stabilization policy a reconsideration i introduction in 1936 keynes s general theory explained how fiscal and monetary policy could be used to end depressions since that time no developed country has ever seen a downturn on the scale of the 1930s the general theory was not just a how to book on the avoidance of depressions it was an argument for stabilization policy itself the years since the general theory have seen a revolt against keynesian economics in a revisionist mode milton friedman argued that countercyclical policy cannot affect the average level of unemployment and output robert lucas and thomas sargent 1979 went further contending that it is not only impossible to increase average output it is also impossible to stabilize it more recently lucas 1987 2003 has argued that policies to stabilize output even if effective would yield negligible welfare gains thus stabilization policy should not be a macroeconomic priority lucas s conclusion notwithstanding stabilization policy has long been an explicit or implicit objective of monetary policy in most industrial countries even including those countries with inflation targets the volatility of output has in fact declined in most major industrial countries since the mid 1980s and monetary policy arguably deserves at least partial credit see bernanke 2004 mirroring practice monetary policy research commonly takes it as given that along with price stability stabilization policy the minimization of squared deviations of output around potential is an appropriate policy objective see for example clarida et al 1999 in this article we explore the economic rationale for stabilization as a policy goal concluding that it does in fact deserve high policy priority we survey a large body of literature that critiques the validity of key assumptions in lucas s argument we also offer suggestive evidence that stabilization policy can significantly reduce average levels of unemployment by providing stimulus to demand in circumstances where unemployment is high but underutilization of labor and capital does little to lower inflation a monetary policy that vigorously fights high unemployment should however also be complemented by a policy that equally vigorously fights inflation when it rises above a modest target level the federal reserve act thus wisely enunciated price stability and maximum employment as twin goals for monetary policy ii the case against stabilization policy macroeconomic analysis typically assumes that social welfare depends negatively on both inflation above a modest target level here assumed zero and unemployment above some minimum socially efficient level for example a standard social welfare function is the discounted sum of period losses l sub t of the form see among others barro and gordon 1983 pp 592 93 1 l sub t a u sub t 1 k u sup 2 b pi sup 2 sub t where u sub t and pi sub t are the unemployment and inflation rates in period t and u sup is the natural rate of unemployment the coefficient k is positive reflecting the desirability of unemployment below the natural rate because real economies deviate in many respects from perfect competition the natural rate of unemployment is likely to exceed the socially optimal unemployment rate for example with monopolistic competition goods are underproduced because they are priced above marginal cost so potential output is inefficiently low and equilibrium unemployment is too high standard macroeconomic analysis additionally assumes that inflation is determined by an expectations augmented accelerationist phillips curve of the form 2 pi sub t pi sup e sub t f u sub t u sup epsilon sub t where pi sup e sub t is the expected inflation rate at time t with expectations formed at t 1 and epsilon sub t captures supply shocks to the phillips curve at t

using asset prices to measure the cost of business cycles we measure the cost of consumption fluctuations using an approach that does not require the specification of preferences and instead uses asset prices we measure the marginal cost of consumption fluctuations the per unit benefit of a marginal reduction in consumption fluctuations expressed as a percentage of lifetime consumption we find that the gains from eliminating all consumption uncertainty are very large however for consumption fluctuations corresponding to business cycle frequencies we estimate the marginal cost to be between 0 08 percent and 0 49 percent of lifetime consumption

the dual illusion of grants in aid on central and local expenditures a reply in this journal chu chu h y 2003 public choice 114 349 359 offered corrections for inconsistencies in the logan model of dual fiscal illusion logan r r 1986 journal of political economy 94 1304 1318 this paper shows that logan 1986 introduced two prevailing models of fiscal illusion and chose to follow one of them for generalization chu has not corrected any inconsistencies he has instead offered a generalization of the other type of illusion this paper demonstrates that the chu generalization suffers from multiple irrational and unachievable results which is why logan 1986 chose the original version in the first place

