Showing papers by "National Bureau of Economic Research published in 1981"

Intertemporal Substitution in Consumption

Abstract: Does a higher real interest rate induce significant postponement of consumption? According to the theory developed here, this question can be answered by studying the relation between the rate of growth of consumption and expected real interest rates In postwar data for the United States, expected real returns have declined over time in the stock market and for savings accounts Over the same period, the rate of growth of consumption has been almost steady The paper concludes that intertemporal substitution is weak, for if it were strong, the growth rate of consumption would have declined

A Positive Theory of Monetary Policy in a Natural-Rate Model

Abstract: Natural-rate models suggest that the systematic parts of monetary policy will not have important consequences for the business cycle. Nevertheless, we often observe high and variable rates of monetary growth, and a tendency for monetary authorities to pursue countercyclical policies. This behavior is shown to be consistent with a rational expectations equilibrium in a discretionary environment where the policymaker pursues a "reasonable" objective, but where precommitments on monetary growth are precluded. At each point in time, the policymaker optimizes subject to given inflationary expectations, which determine a Phillips Curve-type tradeoff between monetary growth/inflation and unemployment. Inflationary expectations are formed with the knowledge that policymakers will be in this situation. Accordingly, equilibrium excludes systematic deviations between actual and expected inflation, which means that the equilibrium unemployment rate ends up independent of "policy" in our model. However, the equilibrium rates of monetary growth/inflation depend on various parameters, including the slope of the Phillips Curve, the costs attached to unemployment versus inflation, and the level of the natural unemployment rate. The monetary authority determines an average inflation rate that is "excessive," and also tends to behave countercyclically. Outcomes are shown to improve if a costlessly operating rule is implemented in order to precomrnit future policy choices in the appropriate manner. The value of these precommitments -- that is, of long-term agreements between the government and the private sector -- underlies the argument for rules over discretion. Discretion is the sub-set of rules that provides no guarantees about the government's future behavior.

The Optimal Tradeoff Between the Probability and Magnitude of Fines

Abstract: This paper examines the use of fines and imprisonment to deter individuals from engaging in harmful activities. These sanctions are analyzed separately as well as together, first for identical risk-neutral individuals and then for two groups of risk-neutral individuals who differ by wealth. When fines are used alone and individuals are identical, the optimal fine and probability of apprehension are such that there is some "underdeterrence." If individuals differ by wealth, then the optimal fine for the high wealth group exceeds the fine for the low wealth group. When imprisonment is used alone and individuals are identical, the optimal imprisonment term and probability may be such that there is either underdeterrence or overdeterrence. If individuals differ by wealth, the optimal imprisonment term for the high wealth group may be longer or shorter than the term for the low wealth group. When fines and imprisonment are used together, it is desirable to use the fine to its maximum feasible extent before possibly supplementing it with an imprisonment term. The effects of risk aversion on these results are also discussed.

Credit Rationing in Markets with Imperfect Information

Abstract: According to basic economics, if demand exceeds supply, prices will rise, thus decreasing demand or increasing supply until demand and supply are in equilibrium; thus if prices do their job, rationing will not exist. However, credit rationing does exist. This paper demonstrates that even in equilibrium, credit rationing will exist in a loan market. Credit rationing is defined as occurring either (a) among loan applicants who appear identical, and some do and do not receive loans, even though the rejected applicants would pay higher interest rates; or (b) there are groups who, with a given credit supply, cannot obtain loans at any rate, even though with larger credit supply they would. A model is developed to provide the first theoretical justification for true credit rationing. The amount of the loan and the amount of collateral demanded affect the behavior and distribution of borrowers. Consequently, faced with increased credit demand, it may not be profitable to raise interest rates or collateral; instead banks deny loans to borrowers who are observationally indistinguishable from those receiving loans. It is not argued that credit rationing always occurs, but that it occurs under plausible assumptions about lender and borrower behavior. In the model, interest rates serve as screening devices for evaluating risk. Interest rates change the behavior (serve as incentive mechanism) for the borrower, increasing the relative attractiveness of riskier projects; banks ration credit, rather than increase rates when there is excess demand. Banks are shown not to increase collateral as a means of allocating credit; although collateral may have incentivizing effects, it may have adverse selection effects. Equity, nonlinear payment schedules, and contingency contracts may be introduced and yet there still may be rationing. The law of supply and demand is thus a result generated by specific assumptions and is model specific; credit rationing does exist. (TNM)

