Showing papers in "Quarterly Journal of Economics in 1987"

Signaling Games and Stable Equilibria

Abstract: Games in which one party conveys private information to a second through messages typically admit large numbers of sequential equilibria, as the second party may entertain a wealth of beliefs in response to out-of-equilibrium messages. By restricting those out-of equilibrium beliefs, one can sometimes eliminate many unintuitive equilibria. We present a number of formal restrictions of this sort, investigate their behavior in specific examples, and relate these restrictions to Kohlberg and Mertens` notion of stability.

Macroeconomic Policy in a Two-Party System as a Repeated Game

Abstract: This paper considers the interaction of two parties with different objectives concerning inflation and unemployment and rational and forward-looking wage-setters. If discretionary policies are followed, an economic cycle related to the political cycle results in equilibrium. This cycle is significantly different from the traditional "political business cycle." Reputational mechanisms due to the repeated interaction of the two parties and the public or commitments to a common policy rule can improve upon the discretionary outcome by reducing or eliminating the magnitude of the economic fluctuations.

Too Much Investment: A Problem of Asymmetric Information

Abstract: This paper shows that under plausible assumptions, the inability of lenders to discover all of the relevant characteristics of borrowers results in investment in excess of the socially efficient level. Raising the rate of interest above the free market level will restore optimality. This conflicts with generally held views and is contrasted with the Stiglitz-Weiss model. It is shown that the assumptions which yield overinvestment support debt as the equilibrium method of finance. However, under the Stiglitz-Weiss assumptions, used to derive an underinvestment result, equity is shown to be the equilibrium method of finance.

The Existence of Self-Enforcing Implicit Contracts

Abstract: Implicit contracts are nontrivial Nash equilibria to the post-hiring trading game between a worker and the employer. These are supported by intrafirm, rather than labor market, reputations. The existence of an implicit contract that supports efficient trade is proved in a simple model.

Menu Costs and the Neutrality of Money

Abstract: A model of endogenous price adjustment under money growth is presented. Firms follow (s,S) pricing policies, and price revisions are imperfectly synchronized. In the aggregate, price stickiness disappears, and money is neutral. The connection between firm price adjustment and relative price variability in the presence of monetary growth is also investigated. The results contrast with those obtained in models with exogenous fixed timing of price adjustment.

The Cyclical Component of U. S. Economic Activity

Abstract: Quarterly data on industrial production and deflated gross national product in the United States from 1947 through 1985 are decomposed into independent nonstationary trend and stationary cycle components using Kalman filtering and smoothing techniques. Estimates of the model parameters imply that at least half of the quarterly innovation in U. S. economic activity can be attributed to a stationary cyclical component that persists over periods of time as long as five years. This finding is inconsistent with the hypothesis that most of the apparent variation in U. S. economic activity can be attributed to a nonstationary trend component.

Are Output Fluctuations Transitory

Abstract: According to the conventional view of the business cycle, fluctuations in output represent temporary deviations from trend. The purpose of this paper is to question this conventional view. If fluctuations in output are dominated by temporary deviations from the natural rate of output, then an unexpected change in output today should not substantially change one's forecast of output in, say, five or ten years. Our examination of quarterly postwar United States data leads us to be skeptical about this implication. The data suggest that an unexpected change in real GNP of 1 percent should change one's forecast by over 1 percent over a long horizon.

Costly Monitoring, Loan Contracts, and Equilibrium Credit Rationing

Abstract: This paper develops a model with asymmetrically informed agents and costly monitoring of loan contracts, where an equilibrium can exhibit credit rationing. Borrowers are identical ex ante, but some receive loans and others do not. In contrast to existing credit rationing theories, rationing does not occur here due to inflexible prices, adverse selection or moral hazard. Optimizing behaviour produces a standard debt contract in equilibrium. The aggregate quantity of loans and equilibrium interest rates respond differently depending on whether there is rationing in equilibrium.

The Disparity Between Willingness to Accept and Willingness to Pay Measures of Value

Abstract: Psychologists have long argued that people are much more averse to a loss than attracted to an equivalent gain. This behavior, termed loss aversion, has been formalized by Kahneman and Tversky [1979] in their reformulation of expected utility theory, prospect theory. In prospect theory the utility function is replaced by a value function that evaluates changes in income from the current level. Increases in income are weighted by a relatively small marginal utility. Decreases in income are weighted by a much larger marginal utility. In effect, the value function implies that a kink in the relationship between utility and income occurs at the initial income or reference point and that the slope of the utility function for losses in income is steeper than it is for gains. In a recent paper Knetsch and Sinden [1984] report a series of experiments that demonstrate the existence of a large disparity between willingness to accept (WTA) and willingness to pay (WTP) measures of value. They argue that the psychological theory of loss aversion explains this difference. Economic theory would suggest that individuals who exhibit a large disparity between WTA and WTP are perhaps underperceiving the value of gains or overperceiving the value of losses, are behaving in an irrational manner, and will consequently achieve a lower level of well-being than if they behaved in a true utility-maximizing manner. This would, in contrast to loss aversion, usually imply near equal values for WTA and WTP (see Willig [1976]). Further documentation of a larger than expected disparity between WTA and WTP has been obtained in surveys asking for the value of a variety of public goods. For example, Cummings, Brookshire, and Schulze [1986] document six

A Specification Test for Speculative Bubbles

Abstract: The set of parameters needed to calculate the expected present discounted value of a stream of dividends can be estimated in two ways. One may test for speculative bubbles, or fads, by testing whether the two estimates are the same. When the test is applied to some annual U. S. stock market data, the data usually reject the null hypothesis of no bubbles. The test is of general interest, since it may be applied to a wide class of linear rational expectations models.

