On a simple rule for the optimal inflation rate in second best taxation

The optimal inflation rate is analyzed in the framework of dynamic second best with endogenous factor prices. It is shown that when the marginal excess burden of taxation is relatively small, the optimal inflation rate is approximated by a simple rule. The paper also analyzes the robustness of this rule to the specification of the model (money as an input in utility or production).     

Quotas and the second best

This note makes two observations about trade restrictions on subgroups of commodities. First, unlike tariffs, unalterable quotas provide no second-best justification for general restrictions. Second, the optimal allocation of intra-subgroup trade depends on the form of restraint imposed.     

Pareto optimal improvements for sunspots: The golden rule as a target for stabilization

Summary The stationary sunspot equilibria of a simple one good OLG economy are considered. These equilibria are known to be suboptimal. We show that, for any such equilibrium allocation, there always exists a Pareto optimal improvement which has the additional property of reaching the Golden Rule in finite time, i.e., the monetary steady state acts as a target. We also show that, in general, periodic allocations cannot be used as targets. The result is interpreted as a welfare theoretical justification for stabilization policy.This paper is based on my dissertation at SUNY Stony Brook. I would like to thank my supervisor, T. J. Muench, for his advice and encouragement. O. Galor's comments on a previous draft, and discussions with M. Kurz, J. Peck, H. M. Polemarchakis, B. Smith, and I. Zilcha, are gratefully acknowledged. Comments from F. Marhuenda, two referees and, especially, the Co-Editor, M. Woodford, did much to improve the exposition. Thanks are due to the Lady Davis Foundation for supporting my stay at the Hebrew University, and the IVIE and DGICYT PB92-0342 at Alicante, where successive drafts were prepared.     

The golden rule of public finance and the composition of government expenditures: a growth and welfare analysis

This paper employs an endogenous growth model to study the growth and welfare effects of the golden rule of public finance. Two versions are compared, whereby government deficits are restricted for the use of public investments. It is shown that the growth effect of the golden rule depends on what kind of expenditure is adjusted to meet debt obligations. A transition from a balanced budget to a golden rule is performed to study welfare. The results indicate that a budget rule with detrimental growth effects can still have positive welfare implications, and vice versa, if the composition of government expenditures and transitional dynamics are taken into account.     

Cost inefficiency and second best pricing

It is a wellknown and widespread opinion that public production in reality is neither cost nor production efficient, i.e. the commodities are not produced at minimum costs, and additionally, the realized production plan will lie below the production possibility frontier. Such an initial situation is undoubtedly perceived as suboptimal. And as welfare maximization contradicts any kind of waste, most politicians believe in the necessity of cost efficient public production. But the welfare oriented policy only implies technically efficient production. As this paper shows, advising the management of public enterprises to produce at minimum costs, leads to welfare losses.     

Manifolds of golden rule and balanced steady state equilibria

Summary. We show that the set of balanced steady state (resp. golden rule) equilibria, parameterized by endowments, of stationary overlapping-generations economies are smooth manifolds diffeomorphic to Euclidean spaces. These properties extend similar properties of the Walrasian equilibria and enable one to apply the natural projection approach to the study of these equilibria. Received: October 30, 1995; revised version: October 10, 1996     

Preference structure and piecemeal second best policy

This paper examines the question: When should prices in a subset of markets be set proportional to marginal costs even if other markets are distorted? The conditions on preferences and demand functions are derived; they are found to be weaker than have been required by previous authors.     

Electoral competition with environmental policy as a second best transfer

This paper explains why some governments fail to adopt policies that are sufficiently strong, while others adopt policies that are too stringent. Constructing a political economy model in which voters face uncertainty due to the types of politicians and the risk of environmental damage, we show that there is an equilibrium in which a politician uses a weaker environmental policy rather than efficient direct transfers for redistribution. We also show that there is an equilibrium in which a stricter environmental policy can be implemented by a politician who has no incentive to make transfers. Then, we discuss which equilibrium should be more plausible. We conclude that the latter equilibrium in which a too stringent environmental policy emerges can dominate the former unless the citizen’s estimate of environmental risk is sufficiently low.     

