Specific factors meet intermediate inputs: implications for strategic complementarities and persistence.
A central challenge to monetary business-cycle theory is to find a solution to the problem of persistence and delay in the real effects of monetary shocks. Previous research has identified separately specific factors and intermediate inputs as two promising mechanisms for generating the persistence and delay in a staggered price-setting framework. Models based on either of these two mechanisms have also been used in the design of optimal monetary policy. ; By examining a staggered price model that features both specific factors and intermediate inputs, the author finds an offsetting ...
Optimal monetary policy under financial sector risk
We consider whether or not a central bank should respond directly to financial market conditions when setting monetary policy. Specifically, should a central bank put weight on interbank lending spreads in its Taylor rule policy function? ; Using a model with risk and balance sheet effects in both the real and financial sectors (Davis, "The Adverse Feedback Loop and the Effects of Risk in the both the Real and Financial Sectors" Federal Reserve Bank of Dallas, Globalization and Monetary Policy Institute Working Paper No. 66, November 2010) we find that when the conventional parameters in ...
Ups and downs: how wages change over the business cycle
In ?Ups and Downs: How Wages Change Over the Business Cycle,? Kevin Huang discusses the shift in the cyclicality of real wages ? from countercyclical before World War II to procyclical postwar. He outlines the standard explanation for this change but offers evidence of an alternative explanation: the increased role that intermediate goods play in the production process in the postwar era.
Learning, adaptive expectations, and technology shocks
This study explores the macroeconomic implications of adaptive expectations in a standard real business cycle model. When rational expectations are replaced by adaptive expectations, we show that the self-confirming equilibrium is the same as the steady-state rational expectations equilibrium for all admissible parameters but that dynamics around the steady state are substantially different between the two equilibria. The differences are driven mainly by the dampened wealth effect and the strengthened intertemporal substitution effect, not by the escapes emphasized by Williams (2003). As a ...
Overconfidence in financial markets and consumption over the life cycle
Overconfidence is a widely documented phenomenon. Empirical evidence reveal two types of overconfidence in financial markets: investors both overestimate the average rate of return to their assets and underestimate uncertainty associated with the return. This paper explores implications of overconfidence in financial markets for consumption over the life cycle. The authors obtain a closed-form solution to the time-inconsistent problem facing an overconfident investor/consumer who has a CRRA utility function. They use this solution to show that overestimation of the mean return gives rise to a ...
Financial intermediaries, markets, and growth.
We build a model in which financial intermediaries provide insurance to households against a liquidity shock. Households can also invest directly on a financial market if they pay a cost. In equilibrium, the ability of intermediaries to share risk is constrained by the market. This can be beneficial because intermediaries invest less in the productive technology when they provide more risk-sharing. Our model predicts that bank-oriented economies should grow slower than more market-oriented economies, which is consistent with some recent empirical evidence. We show that the mix of ...
Implementing Arrow-Debreu equilibria by trading infinitely-lived securities
We show that Arrow-Debreu equilibria with countably additive prices in infinite-time economy under uncertainty can be implemented by trading infinitely-lived securities in complete sequential markets under two different portfolio feasibility constraints: wealth constraint, and essentially bounded portfolios. Sequential equilibria with no price bubbles implement Arrow-Debreu equilibria, while those with price bubbles implement Arrow-Debreu equilibria with transfers. Transfers are equal to price bubbles on initial portfolio holdings. Price bubbles arise in sequential equilibrium under the ...
Chain of production as a monetary propagation mechanism
This paper studies a general equilibrium model with multiple stages of production and asynchronized price setting that provides a new explanation for the observed persistent real effects of monetary shocks. The key feature of the model is a vertical chain-of-production structure. In this model, the effects of monetary shocks on price adjustment are gradually dampened via the interactions of firms through their input-output relations and the timing of their price decisions. The model predicts that prices adjust by a smaller amount and less rapidly at later stages than at earlier stages, which ...
Why does the cyclical behavior of real wages change over time?
This paper seeks to understand the evolution of the cyclical behavior of U.S. real wage rates from the interwar period to the post World War II period using a dynamic general equilibrium model that emphasizes demand-driven business cycle fluctuations. In the model, changes in the cyclical behavior of real wages arise endogenously from the interactions between nominal wage and price rigidities and an evolving input-output structure.
Vertical production and trade interdependence and welfare
The authors study international transmissions and welfare implications of monetary shocks in a two-country world with multiple stages of production and multiple border-crossings of intermediate goods. This empirically relevant feature is important, as it has opposite implications for two external spillover effects of a unilateral monetary expansion. If all production and trade are assumed to occur in a single stage, the conflict-of-interest terms-of-trade effect tends to dominate the common-interest efficiency-improvement effect for reasonable parameter values, so that the international ...