portfolio choice and liquidity constraints we study the infinite horizon model of household portfolio choice under liquidity constraints and revisit the portfolio specialization puzzle we show why the puzzle is robust to several model variations and argue that positive correlation between earnings shocks and stock returns is unlikely to provide an empirically plausible resolution we find that relatively small fixed costs for stock market entry are sufficient to deter stockholding because for a plausible range of parameter values households can achieve desired consumption smoothing with small or zero holdings of stocks such costs could arise from informational considerations sign up fees and investor inertia

international evidence on investment and fundamentals abstract if a firm s costs of installing capital are not quadratic then its optimal investment is not a linear function of fundamentals such as the returns and costs of capital this study specifies a model in which a firm may face fixed linear and convex costs of investing and estimates the resulting investment function using firm level data from 11 countries the evidence suggests important nonlinearities consistent with the presence of fixed or other non quadratic costs in the relationship between investment and fundamentals for most countries these findings are statistically signficant at the level of the firm and economically significant when aggregated by country

acting on climate finance pledges inter agency dynamics and relationships with aid in contributor states developed countries have relied heavily on aid budgets to fulfill their pledges to boost funding for addressing climate change in developing countries however little is known about how interaction between aid and other ministries has shaped contributors diverse approaches to climate finance this paper investigates intra governmental dynamics in decision making on climate finance in seven contributor countries australia denmark germany japan switzerland the uk and the us while aid agencies retained considerable control over implementation environment and finance ministries have played an influential and often contrasting role on key policy issues including distribution between mitigation and adaptation and among geographical regions

long run inflation and the distorting effects of sticky wages and technical change we show that the calvo price setting model is not necessarily inconsistent with evidence of a weak relation between positive trend inflation and price dispersion we identify the interaction between sticky wages and technical change as factors disrupting the allocative role of the wage system under positive trend inflation in turn this interaction generates inefficient wage dispersion as opposed to price dispersion which fuels inflation costs we conclude that it is too early to dismiss the new keynesian model as a useful vehicle to assess the costs of inflation

pareto improving social security reform when financial markets are incomplete this paper studies an overlapping generations model with stochastic production and incomplete markets to assess whether the introduction of an unfunded social security system leads to a pareto improvement when returns to capital and wages are imperfectly correlated a system that endows retired households with claims to labor income enhances the sharing of aggregate risk between generations our quantitative analysis shows that abstracting from the capital crowding out effect the introduction of social security represents a pareto improving reform even when the economy is dynamically efficient however the severity of the crowding out effect in general equilibrium tends to overturn these gains

market frictions and consumption based asset pricing a fundamental equilibrium condition underlying most utility based asset pricing models is the equilibration of intertemporal marginal rates of substitution imrs previous empirical research however has found that the comovements of consumption and asset return data fail to satisfy the restrictions imposed by this equilibrium condition in this paper we examine whether market frictions can explain previous findings our results suggest that a combination of short sale borrowing solvency and trading cost frictions can drive a large enough wedge between imrs so that the apparent violations may not be inconsistent with market equilibrium

intergenerational risk sharing via social security when financial markets are incomplete this paper develops an overlapping generations model with stochastic production and incomplete markets to assess whether the introduction of an unfunded social security system can lead to a pareto improvement even if the initial equilibrium is neither production ine cient in the spirit of diamond 1965 nor dynamically ine cient in the spirit of samuelson 1957 when returns to capital and wages are imperfectly correlated and subject to aggregate shocks then the consumption variance of all generations can be reduced if private markets or government policies enable them to pool their labor and capital incomes a social security system that endows retired households with a claim to labor income may serve as an e ective tool to share aggregate risk between gener