A closed-form solution to the Ramsey model with logistic population growth

In this paper, we consider the Ramsey growth model with CIES utility function, Cobb–Douglas technology, and logistic-type population growth law. We show the model to have a unique non-trivial steady-state equilibrium (a saddle point) and prove the optimal path to be non-monotonic over time. Moreover, we derive a closed-form solution for the case where capital's share is equal to the reciprocal of the intertemporal elasticity of substitution.     

Contracting for the second best in dysfunctional electricity markets

Power pools constitute a set of sometimes complex institutional arrangements for efficiency-enhancing coordination among power systems. In many developing countries, where such institutional arrangements can’t be established over the short term, there still can be scope for voluntary electricity-sharing agreements among power systems. Using a particular type of efficient risk-sharing model with no commitment we demonstrate that second-best coordination improvements can be achieved with low to moderate risks of participants leaving the agreement. In the absence of an impartial market operator who can observe production fluctuations in connected power systems, establishing quasi-markets for trading excess electricity helps to achieve some cooperation in mutually beneficial electricity sharing.     

Enforcement of resource allocation mechanisms and second best industrial policy

If a number of firms deviate from the rules of behavior laid down by the planner and this distorting behavior is accepted as a constraint upon the system, then for a wide class of such distortions it is welfare optimal for all other agents to continue following the rules. This result leads to the design of a piecemeal industrial policy that is always welfare enhancing.     

The Ramsey Discounting Formula for a Hidden-State Stochastic Growth Process

The long term discount rate is critically dependent upon projections of future growth rates that are fuzzier in proportion to the remoteness of the time horizon. This paper models such increasing fuzziness as an evolving hidden-state stochastic process. The underlying trend growth rate is an unobservable random walk hidden by noisy transitory shocks and recoverable only as a probability distribution via Bayesian updating. A simple expression is derived for the time-declining Ramsey discount rate. The components of this hidden-state Ramsey discounting formula are then analyzed, followed by a few remarks about possible implications and applications.     

The Ramsey model with AK technology and a bounded population growth rate

This paper generalizes the Ramsey AK model by allowing the population growth rate to be variable over time subject only to be between prescribed upper and lower limits. Contrary to the standard AK setting, convergence can occur. Moreover, monotonicity as well as an asymptotic balanced growth path equilibrium may arise in the model.     

A second best strategy for the recovery of full employment in the open economy

The second best strategy for recovering employment is composed of a policy augmented wage and price freeze, which is preferred by the policy maker because full price flexibility is infeasible in the short run. The efficacy of this strategy is assessed by applying a fixed price, constrained equilibrium model of the open economy in which four unemployment disequilibria are identified. The application of the strategy in two of the four unemployment regions simply transforms the nature of the unemployment problem and raises a further policy dilemma: the policy authority must be able to recognize the switch from one unemployment region to another and revise the policy mix accordingly. The strategy has its best chance of success in regions of Keynesian unemployment, but there is the associated risk of pushing recovery into repressed inflation. Furthermore, the strategy, and in particular commercial policies, promise the most propitious outcome if the exchange rate is fixed.     

Pollution control and the Ramsey problem

Pollution is an inevitable by-product of production and is only gradually dissolved by the environment. It can be reduced by producing less and by cleaning up the environment, but neither occur when they are left to the market. Cleaning activities and the optimal emission charges increase with the stock of pollutants. When one allows for pollution of the environment in the classical Ramsey problem, the capital stock is less than in the market outcome and a fortiori less than under the golden rule. The analysis distinguishes between stock and flow externalities arising from pollution. An increase in impatience can lead to more capital accumulation, even though this leaves less room for current consumption.