Cooperation, Productivity, and Profit Sharing

Abstract: Firm-specific assets generate an ex post bargaining problem over surplus-division, and rational workers may collude to obtain a surplus-share in nonpecuniary form through restriction of effort. Conversely, profit sharing should motivate cooperation to increase productivity when work organization facilitates interaction and horizontal monitoring, since productive effort yields positive externalities to workers under contractual surplus sharing. In simultaneous Tobit estimates we find a strong influence of profit sharing on factor productivity in a sample of medium-sized metalworking capitalist firms in West Germany. Proxies for human capital and organizational factors were included.

Job Discrimination, Market Forces, and the Invisibility Hypothesis

Abstract: The Invisibility Hypothesis holds that the job skills of disadvantaged workers are not easily discovered by potential new employers, but that promotion enhances visibility and alleviates this problem Then, at a competitive labor market equilibrium, firms profit by hiding talented disadvantaged workers in low-level jobs Consequently, those workers are paid less on average and promoted less often than others with the same education and ability As a result of the inefficient and discriminatory wage and promotion policies, disadvantaged workers experience lower returns to investments in human capital than other workers

Testing the Response of Consumption to Income Changes with (Noisy) Panel Data

Abstract: This paper tests the rational expectations lifecycle model of consumption against (i) a Keynesian model and (ii) the rational expectations lifecycle model with imperfect capital markets. The tests are based upon the relative responsiveness of consumption to income changes that can be predicted from past information and income changes that cannot he predicted. The tests allow for measurement error in income. The results reject the Keynesian model and generally support the lifecycle model. But the results are not sufficiently precise to rule out the possibility that some households are liquidity constrained. Measurement error has a strong influence on the relationship between consumption and income.

Confidence and the Real Value of Money in an Overlapping Generations Economy

Abstract: We demonstrate that stochastic bubbles which have a constant, exogenous, probability of collapsing may exist, in general equilibrium, on an intrinsically useless and unbacked asset (money). This may happen provided that the probability q that the bubble will persist next period is large enough and exceeds a threshold level Q which we call the minimum rate of confidence. This condition is always violated when the economy without bubble is dynamically efficient. It is more likely to be satisfied, in dynamically inefficient economies, the larger the “size” of the inefficiency (as measured by the excess of the growth rate over the no-bubble interest rate). We study both exchange and production economies.

Micro Shocks and Aggregate Risk

Abstract: The paper presents a "micro" shock explanation of aggregate risk. Shocks are independent over agents, and equilibria are always unique. It is shown that any amount of aggregate risk can be generated by games in which shocks to players are independent. Explicit examples are given, some of which elaborate on examples in the literature. Implications are drawn for factor-analytic methods of extracting aggregate shocks.

The Costs of Worker Displacement

Abstract: This study identifies part of the social loss attendant upon displacement as the remaining value of the assets specific to the severed employment relationship. A bargaining model is used to link wage-tenure profiles to the amount of information firms and workers possess about the duration of that relationship. If information is good, the profile will flatten as displacement approaches. Using PSID data for workers separated between 1977 and 1981, wage-tenure profiles are found not to change. This suggests that either workers, or both firms and workers, are surprised by the displacement. The present value of that part of the social loss attributable to the worker's share of firm-specific capital is around $7,000 (1980 dollars).

Stabilization with Exchange Rate Management

Abstract: Stabilization programs in open economies typically consist of two stages. In the first stage the rate of currency devaluation is reduced, but the fiscal adjustment does not eliminate the fiscal deficit that causes growth of debt and loss of reserves, making a future policy change necessary. Only later, at a second stage, is this followed by either an abandonment of exchange rate management or by a sufficiently large cut in the fiscal deficit. We study how different second-stage policy changes affect economic dynamics during the first stage. These changes include tax increases, budget cuts on traded and nontraded goods, and increases in the growth rate of money.

Information, Incentives, and Organizational Mode

Abstract: We examine the choice of organizational mode for a two-stage production process wherein cost realizations at each stage are observed only by the producing party. When these costs are positively correlated, the principal prefers to undertake second-stage production herself. When the correlation is negative and sufficiently small, she will prefer that the agent who performs the first stage also perform the second. For large negative correlation, either mode might be preferred. When costs are uncorrelated, the principal is indifferent between modes.

