wage contracts and business cycle models abstract the paper introduces an explicit production technology into a business cycle model with nominal rigidities and evaluates the modified model using criteria similar to those commonly used to assess real business cycle rbc models in general the model compares favorably to standard rbc models and is superior in several important respects it reproduces the observed correlation of average labor productivity and hours as well as the relative volatilities of hours and output and requires technological shocks of a lower magnitude to generate the observed volatility of output finally the modified model is capable of reproducing some of the stylized response patterns from the recent empirical literature

credible commitment and success with public enterprise reform abstract this paper studies why some efforts at public enterprise reform fail and why others succeed economic reforms are intended to increase efficiency and thus help sustain long term growth yet many governments have had difficulty sustaining the reforms they initiated and have reintroduced rigid controls over markets and enterprises this is because either in the process of implementation the government discovers that the costs of carrying the reform further are greater than the expected efficiency gains or the public is skeptical that the new policies can be sustained and does not take the actions necessary for the gains to be realized this paper develops a new institutionalist framework and employs various measures of policy commitment and net gain from continued reform to analyze these issues the paper suggests ways in which the potential success or failure of a reform can be assessed with implications for the steps that reformers might take to increase the chances of success

why haven t developing countries privatized deeper and faster abstract despite a decade of privatization in the developing world the vast majority of state owned enterprise soe assets continue to be in government hands bureaucrats in business world bank 1995 correctly identifies politics as one reason for the slow pace of privatization but it underestimates the role of institutional and economic constraints success stories of privitization are rare in low income countries and the long term promise of privatization in sectors posing regulatory complications remains to be established countries in crisis may reform soes quickly and deeply despite these uncertainties but others may opt for gradual reform which need not be altogether bad if speedy privatization results in poorly conceived schemes the cure can be worse than the illness finally bureaucrats are likely to stay in business for years to come and therefore it is important to improve their effectiveness in the roles they are unlikely to shed in the future a market friendly approach to soe reform need not be government un friendly

why has u s inflation become harder to forecast we examine whether the u s rate of price inflation has become harder to forecast and to the extent that it has what changes in the inflation process have made it so the main finding is that the univariate inflation process is well described by an unobserved component trend cycle model with stochastic volatility or equivalently an integrated moving average process with time varying parameters this model explains a variety of recent univariate inflation forecasting puzzles and begins to explain some multivariate inflation forecasting puzzles as well

wage indexation and discretionary monetary policy since the early 1970 s both academic researchers and policymakers have devoted considerable attention to the macroeconomic effects of wage indexation however these two groups have focused on different effects starting with jo anna gray 1976 and stanley fischer 1977a formal models emphasize the role of indexation in stabilizing or destabilizing output in contrast informal policy discussions usually focus on the allegation that indexation is inflationary e g arthur okun 1971 mario simonsen 1983 eliana cardoso and rudiger dornbusch 1987 to reduce this gap this paper presents a model of the effects of indexation on inflation and asks whether indexation raises economic welfare when these effects are taken into account until recently it was difficult to formalize the argument that indexation is inflationary because economists lacked models of the sources of inflation this paper applies the insight of robert barro and david gordon 1983a that with discretionary policy the employment gains from surprise inflation tempt the monetary authority to create positive trend inflation as stressed by fischer and lawrence summers 1989 policies that reduce the costs of inflation such as indexation cause barro gordon policymakers to choose higher inflation indeed inflation can rise so much that welfare falls despite greater protection against inflation this effect is appealing because it captures the common argument that indexation weakens policymakers will to fight inflation 1 this is not the end of the story however because wage indexation has a second effect it reduces the employment effects of surprise inflation that is unlike most policies to reduce the costs of inflation such as indexation of interest rates wage indexation steepens the phillips curve in the barrogordon model a steeper phillips curve reduces the temptation to inflate and hence reduces equilibrium inflation since indexation has one inflationary effect lower costs of inflation and one anti inflationary effect a steeper phillips curve the net effect appears ambiguous even if the net effect on inflation is determined the welfare effect may remain unclear if inflation rises the welfare loss might or might not be outweighed by the lower cost of a given amount of inflation 2 these ambiguities cannot be resolved with the barro gordon model alone because the phillips curve and the effect of inflation on welfare are ad hoc it is plausible that indexation affects these relations but the relative strengths of the effects are unclear resolving the ambiguities requires a more structural model in which the effects of indexation are derived rather than assumed this paper studies such a model specifically we use a model of staggered wagesetting based on gray 1976 fischer 1977a b and john taylor 1980 the degree of indexation is an explicit parameter and so we can derive its net effects on inflation and welfare section i of this paper presents our basic model and derives equilibrium inflation in

wage stickiness and the non neutrality of money a cross industry analysis abstract the paper provides an empirical test of sticky wage models of business fluctuations by focusing on industry level cross sectional implications that emerge this breaks the observational equivalence existing at the aggregate level between rational expectations long term contracting and imperfect information models the specific implication tested is whether output responses to nominal disturbances industry phillips curve slopes are inversely related to wage indexation elasticities the phillips curve slopes are found to vary across industries for the canadian economy but bear no relationship to indexation elasticities casting doubt on the role of nominal wage rigidity in generating the observed non neutrality of money

contract length monetary policy and exchange rate variability abstract this paper investigates the dependence of exchange rate variability on average contract length in the goods market when changes in the money supply are the driving force for movements in the exchange rate it is shown that in general an increase in average contract length will increase the volatility of the exchange rate we then discuss how changes in the money supply process affect average contract length besides providing an explanation for changes in the conditional variance of the exchange rate our results are interesting in the light of the changes in monetary control procedures implemented by the federal reserve board in october 1979 and the consequent increase in exchange rate volatility

bargaining structure and nominal wage flexibility in a model with hetergenous agents wage setting by monopoly unions and monetary policy conducted by a central bank we show that the duration of nominal wage contracts is u shaped in the degree of centralization with intermediate bargaining systems yielding contracts of shorter duration and thus more flexible nominal wages than both decentralized and centralized systems we also find the degree of heterogeneity in the economy the theoretical predictions of the model are tested on oecd data there is empirical support for the main results regarding contract length while there is less support for the predictions regarding the level of centralization