optimal portfolio choice for long horizon investors with nontradable labor income this paper examines how risky labor income and retirement affect optimal portfolio choice with idiosyncratic labor income risk the optimal allocation to stocks is unambiguously larger for employed investors than for retired investors consistent with the typical recommendations of investment advisors increasing idiosyncratic labor income risk raises investors willingness to save and reduces their stock portfolio allocation towards the level of retired investors positive correlation between labor income and stock returns has a further negative effect and can actually reduce stockholdings below the level of retired investors financial advisors typically recommend that their customers invest more in stocks than in safe assets when they are working and to shift their investments towards safe assets when they retire jagannathan and kocherlakota 1996 malkiel 1996 by contrast the standard academic models of portfolio choice merton 1969 1971 samuelson 1969 show that retirement is irrelevant for portfolio decisions if investment opportunities are constant and human capital is tradable in this case the fraction of wealth optimally invested in risky assets should be constant over the lifetime of an individual recent research building on the pioneering work by merton 1971 shows that time varying investment opportunities result in portfolio rules with an intertemporal hedging component whose magnitude depends on the investment horizon of the investor kim and omberg 1996 balduzzi and lynch 1997 brennan schwartz and lagnado 1997 brandt 1999 campbell and viceira 1999 2001 barberis 2000 with time variation in investment opportunities retirement and death play an instrumental role as events that exogenously fix the individual s investment horizon more importantly retirement also marks the time at which individuals stop working and thereafter must live off their lifetime savings and possibly transfers from this perspective retirement matters for portfolio choice

life cycle portfolio choice with additive habit formation preferences and uninsurable labor income risk this article explores the implications of additive and endogenous habit formation preferences in the context of a life cycle model of an investor who has stochastic uninsurable labor income to solve the model i analytically derive the habit wealth feasibility constraints and show that they depend on the worst possible path of future labor income and on the habit strength but not on the probability of the worst income when there is only a slim chance of a severe income shock the model implies much more conservative portfolios the model also predicts that for some low to moderately wealthy households the portfolio share allocated to stocks increases with wealth because of this feature the model can generate more conservative portfolios for younger than for middle aged households the effects of habits on portfolio choice are robust to income smoothing through borrowing or flexible labor supply one controversial finding is that for high values of the habit strength parameter usually required for the resolution of asset pricing puzzles in general equilibrium the life cycle model predicts counterfactually high wealth accumulation jel g11 g12 copyright 2007 oxford university press

rules based monetary policy and the threat of indeterminacy when trend inflation is low abstract indeterminacy in new keynesian models with calvo contracts can occur even at low trend inflation levels of 2 or 3 the interaction of trend inflation with nominal wage rigidity and trend growth in output causes large distortions in the steady state and expands the indeterminacy region consequently even interest rate rules with strong inflation responses may not be sufficient to ensure determinacy a policy rule reacting to output growth but not to output gap significantly increases the prospect of determinacy although the threat of indeterminacy is less severe under taylor contracts significant departures from the original taylor principle are required for determinacy

reconsidering the natural rate hypothesis in a new keynesian framework abstract this paper formulates a stylized new keynesian model in which each individual firm can select the frequency of its price adjustments the endogeneity of contract duration has a dramatic impact on the magnitude of the aggregate effects of steady state inflation with a plausible calibration of the magnitude of menu costs and other structural parameters this model predicts a relationship between steady state inflation and the frequency of price adjustment that is reasonably close to the empirical findings of cross country studies furthermore at moderate inflation rates steady state inflation generates relative price distortions that have a non trivial impact on aggregate output but this impact wanes and eventually disappears at much higher annual inflation rates because the frequency of price adjustment approaches that of the flexible price economy

the real interest rate and aggregate supply abstract this paper analyzes the effects of the anticipated real interest rate on aggregate supply variables in a model where time to produce and variable capital utilization play a crucial role the potential importance of the present mechanism for business cycle theory lies in its ability to generate positive co movements of employment capital utilization labor productivity output and investment these variables are predicted to be affected negatively by the real interest rate reduced forms for output and employment are derived and tested with canadian data taking estimates of the real interest rate prevailing in the united states as the relevant exogenous price

