Essays in the Fundamental Theory of Monetary Economics and Macroeconomics

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The first essay is my work in macroeconomics, particularly Chinese economy.

Rethinking Macroeconomic Theory Before the Next Crisis

The rest two essays are my work in monetary economics, and also the focus of my doctoral thesis. In the second and third essays, I build micro-founded models with money and government bonds to address those questions. The first essay studies the real exchange rate appreciation caused by non-traded factor misallocation in China. China is an ideal case for non-traded factor appreciation, since it has not completed its structural transformation. My model identifies non-traded goods with rural output produced in the West of China, and traded goods with manufactures produced on the Eastern Seaboard using overseas capital.

The second essay develops a micro-founded model of money and bonds to address effects of monetary policy on output and unemployment. The baseline model considers both money and short-term government bonds serving as media of exchange. We analyze the effects of conventional monetary policy when Central Bank conducts open market operations OMOs by adjusting short-term bonds holdings.


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Conventional monetary policy is effective only when the short-term interest rate is positive. Then we introduce long-term government bonds to address the effects of unconventional monetary policy, particularly when the short-term interest rate hits the zero-lower bound. Quantitative analysis shows that unconventional monetary policy can reduce unemployment only when the fraction of households holding the portfolio of money and bonds is not too big. On the Shelf Monnaie : salaires et profits. Nachlass hrsg. Reg von Karl Weinhard. Money and banking. Money, income, and monetary policy.

Slovin, Marie Elizabeth Sushka. Money, credit and public policy. Versuch einer Verzahnung der Geldtheorie mit der Gutertheorie Struthers and H. Another way to examine labor markets is to focus on employment rates, measured as the annual average hours worked per adult of working age. Figure 4 displays the behavior of this measure of employment rates in Europe and the United States from to According to this figure, employment steadily declined over the entire period in Europe, whereas in the United States, it was roughly stable until the s and then sharply increased.

What explains these contrasting patterns? The macroeconomics literature has advanced three explanations for these patterns: labor market rigidities, taxes, and unemployment benefits. One widely held view is that labor markets are much more rigid in Europe than in the United States. For example, European legal employment protections that make it difficult to fire workers are typically more stringent than those in the United States.

Using cross-country evidence, Nickell finds that the effect of hiring costs is also ambiguous. Although the effect of firing costs on unemployment is ambiguous, the effect on productivity in the Hopenhayn and Rogerson model is not. Firing costs tend to inhibit the efficient reallocation of labor to more productive firms and thereby reduce aggregate productivity. Thus, this model implies that welfare can be raised by reducing firing costs.

Note that if workers cannot borrow against future earnings to invest in general human capital, then firing costs may provide incentives for firms to invest in such capital and thus raise productivity, as in the models of Acemoglu and Pischke and Chari, Restuccia, and Urrutia Prescott and Rogerson point to differences in taxes as a key source of the differences in European and U. To study this possibility, the discipline of general equilibrium theory is essential, because the effect of taxes on labor market outcomes depends not only on how tax revenue is raised but also, as Rogerson emphasizes, on how it is used.

A tax has both a substitution effect that reduces the incentive to work and an income effect that increases the incentive to work, but the way in which tax revenue is spent can alter the income effects.

Modern Monetary Theory (MMT) Definition

To see why the details of how tax revenues are spent are important, suppose first that the revenue is used to provide public goods that are poor substitutes for private consumption. Then, as long as the utility function has near unit elasticity of substitution between consumption and leisure, the income and substitution effects nearly cancel so that labor supply effects of taxes are approximately zero.

Hence, to a first approximation, the public good expenditures crowd out private consumption dollar for dollar. Suppose next that the revenue is either transferred back to private citizens in a lump-sum fashion or, equivalently, used to purchase private goods for citizens. Then taxes have only a substitution effect—because the expenditures offset the income effect—and labor supply falls. Prescott cleverly sidesteps these issues by noting that in a general equilibrium model, the details of the expenditures are captured by their effects on consumption. Prescott begins his analysis by noting that in a general equilibrium model with a stand-in household, the first-order condition determining labor supply equates the marginal rate of substitution between consumption and leisure to the after-tax marginal product of labor.