the timing of monetary policy shocks a vast empirical literature has documented delayed and persistent effects of monetary policy shocks on output we show that this finding results from the aggregation of output impulse responses that differ sharply depending on the timing of the shock when the monetary policy shock takes place in the first two quarters of the year the response of output is quick sizable and dies out at a relatively fast pace in contrast output responds very little when the shock takes place in the third or fourth quarter we propose a potential explanation for the differential responses based on uneven staggering of wage contracts across quarters using a stylized dynamic general equilibrium model we show that a very modest amount of uneven staggering can generate differences in output responses similar to those found in the data

toward a theory of regulation for developing countries following jean jacques laffont s lead the efficient operation and expansion of infrastructures in developing countries is crucial for growth and poverty reduction however recent reforms aimed at improving the performance of these sectors have had limited success evidence suggests that in many instances this was because the traditional regulatory theory relied on by policymakers was not suitable for the institutional context in developing countries this article surveys more recent theoretical work focusing on problems with regulation in these countries at the heart of the survey is the work of jean jacques laffont who in the last decade of his life set about developing a theoretical framework for regulation in developing countries we consider the implications of his work which focused on the key institutional limitations faced in developing countries we then discuss where experience suggests that there are important omissions from this modeling bringing in extensions and alternative approaches pursued by other authors we conclude by summarizing the key ways in which regulatory policy will be different when institutions are weak overall we find that an understanding of the institutional context and its implications are crucial when designing a regulatory framework for developing countries

islands indexation and monetary policy this paper develops a synthesized macroeconomic model that incorporates the local global informational asymmetries of an islands economy into a setting characterized by endogenous wage indexation in such an economy agents are unable both to filter out the separate influences of demand and supply shocks on observed output prices and to distinguish between the separate price effects of local and aggregate disturbances so that optimal wage indexation depends upon both the variances of supply and demand disturbances and the information conditioned forecasts of agents as a result optimal monetary policy generally depends upon the variances of local and aggregate supply and demand

the equilibrium distribution of wage settlements and economic stability several authors recently have attempted to extend the fischer contract model by allowing agents to endogenize the contract pattern see e g gray 1978 and blanchard 1979 aside from the early literature on the pattern bargaining ross 1948 rees and hamilton 1963 and mcguire and rapping 1968 however the only literature that endogenizes the pattern of negotiation is fethke and policano 1982 1984 adopting a game theoretic framework in which each sector selects the contract length and the timing of its negotiation date so as to minimize the expected resource cost of contracting they investigate the determinants and aggregate implications of alternative negotiation patterns in a twosector model with relative and aggregate disturbances in this paper contract length is assumed to be fixed and indexing provisions are ignored our attention is concentrated on the determinants of the timing of bargaining and the macroeconomic consequences of the resulting year to year distributions of wage settlements these questions will be analyzed in a game theoretic framework where bargaining units choose the timing of bargaining and the authority chooses the money supply rules suppose that the distribution of wage settlements is uniform and that the monetary authority chooses optimum monetary policy such as that given by fischer 1977 then the behaviors of the price level output and the real wage are symmetric between odd and even periods and hence bargaining units are indifferent to the timing of bargaining at the same time the authority minimizes the loss function given the distribution of wage settlements consequently no player has an incentive to change his current strategy and the economy is in nash equilibrium in effect fischer 1977 examines the properties of this equilibrium without providing a game theoretic treatment of the problem we require answers to three questions 1 is uniform distribution the only equilibrium of this labor contract economy 2 if not what is the optimal pattern of negotiation from the

nominal wage flexibility wage indexation and monetary union membership in a monetary union implies stronger incentives for nominal wage flexibility in the form of wage indexation and shorter contract length than non membership this counteracts the stabilisation policy cost of giving up monetary independence but more wage flexibility is only an imperfect substitute for an individual monetary policy it is possible that an increase in wage flexibility is welfare decreasing because of the accompanying rise in price variability the interaction between wage setting and central bank behaviour may result in either multiple equilibria or a unique full indexation equilibrium

government debt management the long and the short of it standard optimal debt management dm models prescribe a dominant role for long bonds and advocate against issuing short bonds they require very large positions in order to complete markets and assume each period that governments repurchase all outstanding bonds and reissue r r new ones these features of dm are inconsistent with u s data we introduce incomplete markets via small transaction costs which serves to make optimal dm more closely resemble the data r r are negligible short bond issuance substantial and persistent and short and long bonds positively co vary intuitively long bonds help smooth taxes over states and short bonds over time solving incomplete market models with multiple assets is challenging so a further contribution of this article is introducing a novel computational method to find global solutions

wage setting patterns and monetary policy international evidence abstract systematic differences in the timing of wage setting decisions among industrialized countries provide an ideal framework to study the importance of wage rigidity for the transmission of monetary policy synchronization in wage setting decisions is prevalent in japan and the united states yielding varying degrees of wage rigidity within the year instead in france germany and the united kingdom decisions are more uniformly spread over time exploiting within year variation in the timing of wage setting decisions in these economies we find support for the long held but scarcely tested view that wage rigidity plays a critical role in the transmission of monetary policy

resistance to reform status quo bias in the presence of individual specific uncertainty comment why do governments so often fail to adopt policies which economists consider to be efficiency enhancing our answer to this question relies on uncertainty regarding the distribution of gains and losses from reform we show that there is a bias towards the status quo and hence against efficiency enhancing reforms whenever some of the individual gainers and losers from reform cannot be identified beforehand there are reforms which once adopted will receive adequate political support but would have failed to carry the day ex ante the argument does not rely on risk aversion irrationality or hysteresis due to sunk costs jel d72 f13 why do governments so often fail to adopt policies that economists consider to be efficiency enhancing this is one of the fundamental questions of political economy the answer usually relies on what may be

