Showing papers on "Price level published in 1994"

A simple model for study of the determination of the price level and the interaction of monetary and fiscal policy

Abstract: A representative-agent model with money holdings motivated by transactions costs, a fiscal authority that taxes and issues debt, no production, and a convenient functional form for agents' utility is presented. The model can be solved analytically, and illustrates the dependence of price determination on fiscal policy, the possibility of indeterminacy, even stochastic explosion, of the price level in the face of a monetary policy that holdsM fixed, and the possibility of a unique, stable price level in the face of a monetary policy that simply pegs the nominal interest rate at an arbitrary level. In a rational expectations, market-clearing equilibrium model with a costlessly-produced fiat money that is useful in transactions, the following things are true under broad assumptions. - A monetary policy that fixes the money stock may (depending on the transactions technology) be consistent with indeterminacy of the price level—indeed with stochastically fluctuating, explosive inflation. - A monetary policy that fixes the nominal interest rate, even if it holds the interest rate constant regardless of the observed rate of inflation or money growth rate, may deliver a uniquely determined price level. - The existence and uniqueness of the equilibrium price level cannot be determined from knowledge of monetary policy alone; fiscal policy plays an equally important role. Special case models with interest-bearing debt and no money are possible, just as are special cases with money and no interest-bearing debt. In each the price level may be uniquely determined. Determinacy of the price level under any policy depends on the public's beliefs about what the policy authority would do under conditions that are never observed in equilibrium. These points are not new. Eric Leeper [1991] has made most of them within a single coherent model. Woodford [1993], in a representative agent cash-in-advance model, has displayed the possibility of indeterminacy with a fixed quantity of money and the possibility of uniqueness with an interest-rate pegging policy. Aiyagari and Gertler [1985] use an overlapping generations model to make many of the points made in this paper, without discussing the possibility of stochastic sunspot equilibria. Sargent and Wallace [1981] and Obstfeld [1983] have also discussed related issues. This paper improves on Leeper by moving beyond his analysis of local linear approximations to the full model solution, as is essential if explosive sunspot equilibria are to be distinguished from explosive solutions to the Euler equations that can be ruled out as equilibria. It improves on the other cited work by pulling together into the context of one fairly transparent model discussion of phenomena previously discussed in isolation in very different models. We study a representative agent model in which there is no production or real savings, but transactions costs generate a demand for money. The government costlessly provides fiat money balances, imposes lump-sum taxes, and issues debt, but has no other role in the economy. We make restrictive assumptions about the form of the utility function and the form of a transactions cost term in the budget constraint. The model could be extended to include production, capital accumulation, non-neutral taxation, productive government expenditure, and a more general utility function without affecting the conclusions discussed in this paper. Indeed the model I informally matched to data in an earlier paper [1988] makes some such extensions. While such an extended model is more realistic, it is harder to solve. The version in my earlier paper [1988] was solved numerically and simulated. The bare-bones model of this paper allows an explicit analytic solution that may make its results easier to understand.

Monetary policy and price level determinacy in a cash-in-advance economy*

Abstract: Summary. The paper considers the determinacy of the equilibrium price level in the cash-in-advance monetary economy of Lucas and Stokey (1983, 1987), in the case of deterministic "fundamentals". The possibilities both of a multiplicity of perfect foresight equilibria and of "sunspot equilibria" are considered. Two types of monetary policy regimes are considered and compared, one in which the money supply grows at a given exogenous rate (that may be positive or negative), and one in which the nominal interest rate on one-period government debt is pegged at a given non-negative level. In the case of constant money growth rate regimes, it is shown that one can easily have both indeterminacy of perfect foresight equilibrium and existence of sunspot equilibria; indeed, in the case of negative rates of money growth (as called for by Friedman (1969)), both types of indeterminacy necessarily occur. On the other hand, sufficient conditions for uniqueness of equilibrium (and non-existence of equilibria other than a deterministic steady state) are also given, and a class of cases is identified in which a sufficiently high rate of money growth guarantees this. Thus there may be a conflict between the aims of choosing a rate of money growth that results in a high level of welfare in the steady state equilibrium and choosing a rate that makes this steady state the unique equilibrium.) In the case of the interest rate pegging regimes, sufficient conditions are given for uniqueness of equilibrium (and impossibility of sunspot equilibria), and it is shown that these necessarily hold in the case of any low enough nominal interest rate. Thus the nominal interest rate peg allows simultaneous achievement of price level determinacy and a high level of welfare in the unique (steady state) equilibrium. In this paper I consider the consequences of alternative choices of the monetary policy regime for the determinacy of the rational expectations equilibrium value of money, and in particular for the existence or not of "sunspot" equilibria, i.e., rational

