OPTIMAL MONETARY POLICY AND FINANCIAL STABILITY IN A NON‐RICARDIAN ECONOMY

I present a model with discontinuous asset‐market participation (DAMP), where all agents are non‐Ricardian, and where heterogeneity among market participants implies financial‐wealth effects on aggregate consumption. The implied welfare criterion shows that financial stability arises as an additional and independent target, besides inflation and output stability. Evaluation of optimal policy under discretion and commitment reveals that price stability may no longer be optimal, even absent inefficient supply shocks: some fluctuations in output and inflation may be optimal as long as they reduce financial instability. Ignoring the heterogeneity among market participants may lead monetary policy to induce substantially higher welfare losses.     

HOUSING FINANCE AND MONETARY POLICY

We document three facts concerning how the structure of housing finance affects the monetary transmission mechanism: first, the characteristics of residential mortgage markets differ markedly across industrialized countries; second, the impact of monetary policy shocks to residential investment and house prices is significantly stronger in those countries with larger flexibility/development of mortgage markets; third, the transmission to consumption is stronger only in those countries where mortgage equity release is common and mortgage contracts are predominantly of the variable‐rate type. We then build a two‐sector DSGE model with financial constraints to rationalize those facts.     

INSULATION IMPOSSIBLE: MONETARY POLICY AND REGIONAL DEBT SPILLOVERS IN A FEDERATION

This paper studies the effects of monetary policy in the presence of debt spillovers within a monetary union. When capital markets are integrated, the fiscal policy of any member country will generally influence equilibrium wages and interest rates across the whole union. We ask whether there exists a monetary policy which can offset these spillovers. Within a general class of monetary policy rules, there does not exist one that completely insulates agents in one region from fiscal policy in the other. These debt spillovers will affect welfare through two channels: intertemporal efficiency and redistribution.     

DEBT,POLICY UNCERTAINTY,AND EXPECTATIONS STABILIZATION

This paper develops a model of policy regime uncertainty and its consequences for stabilizing expectations. Because of learning dynamics, uncertainty about monetary and fiscal policy is shown to restrict, relative to a rational expectations analysis, the set of policies consistent with macroeconomic stability. Anchoring expectations by communicating about monetary and fiscal policy enlarges the set of policies consistent with stability. However, absent anchored fiscal expectations, the advantages from anchoring monetary expectations are smaller the larger is the average level of indebtedness. Finally, even when expectations are stabilized in the long run, the higher are average debt levels the more persistent will be the effects of disturbances out of rational expectations equilibrium.     

LABOR‐MARKET HETEROGENEITY,AGGREGATION, AND POLICY (IN)VARIANCE OF DSGE MODEL PARAMETERS

Data from a heterogeneous‐agents economy with incomplete asset markets and indivisible labor supply are simulated under various fiscal policy regimes and an approximating representative‐agent model is estimated. Preference and technology parameter estimates of the representative‐agent model are not invariant to policy changes and the bias in the representative‐agent model’s policy predictions is large compared to predictive intervals that reflect parameter uncertainty. Since it is not always feasible to account for heterogeneity explicitly, it is important to recognize the possibility that the parameters of a highly aggregated model may not be invariant with respect to policy changes.     

MODELING THE BIRTH AND DEATH OF CARTELS WITH AN APPLICATION TO EVALUATING COMPETITION POLICY

One of the primary challenges to measuring the impact of antitrust or competition policy on collusion is that the cartel population is unobservable; we observe only the population of discovered cartels. To address this challenge, a model of cartel creation and dissolution is developed to endogenously derive the populations of cartels and discovered cartels. With this theory, one can infer the impact of competition policy on the population of cartels by measuring its impact on the population of discovered cartels. In particular, changes in the duration of discovered cartels can be informative in assessing whether a new policy is reducing the latent rate of cartels. (JEL: L13, L41)     

RISK AVERSION AND EXPECTED UTILITY THEORY: AN EXPERIMENT WITH LARGE AND SMALL STAKES

We employ a novel data set to estimate a structural econometric model of the decisions under risk of players in a game show where lotteries present payoffs in excess of half a million dollars. The decisions under risk of players in the presence of large payoffs allow us to estimate the parameters of the curvature of the von Neumann–Morgenstern utility function—not only locally, as in previous studies in the literature, but also globally. Our estimates of relative risk aversion indicate that a constant relative risk aversion parameter of about 1 captures the average of the sample population. We also find that individuals are practically risk neutral at small stakes and risk averse at large stakes—a necessary condition, according to Rabin’s calibration theorem, for expected utility to provide a unified account of individuals’ attitudes toward risk. Finally, we show that for lotteries characterized by substantial stakes, nonexpected utility theories fit the data equally as well as expected utility theory.     