long forward and zero coupon rates can never fall in frictionless markets having no arbitrage the asymptotic zero coupon rate never falls the same is true of the long forward rate the long par coupon rate can rise and fall due to forward rate movements at short maturities this article relates the three types of interest rates and formalizes and proves the impossibility results for falling asymptotic rates these results can be tested in a parametric term structure specification that is rich enough to identify a time series of long rates the results show that it is not possible to specify arbitrarily the long forward or zero coupon rate process copyright 1996 by university of chicago press

the dual illusion of grants in aid on central and local expenditures the purpose of this paper is to clarify some misspecificationsthat prevail in the dual illusion hypothesis which is animportant influential theory in fiscal illusion studies avoter s behavior can hence be self fulfilling and the dual illusion will not contradict each other our findings alsosupport what the dual illusion hypothesis expects that aidraises the demand for recipient government output and reducesthe demand for grantor government output the intergovernmentgrants therefore do appear to be a common source of fiscalillusion

doubts or variability reinterpreting most of the market price of risk as a price of model uncertainty eradicates a link between asset prices and measures of the welfare costs of aggregate fluctuations that was proposed by hansen et al 1999 tallarini 2000 and alvarez and jermann 2004 prices of model uncertainty contain information about the benefits of removing model uncertainty not the consumption fluctuations that lucas 1987 2003 studied a max min expected utility theory lets us reinterpret tallarini s riskaversion parameter as measuring a representative consumer s doubts about the model specification we use model detection instead of risk aversion experiments to calibrate that parameter plausible values of detection error probabilities give prices of model uncertainty that approach the hansen and jagannathan 1991 bounds fixed detection error probabilities give rise to virtually identical asset prices as well as virtually identical costs of model uncertainty for tallarini s two models of consumption growth

the welfare cost of macroeconomic uncertainty in the post war period abstract with standard assumptions on preferences and a fully fledged econometric model we computed the welfare costs of macroeconomic uncertainty for post war u s using the beveridge nelson decomposition welfare costs are about 0 9 per capita consumption 175 77 a year and marginal welfare costs are about twice as large

volatility growth and welfare this paper constructs an endogenous growth model driven by self ful lling expectation shocks to explain the stylized fact that the average growth rate of gdp is related negatively to volatility and positively to capacity utilization the implied welfare gain from further stabilizing the u s economy is about a quarter of annual consumption which is consistent in order of magnitude with estimates based on the empirical studies of ramey and ramey 1995 and alvarez and jermann 2004 hence policies designed to reduce uctuations can generate large welfare gains because smaller uctuations are associated with permanently higher rates of growth

welfare gains from financial liberalization financial liberalization has been a controversial issue as empirical evidence for growth enhancing effects is mixed here we find sizable welfare gains from liberalization cost to repression though the gain in economic growth is ambiguous we take the view that financial liberalization is a government policy that alters the path of financial deepening while financial deepening is endogenously chosen by agents given a policy and occurs in transition towards a distant steady state this history dependent view necessitates the use of simulation analysis based on a growth model our application is a specific episode thailand from 1976 to 1996

the welfare cost of bank capital requirements abstract capital requirements are the cornerstone of modern bank regulation yet little is known about their welfare cost this paper measures this cost and finds that it is surprisingly large i present a simple framework which embeds the role of liquidity creating banks in an otherwise standard general equilibrium growth model a capital requirement limits the moral hazard on the part of banks that arises due to deposit insurance however this capital requirement is also costly because it reduces the ability of banks to create liquidity the key insight is that equilibrium asset returns reveal the strength of households preferences for liquidity and this allows for the derivation of a simple formula for the welfare cost of capital requirements that is a function of observable variables only using us data the welfare cost of current capital adequacy regulation is found to be equivalent to a permanent loss in consumption of between 0 1 and 1

bond and stock returns in a simple exchange model this paper studies asset pricing in a general equilibrium representative agent exchange model the assumptions of isoelastic period utility and lognormal endowment allow the derivation of closed form solutions for asset returns without restricting the serial correlation of the log endowment risk premiums on stocks and real bonds are found to be simple functions of relative risk aversion the variance of the log endowment innovation and the weights in the moving average representation of the log endowment the paper analyzes the sign of term premiums the size of the equity premium and the effect of taste shocks on asset prices

