Production and price smoothing by inventory adjustment?

The present paper examines the role of inventories for the short run adjustment behavior of firms. A theoretical model of a monopolistic firm carrying inventories that includes costs of adjusting output is examined. The model is tested empirically by using business survey data collected by the IFO-Institute, Munich. It is shown, that if data on individual firms are used and econometric estimation techniques are applied that properly take this into account, the estimates derived are fully compatible with the appealing idea of production smoothing by inventories.     

An intertemporal system of dynamic consumer demand functions

This paper constructs and estimates a system of dynamic consumer demand equations under the assumption of rational expectations about anticipated human wealth. The traditional one-period budget constraint is replaced by the lifetime anticipated wealth constraint. Lagged dependent variables are rationalized by an adjustment cost argument. In the model presented, both the dynamic adjustment coefficients as well as the parameters characterizing the underlying long-run preferences are identified and can be estimated. We find that a weak version of the REH cannot be rejected on the data. In common with most empirical studies on demand behaviour we have to reject the symmetry restrictions.     

The ECB's New Multi-Country Model for the euro area: NMCM — Simulated with rational expectations

The model presented here is an estimated medium-scale New Multi-Country Model (NMCM) which covers the five largest euro area countries and is used for forecasting and scenario analysis at the European Central Bank. The model has a tight theoretical structure which allows for non-unitary elasticity of substitution, non-constant augmenting technical progress and heterogeneous sectors with differentiated price and income elasticities of demand across sectors. Furthermore, it has the explicit inclusion of expectations on the basis of three optimising private sector decision making units: i.e. firms, trade unions and households, where output is in the short run demand-determined and monopolistically competing firms set prices and factor demands. Labour is indivisible and monopoly-unions set wages and households make consumption/saving decisions.We assume that agents optimise under limited information where each agent knows only the parameters related to his/her optimisation problem. Therefore we estimate with GMM, which implicitly assumes limited information boundedly rational expectations. In this paper we provide some simulation results under the assumption of model-consistent rational expectations, we show that there is some heterogeneity across countries and that the reactions of the economies to shocks depend strongly on whether the shocks are pre-announced, announced and credible or unannounced and uncredible.     

Trade Marks and Performance in Services and Manufacturing Firms: Evidence of Schumpeterian Competition through Innovation

We develop Lancaster's model of consumer behaviour under product differentiation to analyse Schumpeterian creative destruction. Launching new products with novel characteristics enables firms to temporarily steal market share from rivals. Product launch is monitored by using trade marks, patents and research and development. The dataset covers a large sample of UK service and manufacturing firms. We find that stock market value is positively associated with own trade mark activity and trade mark‐active firms achieve significantly higher value‐added. Greater trade mark activity by competitors reduces net output of firms, but raises their stock market value. This is consistent with the Schumpeterian process of competition through innovation.     

Qualitatively Rational Expectations and Adjustment in the Specific-Factors Model

This paper considers adjustment in a dynamic specific-factors model with endogenous capital stocks. Investment is analyzed under the assumption that expectations are rational with respect to qualitative aspects of the adjustment process (qualitatively rational expectations, QRE). QRE leave considerable scope for systematic errors in expectations formation. Adjustment under rational expectations is similar to QRE adjustment; however, only in the former case is the speed of adjustment optimal. Overshooting of capital stocks is possible and may be optimal. Comparative-static analysis shows an asymmetry between inflows of labor and capital: only capital inflows may cause a Rybczynski effect.     

Markup cyclicality and input factor adjustments

This paper investigates the existence of markups and their cyclical behaviour at the industry sector level. Markups are given as a price-cost relation that is estimated from a dynamic, structural model of the firm. The firms face costly adjustment of labour and potential financial constraints. The model is tested on a panel of firm- and plant-level data from Norwegian manufacturing industries. The results indicate a frequent presence of moderate pro-cyclical markups. Labour adjustment costs are present in four out of seven sectors but small in magnitude. The results are related to the role played by unions in a setting with high union density.     

Cost Behaviour of Chinese State-owned Manufacturing Enterprises in the 1980s

This paper aims to model the cost behaviour of Chinese state-owned enterprises in the 1980s. Given production autonomy and profit-related bonus incentives, state firms are expected to increase profits and therefore bonuses by changing their cost behaviours more rationally. However, since institutional constraints remain and distort the rational demand of the firm for input factors, the changes cannot go as far as expected by the standard neoclassical cost minimisation theory. Based on this, we derived a total cost function for Chinese state firms restricted by the government control over their total wage bills. We then test it using a panel data of 386 state manufacturing enterprises in the period 1983–87. It is found that the model predicted well. Despite the constraints, the reform did lead the firms to respond to both changes in factor prices in the directions expected by cost minimising behaviour and to bonus incentives to produce more efficiently.     