Welfare Analysis of Tax Reforms Using Household Data

Abstract: The paper discusses a methodology for calculating the distribution of gains and losses from a policy change using data for a large sample of households. Estimates are based on the equivalent income function, which is money metric utility defined over observable variables. This enables calculations to be standardised, and a computer program to compute the statistics presented in the paper is available for a general demand system. Equivalent income is related to measures of deadweight loss, and standard errors are computed for each of the welfare measures. An application to UK data for 5895 households is given which simulates a reform that involves eliminating housing subsidies.

Inventories and Sticky Prices: More on the Microfoundations of Macroeconomics

Abstract: The role of inventories in making prices "sticky" is studied by analyzing a dynamic linear-quadratic model of a monopoly firm facing stochastic demand, but able to store its finished goods in inventory. It is shown that, in contrast to the usual presumption, firms that exhibit the smallest output responses to demand fluctuations may also exhibit the smallest price fluctuations. Specifically, firms which have very flexible inventory storage facilities or are subjected to very transitory demand shocks will rely on inventories as buffers, and will change neither production nor price very much. On the other hand, firms which have very inflexible storage facilities or whose demand shocks are quite permanent will display large swings in both price and output. The standard assumption about inventory carrying costs that has been used in the literature (that they are linear) is shown to imply that production is impervious to fluctuations in demand. It is also established that prices may respond more strongly to positive demand shocks than to negative ones if it is impossible to hold negative inventories (i.e., to have unfilled orders). The model offers an explanation for "stickiness" in relative prices. However, under certain circumstances, it may help explain the persistence of inflation

The Real Interest Rate: An Empirical Investigation

Abstract: This paper is an empirical exploration of real interest rate movements in the United States over the last fifty years. It focuses on several questions which have repeatedly arisen in the literature. How valid is the hypothesis associated with Fama (1975) that the real rate of interest is constant? Does the real rate decline with increases in expected inflation? Are cyclical movements in real variables correlated with real rate movements? How reliable is the Fishei (1930) effect where nominal interest rates reflect changes in expected inflation? What kind of variation in real interest rates have we experienced in the last fifty years? Have real rates turned negative in the 1970s, as is commonly believed, and were they unusually high in the initial stages of the Great Depression? In pursuing these questions, this paper first outlines in section II the methodology and theory used in the empirical analysis. The empirical results then follow in section III, and a final section contains the concluding remarks.

Schooling and Health: The Cigarette Connection

Abstract: Numerous studies by economists during the past decade have revealed a large, statistically significant correlation between health and years of schooling after controlling for differences in income and other variables. Cigarette smoking is a likely intervening variable because of the strong effect of smoking on morbidity and mortality, and because there is a strong negative correlation between smoking and years of schooling -- at least at high school levels and above. This paper tests the hypothesis that schooling causes differences in smoking behavior. We use retrospective smoking histories of 1,183 white, non-Hispanic men and women who had completed 12 to 18 years of schooling. The data were collected in 1979 by the Stanford University Heart Disease Prevention Program from randomly selected households in four small California cities. The most striking result is that the negative relation between schooling and smoking observed at age 24 is accounted for by differences in smoking behavior present at age 17, when all subjects were still in approximately the same grade. We conclude that additional years of schooling cannot be the cause of differential smoking behavior; one or more "third variables" must cause changes in both smoking and schooling. Analysis of smoking by cohort reveals that the schooling-smoking correlation developed only after the health consequences of smoking became widely known; it has remained strong even in the most recent cohorts. This implies that the mechanism behind the schooling-smoking correlation may also give rise to the schooling-health correlation.

Output Fluctuations and Gradual Price Adjustment

Abstract: This paper reviews the leading ideas that have emerged within two paradigms of price adjustment. Neither, it appears, provides a satisfactory theoretical scheme when taken in isolation. This paper concludes that an attempt to merge the more convincing elements of each is needed, and some suggestions for such a merger are put forward.