individual consumption risk and the welfare cost of business cycles we measure the welfare gain from removing aggregate consumption fluctuations in a model where each individual faces incomplete consumption insurance we show that because this welfare gain is a convex function of the overall consumption risk aggregate plus idiosyncratic each individual faces to gauge the magnitude of the gain it is important to match individuals overall risk prior to any policy in an economy calibrated to match individuals overall risk even removing 10 percent of aggregate fluctuations can result in a large welfare gain further large gains do not necessarily depend on the countercyclical nature of idiosyncratic risk jel e21 e32

risk preferences and the macroeconomic announcement premium this paper develops a revealed preference theory for the equity premium around macroeconomic announcements stock returns realized around pre scheduled macroeconomic announcements such as the employment report and the fomc statements account for 55 of the market equity premium we provide a characterization theorem for the set of intertemporal preferences that generates a nonnegative announcement premium our theory establishes that the announcement premium identifies a significant deviation from time separable expected utility and provides asset market based evidence for a large class of non expected utility models we also provide conditions under which asset prices may rise prior to some macroeconomic announcements and exhibit a pre announcement drift

some evidence on the effect of the separation of spending and taxing decisions it is often argued that separation of public spending and taxing decisions engenders in the voter overoptimistic hopes that someone else will bear the cost of public services thereby inducing an increase in the size of government but are perceived tax prices systematically and persistently reduced by separation although in stock markets all agents expectations may be unbiased they may or may not be unbiased in political markets this paper analyzes the separation created in federal states when the central government finances local expenditures evidence from a dynamic decisive voter model is presented that indicates that the separation introduced by federal grants to canadian provinces did in fact reduce the perceived tax price of provincial public services and raise provincial expenditures the results suggest also that the effect of separation diminished over time

fiscal illusion budget maximizers and dynamic equilibrium this paper extends previous work in grant induced fiscal illusion in two ways while previous models have focused on the existence of rational comparative static equilibria in the presence of illusion this work focuses on the dynamic process by which steady state equilibria can be achieved furthermore endogeneity in grants is incorporated which necessitates the use of a budget maximizing hypothesis however it is shown that a broader interpretation of the budget maximizing assumption is necessary in order for this characterization to make sense in a grantor recipient framework

how big are potential welfare gains from international risksharing abstract there is extensive evidence that risksharing across countries is far from perfect some have attributed this to small benefits from risksharing gains from riskpooling that have been reported range from negligible to enormous this paper documents to what extent the results are sensitive to the parameterization of preferences the stochastic process of the endowment and its measurement we find that gains from risksharing are quite sizable for realistic assumptions about the underlying factors for oecd countries they are equivalent to a permanent increase in tradables consumption in the range of 1 1 to 3 5 for a 50 year horizon and 2 5 to 7 4 for a 100 year horizon

the term structure of currency carry trade risk premia we nd that average returns to currency carry trades decrease signicantly as the maturity of the foreign bonds increases because investment currencies tend to have small local bond term premia the downward term structure of carry trade risk premia is informative about the temporal nature of risks that investors face in currency markets we show that long maturity currency risk premia only depend on the domestic and foreign permanent components of the pricing kernels since transitory currency risk is automatically hedged by interest rate risk for long maturity bonds our

asset pricing and the propagation of macroeconomic shocks this paper considers the implications of habit formation and financial frictions for the propagation of macroeconomic shocks in a model that is capable of matching asset pricing moments a short lived shock that destroys a small fraction of the economy s stock of pledgeable collateral generates a persistent recession a stock market crash and a flight to safety effect this novel mechanism creates a tight link between the asset pricing implications of macroeconomic models and their ability to propagate and amplify the effects of macroeconomic shocks

volatility and welfare abstract this paper explores the relationship between volatility and welfare even though households prefer smooth streams of consumption and leisure welfare can be increasing in the volatility of an exogenous driving force if factor supply is sufficiently elastic we provide some analytical results for a model without capital and do some quantitative exercises in a model with capital and a variety of shocks welfare is greater in high shock volatility regimes under plausible parameter values augmenting the model with features that increase the elasticity of factor supply extends the range of parameters over which higher volatility results in greater welfare