Monopoly and Quality Distortion: Effects and Remedies

Abstract: A monopolist that sells in a market in which consumers differ in their willingness to pay for quality will distort and enlarge the range of products offered for sale. We examine the positive and normative impacts of remedies used to counteract such distortions. For the case of a price ceiling, the monopolist improves quality at the low quality end of the market, offsetting the distortion induced by the unregulated exercise of monopoly power. Social welfare can be shown to increase for a sufficiently slight degree of price regulation. For minimum quality standards, the social welfare implications are ambiguous because the standards may exclude some consumers from the market.

Real Estate Assets and Consumer Spending

Abstract: In an interesting contribution to this Journal, Elliott [1980] shows that consumer spending is better explained if permanent income is estimated from explicit measures of wealth (the wealth approach) rather than current and past incomes (the income approach). In the income approach, permanent income (Yp,) is computed as a distributed lag mechanism. In the wealth approach this procedure is followed for labor income, but permanent nonhuman income is specified as a constant multiple (72) of actual nonhuman wealth at the beginning of a period (Ant,-). The distinction between income and wealth approaches is intuitively appealing and has been tried before: Elliott's equation (12) is the same as equation (5) in Bhatia [1972] except that Elliott uses actual wealth instead of Bhatia's expected wealth. The novelty in Elliott's specification lies in considering different components of wealth, which is also appealing, because measures of wealth ranging from real money balances to broad aggregates of human and nonhuman wealth have been used in the literature. Elliott's most striking result that real assets (mainly real estate and durable goods) have no significant effect on consumer spending, however, is disturbing because real estate is a major household asset, in fact, the largest one in many years, according to FRB balance sheets [1983], and accrued gains on real estate have often been larger than gains on corporate equities during the last decade or two. Also, there is some recent empirical evidence that gains on real assets significantly reduce personal saving [Peek, 1983]. The main purpose of this note is to reexamine and rehabilitate the role of real assets. One can question Elliott's specification, which does not adequately allow for expected gains, or his use of undistributed corporate profits as a contemporaneous proxy for all capital gains (tenuous, at best), but the heart of the matter is the residential value series derived by Elliott from perpetual inventory benchmarks [pp. 533-34], which, being accumulations of construc-

The Pure Compensation Problem: Egalitarianism Versus Laissez-Fairism

Abstract: A binary choice problem with side-payments and quasi-linear utilities is considered. We study two compensation rules, called social choice functions. The egalitarian rule divides equally the surplus above the average utility level. The laissez-faire rule chooses an efficient decision but performs no transfer. Egalitarianism is characterized by a monotonicity axiom called Agreement: no two agents ever disagree in comparing two distinct preferences of a third one. Laissez-fairism is characterized by the No Subsidy axiom: a coalition would not be worse off if the other agents were not present.

The Economics of Export-Performance Requirements

Abstract: This paper analyzes the resource-allocation and welfare effects of export-performance requirements imposed on foreign investors. It argues that a satisfactory analysis must consider the presence of tariff distortions and oligopolistic behavior in host-country markets. These create a second-best environment in which an evaluation of the welfare effects of such requirements is no longer straightforward. It is concluded that export requirements can improve home welfare by reducing payments to foreign capital, reducing the output of commodities which are being overproduced, and shifting profits toward domestically owned firms.

Incomplete Information Bargaining with Outside Opportunities

Abstract: We consider two kinds of "outside opportunity" that a seller of an indivisible good might have: selling to a different buyer and consuming the good herself. In both models the seller is uncertain about the buyer's valuation, and becomes more pessimistic over time. When the seller becomes sufficiently pessimistic, she prefers the outside opportunity, so she will not bargain indefinitely with the current buyer. Despite the resulting finite-horizon nature of negotiations, the link between the buyer's willingness to accept an offer and the seller's eagerness to go "outside" generates multiple equilibria.

“Making Book Against Oneself,” the Independence Axiom, and Nonlinear Utility Theory

Abstract: An individual with known preferences over lotteries can be led to accept random wealth distributions different from his initial endowment by a sequential process in which some uncertainty is resolved and he is offered a new lottery in place of the remaining uncertainty. This paper examines the restrictions that can be placed on an individual's preferences by axioms that stipulate that such a process not be able to generate a new wealth distribution that is prima facie inferior to the original. The relationship of these axioms to the independence axiom of von Neumann and Morgenstern and to the quasi convexity of preferences in the wealth distribution are explored.

An Extension of the Second Welfare Theorem to Economies with Nonconvexities and Public Goods

Abstract: In this paper we report a generalization of the results of Foley and Guesnerie on the second welfare theorem to economies with arbitrary nonconvex production sets. The nature of marginal cost prices in such economies is clarified through the use of the Clarke tangent cones.

Consumption and Unemployment

Abstract: This paper examines consumption changes of workers following experiences of unemployment in different stochastic environments. The model developed in the paper predicts that consumption changes following unemployment spells should be small for workers the higher are their layoff and recall probabilities. These predictions are confirmed in estimates with panel data.