advance constraint in this setting we find that inflation adversely affects long run growth even when the cash in advance constraint applies only to consumption at the same time we find that inflation and growth are positively related in the short run furthermore variability increases average growth through a precautionary savings motive since inflation and inflation variability tend to be highly correlated the presence of uncertainty attenuates the negative long run relationship between inflation and real growth it also provides a partial rationale for the apparent lack of robustness in cross country regressions of growth and inflation

designing monetary policy when unemployment persists this paper investigates how unemployment persistence affects the optimal delegation of monetary policy to an independent central banker cb two opposing forces are shown to be at work with more persistence the government s incentive to stabilize the economy is greater but if the cb is forward looking its incentive to create inflation surprises is also greater we show that owing to the second effect the government may wish not to delegate at all unlike the case where there is no persistence in the event that the government does delegate the paper identifies conditions under which either effect dominates in the government s choice of conservatism of the cb we compare delegation to discretion and precommitment using a diagrammatic approach that may be of independent interest we also present some preliminary empirical evidence on the cross country relationship between unemployment persistence and inflation that appears consistent with the model s predictions

conservative central banks and nominal growth exchange rate and inflation targets a framework is developed in which inflation biases with different target variables are compared a nominal growth target measured in consumer prices may yield less stabilization bias than a nominal income growth target exchange rate and inflation targets result in less stabilization bias than an income growth target the more important the terms of trade stabilization persistence in output causes excessive stabilization of productivity shocks and of shocks to the terms of trade under discretion an inflation weight conservative central bank is more likely under an inflation target than under an exchange rate target and less likely under a nominal income growth target

assessing nominal income rules for monetary policy with model and data uncertainty nominal income rules for monetary policy have long been debated but two issues are of particular recent interest first there are questions about the performance of such rules over a range of plausible empirical models especially models with and without explicit rational inflation expectations second there are questions about the performance of these rules in real time using the type of data that is actually available contemporaneously to policy makers rather than final revised data this paper determines optimal monetary policy rules in the presence of such model uncertainty and real time data uncertainty and finds only a limited role for nominal output growth

inflation and welfare in a monetary economy it is in everyone s private interest to try to get someone else to hold non interest bearing cash and reserves but someone has to hold it all so these efforts must simply cancel out all of us spend several hours per year in this effort and employ thousands of talented and highly trained people to help us these person hours are simply thrown away wasted on a task that should not have to be performed at all

growth and the effects of inflation abstract in this paper we study the relationship between the rate of increase of the money supply and the rate of growth of output in an economy we show that in some models of endogenous growth inflation has direct effects on the growth rate of the economy despite this the estimated welfare cost of inflation from calibrated examples is similar to that found in exogenous growth models

when preferences for a stable interest rate become self defeating monetary policymakers often seem to have preferences for a stable interest rate in addition to stable inflation and output in this paper we investigate the implications of having an interest rate level term in the loss function when the policymaker lacks commitment technology we show that such preferences may become self defeating in the sense that they generate a less stable interest rate than in the case without preferences for interest rate stability

the long run relationship between inflation and output in postwar economies abstract we investigate the relationship between inflation and real output in a large sample of postwar economies our methodology is to use a structural vector autoregression to estimate the response of the level of real output to permanent inflation shocks separately for each country we find that a permanent shock to inflation is not associated with a permanent movement in the level of real output for most countries in our sample the main exceptions are certain low inflation countries in which permanent inflation shocks permanently increase the level of output we also find that permanent inflation shocks do not permanently influence real output growth rates in our sample