the birth and growth of toshiba s laptop and notebook computers a case study in japanese corporate venturing abstract this case study presents the under the table birth accelerated growth and ultimate success of two major technological and market innovations 1 the toshiba laptop computer a project vetoed twice by corporate headquarters and 2 the notebook computer a project hidden from headquarters because of the vision persistence and championing efforts of a team of passionate japanese corporate entrepreneurs a new business was created that is now part of toshiba s mainstream operations and that has become a significant contributor to the growth and profitability of the corporation we follow the evolution of this corporate venture from initial failures in 1978 to the success of the laptop computer first in europe 1985 then in the united states and finally in japan this was followed by the reincorporation of the venture in the corporate mainstream 1987 the worldwide success of the notebook computer 1989 and the continued growth of the business in parallel with repeated promotions of the entrepreneurs first a framework is presented for interpreting the case within current theories and practices of the management of innovation and the processes of championing innovative corporate ventures this framework is expanded to include recent studies on how major corporations have achieved worldwide leadership in high tech markets second using the analogy of human life from conception to adulthood the key phases events and entrepreneurial actions of toshiba s pc business are summarized in table 1 third the theoretical framework is applied to a discussion of the unusual aspects of this case fourth we analyze the business strategy and the technology strategy developed by toshiba finally we summarize the cultural and organizational context of toshiba as well as other critical factors that contributed to the enduring success of this corporate venture there are four aspects in addition to the international setting that make this case interesting for both scholars and practitioners 1 the under the table development of both the laptop and notebook 2 the unexpected success of the first product followed by a second success 3 the evolution of champi oning at various organizational levels and 4 the continuity of the strategic vision for toshiba s information systems business from 1978 to the present and how this vision was translated into specific business and technological strategies from the perspective of management of innovation the successes of both the laptop and the notebook computers were due to the back to the future market research and design process summarized in table 2 this process where market requirements drive the design process was developed by the lead entrepreneur tetsuya mizoguchi after repeated failures of the conventional process where the results of rd executive champion mizushima orchestrated the difficult transition of the venture into a corporate mainstream operation the evolution of the championing process is summarized in table 3 using the venkatamaran et al model 1992 we conclude that the most appropriate model for interpreting this case is a combination of the day and venkatamaran et al models which emphasizes both multiple championing roles and the transfer of the lead role from one champion to another during the corporate entrepreneurship process the business strategy and market and technological strategies developed by toshiba for achieving worldwide leadership in the portable pc market are summarized in figures 1 and 2 more broadly the process and critical factors that determined toshiba s success can be visualized according to figure 3 the corporate entrepreneurs and champions were driven away from mainframes by a vision of distributed and interconnected computing that compelled them to focus on personal computers this focus determined the winning business strategy fully compatible portable units which in turn determined the technological and market strategies miniaturization and complementarity to ibm at the same time this focus allowed the entrepreneurs to concentrate their scarce resources on the back to the future design process and develop unique core competencies this coupling of winning strategies with unique core competencies made possible toshiba s potential leadership in the marketplace actual leadership was achieved through continuous step by step learning by doing and through market feedback that further reinforced the adopted strategies and enhanced the core competencies six critical factors contributed to the long term success of the corporate venture 1 the venture had the potential to achieve worldwide leadership in a mainstream area of the corporation 2 the pc market in europe and the united states but not initially in japan was fragmented and highly receptive to unique innovations 3 the corporate entrepreneurs were driven by a long range vision of the business with focused strategies and well defined objectives 4 the entrepreneurs were persistent and undeterred by repeated failures in the marketplace and by the distrust and hostility of headquarters 5 the organizational context because of slack internal controls allowed the diversion of funds and manpower to the under the table venture and finally 6 the role of entrepreneurs evolved from underground innovators to product executive and corporate champions in order to reinforce broaden and implement their vision