institutions and government controls abstract this paper develops a model of government policy toward industrial control and regulation that sheds light on the determinants of differential country experiences in terms of organizational arrangement and enterprise performance in contrast to the model developed by shleifer and vishny shleifer a vishny r w 1994 politicians and firms quarterly journal of economics 109 995 1025 shleifer a vishny r w 1998 the grabbing hand government pathologies and their cures harvard univ press cambridge ma which suggests that government controls over firms come about when politicians can use public funds to buyoff the managers and solicit their cooperation in politically motivated redistribution of rents the present shows that it may be the ability to use the government s regulatory powers at discretion that encourages politicians to impose controls on firms and redistribute their rents the model implies that the politicians appetite for intervention tends to be greater when the cost of collecting and using public funds is higher which is the opposite of what the shleifer vishny model predicts the present model helps explain the puzzling observation that countries with poor institutions are more likely to impose extensive controls on production and maintain large and inefficient public sectors the model also sheds light on a variety of other stylized facts and puzzles and offers new hypotheses to be tested

the us treasury floating rate note puzzle is there a premium for mark to market stability abstract we find that treasury floating rate notes frns trade at a significant premium relative to the prices of treasury bills and notes this premium is directly related to the near constant nature of frn prices and is correlated with measures reflecting investor demand for safe assets money market funds are often the primary investors in frns and the frn premium is related to flows into funds with fixed net asset values but not to flows into funds with variable net asset values these results provide strong evidence that the frn premium represents a convenience yield for the mark to market stability feature of frns

information incentives and contract timing patterns a prominent feature of wage contracting in the united states is the bunched timing pattern that is often associated with the process of pattern bargaining the model describes the bunching of wage contracts as the equilibrium outcome of decentralized decisions in an economy composed of both competitive and monopolistically competitive product markets agents time their wage adjustment to take advantage of the information associated with the timing decisions of others this information based motive leads to staggered contracting a bunching equilibrium requires the presence of heterogeneous product markets and occurs because the information transmitted by contracting agents differs across the market structures copyright 1990 by economics department of the university of pennsylvania and the osaka university institute of social and economic research association

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

optimal taxation without state contingent debt in an economy studied by lucas and stokey tax rates inherit the serial correlation structure of government expenditures belying barro s earlier result that taxes should be a random walk for any stochastic process of government expenditures to recover a version of barro s random walk tax smoothing outcome we modify lucas and stokey s economy to permit only risk free debt having only risk free debt confronts the ramsey planner with additional constraints on equilibrium allocations beyond one imposed by lucas and stokey s assumption of complete markets the ramsey outcome blends features of barro s model with lucas and stokey s in our model the contemporaneous effects of exogenous government expenditures on the government deficit and taxes resemble those in lucas and stokey s model but incomplete markets put a near unit root component into government debt and taxes an outcome like barro s however we show that without ad hoc limits on the government s asset holdings outcomes can diverge in importa

optimal maturity of government debt without state contingent bonds abstract this paper shows that state contingent debt can be synthetically constructed using non contingent debt of different maturities a main policy implication of this principle is that the ramsey allocation with complete markets can be sustained with non contingent debt only by properly managing its maturity structure the numerical experiments however suggest that this policy implication ought to be taken with care we find that the debt positions that sustain the ramsey allocation are very high on the order of a few hundred times total gdp for a very simple four state economy and increasing in the number of states in addition they are very sensitive to small variations in the parameters of the model

why are stabilizations delayed when a stabilization has significant distributional implications e g tax increases to eliminate a large budget deficit socioeconomic groups may attempt to shift the burden of stabilization onto other groups the process leading to stabilization becomes a war of attrition each group attempting to wait the others out and stabilization occurring only when one group concedes and bears a disproportionate share of the burden the authors solve for the expected time of stabilization in a model of rational delay and relate it to several political and economic variables they motivate this approach and its results by comparison to historical and current episodes copyright 1991 by american economic association

supply shocks wage stickiness and accommodation the key issue in the supply shock literature that developed after the 1973 74 oil and food price shocks was whether to accommodate l there is of course nothing to be done about the reduction in the equilibrium level of output caused by the supply shock but twice in the 1970s supply shocks resulted in output falling below its potential level the question discussed in the supply shock literature and taken up here is whether government policy is either responsible for or can offset the fall in the level of output to below its potential level i also discuss the costs and benefits of alternative policy responses to a supply shock it will be seen that the basic issues are precisely those that arise in considering activist policy in general the paper opens by discussing optimal responses to a supply shock in a one sector model these would be observed if markets cleared at all times in section 2 i examine the behavior of output and prices when wages are slow to adjust to the supply shock the key factors here are whether the supply shock requires a reduction in the real wage and whether there is real wage resistance by workers in contrast to much of the recent literature i concentrate on the closed economy 2 the supply shock is domestic and there is no recourse to foreigners to mitigate its effects the main result of the paper is that supply shocks by themselves are unlikely to lead to unemployment if monetary policy remains passive and so long as there is no

coordination failure multiple equilibria and economic institutions models of coordination failure have equilibria that are not first best because of externalities usually these models display multiple equilibria we provide an example of how the existence of some economic institutions and government policies can be explained as mechanisms for internalizing externalities and selecting the best equilibrium in these settings the example we analyse is that of nominal wage and debt contracts nominal contracts can improve on the underinvestment equilibrium by implementing pareto improving transfers between agents if there are multiple underinvestment equilibria then monetary policy can have real effects because the monetary authority can choose a money supply rule to coordinate beliefs and thereby select the best equilibrium

the euro area bond free float and the implications for qe this paper examines how shocks to government bond duration risk held by price sensitive investors affect the euro area term structure of interest rates and the wider macroeconomy we construct a new measure of the bond free float which adjusts total debt for foreign official holdings and weights by residual maturity using a small macrofinance bayesian vector autoregression var model we estimate that the first round of asset purchases under the european central bank s ecb public sector purchase program reduced euro area 10 year bond yields by around 30 bps in 2015 the positive impact on the output gap and inflation in 2016 was about 0 2 and 0 3 ppt respectively