efficiency wages and subjective performance pay i introduction how to design incentive schemes to motivate workers is an important topic in economics the shirking models of efficiency wages such as shapiro and stiglitz 1984 establish that firms need to pay a wage premium efficiency wages to motivate workers with unemployment serving as a punishment device however one shortcoming of these models is that performance pay plays no role one justification for their omission of performance pay is that individual performance may not be verifiable nevertheless if workers performance is observable and employment relationships are repeated firms can use implicit bonuses or relational contracts based on workers subjectively assessed performance to motivate workers since subjective performance pay cannot be legally enforced it has to be self enforcing given that both efficiency wages and subjective performance pay motivate workers what is the optimal wage contract from the firm s perspective will different labor markets occupations use different forms of wage contracts what are the impacts of different forms of wage contracts on unemployment and social welfare to answer these questions this paper provides a theory of contract selection in a market setting in a seminal paper macleod and malcomson 1998 mm hereafter provided a model of contract selection between efficiency wages and subjective performance pay the driving force in their model is the market condition in a market with more workers than jobs a firm can always immediately and costlessly fill its vacancy after reneging on the promised bonus therefore no subjective performance pay is credible and firms have to use solely efficiency wages to motivate workers on the other hand in a market with more jobs than workers efficiency wages are useless in providing incentives because a worker can find another job immediately after being fired as a result firms use solely subjective performance pay to motivate workers in mm there are no exogenous turnover costs complementary to mm this paper provides a model of contract selection driven by exogenous turnover costs in labor markets we focus on the situation in which unemployment always exists in labor markets thus ruling out market condition as a determinant of contract selection it turns out that turnover costs affect the amount of efficiency wages and performance pay in optimal contracts while in mm efficiency wages and subjective performance pay cannot be used together to motivate workers in our model firms are able to use combinations of both methods of payments by affecting optimal contracts turnover costs also have impacts on the equilibrium employment level and social welfare finally our model generates rich empirical implications about the relationships among turnover costs forms of employment contracts and levels of employment our basic model studies how turnover costs borne by firms affect contract selection from the firm s point of view subjective performance pay is cheaper since efficiency wages entail a wage premium thus the optimal wage contract uses the maximum amount of bonus to motivate workers however subjective performance pay may not be credible due to the firm s moral hazard problem in labor markets with positive unemployment a firm can immediately hire a new worker after reneging on the implicit bonus the presence of turnover costs can alleviate this moral hazard problem this is because a worker can punish a reneging firm by quitting and the firm has to incur turnover costs in hiring new workers therefore in the optimal contract the amount of bonus is increasing in turnover costs since subjective performance pay is cheaper as the turnover costs increase more subjective performance pay leads to a lower total wage payment after deriving the optimal contracts we turn to study market equilibrium which is determined by firms free entry condition

macroeconomic policies growth and welfare in a stochastic economy an integrated stochastic equilibrium growth model is constructed and directed to various questions pertaining to monetary and tax policy two main issues addressed include 1 the tradeoff between the rate of capital accumulation and inflation in a stochastic environment and 2 economic welfare and optimal policy making the key result is that policy variables impact on welfare through their effect on the after tax nominal interest rate which therefore serves as an intermediate policy target the welfare maximizing interest rate target is derived and the author discusses its attainment through appropriate monetary and tax policies tradeoffs between policy instruments are also addressed copyright 1993 by economics department of the university of pennsylvania and the osaka university institute of social and economic research association

institutional arrangements for monetary policy when output is persistent a discretionary monetary policy gives rise to a constant average inflation bias a state contingent inflation bias and a stabilization bias when output is persistent the paper considers institutional arrangements contracts for central banks that remove these policy imperfections the average and state contingent inflation biases can be removed by directing the central bank to target the growth of nominal income and appoint a central banker with a specific relative weight attached to output stabilization an alternative to this institutional solution is to direct central banks to aim for a feasible output target although this would remove the inflationary biases the government must appoint a liberal as opposed to conservative central banker in order to implement optimal stabilization

the foundations of money illusion in a neoclassical micro monetary model comment 1 that their equation 2 is logically equivalent to our hereafter d k sufficiency conditions presented in the 1974 issue of this review 2 that the assumption of degree zero homogeneity in the variables m and p of the utility function serves completely to characterize the class of illusion free demand functions derivable from ordinal utility theory 3 that it is possible to reinstate the usual slutsky properties by adopting the semi separable utility function given in their equation 4

on the optimality of interest rate smoothing abstract this paper studies some continuous time cash in advance models in which interest rate smoothing is optimal we consider both deterministic and stochastic models in the stochastic case we obtain two results of independent interest i we study what is to our knowledge the only version of the neoclassical model under uncertainty that can be solved in closed form in continuous time and ii we show how to characterize the competitive equilibrium of a stochastic continuous time model that cannot be computed by solving a planning problem we also discuss the scope for monetary policy to improve welfare in an economy with a suboptimal real competitive equilibrium focusing on the particular example of an economy with externalities