Bubbles in Metropolitan Housing Markets

Abstract: A commonsense and empirically supported approach to explaining metropolitan real house price changes is for the theory to describe an equilibrium price level to which the market is constantly adjusting. The determinants of real house price appreciation, then, can be divided into two groups, one that explains changes in the equilibrium price and the other that accounts for the adjustment dynamics or changing deviations from the equilibrium price. The former group includes the growth in real income and real construction costs and changes in the real after-tax interest rate. The latter group consists of lagged real appreciation and the difference between the actual and equilibrium real house price levels. Either group of variables can explain a little over two-fifths of the variation in real house price movements in 30 cities over the 1977-92 period; together, they explain three-fifths.

Valuation of new goods under perfect and imperfect competition

Abstract: The Consumer Price Index (CPI) attempts to answer the question of how much more (or less) income does a consumer require to be as well off in period 1 as in period 0 given changes in prices, changes in the quality of goods, and the introduction of new goods (or the disappearance of existing goods) In this paper I explain the theory of cost-of-living indices and demonstrate how new goods should be included using the classical theory of Hicks and Rothbarth The correct price to use for the good in the pre-intro- duction period is a `virtual' price which sets demand to zero Estimation of this virtual price requires estimation of a demand function which in turn provides the expenditure function which allows exact calucation of the cost of living index The data requirements and need to specify and estimate a demand function for a new brand among many existing brands requires extensive data and some new econometric methods which may have proven obstacles to the inclusion of new goods in the CPI up to this point As an example I use the introduction of a new cereal brand by General Mills in 1989-Apple Cinnamon Cheerios I find the virtual price is about 2 times the actual price of Apple Cinnamon Cheerios and that increase in consumer surplus is substantial Based on some simplifying approximations, I find that CPI may be overstated for cereal by about 25% because of its neglect of the effect of new brands When I take imperfect competition into account I find that the increase in consumer welfare is only 85% as high with perfect competition so CPI for cereal would still be 20% too high

Ex-Dividend Price Behavior of Common Stocks

Abstract: This study examines common stock prices around ex-dividend dates. Such price data usually contain a mixture of observations--some with and some without arbitrageurs and/or dividend capturers active. Our theory predicts that such mixing will result in a nonlinear relation between percentage price drop and dividend yield--not the commonly assumed linear relation. This prediction and another important prediction of theory are supported empirically. In a variety of tests, marginal price drop is not significantly different from the dividend amount. Thus, over the last several decades, one-for-one marginal price drop has been an excellent (average) rule of thumb. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

The Relevance of P-Star Analysis to UK Monetary Policy

Abstract: Recent articles have attempted to restore the use of a simple measure of the money supply as an indicator of future price levels, P[star], and to reestablish a causal link from money to prices. In this paper we argue that the P[star] approach is flawed. It is certainly more complex than traditional monetarist approaches but the fundamental questions of causality are in no way either affected or resolved. We argue that the P[star] relationship does not have a causal link with prices but rather the causality runs from prices to money. We also find that there is some causality running from money to real income, so that monetary conditions do seem to have some predictive power for future levels of activity. Copyright 1994 by Royal Economic Society.

Staggering and Synchronization in Price-Setting: Evidence from Multipro-duct Firms

Abstract: Most of the theoretical literature on price-setting behavior deals with the special case in which only a single price is changed. At the retail-store level, at least, where dozens of products are sold by a single price-setter, price-setting policies are not formulated for individual products. This feature of economic behavior raises a host of questions whose answers carry interesting implications. Are price setters staggered in the timing of price changes? Are price changes of different products synchronized within the store? If so, is this a result of aggregate shocks or of the presence of a store- specific component in the cost of adjusting prices? Can observed small changes in prices be rationalized by a menu cost model? We exploit the multiproduct dimension of the dataset on prices used in Lach and Tsiddon (1992a) to explore several of these and other issues. To the best of our knowledge this is the first empirical work on this subject.