the interaction between indexation contract duration and non contingent wage adjustment a model of the elasticity of indexation contract duration and non contingent wage adjustment is estimated using canadian wage agreements results suggest that the degree of indexation and contract duration are interdependent and are affected by their past values labour market conditions and inflation uncertainty the correlation between the industry product prices and the cpi affects the degree of indexation non contingent wage adjustment depends on expected inflation uncompensated past inflation duration and indexation values past and present and labour market conditions this model explains total wage adjustment as well as more aggregative models designed solely for that purpose

unemployment benefits contract length and nominal wage flexibility we show in a union bargaining model that a decrease in the unemployment benefit level increases not only equilibrium employment but also nominal wage flexibility and thus reduces employment varia

is equilibrium indexation efficient this paper investigates the welfare properties of equilibrium indexation in a decentralized economy if indexation is costless so all firms index then the equilibrium degree of indexation is efficient but if indexation is costly and this leads some firms not to index equilibrium indexation is inefficient because indexation has externalities for nonindexed firms firms choose too little indexation if labor demand is more responsive to movements in real money than to movements in real wages the results do not depend on the relative importance of real and nominal shocks

a positive theory of fiscal deficits and government debt this paper considers an economy in which policymakers with different preferences alternate in office as a result of elections government debt is used strategically by each policymaker to influence the choices of his successors if different policymakers disagree about the desired composition of government spending between two public goods the economy exhibits a deficits bias that is debt accumulation is higher than it would be with a social planner the equilibrium level of debt is larger the larger is the degree of polarization between alternating governments and the less likely it is that the current government will be re elected

persistency in sticky price models abstract nominal rigidities imply that nominal shocks have an impact effect which may be propagated by standard mechanisms however the nominal adjustment process may in itself be a propagation mechanism causing persistent effects of nominal shocks this may be caused by inertia in nominal wage and price adjustment arising due to input output networks or multiperiod nominal contracting as captured in models with staggered price wage decisions it has recently been contested whether staggering can account for persistency of any quantitative importance this paper reviews the theory and empirical evidence on this issue and it is concluded that staggering may be a quantitative important propagation mechanism

optimal fiscal and monetary policy in an economy without capital abstract this paper is concerned with the structure and time consistency of optimal fiscal and monetary policy in an economy without capital in a dynamic context optimal taxation means distributing tax distortions over time in a welfare maximizing way for a barter economy our main finding is that with debt commitments of sufficiently rich maturity structure an optimal policy if one exists is time consistent in a monetary economy the idea of optimal taxation must be broadened to include an inflation tax and we find that time consistency does not carry over an optimal inflation tax requires commitment by rules in a sense that has no counterpart in the dynamic theory of ordinary excise taxes the reason time consistency fails in a monetary economy is that nominal assets should from a welfare maximizing point of view always be taxed away via an immediate inflation in a kind of capital levy this emerges as a new possibility when money is introduced into an economy without capital

why and when do governments initiate public enterprise reform initiating public enterprise reform is a complex decision influenced by economic factors as well as the ideological biases and personalities of political leaders nevertheless the use of a contracting framework yields important generalizations about what drives the decision this article argues that the decision depends fundamentally on the potential efficiency gains from the reform and its associated transactions costs costs arise because of asymmetries in information and opportunism problems that usually plague contract negotiations the article identifies observable variables that may affect either the potential gains or the transactions costs uses them to construct a simple probit decision making model and tests the model using data from fifteen developing countries over a twenty year period

economic crisis and policy choice the politics of adjustment in the third world the acute economic pressures of the 1980s have forced virtually all of latin america and africa and some countries in asia into painful austerity programs and difficult economic reforms scholars have intensively analyzed the economics of this situation but they have given much less attention to the political forces involved in this volume a number of eminent contributors analyze the politics of adjustment in thirteen countries and nineteen governments drawing comparisons not only across the full set of cases but also within clusters selected to clarify specific issues why do some governments respond promptly to signs of economic trouble while others muddle indecisively for years why do some confine their response to temporary macroeconomic measures while others adopt broader even sweeping programs of reform what leads some countries to experiment with heterodox approaches while most however reluctantly pursue orthodox courses why confronted with intense political protest have some governments persisted while others have altered or abandoned course the answers to these questions are political not economic and they are examined here by thomas m callaghy stephan haggard miles kahler robert r kauman joan m nelson and barbara stallings

why do we have nominal government debt abstract we study the choice between nominal and indexed debt in a stochastic macroeconomic model with discretionary monetary and fiscal policy with distortionary taxes nominal debt provides valuable insurance against the budgetary effects of economic fluctuations we show that a welfare maximizing government always issues some nominal debt even though nominal debt increases inflation along the time consistent path of the economy the result is fairly robust with respect to changes in assumptions about policy constraints and about the macroeconomic setting

institutional investors and long term investment evidence from chile developing countries are trying to develop long term financial markets and institutional investors are expected to play a key role this paper uses unique evidence on the universe of institutional investors from the leading case of chile to study to what extent mutual funds pension funds and insurance companies hold and bid for long term instruments and which factors affect their choices the paper uses monthly asset level portfolios to show that despite the expectations mutual and pension funds invest mostly in short term assets relative to insurance companies the significant difference across maturity structures is not driven by the supply side of debt or tactical behavior instead it seems to be explained by manager incentives related to short run monitoring and the liability structure that combined with risk factors tilt portfolios toward short term instruments even when long term investing yields higher returns thus the expansion of large institutional investors does not necessarily imply longer term markets

understanding economic policy reform one of the eventual consequences of the global debt crisis was a wave of market oriented economic reforms this paper discusses the state of our knowledge on the political economy of this process why were inefficient and often unsustainable policies maintained for so long why are so many governments reforming now after decades of adherence to policies of an opposite kind have the reformers internalized the correct lessons from the east asian experience finally are there any helpful rules for reformers to follow in guiding their policies through complicated political terrain

aggregate pattern of time dependent adjustment rules i a game theoretic analysis of staggered versus synchronised wage setting this paper studies the benefits of staggered wage setting in reducing strategic conflicts it is shown that when wage setters interact strategically and dynamically they prefer moving alternatingly because by doing so they are able to commit temporarily not to offset the effects of each other s action it is also shown that synchronization represents a better arrangement when agents are able to coordinate these results are consistent with the presence of nonsynchronous and decentralized wage decisions in the united states and the united kingdom and the presence of synchronous bargaining in shunto and coordination in wage determination in japan copyright 1996 by royal economic society

