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Working Paper
Designing a simple loss function for the Fed: does the dual mandate make sense?
Variable and high rates of price inflation in the 1970s and 1980s led many countries to delegate the conduct of monetary policy to "instrument-independent" central banks and to give their central banks a clear mandate to pursue price stability and instrument independence to achieve it. Advances in academic research supported a strong focus on price stability as a means to enhance the independence and credibility of monetary policymakers. An overwhelming majority of these central banks also adopted an explicit inflation target to further strengthen credibility and facilitate accountability. ...
Working Paper
Cyclical Fluctuations, Financial Frictions, and Productivity Differences across Firms
Within narrowly defined industries, the most productive firms produce far more than the least productive from the same inputs, and this dispersion widens in downturns. We build a tractable representative-agent model in which financial frictions—adverse selection and moral hazard—make firms sort endogenously into lenders, strategic defaulters, and producers. As credit conditions vary, the resulting misallocation gives aggregate total factor productivity (TFP) an endogenous component that accounts for about 30 percent of the variance of TFP at business-cycle frequencies, a third of it from ...
Working Paper
Indeterminacy and investment adjustment costs
It is widely known that a neoclassical growth model with sufficient increasing returns to production may feature an indeterminate steady state. This note shows how investment adjustment costs increase the degree of increasing returns required for indeterminacy to arise. We also argue that sector-specific externalities are observationally equivalent to negative adjustment costs. It is widely known that a neoclassical growth model with sufficient increasing returns to production may feature an indeterminate steady state. This note shows how investment adjustment costs increase the degree of ...
Working Paper
Adjustment costs of investment in general equilibrium: analytic results
This paper formulates and compares various specifications of investment adjustment costs in a simple dynamic general-equilibrium model and studies their implications by showing some analytic results. One way to introduce costs is to incorporate them as a constant elasticity of substitution between investment and capital in the capital accumulation equation. Another way is as a nonlinear transformation between consumption and investment in the national income identity. We observe that there is a problem in identifying the two types of adjustment costs and show how to solve the problem. The ...
Working Paper
Monetary policy in a stochastic equilibrium model with real and nominal rigidities
A dynamic stochastic general-equilibrium (DSGE) model with real and nominal rigidities succeeds in capturing some key nominal features of U.S. business cycles. Additive technology shocks, as well as multiplicative shocks, are introduced. Monetary policy is specified following the developments in the structural vector autoregression (VAR) literature. Interaction between real and nominal rigidities is essential to reproduce the liquidity effect of monetary policy. The model is estimated by maximum likelihood on U.S. data, and its fit is comparable to that of an unrestricted first-order VAR. ...
Working Paper
Welfare effects of tax policy in open economies: stabilization and cooperation
This paper studies an international tax policy design problem by employing a two-country dynamic general equilibrium model with incomplete asset markets. We investigate the possibility of welfare improving active tax policies, in particular capital and labor income tax, under the non-cooperative Nash equilibrium and the cooperative equilibrium. Unlike the conventional wisdom regarding stabilization policies, optimal tax policies in our economy are procyclical. Relative to the non-cooperative setting, international tax policy cooperation requires more active tax policies (about two times) and ...
Working Paper
Three sources of increasing returns to scale
This paper reviews various types of increasing returns from a critical perspective. Increasing returns have been introduced in a monopolistic-competition model both at the firm level and at the aggregate level. We show that the degree of the aggregate returns to scale is a linear combination of three return parameters, with the weights determined by the specification of a zero-profit condition. Identification issues are discussed with an emphasis on recent macro literature. We argue that disaggregate data give information on the market structure rather than the technology. Welfare ...
Working Paper
Interpreting Shocks to the Relative Price of Investment with a Two-Sector Model
Consumption and investment comove over the business cycle in response to shocks that permanently move the price of investment. The interpretation of these shocks has relied on standard one-sector models or on models with two or more sectors that can be aggregated. However, the same interpretation continues to go through in models that cannot be aggregated into a standard one-sector model. Furthermore, such a two-sector model with distinct factor input shares across production sectors and commingling of sectoral outputs in the assembly of final consumption and investment goods, in line with ...
Working Paper
Two pitfalls of linearization methods
This paper illustrates two types of pitfalls in using linearization methods. First, if constraints are linearized before deriving optimality conditions, the derived conditions are not correct up to first order. Second, even when the behavior of the economy is correct to the first order, applying this behavior to welfare implications may lead to incorrect results.
Working Paper
Monetary policy and the housing bubble
We examine the role of monetary policy in the housing bubble. Our review examines the setting of monetary policy in the middle of this decade, the impetus from monetary policy to the housing market, and other factors that may have contributed to the run-up, and subsequent collapse, in house prices.