on the welfare and cyclical implications of moderate trend inflation abstract the welfare and cyclical implications of moderate trend inflation are addressed in an augmented medium scale dsge model increasing trend inflation from 2 to 4 percent generates a consumption equivalent welfare loss of about 4 percent welfare costs of this magnitude are driven by staggered wage contracts trend growth extended borrowing a roundabout production structure and the interaction between trend inflation and shocks to the marginal efficiency of investment mei a sticky price model abstracting from these features generates much smaller losses moderate trend inflation also has important business cycle implications interacting much more strongly with mei shocks than with productivity or monetary shocks

saving and liquidity constraints this paper is concerned with the theory of saving when consumers are not permitted to borrow and with the ability of such a theory to account for some of the stylized facts of saving behavior the models presented in the paper seem to account for important aspects of reality that are not explained by traditional life cycle models copyright 1991 by the econometric society

endogenous price stickiness trend inflation and macroeconomic stability previous studies show that higher trend inflation is more likely to induce indeterminacy of equilibrium in sticky price models based on micro evidence that each period a fraction of prices is kept unchanged this paper demonstrates that when the degree of price stickiness is endogenously determined in a calvo model indeterminacy caused by higher trend inflation is less likely a key factor for determinacy is the long run inflation elasticity of output implied by the new keynesian phillips curve this elasticity declines substantially with higher trend inflation in the case of exogenously given price stickiness whereas in the case of endogenous price stickiness the decline in the elasticity is mitigated because higher trend inflation leads to a higher probability of price adjustment

optimal monetary policy under commitment with a zero bound on nominal interest rates we determine optimal monetary policy under commitment in a forwardlooking new keynesian model when nominal interest rates are bounded below by zero the lower bound represents an occasionally binding constraint that causes the model and optimal policy to be nonlinear a calibration to the u s economy suggests that policy should reduce nominal interest rates more aggressively than suggested by a model without lower bound rational agents anticipate the possibility of reaching the lower bound in the future and this amplifies the effects of adverse shocks well before the bound is reached while the empirical magnitude of u s mark up shocks seems too small to entail zero nominal interest rates shocks affecting the natural real interest rate plausibly lead to a binding lower bound under optimal policy however this occurs quite infrequently and does not imply positive average inflation rates in equilibrium interestingly the presence of binding real rate shocks alters the policy response to non binding markup shocks

asset returns with transactions costs and uninsured individual risk abstract we explore whether incorporating an explicit motive for holding liquid assets within an equilibrium asset pricing model helps explain the following features of asset returns and turnover in the post war u s economy i the low risk free real interest rate ii the large spread between returns on liquid assets and stocks and iii the greater transaction velocity of liquid assets relative to stocks we introduce a demand for liquid assets by adding uninsured individual risk together with differential costs of trading securities numerical simulations attempting to match the return data generate a ratio of liquid assets to income considerably below observed levels

borrowing costs and the demand for equity over the life cycle abstract we construct a life cycle model that delivers realistic behavior for both equity holdings and borrowing the key model ingredient is a wedge between the cost of borrowing and the risk free investment return borrowing can either raise or lower equity demand depending on the cost of borrowing a borrowing rate equal to the expected return on equity which we show roughly matches the data minimizes the demand for equity alternative models with no borrowing or limited borrowing at the risk free rate cannot simultaneously fit empirical evidence on borrowing and equity holdings

income and wealth heterogeneity in the macroeconomy how do movements in the distribution of income and wealth affect the macroeconomy we analyze this question using a calibrated version of the stochastic growth model with partially uninsurable idiosyncratic risk and movements in aggregate productivity our main finding is that in the stationary stochastic equilibrium the behavior of the macroeconomic aggregates can be almost perfectly described using only the mean of the wealth distribution this result is robust to substantial changes in both parameter values and model specification our benchmark model whose only difference from the representative agent framework is the existence of uninsurable idiosyncratic risk displays far less cross sectional dispersion and skewness in wealth than u s data however an extension that relies on a small amount of heterogeneity in thrift does succeed in replicating the key features of the wealth data furthermore this extension features aggregate time series that depart significantly from permanent income behavior