aspects of monetary and banking theory and moral hazard we consider two problems in monetary and banking theory in this paper the first of these deals with differences between monetary and tax transfer resolutions of risk sharing problems in overlapping generations 12 15 models of fiat money under uncertainty our second contribution the scenario for which is also motivated in part by interventions needed for risk sharing reasons is an attempt to provide a rationale for interest rate controls on the liabilities of intermediaries that invest in risky assets both models consider environments in which uncertainty exists private markets are incomplete and most importantly some material payoff relevant actions are not perfectly observable the goal of this research is to provide further momentum to theoretical developments that serve to integrate information based models of investment and intermediation with theories of unbacked fiat money and the control of monetary institutions in recent years there has been a great deal of research interest in explicating the micro economic foundations of fiat money i e valued government created assets which are unbacked by payoffs from productive investments or taxes and the uniqueness and criteria for regulation of depository intermediary firms important contributions have been among others the works of bryant 3 the papers in kareken and wallace 7 fama 6 merton 10 and diamond and dybvig 5 asymmetric information based foundations of intermediary functioning have been provided by the papers of leland and pyle 9 followed by diamond 4 in most of this work there has usually been a dichotomy between models that focus on providing and analyzing a role for fiat money and those which analyze the rationale regulation and pricing of capital market intermediaries and their contracts regrettably we persist in having this dichotomy in our work some recent work like fama 6 does merge these two aspects however by emphasizing perfect information complete market environments in which the financial structure irrelevance theorems of modigliani and miller 10 apply models of unbacked fiat money many different types of which are to be found in kareken and wallace 7 can be usefully dichotomized as being of two types in the first fiat money serves the function of opening up or expanding trading opportunities among contemporaneously living agents who have endowment

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

a theory of privatization or why bureaucrats are still in business abstract privatization is a dynamic phenomenon and changes in ownership arrangements require explanations based upon changes in background variables without movements in these variables bureaucrats are likely to stay in business even if reform would increase efficiency it is argued that changes in one such variable the cost of government finance have played a particularly significant role in trigerring privatizations and related reforms the increasing cost of government finance resulting from higher levels of general public expenditure and taxation also explains the policy sequence observed in many countries in which comprehensive ownership reform is preceded by a period of increased financial stringency for state owned enterprises soes

externalities from contract length an increase in the length of a firm s labor contract contributes to rigidity in the aggregate price level this increases the variance of aggregate demand but decreases the variance of other firms real wages under certain conditions the net effect is to increase the variance of other firms employment this negative externality implies that the equilibrium contract length in a decentralized economy is greater than the social optimum in other words wages are too rigid copyright 1987 by american economic association

optimal time consistent government debt maturity this paper develops a model of optimal debt maturity in which the government cannot issue statecontingent debt as the literature has established if the government can perfectly commit to fiscal policy it fully insulates the economy against government spending shocks by purchasing short term assets and issuing long term debt these positions are quantitatively very large relative to gdp and do not need to be actively managed by the government our main result is that these conclusions are not robust when lack of commitment is introduced under lack of commitment large and tilted debt positions are very expensive to finance ex ante since they ex post exacerbate the government s problem stemming from a lack of commitment in contrast a flat maturity structure minimizes the cost entailed by a lack of commitment though this structure also limits the ability to insure against shocks and increases the volatility of fiscal policy distortions we show that the optimal time consistent maturity structure is nearly flat because reducing average borrowing costs is quantitatively more important for welfare than reducing fiscal policy volatility thus under lack of commitment the government actively manages its debt positions and can approximate optimal policy by confining its debt instruments to consols

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

bond market clienteles the yield curve and the optimal maturity structure of government debt we propose a clientele based model of the yield curve and optimal maturity structure of government debt clienteles are generations of agents at different life cycle stages in an overlappinggenerations economy an optimal maturity structure exists in the absence of distortionary taxes and induces efficient intergenerational risksharing if agents are more risk averse than log then an increase in the long horizon clientele raises the price and optimal supply of long term bonds but while a welfare maximizing government caters to clienteles it does not accommodate fully their demand and limits issuance of long term bonds to a level where these earn negative expected excess returns

will wage setters ever stagger decisions models featuring the implications of long term contracts typically impose the pattern of negotiation and then develop the implications of this particular structure with no analysis of whether the structure is optimal or stable recent work however focuses on the choice of the timing of wage negotiations across sectors 1 in fethke and policano 1984 we develop a two sector model in which each sector is subject to both aggregate and relative disturbances the main result is that whenever the variability of relative disturbances exceeds the weighted variability of aggregate disturbances a uniformly staggered pattern of negotiation represents a symmetric noncooperative nash solution the twosector case has special properties first the benefit associated with staggered negotiation apparently depends on the existence of large negotiating sectors in the economy second symmetry of relative disturbances in the two sector case leads to the unusual equivalence of the noncooperative and the joint optimization solutions to the problem of determining the optimal negotiation pattern one natural question concerns whether the incentive to stagger negotiation dates will diminish as the number of sectors increases in this paper we develop the three sector case in detail and then generalize the analysis to any number of sectors the results indicate that the more significant are relative disturbances the larger is the number of sectors that will be supported by a stable nash equilibrium with uniformly staggered negotiation dates in an economy characterized by atomistic sectors the incentive to stagger negotiation dates disappears we also compare the joint optimization solution with the nash solution and find that when there are more than two sectors the requirement for uniform staggering to be optimal is more difficult to satisfy under joint optimization than under the nash strategy this di

central bank independence revisited the case for central bank independence cbi while not a new one has been strengthened by a growing body of empirical evidence by recent developments in economic theory and by the temper of the times the case is a strong one 1 which is becoming part of the washington orthodoxy the purposes of this paper are both to make more precise the type of cbi that is likely to enhance economic performance and to point to some remaining open issues and anomalies i start with the two theoretical approaches to cbi

