Showing papers by "National Bureau of Economic Research published in 1988"

Credit, Money, and Aggregate Demand

Abstract: Standard models of aggregate demand treat money and credit asymmetrically; money is given a special status, while loans, bonds, and other debt instruments are lumped together in a "bond market" and suppressed by Walras' Law. This makes bank liabilities central to the monetary transmission mechanism, while giving no role to bank assets. We show how to modify a textbook IS-UI model so as to permit a more balanced treatment. As in Tobin (1969) and Brunner-Meltzer (1972), the key assumption is that loans and bonds are imperfect substitutes. In the modified model, credit supply and demand shocks have independent effects on aggregate demand; the nature of the monetary transmission mechanism is also somewhat different. The main policy implication is that the relative value of money and credit as policy indicators depends on the variances of shocks to money and credit demand. We present some evidence that money-demand shocks have become more important relative to credit-demand shocks during the 1980s.

Industrialization and the Big Push

Abstract: This paper explores Rosenstein-Rodman's (1943) idea that simultaneous industrialization of many sectors of the economy can be profitable for all of them, even when no sector can break even industrializing alone. We analyze this ides in the context of an imperfectly competitive economy with aggregate demand spillovers, and interpret the big push into industrialization as a move from a bad to a good equilibrium. We show that for two equilibria to exist, it must be the case that an industrializing firm raises the demand for products of other sectors through channels other than the contribution of its own profits to demand. For example, a firm paying high factory wages raises demand in other manufacturing sectors even if it loses money. In a similar vein, a firm investing today in order to produce at low cost tomorrow shifts income and hence demand for other goods into the future and so makes it more attractive for other firms also to invest today. Finally, an investing firm can benefit firms in other sectors if it uses a railroad or other shared infrastructure, and hence helps to defray the fixed cost of building the railroad. All these transmission mechanisms that help generate the big push seem to be of some relevance for less developed countries.

The Efficiency of the Market for Single-Family Homes

Abstract: Tests of weak-form efficiency of the market for single family homes are performed using data on repeat sales prices of 39,210 individual homes, each for two sales dates. Tests were done for Atlanta, Chicago, Dallas, and San Francisco/Oakland for 1970-86. While evidence for seasonality in real housing prices is weak, we do find some evidence of inertia in housing prices. A city-wide real log price index change in a given year tends to be followed by a city-wide real log price index change in the same direction (and between a quarter to a half as large in magnitude) in the subsequent year. However, the inertia cannot account for much of the variation in individual housing real price changes. There is so much noise in individual housing prices relative to city-wide price index changes that the R[squared] in forecasting regressions for annual real price change in individual homes is never more than .04.

Tests for Unit Roots: a Monte Carlo Investigation

Abstract: Recent work by Said and Dickey (1984 ,1985) , Phillips (1987), and Phillips and Perron(1988) examines tests for unit roots in the autoregressive part of mixed autoregressive-integrated-moving average (ARIHA) models (tests for stationarity). Monte Carlo experiments show that these unit root tests have different finite sample distributions than the unit root tests developed by Fuller(1976) and Dickey and Fuller (1979, l981) for autoregressive processes. In particular, the tests developed by Philllps (1987) and Phillips and Perron (1988) seem more sensitive to model misspeciflcation than the high order autoregressive approximation suggested by Said and Diekey(1984).

Job Mobility and the Careers of Young Men

Abstract: We study the joint processes of job mobility and wage growth among young men drawn from the Longitudinal Employee-Employer Data. Following individuals at three month intervals from their entry into the labor market, we track career patterns of job changing and the evolution of wages for up to 15 years. Following an initial period of weak attachment to both the labor force and particular employers, careers tend to stabilize in the sense of strong labor force attachment and increasing durability of jobs. During the first 10 years in the labor market, a typical young worker will work for seven employers, which accounts for about two-thirds of the total number of jobs he will hold in his career. The evolution of wages plays a key role in this transition to stable employment: we estimate that wage gains at job changes account for at least a third of early-career wage growth, and that the wage is the key determinant of job changing decisions among young workers. We conclude that the process of job changing for young workers, while apparently haphazard, is a critical component of workers' move toward the stable employment relations that characterize mature careers.

Liquidity and Market Structure

Abstract: Market liquidity is modeled as being determined by the demand and supply of immediacy. Exogenous liquidity events coupled with the risk of delayed trade create a demand for immediacy. Market makers supply immediacy by their continuous presence. and willingness to bear risk during the time period between the arrival of final buyers and sellers. In the long run the number of market makers adjusts to equate the supply and demand for immediacy. This determine the equilibrium level of liquidity in the market. The lower is the autocorrelation in rates of return, the higher is the equilibrium level of liquidity.

