Price stability: is a tough central bank enough?
What is the best way to achieve price stability? Conventional wisdom says that a tough, independent central bank is all that is necessary. However, a new view?the fiscal theory of the price level?argues that an appropriate fiscal policy is also required, no matter how tough the central bank may be. The choice of the fiscal theory versus the conventional view has significant implications for the way central banks do business.
Resolving the liquidity effect: commentary
Two flaws in business cycle dating
Using ?business cycle accounting,? Chari, Kehoe, and McGrattan (2006) conclude that models of financial frictions which create a wedge in the intertemporal Euler equation are not promising avenues for modeling business cycle dynamics. There are two reasons that this conclusion is not warranted. First, small changes in the implementation of business cycle accounting overturn Chari, Kehoe, and McGrattan?s conclusions. Second, one way that shocks to the intertemporal wedge affect the economy is by their spillover effects onto other wedges. This potentially important mechanism for the ...
Is consumption insufficiently sensitive to innovations in income?
Deaton (1986) has noted that if income is a first-order autoregressive process in first differences, then a simple version of Friedman?s permanent income hypothesis (SPIH) implies that measured U.S. consumption is insufficiently sensitive to innovations in income. This paper argues that this implication of the SPIH is a consequence of the fact that it ignores the role of the substitution effect in the consumption decision. Using a parametric version of the standard model of economic growth, the paper shows that very small movements in interest rates are sufficient to induce an empirically ...
Understanding Japan's saving rate: the reconstruction hypothesis
This paper evaluates Hayashi's conjecture that Japan's postwar saving experience can be accounted for by the neoclassical model of economic growth as that country's efforts to reconstruct its capital stock that was severely damaged in World War II. I call this the reconstruction hypothesis. I take a simplified version of a standard neoclassical growth model that is in widespread use in macroeconomics and simulate its response to capital destruction. The saving rate path implied by the model differs significantly from the path taken by actual Japanese postwar saving data. I discuss several ...
Unit roots in real GNP: do we know, and do we care?
Rational expectations, hyperinflation, and the demand for money
This paper shows how to derive the family of models in which Cagan?s model of hyperinflation is a rational expectations model. The slope parameter in Cagan?s portfolio balance equation is identified in some of these models and in others it is not?a fact which clarifies results obtained in several recent papers.
Time to plan and aggregate fluctuations
This article investigates the business cycle implications of the planning phase of business investment projects. Time to plan is built into a Kydland-Prescott time-to-build model, which assumes that investment projects take four periods to complete. In the Kydland-Prescott time-to-build model, resources for these projects flow uniformly across the four periods; in the time-to-plan model, few resources are used in the first period. The investigation determines that incorporating time to plan in this way improves the model's ability to account for three key features of U.S. business cycles: ...
The Great Depression and the Friedman-Schwartz hypothesis
The authors evaluate the Friedman-Schwartz hypothesis--that a more accommodative monetary policy could have greatly reduced the severity of the Great Depression. To do this, they first estimate a dynamic, general equilibrium model using data from the 1920s and 1930s. Although the model includes eight shocks, the story it tells about the Great Depression turns out to be a simple and familiar one. The contraction phase was primarily a consequence of a shock that induced a shift away from privately intermediated liabilities, such as demand deposits and liabilities that resemble equity, and ...