asset pricing puzzles and incomplete markets the representative agent theory of asset pricing is modified to incorporate heterogeneous agents and incomplete markets the model features two types of agents who differ up to a nontradable idiosyncratic component in their endowment processes numerical solutions indicate that individuals are able to diversify a substantial portion of their idiosyncratic income risk through riskless borrowing and lending alone restrictions on the variability of intertemporal marginal rates of substitution hansen and jagannathan 1991 are used to argue that incomplete markets as modeled here cannot account for the properties of asset returns that are anomalous from the perspective of representative agent theory a large literature in financial economics has investigated the extent to which variants of the lucas 1978 general equilibrium theory of asset pricing can account for the joint behavior of aggregate u s consumption and asset returns by and large this literature has concluded that a theory based upon frictionless arrow debreu markets and or a representative agent makes strongly counterfactual predictions regarding even the simple unconditional properties of this relationship mehra and prescott 1985 for instance show that the theory drastically underpredicts the average excess rate of return on u s stocks the so called equity premium puzzle weil 1989 points out as did mehra and prescott that the magnitude of the average risk free rate is far below that predicted by the theory this has been dubbed the risk free rate puzzle numerous authors including grossman melino and shiller 1987 and backus gregory and zin 1989 show that the theory cannot account for term premia inherent in the yield curve hodrick 1987 surveys a large literature which documents the theory s shortcomings in accounting for excess expected returns in foreign exchange markets the notion that the representative agent model cannot account for excess returns across a wide array of asset markets can be made more precise by using tools developed by hansen and jagannathan 1991 and shiller 1982

does productivity growth lower inflation in korea we investigate granger causality between productivity growth and inflation in korea using quarterly data for the period 1985q1 2002q4 our results indicate unidirectional granger causality from productivity growth to inflation in light of such causality we estimate the effect of productivity and other variables on productivity according to our regression results a 1 increase in labour and total factor productivity tfp reduces consumer price index cpi inflation by 0 07 0 08 and 0 37 0 44 respectively our results also suggest that the productivity inflation nexus became stronger in korea since the asian financial crisis and that this was largely due to structural reform and technological progress

heterogeneity aggregate uncertainty and the short term interest rate this article analyzes the relationship between the short term interest rate and diversity i e the number of types in models with heterogeneous agents and incomplete markets the number of types needed to approximate a continuum varies across examples in all cases however the number of types has little effect on the average interest rate and consumption variability in these models the set of state variables is large because the equilibrium law of motion depends on the cross sectional wealth distribution the article shows how to solve these models numerically by approximating the distribution using moments or percentiles

optimal consumption and investment with capital gains taxes this article characterizes optimal dynamic consumption and portfolio decisions in the presence of capital gains taxes and short sale restrictions the optimal decisions are a function of the investor s age initial portfolio holdings and tax basis our results capture the trade off between the diversification benefits and tax costs of trading over an investor s lifetime the incentive to rediversify the portfolio is inversely related to the size of the embedded gain and investor s age contrary to standard financial advice the optimal equity holding increases well into an investor s lifetime in our model due to the forgiveness of capital gains taxes at death taxes play an important role in the decision making process of individuals concerning their consumption and investment plans the taxation of returns on financial assets alters the benefits of saving for future consumption and thus affects the trade off between current consumption and investment moreover the ability of investors to defer the taxation of capital gains alters the relative valuation of stocks and bonds and thus affects the optimal portfolio composition of investors the deferral feature of capital gains taxes also affects the trade off investors face regarding taxes and diversification investors would like to maintain an optimally diversified portfolio over time