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

economic growth under money illusion abstract empirical and experimental evidence documents that money illusion is persistent and widespread this paper incorporates money illusion into a stochastic continuous time monetary model of endogenous growth we model an agent s money illusion behavior by assuming that he maximizes nonstandard utility derived from both nominal and real quantities money illusion affects an agent s perception of the growth and riskiness of real wealth and distorts his consumption savings decisions it influences long run growth via this channel we show that the welfare cost of money illusion is negligible whereas its impact on long run growth is noticeable even if the degree of money illusion is low

fiscal policy inflation and the accumulation of risky capital the effect of government policies on the level of investment and inflation has become a major concern of policy makers in a number of industrial countries proposals to raise the level of business investment have included overall tax cuts tax incentives to spur investment and a reduction in the level of government spending this paper presents a theoretical apparatus to explore the relationships between fiscal policy government debt inflation and capital accumulation it develops a one sector growth model embodying a stochastic production function and government fiscal policy atomistic agents in the economy choose consumption levels and allocate their wealth between risky capital and risky government debt to maximize expected discounted utility over an infinite horizon fiscal policy by affecting asset yields affects the composition of portfolios the price of government bonds and the accumulation of capital the model is used to answer three general questions 1 does the level of government expenditure affect the rate of capital accumulation and inflation in steady state 2 does the mode of government finance when the choice is between an income tax and deficit finance affect these magnitudes 3 what is the effect of uncertainty in the productivity of capital on growth the analysis relates to several areas of literature 1 the analysis of the relationship between capital accumulation and debt 2 the theory of the demand for government debt 3 considerations of the effect of income taxation on risk bearing and 4 the analysis of capital accumulation under uncertainty 1 the effects on output and the capital stock of the government s expenditure decision and its decision to finance its expenditure by taxation or debt issue are explored in two major bodies of economic theory the literature on the burden of the debt as developed by modigliani 1961 diamond 1965 and phelps and shell 1969 for example implies that policies which increase the value of outstanding government debt will tend to lower the level of the capital stock by displacing capital with public debt in private wealth the theory of money and growth as represented by tobin 1965 and sidrauski 1967b also implies that government debt displaces capital but specifically recognizes the role of capital gains on government debt

optimal monetary policy and the role of hybrid inflation price level targets this study investigates the role of hybrid inflation price level targets as a solution to the well known stabilization bias problem that arises under discretionary policies the analysis shows that social welfare will be improved by employing a weighted average of inflation and price level as one of the central bank s target variables in addition to the output gap growth target the reason is that imposing the optimal hybrid target will reduce inflation variability in a highly efficient way in particular the optimal hybrid regime outperforms other previously suggested regimes when the degree of inflation persistence is moderate

inflation expectations and the stability properties of nominal gdp targeting ball 1999 uses a small closed economy model to show that nominal gdp targeting can lead to instability this paper extends ball s model to uncover the role inflation expectations play in generating this instability allowing inflation expectations to be formed by the more general mixed expectations process which encompasses ball s model we show that nominal gdp targeting is unlikely to lead to instability we further show that in ball s model where exact targeting causes instability that moving to inexact targeting restores stability

anticipated inflation in a monetary economy with endogenous growth this paper makes a new attempt to investigate the role of anticipatedmonetary growth in economic growth combining the barro 1990 rebelo 1991 type endogenous growth model with sidrauski s 1967 framework we show that the pre announcement of money supply behaviour may have significant effects on the rate of growth during the transition process the key factor indetermining adjustment patterns of the economy to anticipated monetary changes is the degree of relative risk aversion however changes in the rate of monetary growth do not affect the rate of long run growth regardless of the degree of relative risk aversion

the stabilizing properties of a nominal gnp rule the author examines the ability of a nominal gnp rule for monetary policy to stabilize output and inflation other regimes considered are a money rule an exchange rate rule a price level rule and discretion the rules compare favorably to discretion to the extent that a time consistent commitment to a nominal anchor is needed to eliminate an inflationary bias in the economy the choice among the four rules depends on the relative magnitudes of the disturbances considered supply shocks velocity shocks and exchange rate shocks the nominal gnp rule dominates the exchange rate and other rules for plausible parameter values copyright 1995 by ohio state university press