evaluating risky consumption paths the role of intertemporal substitutability abstract in dynamic stochastic welfare comparisons a failure clearly to distinguish between risk aversion and intertemporal substitutability can result in misleading assessments of the impact of risk aversion on the welfare costs of consumption risk changes the problem arises in any setting in which uncertainty is propagated over time notably but not exclusively in economies with stochastic consumption trends regardless of the preference setup adopted an increase in risk aversion amplifies the per period costs of risks the weights consumers use to cumulate the per period costs of risks with persistent effects should however depend on intertemporal substitutability as well as on risk aversion under time separable expected utility preferences an increase in the period utility function s curvature therefore alters the welfare effect of risk for reasons that are in part unrelated to risk aversion to illustrate these points i reconsider lucas s estimate of the cost of consumption instability for the postwar united states

spectral welfare cost functions if preferences are not time separable economic agents care not only about the magnitude of fluctuations in consumption but also about the persistence and other temporal characteristics of those fluctuations this paper extends and develops the theory of spectral utility functions which measure utility frequency by frequency to illustrate the interaction between consumption volatility and time non separable preferences to highlight the economic implications of the interaction spectral welfare cost functions are developed to provide a quantitative measure of the importance to economic agents of the temporal delivery of consumption volatility

venture capital and the macroeconomy i develop a model of venture capital vc intermediation that quantitatively explains central empirical facts about vc activity and can evaluate its macroeconomic relevance the impact of vc backed innovations is significantly larger than suggested by observed aggregate venture exit valuations even after accounting for large exposures to systematic and uninsurable idiosyncratic risks the risk properties of venture capital play a quantitatively important role in both explaining empirical regularities and shaping the value of ventures contributions to economic growth the model is analytically tractable and yields exact solutions despite the presence of matching frictions imperfect risk sharing and endogenous growth received january 16 2018 editorial decision november 7 2018 by editor stijn van nieuwerburgh

measuring the cost of economic fluctuations with preferences that rationalize the equity premium lucas 2003 argues that the potential welfare gains from stabilizing the business cycle are small in fact he shows that the benefits of eliminating all economic fluctuations are small especially when compared with the potential gains from other reforms his estimates are obtained using standard preferences i show that a model consistent with observed data on asset returns leads to very different conclusions calibrating preferences to observed asset market data raises the estimated welfare gains from completely eliminating aggregate fluctuations by approximately two orders of magnitude most of the gains however come from the elimination of low frequency contributions lucas 2003 suggere que les gains de bien etre potentiels qui emergeraient d une stabilisation du cycle economique sont faibles de fait il montre que les avantages aeliminer toutes les fluctuations economiques sont specialement faibles quand on les compare aux gains potentiels qu on peut attendre d autres reformes il developpe ces estimations a l aide de preferences standards on montre qu un modele consistant avec les donnees observees sur le rendement des actifs nous amene a des conclusions differentes le fait d arrimer les preferences aux donnees observees sur le marche des actifs double a peu pres la magnitude des gains de bien etre si on eliminait completement les fluctuations agregees le gros des gains cependant emergerait de l elimination des evenements peu frequents

ambiguity aversion asset prices and the welfare costs of aggregate fluctuations under the hypothesis that aggregate u s consumption is random and more importantly viewed as ambiguous by consumers we examine the implications for asset prices and for how consumption uctuations in uence consumer welfare first considering a simple mehra prescott style endowment economy with a representative agent facing consumption uctuations calibrated to match u s data we study to what extent ambiguity aversion can deliver asset prices that are consistent with data a high return on equity and a low return on riskfree bonds for some conflgurations of preference parameters a discount factor a degree of relative risk aversion and a measure of ambiguity aversion we flnd that it can we then use these parameter conflgurations to investigate how much consumers would be willing to pay to reduce endowment uctuations to zero thus delivering a lucas style welfare cost of uctuations these costs turn out to be very large consumers can be willing to pay over 10 of consumption in permanent terms

rare disasters asset prices and welfare costs a representative consumer model with epstein zin weil preferences and i i d shocks including rare disasters accords with observed equity premia and risk free rates if the coefficient of relative risk aversion equals 3 4 if the intertemporal elasticity of substitution exceeds one an increase in uncertainty lowers the price dividend ratio for equity and a rise in the expected growth rate raises this ratio calibrations indicate that society would willingly reduce gdp by around 20 percent each year to eliminate rare disasters the welfare cost from usual economic fluctuations is much smaller though still important corresponding to lowering gdp by about 1 5 percent each year