The consumer price index

Abstract: The consumer price index (CPI) is probably the most closely watched indicator of inflation in the U.S. economy. In this article, Mark Wynne and Fiona Sigalla explain the construction of the CPI and evaluate some of its potential shortcomings as a measure of inflation. Specifically, they examine the discrepancies that arise between the CPI and the true cost- of-living index as a result of improvements in the quality of goods, the introduction of new goods, substitution on the part of consumers between different goods and retail outlets, and the difficulty of measuring the prices actually paid by consumers for the goods they purchase. ; The authors review the literature that quantifies these discrepancies, with the objective of estimating the magnitude of the overall bias in the CPI. Wynne and Sigalla argue that, in fact, remarkably little is known about the extent or significance of the overall bias in the CPI. They conclude that biases in the CPI cause it to overstate inflation by no more than 1 percent a year, and probably less.

Nominal Income Targeting

Abstract: This paper discusses nominal income targeting as a possible rule for the conduct of monetary policy. We begin by discussing why a rule for monetary policy may be desirable and the characteristics that a good rule should have. We emphasize, in particular, three types of nominal income targets, which differ in how they respond to past shocks, to prices, and real economic activity. A key question is how any of these rules might be implemented in practice. We suggest that the consensus forecast of future nominal income could playa role in ensuring that the central bank does not deviate from its announced target. To show how economic performance might have differed historically if the Fed had been committed to some type of nominal income target, we offer simulations of a simple model of the economy. According to the simulations, the primary benefit of nominal income targeting would have been reduced volatility in the price level and the inflation rate. Whether real economic activity would have been less volatile is unclear.(This abstract was borrowed from another version of this item.)

Toward a Modern Macroeconomic Model Usable for Policy Analysis

Abstract: This paper presents a macroeconomic model that is both a completely specified dynamic general equilibrium model and a probabilistic model for time series data. We view the model as a potential competitor to existing ISLM-based models that continue to be used for actual policy analysis. Our approach is also an alternative to recent efforts to calibrate real business cycle models. In contrast to these existing models, the one we present embodies all the following important characteristics: i) It generates a complete multivariate stochastic process model for the data it aims to explain, and the full specification is used in the maximum likelihood estimation of the model; ii) It integrates modeling of nominal variables -- money stock, price level, wage level, and nominal interest rate -- with modeling real variables; iii) It contains a Keynesian investment function, breaking the tight relationship of the return on investment with the capital-output ratio; iv) It treats both monetary and fiscal policy explicitly; v) It is based on dynamic optimizing behavior of the private agents in the model. Flexible-price and sticky-price versions of the model are estimated and their fits are evaluated relative to a naive model of no-change in the variables and to an unrestricted VAR. The paper displays the model's implications for the dynamic responses to structural shocks, including policy shocks, and evaluates the relative importance of various shocks for determining economic fluctuations.

Scanner Data: New Opportunities for Demand and Competitive Strategy Analysis

Abstract: This paper reviews prior research by agricultural economists on the demand for food products using scanner data. Thereafter, a differentiated product's oligopoly model with Bertrand price competition is developed and used to specify brand level demand and oligopoly price reaction equations. The model has sufficient detail to estimate brand level price elasticities and price response elasticities which in turn can be used to estimate three indices of market power. The first index estimated is the familiar Rothschild Index. The paper develops estimates two new indexes, the observed index and the Chamberlin quotient for tacit collusion. It concludes with comments on how the proposed method for the measurement of market power in a differentiated oligopoly can be improved.