Sovereign Debt: is to Forgive to Forget?

Abstract: International lending to a less-developed country cannot be based on the debtor's reputation for making repayments. That is, loans to LDCs will not be made or repaid unless foreign creditors have legal or other direct sanctions they can exercise against a sovereign debtor who defaults Even if some lending is feasible because of direct sanctions, having a reputation for repayment in no way enhances a small LDC's ability to borrow.

Financing vs. Forgiving a Debt Overhang

Abstract: This paper examines the tradeoffs facing creditors of a country whose debt is large enough that the country cannot attract voluntary new lending. If the country is unable to meet its debt service requirements out of current income, the creditors have two choices. They can finance the country, lending at an expected loss in the hope that the country will eventually be able to repay its debt after all; or they can forgive, reducing the debt level to one that the country can repay. The post-1983 debt strategy of the IMF and the US has relied on financing, but many current calls for debt reform call for forgiveness instead. The paper shows that the choice between financing and forgiveness represents a tradeoff. Financing gives the creditors an option value: if the country turns out to do relatively well, creditors will not have written down their claims unnecessarily. However, the burden of debt distorts the country's incentives, since the benefits of good performance go largely to creditors rather than itself. The paper also shows that the tradeoff itself can be improved if both financing and forgiveness are made contingent on states of nature that the country cannot affect, such as oil prices, world interest rates, etc.

Sources of Business Cycle Fluctuations

Abstract: What shocks account for the business cycle frequency and long run movements of output and prices? This paper addresses this question using the identifying assumption that only supply shocks, such as shocks to technology, oil prices, and labor supply affect output in the long run Real and monetary aggregate demand shocks can affect output, but only in the short run This assumption sufficiently restricts the reduced form of key macroeconomic variables to allow estimation of the shocks and their effect on output and price at all frequencies Aggregate demand shocks account for about twenty to thirty percent of output fluctuations at business cycle frequencies Technological shocks account for about one-quarter of cyclical fluctuations, and about one-third of output's variance at low frequencies Shocks to oil prices are important in explaining episodes in the 1970's and 1980's Shocks that permanently affect labor input account for the balance of fluctuations in output, namely, about half of its variance at all frequencies

Is Theory Really Ahead of Measurement? Current Real Business Cycle Theories and Aggregate Labor Market Fluctuations

Abstract: In the l93Os, Dunlop and Tarshis observed that the correlation between hours and wages is close to zero. This classic observation has become a litmus test by which macroeconomic models are judged. Existing real business cycle models fail this test dramatically. Based on this result, we argue that technology shocks cannot be the sole impulse driving post-war U.S. business cycles. We modify prototypical real business cycle models by allowing government spending shocks to influence labor market dynamics in a way suggested by Aschauer (1985), Barro (1981, 1987) and Kormendi (1983), This modification can, in principle, bring the models into closer conformity with the data. While the empirical performance of the models is significantly improved, they still fail to account for the Dunlop-Tarshis observation. Accounting for that observation will require further advances in model development. Consequently, we conclude that theory is behind, not ahead of, business cycle measurement.

The Survival of Noise Traders in Financial Markets

Abstract: We use the revised estimates of U.S. GNP constructed by Christina Romer (1989) to assess the time-series properties of U.S. output per capita over the past century. We reject at conventional significance levels the null that output is a random walk in favor of the alternative that output is a stationary autoregressive process about a linear deterministic trend. The difference between the lack of persistence of output shocks either before WWII or over the entire century, on the one hand, and the strong signs of persistence of output shocks found by Campbell and Mankiw (1987) and by Nelson and Plosser (1982) for more recent periods is striking. It suggests to us a Keynesian interpretation of the large unit root in post-WWII U.S. output: perhaps post-WWII output shocks appear persistent because automatic stabilizers and other demand-management policies have substantially damped the transitory fluctuations that made up the pre-WWH Bums-Mitchell business cycle.

A Probability Model of the Coincident Economic Indicators

Abstract: The Index of Coincident Economic Indicators, currently compiled by the U.S. Department of Commerce, is designed to measure the state of overall economic activity. The index is constructed as a weighted average of four key macroeconomic time series, where the weights are obtained using rules that dare to the early days of business cycle analysis. This paper presents an explicit rime series model (formally, a dynamic factor analysis or "single index" model) that implicitly defines a variable that can be thought of as the overall state of the economy. Upon estimating this model using data from 1959-1987, the estimate of this unobserved variable is found to be highly correlated with the official Commerce Department series, particularly over business cycle horizons. Thus this model provides a formal rationalization for the traditional methodology used to develop the Coincident Index. Initial exploratory exercises indicate that traditional leading variables can prove useful in forecasting the short-run growth in this series.