Human Capital and Economic Growth

Abstract: Individuals differ in both inherited and acquired abilities, but only the latter differ among countries and time periods. Human capital analysis deals with acquired capabilities which are developed through formal and informal education at school and at home, and through training, experience, and mobility in the labor market. Just as accumulation of personal human capital produces individual economic (income) growth, so do the corresponding social or national aggregates. At the national level, human capital can be viewed as a factor of production coordinate with physical capital. This implies that its contribution to growth is greater the larger the volume of physical capital and vice versa. The framework of an aggregate production function shows also that the growth of human capital is both a condition and a consequence of economic growth. Human capital activities involve not merely the transmission and embodiment in people of available knowledge, but also the production of new knowledge which is the source of innovation and of technical change which propels all factors of production. This latter function of human capital generates worldwide economic growth regardless of its initial geographic locus. Contrary to Malthus, economic growth has not been eliminated by population growth. Indeed, spatial and temporal patterns of the "demographic transition" appear to be congruent with economic growth. Human capital is a link which enters both the causes and effects of these economic-demographic changes.

Accelerating Inflation, Technological Innovation, and the Decreasing Effectiveness of Banking Regulation

Abstract: To explain the evolution of U.S. deposit institutions and markets in the 1960sand 1970s, we feed into the regulatory dialectic assumptions about the objectives of federal banking regulation and about outside forces that disturb the adjustment process. The disturbing exogenous forces are accelerating change in the technological and market environment of commercial banking and increasing uncertainty concerning the future speed of enviromental change. We hypothesize that, in the face of these environmental changes, the adaptive efficiency shown on average by deposit-institution managers is greater than that shown by managers of the several competing banking agencies. Incorporating this differential adaptive capacity into the regulatory dialectic helps us to understand how increases in the pace of environmental change and in the degree of environmental uncertainty led regulatee responses to come more quickly and regulatory responses to come more slowly. The bottom line is that, when the environment changes rapidly and becomes more uncertain, traditional forms of U.S. banking regulation can be overwhelmed by technological and regulation-induced innovation.

Speculative Hyperinflations in Maximizing Models: Can We Rule Them Out?

Abstract: This paper uses an infinite-horizon model based on individual maximizing behavior to study whether explosive price-level paths unrelated to monetary growth--speculative hyperinflations--can be equilibrium paths under rational expectations. In a pure fiat money regime, speculative hyperinflations can be excluded only through severe restrictions on individual preferences; but when the government fractionally backs the currency by guaranteeing a minimal real redemption value for money, speculative hyperinflations are impossible, even if agents are not completely certain that they can redeem their money in any given period. The analysis also confirms that implosive price-level paths and divergent paths for capital asset prices are not equilibria under either monetary regime.

Tax Policy and Foreign Direct Investment

Abstract: This paper examines the implications of the most common system of taxing foreign source income. It is argued that, because the repatriation of earnings to the home country investor and not the earnings themselves are typically the source of tax liability, the foreign source income tax should affect foreign investment differently depending on the required transfers of funds within the firm. One implication of viewing the tax in this fashion is that in order to maximize after tax profits, a firm should finance its foreign investment out of foreign earnings to the greatest extent possible. That is, a firm's required foreign return jumps at the point at which desired foreign investment just exhausts foreign earnings. This allows us to draw a distinction between "mature" foreign operations, which are at any point in time financed at the margin by reinvested earnings (and perhaps also pay dividends to their: parent firm in the home country), and "immature" foreign affiliates, which rely on funding from their parents (and should not be paying dividends). It is noted that survey evidence on multinational firm behavior is consistent with this distinction. Direct investment data indicate that mature foreign operations probably account for nearly ninety percent of U. S. foreign direct investment. The discussion then turns to investment incentives. It is shown that the home country's rate of tax on foreign source income and the presence or absence of a foreign tax credit should be irrelevant to a mature foreign operation's investment and dividend decisions. This conclusion, which conflicts sharply with the conventional wisdom, follows because the home country tax acts as an unavoidable cost. New firms' investment decisions are, on the other hand, influenced by home country taxes.