A duration model of irreversible oil investment: Theory and empirical evidence

Abstract: The aim of this paper is to analyse the implications of the theory of irreversible investment under uncertainty for investment in oil fields on the United Kingdom Continental Shelf (UKCS). We consider the problem of an operator who owns a licence to develop and extract oil from a field of known capacity. An intertemporal optimization model in discrete time is developed to derive decision rules for the timing of the irreversible development investment and for the optimal rate of extraction. Model simulation is then used to describe the properties of the numerical solutions. The predictions of the theory on the determinants of the irreversible investment decision are then examined using statistical duration analysis. Data on the length of the time period between discovery and development are available for individual fields on the UKCS. We measure the duration of the irreversible investment gestation lag for each field and test the model by assessing the significance of the theoretical variables in explaining the significance of such a lag. Both our theoretical model and our empirical results suggest the importance of a nonlinear interaction of the level of oil prices and the volatility of oil prices in determining the development lag. The simulation of our theoretical model shows a nonlinear impact of oil price volatility on the trigger level of oil prices. Our empirical results suggest that the effect of price volatility is a function of the expected price level, with increased price volatility having a positive impact on the duration of investment appraisal when expected prices are low and a negative impact when they are high.

Models of UK private sector quarterly construction demand

Abstract: An analysis is made of private sector construction demand (quarterly new orders) grouped into housing, commercial and industrial construction, respectively and their relationship with a priori selected leading indicators of GNP, price level, real interest rate, unemployment and manufacturing profitability over the period 1974–1988. The results indicate that different variables explain the trends in these private sector construction demand subsectors. While construction price appeared to be an important elastic influence in housing investment, it was not found to be an important factor with respect to commercial and industrial construction. Trends in commercial and industrial constructions are explained by manufacturing profitability and economic conditions. The level of unemployment influences commercial construction only and with a negative inelastic relationship. Lead indicator forecasts of the groupings of private sector investment are above 10% accuracy due to the unusually deep cut in private constru...

List price signaling and buyer behavior in the housing market

Abstract: To determine whether list price contains useful information for anticipating trends in eventual transactions prices, we develop a model of buyer behavior from a search-theoretic perspective. Using data from the Baton Rouge, Louisiana, housing market between 1985 and 1992, we estimate separate price indexes with list price and selling price as the respective dependent variables in the hedonic regressions. Consistent with our theory, we find that the list price may lead the market when functioning as a signal of seller intent, but list price will probably lag a market driven by buyer willingness to purchase. Granger causality tests conducted on quarterly data for the eight-year study support listing price as a leading indicator of selling price. However, an examination of the indexes around the period of market reversal suggest otherwise. Indeed, listing prices appear to contain the least useful information at the times when information would be most valuable: at the peaks and troughs of the market cycle.

Free Banking and Monetary Control

Abstract: Despite growing interest in competitive payments systems and the continuing progress of bank deregulation, relatively little is known about the macroeconomic implications of completely unregulated or 'free' banking. Its advocates view free banking, where competing banks freely issue monetary liabilities redeemable in base money,1 as a means for 'depoliticising' the money stock by replacing public holdings of government money with private bank money while limiting changes in the monetary base. Such a programme begs many crucial questions. How would the (unregulated) stock of bank money be determined? Would free banking enhance or reduce macroeconomic stability compared to regulated banking? What implications would free banking have for the proper conduct of monetary policy? Lawrence H. White (i 984, ch. I) employs a model of a free banking system to answer some of these questions. However, because it concerns free banklng as practised in Scotland in the nineteenth century, White's model assumes an open economy operating in an international gold standard, where the price level is given and there is no such thing as monetary policy in its modern sense. Were free banking to reemerge today, it would probably be based, not on a gold standard, but on irredeemable paper ('fiat') base money issued by a former or extant central bank. Under this form of free banking, the price level is no longer given, and conventional monetary policy questions remain relevant. In particular, would free banking on a fiat standard simplify or complicate the control of nominal variables, including the price level and nominal income? Would it be easier or more difficult to adhere to a simple monetary rule? What would happen if the stock of base money were frozen as a means for ruling out discretion altogether? Answers to such questions require an analysis of determinants of the money stock in a closed free banking system with a centrally-determined stock of base money. Here I offer some preliminary answers based upon Carl Christ's (i 989) formal interpretation of Selgin (I988). The features of free banking stressed here because they bear most on questions of monetary control include (i) the freedom of banks to issue notes as well as deposits, where banknotes are a more