Exchange Rate Pass-Through When Market Share Matters

Abstract: We investigate pricing to market when the exchange rate changes in cases where firms' future demands depend on their current market shares. We show that i) profit maximizing foreign firms may either raise or lower their domestic currency export prices when the domestic exchange rate appreciates temporarily (i.e. the "pass-through" from exchange rate changes to import prices may be perverse); ii) current import prices may be more sensitive to the expected future exchange rate than to the current exchange rate; iii) current import prices fall in response to an increase in uncertainty about the future exchange rate. We present evidence that suggests the behavior of expected future exchange rates may provide a clue to the puzzling behavior of U.S. import prices during the 1980s.

The Excess Co-Movement of Commodity Prices

Abstract: This paper tests and confirms the existence of a puzzling phenomenon - the prices of largely unrelated raw commodities have a persistent tendency to move together. We show that this comovement of prices is well in excess of anything that can be explained by the common effects of past, current, or expected future values of macroeconomic variables such as inflation, industrial production, interest rates, and exchange rates. These results are a rejection of the standard competitive model of commodity price formation with storage.

Business Cycles and the Exchange Rate System: Some International Evidence

Abstract: This paper investigates empirically the differences in time?series behavior of key economic aggregates under alternative exchange rate systems. We use a postwar sample of 49 countries to compare the behavior of output. consumption, trade flows, government consumption spending, and real exchange rates under alternative exchange rate systems (pegged, floating, and systems such as the EMS). We then examine evidence from two particular episodes, involving Canada and Ireland, of changes in the exchange rate system. Aside from greater variability of real exchange rates under flexible than under pegged nominal exchange rate systems, we find little evidence of systematic differences in the behavior of other macroeconomic aggregates or international trade flows under alternative exchange rate systems. These results are of interest because a large class of theoretical models implies that the nominal exchange rate system has important effects on a number of macroeconomic quantities.

Government Spending in a Simple Model of Endogenous Growth

Abstract: I extend existing models of endogenous economic growth to incorporate a government sector. Production involves private capital (broadly defined) and public services. There is constant returns to scale in the two factors, but diminishing returns to each separately. Public services are financed by a flat- rate income tax. The economy's growth rate and saving rate initially rise with the ratio of productive government expenditures to CNP, g/y, but each rate eventually reaches a peak and subsequently declines. If the production function is Cobb-Douglas with an exponent o for public services, then the value g/y = a maximizes the growth rate, and also maximizes the utility attained by the representative consumer. The distortion from the income tax implies that the decentralized equilibrium is not Pareto optimal; in particular, the growth and saving rates are too low from a social perspective. In a command optimum, growth and saving rates are higher, but g/y = a turns out still to be the best choice for the size of government. The command optimum can be sustained by picking the expenditure ratio, g/y = a, and then financing this spending by lump sum taxes. If the share of productive spending, g/y, were chosen randomly, then the model would predict a non-monotonic relation between g/y and the economy's long- term growth and saving rates. However, for optimizing governments, the model predicts an inverse association between g/y and the rates of growth and saving.

The Great Crash and the Onset of the Great Depression

Abstract: This paper argues that the collapse of stock prices in October 1929 generated temporary uncertainty about future income which caused consumers to forego purchases of durable and semidurable goods in late 1929 and much of 1930. Evidence that the stock market crash generated uncertainty is provided by the decline in confidence expressed by contemporary forecasters. Evidence that this uncertainty affected consumer behavior is provided by the fact that spending on consumer durables and semidurables declined immediately following the Great Crash and by the fact that there is a negative historical relationship between stock market variability and the production of consumer durables in the prewar era.

The Baby Boom, the Baby Bust, and the Housing Market

Abstract: This paper examines the impact of major demographic changes on the housing market in the United States. The entry of the Baby Boom generation into its house-buying years is found to be the major cause of the increase in real housing prices in the l97Os. Since the Baby Bust generation is now entering its house-buying years, housing demand will grow more slowly in the 1990s than in any time in the past forty years. If the historical relation between housing demand and housing prices continues into the future, real housing prices will fall substantially over the next two decades.