indexation and incomes policy a study of wage adjustment in unionized manufacturing data from nearly 200 collective bargaining units are used to study the frequency of wage change from 1957 to 1978 it is shown that incomes policies during the kennedy johnson and nixon administrations encouraged changes in the length of time between wage adjustments inflation often thought to be responsible for fluctuations in the coverage of indexing provisions is found to play virtually no role the conclusion is that government intervention in the wageprice process aroused fears that the government will intervene again in the future in the presence of this uncertainty the wage adjustment provisions of collective bargaining contracts were changed

trend inflation wage and price rigidities and productivity growth abstract what are the steady state implications of inflation in a general equilibrium model with real per capita output growth and staggered nominal price and wage contracts surprisingly a benchmark calibration implies an optimal inflation rate of 1 9 percent the analysis also shows that trend inflation has important effects on the economy when combined with nominal contracts and real output growth steady state output and welfare losses are quantitatively important even for low values of trend inflation further nominal wage contracting is found to be quantitatively more important than nominal price contracting in generating the results this conclusion does not arise from price dispersion per se but from an effect of nominal output growth on the optimal markup of monopolistically competitive labour suppliers finally accounting for productivity growth is found to be important for calculating the welfare costs of inflation indeed the presence of 2 percent productivity growth increases the welfare costs of inflation in the benchmark specification by a factor of four relative to the no growth case

asset pricing with limited risk sharing and heterogeneous agents we develop a model with incomplete markets and heterogeneous agents that generates a large equity premium while simultaneously matching stock market participation and individual asset holdings the high risk premium is driven by incomplete risk sharing among stockholders which results from the combination of aggregate uncertainty borrowing constraints and a realistically calibrated life cycle earnings profile subject to idiosyncratic shocks we show that it is challenging to simultaneously match asset pricing moments and individual portfolio decisions while limited participation has a negligible impact on the risk premium contrary to the results of models where it is imposed exogenously

labor market frictions and optimal steady state inflation in central theories of monetary non neutrality the ramsey optimal steady state inflation rate varies between the negative of the real interest rate and zero this paper explores how the interaction of nominal wage and search and matching frictions affect the policy prescription we show that adding the combination of such frictions to the canonical monetary model can generate an optimal inflation rate that is significantly positive specifically for a standard u s calibration we find a ramsey optimal inflation rate of 1 16 percent per year

the optimal rate of inflation with trending relative prices relative price trends mean that monetary policy cannot stabilize the nominal prices of all consumption categories if prices are sticky monetary policy must then trade off distortions within different categories more weight should be placed on stabilizing prices for which adjustment entails greater distortions with exogenous price stickiness a simple model calibrated to u s data implies that slight deflation is optimal even absent money demand considerations if price stickiness is endogenous because of fixed costs of adjustment small inflation or small deflation can be optimal depending on whether demand conditions or price adjustment costs vary across sectors

optimal monetary policy optimal monetary policy maximizes the welfare of a representative agent given frictions in the economic environment constructing a model with two sets of frictions costly price adjustment by imperfectly competitive firms and costly exchange of wealth for goods we find optimal monetary policy is governed by two familiar principles first the average level of the nominal interest rate should be sufficiently low as suggested by milton friedman that there should be deflation on average yet the keynesian frictions imply that the optimal nominal interest rate is positive second as various shocks occur to the real and monetary sectors the price level should be largely stabilized as suggested by irving fisher albeit around a deflationary trend path since expected inflation is roughly constant through time the nominal interest rate must therefore vary with the fisherian determinants of the real interest rate although the monetary authority has substantial leverage over real activity in our model economy it chooses real allocations that closely resemble those which would occur if prices were flexible in our benchmark model there is some tendency for the monetary authority to smooth nominal and real interest rates

staggered price setting staggered wage setting and business cycle persistence abstract staggered price setting and staggered wage setting are commonly viewed as similar mechanisms in generating persistent real effects of monetary shocks in this paper we distinguish the two mechanisms in a dynamic stochastic general equilibrium framework we show that although the dynamic price setting and wage setting equations are alike a key parameter governing persistence is linked to the underlying preferences and technologies in different ways with reasonable parameter values the staggered price mechanism by itself is incapable of while the staggered wage mechanism plays an important role in generating persistence