Understanding the price puzzle

Abstract: Recent developments in measuring the stance of monetary policy have highlighted an interesting puzzle--namely, that an unexpected tightening in monetary policy leads to an increase rather than a decrease in the price level. In this article, Nathan Balke and Kenneth Emery present evidence on the price puzzle and discuss possible explanations for it. ; Balke and Emery find that the most plausible explanation is that, during the 1960s and '70s, monetary policy was not implemented in a way that fully offset inflationary supply shocks. During this period, monetary policy would tighten in response to a supply shock but not by enough to prevent inflation from rising. In the data, therefore, contractionary policy is positively correlated with inflation. Since the early 1980s, however, the price puzzle has disappeared for either one, or both, of two reasons: the Federal Reserve has placed greater emphasis on achieving price stability, or there have been fewer inflationary supply shocks to the economy.

Paying for heritage: what price for Durham Cathedral?

Abstract: This study assesses the amount individuals voluntarily contribute when visiting a Cathedral where no charge is made for entry. Contingent valuation methods are used to estimate the maximum individuals would be willing to pay if an entry charge was imposed, the changes in visit rates which would ensue at different price levels and the maximum revenue the Cathedral could be expected to collect by charging an entry fee.

Using vouchers to privatize an economy : the Czech and Slovak case

Abstract: The paper analyzes the process and outcome of Czechoslovakia's 1992 voucher privatization. It first describes the mechanics of the voucher privatization process and assesses the overall outcome. It then uses firm-level data on 1,491 firms that were privatized in the five rounds of the voucher scheme to analyze the patterns of demand for shares (bids) by individual investors and investment privatization funds, respectively. Finally, the paper examines the (share) price setting behavior of the authorities between the rounds. The results show that there were systematic patterns and that individual and institutional investors behaved quite rationally. The price setting behavior of the authorities can be explained precisely by a relatively simple functional form.

The Consequences of Price Instability on Search Markets: Toward Understanding the Effects of Inflation

Abstract: Real price variability depreciates the information about future prices contained in current ones. Repeat-purchase customers have, then, less incentive to acquire price information. The fact that consumers are less well informed allows firms to increase their markups and permits inefficient producers to increase their sales. Production gets reallocated toward higher-cost firms. Given the well-documented correlation between inflation and relative price variability, these results help explain some of the costs of inflation. Copyright 1994 by American Economic Association.

Are Prices Countercvclical?: Evidence from the G-7

Abstract: This paper re-examines the cyclical behavior of prices using postwar quarterly data for the G-7. We confirm recent evidence that the price level is countercyclical. However, we find strong evidence that the inflation rate is procyclical in our sample. Our results show the importance of making a clear distinction between inflation and the cyclical component of the price level when reporting and interpreting stylized facts regarding business cycles.

The Effects of Inflation on Wage Adjustments in Firm-Level Data: Grease or Sand?

Abstract: An analysis of whether inflation facilitates adjustments to shocks or distorts relative prices, examining the wage-setting process across a panel of occupations and employers and finding that the costs of inflation may rise more rapidly than its benefits beyond quite modest rates of increase in the price level.

Price-Cap Regulation

Abstract: This chapter focuses on price-cap regulation. The US Federal Communications Commission, FCC proposed replacing rate-of-return regulation with price-cap regulation in the market for local and long-distance telephone service. Price caps are typically applied only to prices for monopolistically supplied goods. A separate price cap can be defined for every single good in monopolistic supply. If the index m denotes monopolistically supplied goods, a profit-maximizing firm faces constraints where the price ceilings are set by the regulator and the firm can choose any price up to the limit. However, the flexibility of the regulated firm can be greatly enhanced if a joint price ceiling is defined for a basket of services supplied by the firm. The best-known example of such a joint ceiling is the RPI–X regulation; an average price of some bundle of the firm's products must not exceed the retail price index minus an exogenously fixed constant X . This form of price regulation has been proposed by Littlechild and is the basis for the regulation of, among others, British Telecom, British Gas, and the UK public electricity suppliers.