Consumption Correlatedness and Risk Measurement in Economies with Non Trade Assets and Heterogeneous Information

Abstract: The consumption beta theorem of Breeden makes the expected return on any asset a function only of its covariance with changes in aggregate consumption. It is shown that the theorem is more robust than was indicated by Breeden. The theorem obtains even if one deletes Breeden's assumptions that (a) all risky assets are tradable, (b) investors have homogeneous beliefs, (c) other assets can be traded without transactions costs and (d) that all assets have returns which are Ito processes.

Partial Retirement and the Analysis of Retirement Behavior

Abstract: This paper examines the phenomenon of partial retirement . Topics covered include: (1) the quantitative importance of partial retirement, (2) institutional constraints in addition to mandatory retirement which limit the opportunity to retire partially in the main job, (3) the effect of these constraints on the specification of the relevant structural equations in a life cycle retirement model, (4) the impact of standard explanatory variables on four outcomes -- complete retirement, partial retirement both in and outside the main job, and non-retirement, (5) the importance of partial retirement even for those who do not face mandatory retirement, are not covered by a pension and are healthy, (6) the sensitivity of results based on a dichotomous retirement variable to whether the partially retired are classified as retired or not retired. A number of studies have either treated partial retirement inappropriately or have adopted unrealistic assumptions about the opportunity set facing potential retirees. Our findings call their results into question.

Inflation, Flexible Exchange Rates, and the Natural Rate of Unemployment

Abstract: The most important conclusion of this paper is that the growth rate of the money supply influences the U.S. inflation rate more strongly and promptly than in most previous studies, because the flexible exchange rate system has introduced an additional channel of monetary impact, over and above the traditional channel operating through labor-market tightness. Lagged changes in the effective exchange rate of the dollar, through their influence on the prices of exports and import substitutes, help to explain why U.S. inflation was so low in 1976 and why it accelerated so rapidly in 1978. Granger causality tests indicate that lagged exchange rate changes influence inflation, but lagged inflation does not cause exchange rate changes. A policy of monetary restriction in the 1980s is shown to cut the inflation rate by five percentage points at about half the cost in lost output as compared with the consensus view from previous studies. The paper defines the "no shock natural rate of unemployment" as the unemployment rate consistent with a constant rate of inflation in a hypothetical state having no supply shocks and a constant exchange rate. A new estimate of this natural rate concept displays an increase from 5.1 percent in 1954 to 5.9 percent in 1980 that is entirely due to the much-discussed demographic shift in labor-force shares and relative unemployment rates. Other higher estimates of the natural unemployment rate, close to 7 percent in 1980, result from the use of a naive Phillips curve that relates inflation only to labor-market tightness and inertia variables. The paper contains extensive sensitivity tests that examine the behavior of the basic inflation equation over alternative sample periods; that enter the growth rate of money directly and track the behavior of a money- augmented equation in dynamic simulation experiments; and that test and reject the view that wage-setting behavior is dominated by "wage-wage inertia", that is, the dependence of wage changes mainly on their own past values.

The Current Account in the Eacroeconomic Adjustment Process

Abstract: This paper provides a formal analysis of the current account balance in a dynamic model with optimizing agents. Two analytical ideas are stressed. First, an economy's current account balance depends as much on fixture economic trends as on the current economic environment. A shift in fiscal policy, for example, will have one effect on the current account if it is perceived to be temporary and another if it is seen to be permanent. Second, temporary disturbances in the economy have permanent effects, by altering the entire future path of the economy's international indebtedness.

The Effective Tax Rate and the Pretax Rate of Return

Abstract: This paper presents new estimates of the taxes paid on nonfinancial corporate capital, on the pretax rate of return to capital, and on the effective tax rate. The basic time series show that both the pretax rate of return and the effective tax rate have varied substantially in the past quarter century. An explicit analysis indicates that, after adjusting for different aspects of the business cycle, pretax profitability was between one and 1.5 percentage points lower in the 1970's than in the 1960's. The rate of profitability in the 1960's was also about one-half of a percentage point greater than the profitability in the 7 years of the 1950's after the Korean war. Changes in productivity growth, in inflation, in relative unit labor costs, and in other variables are all associated with changes in profitability. None of these variables, however, can explain the differences in profitability between the 1950Ts, 1960's and 1970's. Looking at broad decade averages, the effective tax rate and the pretax rate of return move in opposite directions, higher pretax profits occurring when the tax rate is high. There thus appears to have been no tendency for pretax profits to vary in a way that offsets differences in effective tax rates.