monetary policy and the timing of wage negotiations abstract in a model of long term labor contracts the simultaneous determination of the pattern of contract negotiation and the pattern of monetary policy intervention yields a nash equilibrium in which agents allow a discretionary role for policy the resulting pattern of negotiation depends on the stochastic nature of the system when all disturbances are aggregate in nature a synchronized pattern of negotiation is optimal regardless of the frequency of monetary policy intervention when both aggregate and relative disturbances affect the system a pattern of bunched negotiations can result with the authority intervening at dates away from the negotiation dates

optimal contract length in a reputational model of monetary policy we develop a reputational model of monetary policy with endogenous contract length in choosing contract length private sector agents trade off recontracting costs against the expected costs resulting from trading under contracts based on incorrect inflation expectations however due to an externality the private and socially optimal contract lengths differ when selecting individual contract length private agents do not consider the effect of contract length on the surprise inflation output trade off in a reputational model of monetary policy this results in an excessive equilibrium inflation rate the socially optimal outcome may be achieved by public policies that reduce recontracting costs

intermediate monetary targets and macroeconomic fluctuations it is investigated whether the choice of intermediate target has altered macroeconomic fluctuations and whether the observed changes are consistent with predictions from economic theory since implications from the theoretical literature focus on the effects of structural disturbances an empirical analysis must identify these effects the structural vector autoregressive var technique estimates structural disturbances using restrictions from standard macroeconomic theory based on descriptions of actual targeting procedures by insiders to federal reserve policy decisions the intermediate target for the united states is identified as the interest rate from 1951 to 1969 and money from 1970 to 1986 var models are estimated over each subsample to assess whether the estimated structural disturbances cause endogenous variables to behave as economic theory predicts tests are also performed to assess whether or not the targeting rule affects the variance of endogenous variables attributable to structural sh

wage contingencies the pattern of negotiation and aggregate implications of alternative contract structures abstract a model of long term contracts is developed in which the choice of the negotiation pattern is endogenized when disturbances to the economy derive primarily from relative shocks staggered negotiation is optimal because adjustments made by negotiating agents transmit desirable employment effects into sectors that are looked into previously negotiated contracts the price level acts as the transmission mechanism indexation of wages to the price level enhances the benefits of staggered negotiation because the sector specific information revealed by the price level acts as a substitute for explicit inclusion in the contract of sector specific information the degree of persistence and the level of variation in aggregate output and employment measures which are commonly used in comparing the merits of synchronized versus staggered regimes are shown to be inappropriate criteria upon which to judge the optimality of the negotiation pattern

staggered price setting with endogenous frequency of adjustment abstract a model of staggered price setting in which the frequency of price changes is endogenous is presented

credibility and reputation building in the developmental state a model with east asian applications abstract we use a game theoretic model to analyze the role of credibility reputation and investment coordination in a developmental state our model focuses on why a soft state serving narrow social groups so often obtains in less developed countries and under what conditions a hard or developmental state can emerge the model highlights the dilemma that although state and private sector alike may want economic growth both must simultaneously invest to achieve it but the equilibrium outcome analogous to the prisoner s dilemma is investment by neither even when initial conditions are favorable and a state is potentially developmental with the genuine capability to elicit private sector investment this may not materialize and an equilibrium of low or no investment will prevail to avoid this deadlock and foster growth the successful developmental state must demonstrate commitment by promoting its developmental credentials through a process of reputation building a consequent incentive to act tough together with seeming advantages of authoritarianism in implementing the developmental state may help to explain why it is often associated with an authoritarian political system

the political economy of inaction abstract this paper develops a simple model of political inaction in a two party democracy i e it shows the conditions under which both parties will prefer to live with an unsatisfactory and inefficient status quo rather than to raise an issue the risk of raising the issue to either party is the fear of ending up with the other party s policy for example by losing the electron regarded as even worse than the status quo the model shows that the problem is likely to be particularly serious the more evenly matched is political competition the more risk averse the parties the less voters trust the parties the more divided is public opinion and the more important the issue the model is illustrated with a number of examples of real world inaction e g on fiscal deficits abortion the transition to socialism and the fall of the weimar republic in general the analysis also suggests that over a range more representation of political viewpoints implies a smaller likelihood of political action so that democracy implies a tradeoff between representation and the capacity for political action

privatization and the private sector abstract from the perspective of someone who has observed the private and public sectors in emerging economies for many years it is interesting to recall that in the past it was the world bank that supported the development of state owned utilities and industrial enterprises in developing countries especially latin america it is also in latin america that the world bank became a convert to and promoter of privatization a key lesson of privatization in emerging markets is the importance of competition not only in the sale process but in the subsequent operation of privatized enterprises protective devices such as core shareholders and areas off limits to foreign investors are counterproductive privatization has spawned a new generation of entrepreneurs and been especially beneficial to the development of domestic capital markets

optimal debt management in a liquidity trap we study optimal debt management in the face of shocks that can drive the economy into a liquidity trap and call for an increase in public spending in order to mitigate the resulting recession our approach follows the literature of macroeconomic models of debt management which we extend to the case where the zero lower bound on the short term interest rate may bind we wish to identify the conditions under which removing long maturity government debt from the secondary market can be an optimal policy outcome we show that the optimal debt management strategy is to issue short term debt if the government faces a sizable exogenous increase in public spending and if its initial liability is not very large in this case our results run against the standard prescription of the debt management literature in contrast if the initial debt level is high then issuing long term government bonds is optimal finally we find a role for revisions in the debt management strategy during lt episodes whereby the government actively manages the maturity structure in some cases removing long bonds from the secondary market

incomplete markets liquidation risk and the term structure of interest rates we analyse the term structure of interest rates in a general equilibrium model with incomplete markets borrowing constraint and positive net supply of government bonds uninsured idiosyncratic shocks generate bond trades while aggregate shocks cause uctuations in the trading price of bonds long bonds command a liquidation risk premium over short bonds because they may have to be liquidated before maturity following a bad idiosyncratic shock precisely when their resale value is low due to the simultaneous occurrence of a bad aggregate shock our framework endogenously generates limited cross sectional wealth heterogeneity among the agents despite the presence of uninsured idiosyncratic shocks which allows us to characterise analytically the shape of the entire yield curve including the yields on bonds of arbitrarily long maturities agents desire to hedge the idiosyncratic risk together with their fear of having to liquidate long bonds at unfavourable terms imply that a greater bond supply raises the level of the yield curve while an increase in the relative supply of long bonds raises its slope