NOTES FOR A NEW GUIDE TO KEYNES (I): WAGES,AGGREGATE DEMAND,AND EMPLOYMENT

I revisit the General Theory’s discussion of the role of wages in employment determination through the lens of the New Keynesian model. The analysis points to the key role played by the monetary policy rule in shaping the link between wages and employment, and in determining the welfare impact of enhanced wage flexibility. I show that the latter is not always welfare improving.     

UNEMPLOYMENT INSURANCE AND CULTURAL TRANSMISSION: THEORY AND APPLICATION TO EUROPEAN UNEMPLOYMENT

This paper emphasizes the two‐way causality between the provision of unemployment insurance and the cultural transmission of civicness. The returns to being uncivic are increasing in the generosity of unemployment insurance; but this generosity is decreasing in the number of uncivic individuals. In this context, I determine the evolution of preferences across generations and show that cultural heterogeneity is sustained over the long‐run. The dynamics of cultural transmission can generate a long lag between the introduction of unemployment insurance and an increase in people's willingness to live off government‐provided benefits. Hence, it offers an explanation to the ‘European unemployment puzzle’ due to the coexistence of generous unemployment insurance and low unemployment in the 1950s and 1960s.     

REDUCING OVERREACTION TO CENTRAL BANKS' DISCLOSURES: THEORY AND EXPERIMENT

Financial markets are known for overreacting to public information. Central banks can reduce this overreaction either by disclosing information to only a fraction of market participants (partial publicity) or by disclosing information to all participants but with ambiguity (partial transparency). In theory, overreaction can be similarly reduced by either communication strategy. A laboratory experiment shows that both communication strategies succeed in reducing overreaction, though not as much as theory predicts. The opportunity in our information age for central banks to choose between partial publicity and partial transparency to control the market reaction is then discussed.     

WHY ARE THE 2000s SO DIFFERENT FROM THE 1970s? A STRUCTURAL INTERPRETATION OF CHANGES IN THE MACROECONOMIC EFFECTS OF OIL PRICES

In the 1970s, large increases in the price of oil were associated with sharp decreases in output and large increases in inflation. In the 2000s, even larger increases in the price of oil were associated with much milder movements in output and inflation. Using a structural VAR approach, Blanchard and Gali (in J. Gali and M. Gertler (eds.) 2009, International Dimensions of Monetary Policy, University of Chicago Press, pp. 373–428) argued that this reflected a change in the causal relation from the price of oil to output and inflation. They then argued that this change could be due to a combination of three factors: a smaller share of oil in production and consumption, lower real wage rigidity, and better monetary policy. Their argument, based on simulations of a simple new‐Keynesian model, was informal. Our purpose in this paper is to take the next step, and to estimate the explanatory power and contribution of each of these factors. To do so, we use a minimum distance estimator that minimizes, over the set of structural parameters and for each of two samples (pre‐ and post‐1984), the distance between the empirical SVAR‐based impulse response functions and those implied by a new‐Keynesian model. Our empirical results point to an important role for all three factors.     

SHOCKING STUFF: TECHNOLOGY,HOURS, AND FACTOR SUBSTITUTION

The response of hours to technology shocks is a key controversy in macroeconomics. We show that differences between RBC and NK models hinge on highly restrictive views of technology. We introduce CES production technologies and demonstrate that the response of hours depends on the factor‐augmenting nature of shocks and the capital–labor substitution elasticity in both models. We develop analytical expressions to establish the thresholds determining its sign. This opens new margins for shock identification combining theory and VAR evidence. We discuss how our models provide new robust restrictions for empirical work, especially using the labor income share.     

AN APPROXIMATION TO THE HYPERCUBE MODEL WITH PATROL-INITIATED ACTIVITIES: AN APPLICATION TO POLICE

This paper applies the patrol-initiated-activity hypercube queuing model to historical data from a police agency. The model allows servers to handle both calls assigned by a central dispatcher and activities initiated by the servers. By duplicating a fairly complex dispatch strategy, the model was found to predict both assigned and server-initiated work loads accurately for the overall system and individual servers. The model is apparently ineffective in predicting small unit-travel-time differences for this police agency.     