Gold Monetization and Gold Discipline

Abstract: Gold and its price have emerged as frequent topics of both academic and government debate.2 Public attention, focused on the gold market since gold’s price began fluctuating violently in 1980 and 1981, has turned to gold as a possible means of removing some discretion inherent in the current fiat money system. Since lack of adherence to monetary rules can lead to problems of dynamic policy inconsistency, academic economists have begun seriously to reconsider monetary standards based either on gold or on some other commodity as politically feasible methods of establishing rules.3

Suit and Settlement vs. Trial: A Theoretical Analysis Under Alternative Methods for the Allocation of Legal Costs

Abstract: Will a party who believes that he has a legally admissible claim for money damages decide to bring suit? if so, will he subsequently settle with the opposing party or will he go ahead to trial? These questions are analyzed under four methods for allocating legal costs, namely, under the American system, whereby each side bears its own costs; under the "indemnity" or British system, whereby the losing side bears all costs; under the system favoring the plaintiff whereby the plaintiff pays only his own costs if he loses and nothing otherwise; and under the system favor the defendant, whereby the defendant pays only his own costs if he loses and nothing otherwise. Following the analysis, two brief illustrations are considered and comments are made on the relative social desirability of the methods of allocating legal costs.

Family Size and the Distribution of Per Capita Income

Abstract: This paper is another contribution to the vast literature which addresses this issue: comparison of household income per capita among households of different structures requires judgment about the relationship between real income and family size. Our work uses a revealed preference approach in which household size/structure variables are included in empirical demand studies and the estimated coefficients on these variables are used to infer equivalence; it differs from many of the other studies not in basic concept but in its empirical strategy. While most studies build family composition effects into a relatively formal structural model of demand and impose considerable restriction in order to obtain an estimable system, we use a reduced-form approach which requires much less of the data.

Macroeconomic Determinants of Real Exchange Rates

Abstract: This paper presents a model that integrates money, relative prices, and the current account balance as factors explaining movements in nominal (effective) exchange rates. Thus money and the current account are the proximate determinants of changes in real (effective) rates. The basic model is first analyzed under static expectations. It is an extension of Branson (1977) to include explicitly exogenous disturbances to the current account. Next, rational expectations are introduced, and it is shown that the nominal (and real) rate should be expected to jump instantaneously in response to new information or "innovations" in money, the current account, and relative prices. The model is applied to the quarterly data on effective exchange rates, relative prices, money and the current account for four countries--the U.S., the U.K., Germany and Japan -- since 1973. First the time-series properties of the data are described. All are approximately first-order autocorrelations except all relative prices and Japan's effective exchange rate and current account balance. These are second-order autocorrelations. Then vector autoregressions (VARs) are estimated among the four variables for each country. The residuals from these equations are the "innovations" in the data -- the current movements not predicted by the past. The correlations amongst these innovations are consistent with the theory. Thus the broad conclusion from the paper is that the theoretical model which integrates money, the balance on current account and relative prices, is consistent with movements in these variables since 1973. Real exchange rates adjust to real disturbances in the current account, and time-series innovations in the current account seem to signal the need for adjustment.