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

intergenerational risk sharing in the spirit of arrow debreu and rawls with applications to social security design this paper examines the optimal allocation of risk in an overlapping generations economy it compares the allocation of risk the economy reaches naturally to the allocation that would be reached if generations behind a rawlsian veil of ignorance could share risk with one another through complete arrow debreu contingent claims markets the paper then examines how the government might implement optimal intergenerational risk sharing with a social security system one conclusion is that the system must either hold equity claims to capital or negatively index benefits to equity returns

union wage settlements during a disinflation this paper examines the role of union wage contracts in the persistence of inflation and the implication of these contracts for the problem of disinflation in the united states a quantitative model of overlapping con tracts explicitly oriented toward the major union sector is developed the model takes account of expectations of future wage price and employment conditions as in more aggregated models that have been used in macroeconomic research in addition the distribution of workers according to contract length as well as deferred wage increases and escalator clauses are explicitly used in the model the main aim of the model is to determine the constraints which these contracts impose on disinflation paths the model indicates that the maximum speed of disinflation is extremely slow in the early phases if a rise in unemployment is to be avoided but increases considerably before the new lower rate of inflation is reached the disinflation path is considerably slower than that observed after hyperinflation periods however the existence of a path of inflation reduction raises questions about whether the institution of union wage con tracts is really the direct cause of costly disinflations or whether their influence works indirectly by raising credibility problems about a monetary disinflation this abstract was borrowed from another version of this item

staggering the optimal monetary rule and persistence abstract the purpose of this paper is to show that persistence is not an attribute that derives from the characteristics of wage and price setting alone the structure of demand the monetary rule and the welfare loss function are also crucial determinants of the time series characteristics of the model

alternative time patterns of decisions and dynamic strategic interactions this paper offers a simple approach to study steady state markov perfect equilibria arising in dynamic games when players are obliged to commit their actions for several periods it highlights the importance of spillovers and dynamic strategic interactions when assessing the various time patterns conceivable in such games the obtained results are then applied to various either micro or macroeconomic issues where time patterns of decisions matter

wage interdependence through decentralized bargaining abstract the idea that sector specific unions are influenced by the wages obtained by other unions has mainly been used to support the empirical observation that wages are highly correlated among industries the sources of wage interdependence can mainly be found in unions preferences in the nature of technology and in price and demand determination the presence of externalities and of strategic complementarity among unions leads to suboptimal equilibria which generates non desired inflation unemployment and possibly also trade balance deficit this enforces the idea that part of current unemployment can be eliminated by improving the cooperation between social actors

the debt burden and debt maturity at low and moderate levels of government debt there appears to be little relation between the level of debt and its maturity but at high levels of debt a strong inverse relation emerges we start the paper by documenting this inverse relation for those oecd countries which have reached very high levels of debt we then provide a theory of the joint movements of debt and maturity which can explain both sets of facts it is based on the idea that at high levels of debt the government may need to decrease the maturity of the debt as debt increases in order to maintain the credibility of its anti inflation stance this abstract was borrowed from another version of this item

optimal maturity of nominal government debt an infinite horizon model the role of debt maturity is analyzed in a framework that blends tax smoothing with time inconsistency of optimal policy when policymakers have an incentive to use unanticipated inflation to reduce the real value of nominal government liabilities three conclusions emerge 1 nominal debt leads policymakers to resort to inflation even though in equilibrium inflation collects no revenue 2 when under full precommitment the optimal policy calls for complete tax smoothing and a constant debt level the equilibrium policy without precommitment calls for anticipating tax collection and early debt repayment and 3 management of debt maturity is an essential component of the equilibrium policy copyright 1992 by economics department of the university of pennsylvania and the osaka university institute of social and economic research association

inflation and the demand for money in developing countries abstract the sensitivity of money holdings to yield is an important issue for financial sector reform for low income developing countries this sensitivity has been judged mainly on the basis of demand studies which use inflation as the opportunity cost of holding money but researchers have generally neglected the fact that because changes in prices may appear in dynamic demand for money equations even if the demand for money is not yield sensitive it is not normally possible to make valid inferences about the inflation sensitivity of equilibrium demand for money the severity of the problem is illustrated by reference to ghana and china

price pressure in the government bond market what determines the term structure of interest rates standard economic theory links the interest rate for maturity t to the willingness of a representative agent to substitute consumption between times 0 and t the standard model contrasts sharply with a more informal view based on investors preferred habitat proposed by john culbertson 1957 and franco modigliani and richard sutch 1966 according to the preferred habitat view there are investor clienteles with preferences for specific maturities and the interest rate for a given maturity is influenced by the demand of the corresponding clientele and the supply of bonds with that maturity for example the typical clientele for long term bonds are pension funds an increase in their demand would be expected to raise prices of long term bonds and thus lower long term interest rates in short preferred habitat implies that there is price pressure in the bond market while the preferred habitat view has intuitive appeal it has not entered into the academic mainstream typically being relegated to a paragraph in mba level textbooks one reason for this is the mixed findings in early empirical studies of the term structure specifically between 1962 and 1964 the us treasury and federal reserve raised the supply of short term government debt while simultaneously lowering the supply of long term debt this program known as operation twist aimed to raise shortterm interest rates and so improve the balance of payments while also lowering long term rates to stimulate private investment a number of papers evaluated operation twist and while they reached different conclusions none found strong evidence that the operation was effective in flattening the term structure e g modigliani price pressure in the government bond market