precautionary portfolio behavior from a life cycle perspective abstract the literature on household asset accumulation draws a sharp distinction between short run precautionary motives to buffer consumption from annual income shocks and long run life cycle considerations under income certainty however estimates of shock persistence imply considerable career uncertainty we study long run precautionary motives for life cycle wealth accumulation and portfolios allowing for uncertain returns incomes and lifespan we separate the effects of various factors on mean and median asset holdings including education risk aversion household heterogeneity bequests impatience variance and serial correlation of income shocks numerical solutions are compared with data from the 1992 survey of consumer finances

the macroeconomics of trend inflation most macroeconomic models for monetary policy analysis are approximated around a zero inflation steady state but most central banks target an inflation rate of about 2 percent many economists have recently proposed even higher inflation targets to reduce the incidence of the zero lower bound constraint on monetary policy in this survey we show that the conduct of monetary policy should be analyzed by appropriately accounting for the positive trend inflation targeted by policymakers we first review empirical research on the evolution and dynamics of u s trend inflation and some proposed new measures to assess the volatility and persistence of trend based inflation gaps we then construct a generalized new keynesian model that accounts for a positive trend inflation in this model an increase in trend inflation is associated with a more volatile and unstable economy and tends to destabilize inflation expectations this analysis offers a note of caution regarding recent proposals to address the existing zero lower bound problem by raising the long run inflation target jel e12 e31 e32 e52 e58

asset holding and consumption volatility we investigate the possibility that limited participation in asset markets and the stock market in particular might explain the lack of correspondence between the sample moments of the intertemporal marginal rate of substitution and asset returns in u k data we estimate ownership probabilities to separate likely shareholders from nonshareholders enabling us to control for changing composition effects as well as selection into the group we then construct estimates of the imrs for each of these different groups and consider their time series properties we find that the consumption growth of shareholders is more volatile than that of nonshareholders and more highly correlated with excess returns to shares in particular one cannot reject the predictions of the consumption capital asset pricing model for the group of households predicted to own both assets this is in contrast to the failure of the model when estimated on data for all households

optimal inflation rates with the trending relative price of investment abstract i study the effect of the trending relative price of investment on the optimal target rate of inflation in an estimated dynamic general equilibrium model of the u s economy the price of investment has a decreasing trend relative to that of consumption because of investment specific technological progress if the prices of investment goods are sticky a benevolent planner puts weight on stabilizing these prices which works to raise the optimal target rate of inflation in terms of the price of consumption the estimated model shows a high degree of price stickiness in an investment sector and the resulting optimal target rate of inflation is significantly positive this result is robust to an extended model in which the prices of some categories of investment goods are flexible

state dependent pricing and business cycle asymmetries we present a tractable dynamic general equilibrium model of state dependent pricing and study the response of output and prices to monetary policy shocks we find important non linearities in these responses for empirically relevant shocks this generates substantially different predictions from time dependent pricing we also find a distinct asymmetry with state dependent pricing prices respond more to positive shocks than they do to negative shocks this is due to a strategic linkage between firms in the incentive for price adjustment our state dependent model can account for business cycle asymmetries in output of the magnitude found in empirical studies

the effects of investing social security funds in the stock market when fixed costs prevent some households from holding stocks with fixed costs of participating in the stock market consumers with high income will participate in the stock market but consumers with lower income will not participate if a fully funded defined contribution social security system tries to exploit the equity premium by selling a dollar of bonds per capita and buying a dollar of equity per capita consumers who save but do not participate in the stock market will increase their consumption thereby reducing saving and capital accumulation calibration of a general equilibrium model indicates that this policy could reduce the aggregate capital stock substantially by about 50 cents per capita