ASYMMETRIC LOSS FUNCTION AND OPTIMAL POLICY UNDER UNCERTAINTY: A SIMPLE PROOF

Given an asymmetric quasi-convex loss function and a symmetric quasi-concave probability density function, both continuous, an extremely simple proof is suggested that shows that a policy maker will minimize expected loss by choosing a policy value on the less-damaging side of the loss function. This proof, which is compatible with a wide variety of loss functions and probability density functions, is extended to include cases where a symmetric loss function is matched against an asymmetric probability density function and where an asymmetric loss is matched with an asymmetric probability density function.     

RELATIVE RISK AVERSION IS CONSTANT: EVIDENCE FROM PANEL DATA

Most classical tests of constant relative risk aversion (CRRA) based on individual portfolio composition use cross‐sectional data. Such tests must assume that the distributions of wealth and preferences are independent. We use panel data to analyze how individuals’ portfolio allocation between risky and riskless assets varies in response to changes in total financial wealth. We find the elasticity of the risky asset share to wealth to be small and statistically insignificant, supporting the CRRA assumption; this finding is robust when the sample is restricted to households experiencing large income variations. In addition, we find a small but significant negative correlation between wealth and risk aversion. Various extensions are discussed.     

SOVEREIGNS VERSUS BANKS: CREDIT,CRISES, AND CONSEQUENCES

Two separate narratives have emerged in the wake of the Global Financial Crisis. One interpretation speaks of private financial excess and the key role of the banking system in leveraging and deleveraging the economy. The other emphasizes the public sector balance sheet and worries about the risks of lax fiscal policy. However, the two may interact in important and understudied ways. This paper examines the co‐evolution of public and private sector debt in advanced countries from 1870 to 2012. We find that in advanced economies financial crises are not preceded by public debt build‐ups nor are they more likely when public debt is high. However, history shows that high levels of public debt tend to exacerbate the effects of private sector deleveraging after financial crises. The economic costs of financial crises rise substantially if large private sector credit booms are unwound at times when the public sector has little capacity to pursue macroeconomic and financial stabilization.     

CREDIT CONSTRAINTS AND THE CYCLICALITY OF R&D INVESTMENT: EVIDENCE FROM FRANCE

We use a French firm‐level data set containing 13,000 firms over the period 1994–2004 to analyze the relationship between credit constraints and firms’ R&D behavior over the business cycle. Our main results can be summarized as follows: (i) R&D investment is countercyclical without credit constraints, but it becomes procyclical as firms face tighter credit constraints; (ii) this result is only observed for firms in sectors that depend more heavily upon external finance, or that are characterized by a low degree of asset tangibility; (iii) in more credit‐constrained firms, R&D investment plummets during recessions but does not increase proportionally during upturns.     

A POLITICAL ECONOMY THEORY OF FISCAL POLICY AND UNEMPLOYMENT

This paper presents a political economy theory of fiscal policy and unemployment. The underlying economy is one in which unemployment can arise but can be mitigated by tax cuts and increases in public production. Such policies are fiscally costly, but can be financed by issuing government debt. Policy decisions are made by a legislature consisting of representatives from different political districts. With the available policies, it is possible for the government to completely eliminate unemployment in the long run. However, with political decision making, the economy always has unemployment. Unemployment is higher when the private sector experiences negative shocks. When these shocks occur, the government employs debt‐financed fiscal stimulus plans which involve both tax cuts and public production increases. When the private sector is healthy, the government contracts debt until it reaches a floor level. Unemployment levels are weakly increasing in the economy's debt level, strictly so when the private sector experiences negative shocks. Conditional on the level of workers employed, the mix of public and private output is distorted.     

INDIVIDUAL RISK ATTITUDES: MEASUREMENT,DETERMINANTS, AND BEHAVIORAL CONSEQUENCES

This paper studies risk attitudes using a large representative survey and a complementary experiment conducted with a representative subject pool in subjects' homes. Using a question asking people about their willingness to take risks “in general”, we find that gender, age, height, and parental background have an economically significant impact on willingness to take risks. The experiment confirms the behavioral validity of this measure, using paid lottery choices. Turning to other questions about risk attitudes in specific contexts, we find similar results on the determinants of risk attitudes, and also shed light on the deeper question of stability of risk attitudes across contexts. We conduct a horse race of the ability of different measures to explain risky behaviors such as holdings stocks, occupational choice, and smoking. The question about risk taking in general generates the best all‐round predictor of risky behavior.