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

time inconsistency of protectionist programs protectionist trade policies have long been advocated as second best instruments to achieve certain national objectives in situations where there is a market imperfection in essence protection provides time and resources for firms to undertake cost reducing investments recently there has been an emergence of new arguments to justify the implementation of a national industrial policy to encourage investment and to ensure the competitiveness of targeted industries also at the theoretical level a new argument known as strategic trade policy has emerged according to this argument protectionism gives domestic firms strategic advantage against foreign firms to capture a greater share of export markets where rents are not competed away actually the performance of protectionist programs has been grim industries have not adapted and protection has had to be renewed again and again arguments justifying protection have avoided this issue by implicitly assuming that authorities can credibly precommit to eliminate protection this is a very strong assumption in fact government actions are not exogenous but they are rather the result of an optimization process or they are best responses to political pressures as stressed in the public choice literature 2 therefore if authorities capitulate to protectionist pressures in the present they are unlikely to resist them in the future in the event that the targeted firm would not have adapted the inability of authorities to precommit to the unconditional elimination of protection generates a trade off for the firm if during the program the firm does not invest sufficiently in cost

fiscal hedging with nominal assets abstract we analyze optimal fiscal and monetary policy in an economy with distortionary labor income taxes nominal rigidities nominal debt of various maturities and short selling constraints optimal policy prescribes the almost exclusive use of long term debt such debt mitigates the distortions associated with hedging fiscal shocks by allowing the government to allocate them efficiently across states and periods

fiscal policy and asset prices with incomplete markets we study the simultaneous impact of fiscal policy decisions on macroeconomic activity wealth distribution and asset prices we consider a general equilibrium overlapping generations model with incomplete markets and heterogeneous agents where government debt and capital are imperfect substitutes increases in public debt lead to significant increases in the riskless rate and to a reduction in the equity premium while higher capital income tax rates lead to a higher equity premium the crowding out effects on capital and output are much higher than in models where government debt and capital are perfect substitutes which thus ignore households portfolio reallocation decisions the author 2012 published by oxford university press on behalf of the society for financial studies all rights reserved for permissions please e mail journals permissions oup com oxford university press

equate and conflate political commitment to hunger and undernutrition reduction in five high burden countries summary as political commitment is an essential ingredient for elevating food and nutrition security onto policy agendas commitment metrics have proliferated many conflate government commitment to fight hunger with combating undernutrition we test the hypothesis that commitment to hunger reduction is empirically different from commitment to reducing undernutrition through expert surveys in five high burden countries bangladesh malawi nepal tanzania and zambia our findings confirm the hypothesis we conclude that sensitive commitment metrics are needed to guide government and donor policies and programmatic action without historically inadequate prioritization of non food aspects of malnutrition may persist to imperil achieving global nutrition targets

the effects of real and nominal shocks on union firm contract duration abstract the first theoretical works on labor contract length gray 1978 for example emphasized the existence of a negative relation between contract duration and uncertainty in estimating a linear version of gray s contract length model and an alternative model developed by christofides and wilton our empirical results indicate little evidence of a negative relationship between length and uncertainty in the united states furthermore our findings indicate the presence of significant differences across industries at the two digit sic level in the response of bargain duration to uncertainty

interest costs and the optimal maturity structure of government debt the government faces a trade off between the benefits of tax smoothing and an associated increase in expected interest costs when choosing its optimal debt portfolio the article solves for optimal policies in an incomplete markets model where the government uses two debt instruments long term and short term non contingent nominal bonds in this setup the basic prescription is to borrow long and invest short even though equilibrium expected interest costs are higher on long term debt the resulting welfare gains are close to what the government could achieve with complete markets significant welfare gains are possible even in the presence of leverage constraints

on endogenously staggered prices taylor s model of staggered contracts is an influential explanation for nominal inertia and the persistent real effects of nominal shocks however in standard imperfect competition models if agents are allowed to choose the timing of pricing decisions they will typically choose to synchronize this paper provides a simple model of imperfect competition which produces stable staggering our argument relies on strategic interaction at two levels between firms within an industries and across industries and produces a continuum of staggered price equilibria these equilibria are strict and hence stable under a simple adaptive learning process an enduring problem for business cycle theory is an explanation for the persistent effects of nominal shocks explaining persistence is particularly problematic for theories based on nominal shocks as opposed to real shocks this is because rational expectations implies that nominal shocks themselves cannot be serially correlated since nominal shocks are the deviation of realized nominal magnitudes from expected values in two important papers taylor 1979 1980 provided an argument as to why a nominal shock can have persistent effects taylor s argument required two important assumptions first he assumed that firms could adjust prices only in alternate periods an assumption which may be justified by menu or information costs taylor s second assumption was that price setting was staggered half the firms were constrained to adjust prices in odd periods while the other half were allowed to adjust prices in even periods these two assumptions combined to provide dramatic results on nominal inertia the adjustment of prices to a nominal shock is slow and hence output effects are long lasting taylor s results on persistence arise due to strategic complementarity between price setting decisions this implies that each firm s optimal price is an increasing function of the aggregate price level if a shock arrives in an even period firms in the even cohort will not adjust fully to the nominal shock since firms in the odd cohort have fixed prices in the current period furthermore with rational expectations the even cohort also takes into account the fact that its own failure to adjust fully will also make for partial adjustment in future periods this elegant story has made taylor s model possibly the most influential of new keynesian models by providing a dynamic setting within which small nominal rigidities may result in persistent nominal inertia

in search of a theory of debt management the complete market approach to government debt management argues that a portfolio of non contingent bonds at different maturities should be chosen so that fluctuations in market value offset changes in expected future deficits however this approach recommends huge fluctuations in positions enormous changes in portfolios for minor changes in maturities and no presumption it is always optimal to issue long and invest short term in a wide array of model specifications these extreme volatile and unstable features are undesirable for two reasons firstly fragility of portfolios to small changes in assumptions means that it is often better to follow a balanced budget rather than issue the optimal debt portfolio under some possibly misspecified model secondly for even miniscule transaction costs governments prefer a balanced budget rather than the large positions complete markets recommends the complete market recommendations conflict with a number of features we believe are integral to bond market incompleteness e g transaction costs liquidity effects robustness etc and which need to be explicitly incorporated into the portfolio problem