prosperity and depression prosperity and depression are relative concepts today both france and japan are depressed relative to the united states equivalently the united states is prosperous relative to these countries i say these countries are depressed relative to the united states because their output per working age person is 30 percent less than the u s level an interesting and important policy question is why are these countries depressed the answers for these two countries turn out to be very different the united states is prosperous relative to france because the u s intratemporal tax wedge that distorts the trade off between consumption and leisure is much smaller than the french wedge i will show that if france modified its intratemporal tax wedge so that its value was the same as the u s value french welfare in consumption equivalents would increase by 19 percent consumption would have to increase by 19 percent now and in all future periods to achieve as large a welfare gain as that resulting from this tax reform the united states is prosperous relative to japan because production efficiency is higher in the united states in the united states total factor productivity is approximately 20 percent higher than in japan if japan suddenly became as efficient in production as the united states its welfare gain in consumption equivalents would be 39 percent equally interesting and important are big changes over time in relative output per working age person across countries why are new zealand s and switzerland s economies depressed by over 30 percent relative to their 1970 trend corrected levels both of these countries have small populations but depressions are not restricted to small countries japan with its 125 million people is now depressed by 20 percent relative to its 1991 trend corrected level on the prosperity side why are ireland and south korea so prosperous now relative to their 1970 trend corrected levels this lecture is concerned primarily with big international differences among relatively rich industrial countries and changes in these differences over time the countries that receive primary attention all have market economies and healthy well educated populations in the countries considered the variations in aggregate output per working age person are large and reasonably good measures of the factor inputs are available this permits in many cases the identification of the change in policy or the difference in policy that gave rise to prosperity or depression this is in contrast to business cycle theory which provides little guidance to policy except for the important policy implication that a stabilization effort will have either no effect or a perverse effect the output variations studied and analyzed in this lecture are big an order of magnitude larger than the much studied business cycle fluctuations the variations studied however are an order of magnitude smaller than the muchstudied differences between the richest and poorest countries surprisingly only recently have depressions been systematically studied from the perspective of growth theory which is the theory used university of minnesota and federal reserve bank of minneapolis i thank my colleagues at the university of minnesota and the federal reserve bank of minneapolis for helpful discussions and comments in particular i thank tim kehoe ellen mcgrattan and nancy stokey for their help i also thank martin weale and franck portier for providing some british and french tax information used in this lecture thanks also go to sami alpanda and james macgee for research assistance and helpful discussions this lecture draws heavily on collaborative research with fumio hayashi i thank the economic and social research institute cabinet office government of japan and the u s national science foundation for financial support the views expressed herein are those of the author and not necessarily those of the federal reserve bank of minneapolis or the federal reserve system

targeting nominal income an appraisal the practice of setting target growth rates for a year or more ahead for some measure of the mofiey supply is now followed by many industrialised countries however it has been suggested by a number of authors e g meade i978 in his nobel prize lecture tobin i980 in his retrospective on stabilisation policy brittan i98i that it would be more sensible to pursue targets for nominal income rather than the money supply meade for instance argues that controlling nominal income is in any case the ultimate goal of those who favour fixed monetary targets and that an excessive concentration on the means rather than the end is confusing to private agents and can lead to undesirable fluctuations in the demand for output when velocity shifts he goes on to advocate that nominal income targets should be linked to the development of wage fixing institutions designed to mimic competitive behaviour in this paper we examine the implications of such a proposal for the performance of the economy in the context of a simple stochastic macroeconomic model under rational expectations a contracting framework is adopted in which the wage is fixed in a state of uncertainty about future levels of demand and productivity the objective of the authorities is to minimise the divergence of output from its full information equilibrium level if labour supply is inelastic then it turns out that maintaining the level of nominal income is actually the optimal policy if labour supply is elastic nominal income targetry provides an optimal response to demand is lm shocks but a suboptimal response to productivity shocks however a sufficient condition for a nominal income target to be preferable to a fixed money supply target is that the price elasticity of aggregate demand be less than unity the paper concludes by examining the implications of pursuing target growth rates rather than levels it should be conceded at the outset that there are several pertinent issues not addressed such as the greater comprehensibility of nominal income targets to private agents or the possibility that nominal income targets may leave the authorities with too much discretion e g poole i980 the issue of labour market reform is also ignored this is an enormous subject which it would be impossible to do justice to here see for instance meade s own analysis of the problem in meade i982 such reforms might be expected to affect the parameters of the model nevertheless since changes in labour market practices are neither a precondition for nor a logical consequence of nominal income targets an independent analysis of the macrceconomic implications of the latter is still highly relevant

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

targeting nominal income a closer look abstract i derive conditions under which the monetary authority should target nominal spending the relevant spending target is a weighted average of income and consumption despite sticky nominal wages under optimal policy the economy behaves as if all markets clear