Do Tournaments Have Incentive Effects

Abstract: Much attention has been devoted to studying models of tournaments or situations in which an individual's payment depends only on his output or rank, relative to other competitors. Such models are of more than academic Interest as they may well describe the compensation structures applicable to many corporate executives and professors, to sales people whose bonuses depend on their relative outputs. and to the more obvious example of professional sports tournaments. Academic interest derives from the fact that under certain sets of assumptions tournaments have desirable normative properties because of the incentive structures they provide. Our paper uses nonexperimental data to test if tournaments actually elicit desired effort responses. We focus on golf tournaments because information on the incentive structure (prize distribution) and measures of individual output (players' scores) are both available. Under suitable assumptions, players' scores can be related to players' effort and implications for both players' overall tournament scores and their scores on the last round of a tournament drawn. In addition, data are available to control for factors other than the incentive structure that should affect output; these factors include player quality, quality of the rest of the field, difficulty of the course, and weather conditions. The data used in our analyses cane from the "1985 Golf Digest Almanac", the "Official 1985 PGA Tour Media Guide", and the "1984 PGA Tour Player Record". We find strong support for the proposition that the level and structure of prizes in PGA tournaments influence players' performance.

Why Does Stock Market Volatility Change Over Time

Abstract: This paper analyzes the relation of stock volatility with real and nominal macroeconomic volatility, financial leverage, stock trading activity, default risk, and firm profitability using monthly data from 1857-1986. An important fact, previously noted by Officer [l973], is that stock return variability was unusually high during the 1929-1940 Great Depression. Moreover, leverage has a relatively small effect on stock volatility. The amplitude of the fluctuations in aggregate stock volatility is difficult to explain using simple models of stock valuation.

The Dynamic Effects of Aggregate Demand and Supply Disturbances

Abstract: We interpret fluctuations in GNP and unemployment as due to two types of disturbances: disturbances that have a permanent effect on output and disturbances that do not. We interpret the first as supply disturbances, the second as demand disturbances. We find that demand disturbances have a hump shaped effect on both output and unemployment; the effect peaks after a year and vanishes after two to five years. Up to a scale factor, the dynamic effect on unemployment of demand disturbances is a mirror image of that on output. The effect of supply disturbances on output increases steadily over time, to reach a peak after two years and a plateau after five years. 'Favorab1e supply disturbances may initially increase unemployment. This is followed by a decline in unemployment, with a slow return over time to its original value. While this dynamic characterization is fairly sharp, the data are not as specific as to the relative contributions of demand and supply disturbances to output fluctuations. We find that the time series of demand-determined output fluctuations has peaks and troughs which coincide with most of the NBER troughs and peaks. But variance decompositions of output at various horizons giving the respective contributions of supply and demand disturbances are not precisely estimated. For instance, at a forecast horizon of four quarters, we find that, under alternative assumptions, the contribution of demand disturbances ranges from 40 to over 95 per cent.

Financial Deregulation, Monetary Policy, and Central Banking

Abstract: Financial deregulation is widely understood to have important economic benefits for microeconomic reasons Since Adam Smith, economists have provided arguments and evidence that unfettered private markets yield outcomes that are superior to public sector alternatives But financial regulations - specific rules and overall structures - are sometimes justified on macroeconomic grounds This paper analyzes the need for financial regulations in the implementation of central bank policy Dividing the actions of the Federal Reserve into monetary and banking policy, we find that financial regulations cannot readily be rationalized on the basis of macroeconomic benefits

A Theory of Managed Trade

Abstract: This paper proposes a theory that predicts low levels of protection during periods of "normal" trade volume coupled with episodes of "special" protection when trade volumes surge. This dynamic pattern of protection emerges from a model in which countries choose levels of protection in a repeated game setting facing volatile trade swings. High trade volume leads to a greater incentive to unilaterally defect from cooperative tariff levels. Therefore as the volume of trade expands, the level of protection must rise in a cooperative equilibrium to mitigate the rising trade volume and hold the incentive to defect in check.

Pensions, the Option Value of Work, and Retirement

Abstract: The paper develops a model of retirement based on the option value of continuing to work. Continuing to work maintains the option of retiring on more advantageous terms later. The model is used to estimate the effects on retirement of firm pension plan provisions. Typical defined benefit pension plans in the United States provide very substantial incentives to remain with the firm until some age, often the early retirement age, and then a strong incentive to leave the firm thereafter. (This may be a major reason for the rapidly declining labor force participation rates of older workers in the United States.) The model fits firm retirement data very well; it captures very closely the sharp discontinuous jumps in retirement rates at specific ages. The model is used to simulate the effect on retirement of potential changes in pension plan provisions. Increasing the age of early retirement from 55 to 60, for example, would reduce firm departure rates between ages 50 and 59 by almost forty percent.