Given consumption and the capital stock, this condition thus implies a relation between employment and the tax-induced labor wedge. In this approach, the details of how government revenues are spent play a role in determining labor supply only through its effects on consumption and the capital stock.

Assuming that both the utility function and the production function have unit elasticity of substitution, and using long-term averages to pin down share parameters, Prescott showed that this simple theory works surprisingly well in accounting for employment observations for the G-7 countries for the s and the s. The accompanying table is reproduced from Prescott The closeness between the predictions of his simple model and the data is remarkable.

The Prescott analysis works well in a comparison of the early s and the mids, in part because tax policies clearly changed dramatically during this time. Using his analysis to compare the s and the s, however, does not work as well. Evidence of large changes in tax rates from the s to the s is hard to find, even though Figure 4 shows a sustained decline in employment rates over this period.

As Prescott has acknowledged, his analysis likewise does not work well for the Scandinavian countries that have both high tax rates and high employment. Rogerson argues that changes in taxes and in industry composition can account for the bulk of observed differences in employment between Europe and the United States. These analyses focus on the division of time between market work and all forms of nonmarket activities—including both unemployment and being out of the labor force. As such, these analyses have sharp implications for the behavior of the employment rate. Since they do not distinguish between search activities and other nonmarket activities that lead households to be classified as out of the labor force, they are silent about differences in unemployment rates between Europe and the United States.

One possible reason the unemployment rate is higher in Europe than in the United States is that unemployment benefits are more generous in Europe. A reasonable conjecture is that this greater generosity leads to higher unemployment rates by making workers more reluctant to accept job offers. The problem with this conjecture is that it seems contradicted by facts; in the s and s, unemployment benefits were much more generous in Europe than in the United States, while unemployment rates were lower in Europe than in the United States.

Ljungqvist and Sargent develop a model that focuses on the division of time between market work and the search activities of unemployed workers while abstracting from considerations of nonmarket activities other than search.

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They show that in the s and s, more generous unemployment benefits, together with higher firing costs, led Europe to have lower unemployment rates than the United States, whereas in the s, the same benefits and firing costs led to the opposite relationship. The key difference between the earlier and later periods is that microeconomic turbulence, measured as fluctuations in individual worker productivities, has increased over time in both Europe and the United States Gottschalk and Moffitt, As microeconomic turbulence increases, more workers find themselves in low-productivity jobs as well as in unemployment.

Hence, with increased microeconomic turbulence, the overall unemployment rate rises. Hence, the unemployment rate does not change much. The Ljungqvist and Sargent model assumes that workers are risk-neutral, in which case unemployment compensation has no benefits and is costly because it distorts the search decision.

As the model stands, the policy implication is that government-provided unemployment benefits should be eliminated. With risk aversion and imperfections in private markets for unemployment insurance, unemployment insurance has benefits that need to be weighed against the induced distortions in search decisions. A growing literature has begun to analyze these trade-offs for example, Atkeson and Lucas, ; Hopenhayn and Nicolini, ; Shimer and Werning, In our view, explanations of patterns in European and U.

Here we have argued that macroeconomic theory has had a profound and far-reaching effect on the institutions and practices governing monetary policy and is beginning to have a similar effect on fiscal policy. The marginal social product of macroeconomic science is surely large and growing rapidly. Those economists caught up in the frenzy of day-to-day policymaking often view their colleagues who toil in the ivory towers of academe as having no power to affect practical policy and those economists who whisper in the ears of presidents and members of Congress as having the ability to dramatically affect policy.

The truth, as we have argued, is very far from this view. The course of practical policy is affected primarily by the institutions we devise and how well presidents and members of Congress understand economic trade-offs. The day-to-day economic adviser is useful to the extent that the adviser can educate policymakers about trade-offs, but is largely irrelevant otherwise.

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It is easy to see why those economists caught up in the whirlwind of day-to-day policymaking miss the dramatic changes in policy that result from slow, secular changes in institutions, practices, and mind-sets. The toilers in academe are uniquely placed to develop analyses of institutions and to educate the public and policymakers about economic trade-offs.

The essence of our argument is that, at least in macroeconomics, these toilers have delivered large returns to society over the last several decades.


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