the time series properties of aggregate consumption implications for the costs of fluctuations the properties of the stochastic process followed by aggregate consumption affect the estimates of the costs of fluctuations this paper pursues two approaches to modeling consumption dynamics and measuring how much society dislikes fluctuations one statistical and one economic the statistical approach estimates the properties of consumption and calculates the costs of having consumption fluctuating around its mean growth the paper finds that persistence is a crucial determinant of the costs and that the high persistence in the data severely distorts conventional measures it shows how to compute valid estimates and confidence intervals the economic approach uses a calibrated model of optimal consumption and measures the costs of eliminating income shocks this uncovers a further cost of uncertainty through its impact on precautionary savings and investment the two approaches lead to costs of fluctuations that are higher than the common wisdom between 0 5 and 5 of per capita consumption jel e32 e21 e60

fiscal illusion and the grantor government empirical studies indicate that unconditional intergovernmental grants have a flypaper effect several authors have modeled recipient government spending under fiscal illusion to explain this phenomenon in short grants reduce the perceived marginal cost of recipient government output this paper develops a more general model of illusion that incorporates the grantor government thereby eliminating inconsistencies encountered in previous models the more general model implies that grant finance increases the perceived marginal cost of grantor government output thus grant induced illusion should have two effects an increase in recipient output and a decrease in grantor output the empirical work supports this hypothesis

on the welfare costs of business cycle fluctuations and economic growth variation in the 20th century and beyond lucas 1987 has shown a surprising result in business cycle research the welfare cost of business cycles are very small our paper has several original contributions first in computing welfare costs we propose a novel setup that separates the eects of uncertainty stemming from business cycle uctuations and economic growth variation second we extend the sample from which to compute the moments of consumption the whole of the literature chose primarily to we gratefully acknowledge the comments of caio almeida carlos e da costa robert f engle pedro c ferreira antonio fiorencio rodolfo manuelli samuel pessoa and octavio tourinho on this or on earlier versions of this paper all errors are ours we thank cnpq brazil faperj and inct for nancial support y corresponding author

the social cost of near rational investment abstract we show that the stock market may fail to aggregate information even if it appears to be efficient and that the resulting decrease in the information content of prices may drastically red

using asset prices to measure the persistence of the marginal utility of wealth we derive a lower bound for the volatility of the permanent component of investors marginal utility of wealth or more generally asset pricing kernels the bound is based on return properties of long term zero coupon bonds risk free bonds and other risky securities we find the permanent component of the pricing kernel to be very volatile its volatility is about at least as large as the volatility of the stochastic discount factor a related measure for the transitory component suggest it to be considerably less important we also show that for many cases where the pricing kernel is a function of consumption innovations to consumption need to have permanent effects

the marginal welfare cost of capital taxation discounting matters we interpret the marginal welfare cost of capital income taxes as the present discounted value of consumption distortions such an asset market interpretation emphasizes the importance of the interest rate used to value future distortions especially in the presence of uncertainty we find that the interest rate decreases as the tax rate increases thus increasing the welfare cost the variations in the interest rate are caused by amplified responses of consumption to exogenous shocks as a result of capital taxation the welfare cost may be underestimated if variations in interest rates are ignored especially when tax rates are high

robust permanent income and pricing i suppose there exists an extremely powerful and if i may so speak malignant being whose whole endeavours are directed toward deceiving me rene descartes meditations ii 1

beyond arbitrage good deal asset price bounds in incomplete markets one often wants to value a risky payoff by reference to prices of other assets rather than by exploiting full fledged economic models however this approach breaks down if one cannot find a perfect replicating portfolio we impose weak economic restriction to derive usefully tight bounds on asset prices in this situation the bounds assume that investors would want to buy assets with high sharpe ratios good deals as well as pure arbitrage opportunities we show how to calculate the price bounds in one period multiperiod and continuous time contexts we show that the multiperiod problem can be solved recursively as a sequence of one period problems we calculate bounds in option pricing examples including infrequent trading and an option written on a nontraded event and we use the bounds to explore the economic significance of option pricing predictions we find that much variation in s p 500 index option prices over time and across strike prices fits within the bounds