The Effect of Social Security on Retirement in the Early 1970s

Abstract: Improved understanding of retirement behavior is a key to better understanding of many important economic problems. In as close as we can come to a general "social experiment," real Social Security benefits were increased substantially for the period we study the retirement patterns of a cohort of white males: 28% on average between 1970 and 1972, with the maximum benefit increased by over 50% in real terms between 1968 and 1976. Other important structural changes in the method of computing benefits were also made. Hence, we have extremely detailed longitudinal data on a cohort of people spanning the years of most active retirement behavior (ages 58-67) over a period of abrupt change in the economic incentives surrounding their retirement . We have analyzed these data in a variety of ways to examine the impact of the changes in Social Security, as well as other factors, on retirement probabilities. The most simple to the most sophisticated analyses reveal the same set of inferences: 1. The acceleration in the decline in the labor force participation of elderly men over the period 1969-73 was primarily due to the large increase in real Social Security benefits; our probability equations estimate effects of changes in real benefits combined with the actual changes to predict declines in participation rates virtually identical to actual observed changes from independent data. 2. Social Security wealth interacts with other assets. A substantial fraction of the elderly appear to have few other assets and this group shows a markedly larger propensity to retire early, e.g., at age 62 when Social Security benefits become available. We find strong evidence of this liquidity constraint effect for an important subgroup of the elderly. 3. The magnitude of the induced retirement effect is large enough that if it is ignored in estimating the direct fiscal implications of major changes in benefit provisions, these may be substantially underestimated . 4. We interpret our results in the historical context of a particular cohort undergoing a major, unanticipated transfer of wealth via larger real benefits. We make no attempt to distinguish these from the long- run effects if the system were to remain unchanged for many years or if future changes were readily predictable.

Why U.S. Wage and Employment Behavior Differs from that in Britain and Japan

Abstract: This paper argues that rigid wages cannot provide the underpinnings of a universally valid theory of the business cycle, simply because wages are not universally rigid. Several different statistical techniques suggest that wage rates in the U.K. and Japan are between three and 15 times more flexible than in the U.S. during the postwar period. Corresponding to greater flexibility in wages, these two countries also exhibit more stable employment behavior over the business cycle. In historical data covering the period between the late-nineteenth-century and 1940, U.S. wage behavior appears to be much more similar to that in Britain and Japan. The contrast between the prewar data and the postwar data, where the U.S. is a definite outlier, suggests that the 1948 invention of the three-year staggered U.S. wage contract may be the crucial factor underlying sluggish U.S. postwar wage dynamics. A theoretical section attempts to distill from recent literature those features of labor market institutions that are regarded as optimal by economic theory. Japanese institutions exhibit more similarity to this theoretical paradigm than those in the U.S. or U.K. Economic theory predicts that long-duration contracts, like those in the postwar U.S., are more likely to emerge when the perceived cost of renegotiation is high, but we must appeal to history and cultural differences to explain why conflict avoidance plays a more prominent role in the development of Japanese labor market institutions than in the American case. In this comparison Britain is the odd-man-out, with well-publicized industrial strife, together with short contract durations. I appeal to history, the different legal tradition, and the nature of the British unions themselves to explain why the three-year contract became established in America but not in Britain.

Black-White Earnings Ratios Since the Civil Rights Act of 1964: The Importance of Labor Market Dropouts

Abstract: Previous analyses of postwar black/white earnings ratios have found a more rapid rate of increase in the period since 1964 than before. The reason for this acceleration is unresolved. One view is that federal equal-employment activities have increased the relative demand for black labor. An alternative view is that rising relative earnings reflects (1) reductions in relative supply and (2) the "statistical" effect of low earners raising median earnings by withdrawing from the labor market. This study differs from previous work on the subject in two ways. First, the restrictions on the universe from which published median earnings data by race are calculated are discussed explicitly. The restrict ion most commonly addressed in previous work (having positive earnings in the year in question) is found to be less important than an undiscussed restriction (being employed as a wage and salary worker the following March). Second, data on the distribution of earnings are used to determine the effect of labor market dropouts on median earnings, instead of trying to estimate this effect (as well as demand and supply effects) from time series data. This permits comparison of "corrected" and "uncorrected" post-1964 trends. For males, about half of the "uncorrected" trend remains after the relative earnings variable is corrected for labor market withdrawals. For females, between half and four fifths remains.

Discount Window Borrowing, Monetary Policy, and the Post-October 6, 1979, Federal Reserve Operating Procedure

Abstract: This paper is intended to be an analysis of discount window borrowing as it relates to more general issues of monetary control. The topic deserves a new look because of the central role of discount window borrowing under the post-October 6, 1979 "reserve targeting" operating strategy.