Near rationality in wage setting

This study argues that it is interesting to examine near rational behaviour in the context of an efficiency wage model, where there are positive if decreasing returns to increasing the wage beyond the efficient level. Previous research has found it difficult to distinguish between efficiency wage and bargaining models, which have similar empirical predictions. But unions are a priori more likely to develop in environments in which the technology favours efficiency wage payments. This makes it interesting to investigate what it costs the firm to deviate from the efficiency wage. If it does not cost a lot, firms may give in to union demands. This study derives expressions for the wage deviation and for the associated profit loss. For illustrative purposes, these are calibrated for UK, US and Indian manufacturing, taking a plausible parameterization of the effort-wage function and using available estimates of the wage and employment elasticities of output. While there is evidence of positive effort returns to wages in the UK and India, the results are consistent with wage bargaining pushing the wage above the efficient level. The associated profit loss is considerably larger in the UK than in India. In contrast, US firms pay wages that are insignificantly different from the efficiency wage.     

The Formation of Producers' Price Expectations in Australia*

This paper investigates the formation of price expectations by Australian manufacturing firms. It is shown that the reported expectations are generally consistent with the hypothesis that they are derived as conditional forecasts from the model used by firms in determining their actual price change behaviour. Tests are then undertaken to see whether the expectations are unbiased and efficient forecasts, the cross-section results indicating generally that they are neither, and hence not rational. Alternative time-series tests of the unbiasedness and efficiency hypothesis, however, suggest that neither hypothesis can be rejected, implying rationality.     

The Speed and Stability of Price Adjustment in Australian Manufacturing*

A model of industry speed of price adjustment is derived from firm pricing behaviour. The model is applied to quarterly two‐digit Australian manufacturing data for the period 1985 (Q3) to 2002 (Q3). The results suggest that the industry speed of price adjustment is positively related to the average size of large firms within the industry and is negatively related to industry concentration. We also find that import share has a role in attenuating the effects of industry concentration and that growth in a moving average of real gross domestic product reduces the speed of price adjustment. Calculated industry speeds of price adjustment are both stable across the period of examination and small, suggesting that manufacturing prices are sticky.     

Employment and output effects of financial shocks

This paper develops a New Keynesian model featured with financial frictions in the form of an exogenous credit constraint to explore the employment and output effects of financial shocks. I show that the equity payout adjustment costs are crucial for the transmission mechanism of financial shocks. The model is estimated using the Bayesian methods and simulated using the observed exogenous shocks for two periods, 1954:III–1983:IV and 1984:I–2015:I. Overall, it is found that financial shocks can account for the observed dynamics of employment and output, especially the sharp decreases during the Great Recession 2007–2008. Additionally, the financial shock is the third and second biggest contributor to output and employment variations, respectively, in the earlier period, but it turns out to be the main source of employment and output fluctuations in the later period. I find that firms are faced higher equity payout adjustment costs in the period 1984:I–2015:I, which accounts for greater variations in the equity payouts in the period.     

Delivering endogenous inertia in prices and output

This paper presents a DGE model in which aggregate price level inertia is generated endogenously by the optimizing behavior of price-setting firms. All the usual sources of inertia are absent here i.e., all firms are simultaneously free to change their price once every period and face no adjustment costs in doing so. Despite this, the model generates persistent movements in aggregate output and inflation in response to a nominal shock. Two modifications of a standard one-quarter pre-set pricing model deliver these results: learning-by-doing and habit formation in leisure. While the model delivers persistence, simulations based on estimated shocks to tfp and money growth suggest both output and inflation are too volatile relative to the data and fail to closely follow the historical time series.     

On the endogeneity of output in dynamic labour-demand models

This paper investigates the endogeneity of output in the context of the standard dynamic labour-demand model. Using a panel of Dutch firms, we find that the assumption of endogeneity of output cannot be rejected, so that an adjusted procedure has to be followed in which information on the output expectations of entrepreneurs is used. The estimated effect of the endogenous, current output variable on employment appears to be significantly larger than the effect of the exogenous, expected output variable. The adjustment parameter of employment is however, remarkably robust against distinct specifications for output.     

Accommodation,supply shocks,and sluggish real wages

This paper analyzes the policy dilemmas posed by supply shocks in a rational expectations model featuring sluggish real wages. A discrete time version of the model is used to calculate the variances for prices, wages, and output for alternative policy rules and speeds of adjustment for real wages. The conventional tradeoffs between output and price variability in the model do not always exist.     

The Effect of Nominal Demand Shocks on Manufacturing Output: Evidence from Disaggregated Australian Data*

The menu costs model predicts that during times of rapid inflation firms are less likely to vary output in response to changes in nominal aggregate demand. This paper tests the proposition using a disaggregated sample of Australian three-digit ASIC manufacturing industries. The results show that a significant number of Australian industries exhibit behaviour that is consistent with this prediction. In addition, the results show that the variability of inflation and changes to the import penetration ratio also influence the response of output to nominal demand changes.     

Environmental taxation and mergers in oligopoly markets with product differentiation

We analyze the effect of mergers on optimal environmental taxation in a Cournot oligopoly market with product differentiation. Our result indicates that the adjustment in emission tax crucially depends on the post-merger output distortion and pollution intensities. Specifically, we find that the optimal emission tax increases post-merger as long as pollution intensity of firms is higher and output distortion smaller post-merger than pre-merger. Furthermore, our result suggests that there is no need to revise environmental policy in markets where pollution intensity of firms does not change post-merger and (i) products are completely differentiated, or (ii) there are many firms for any degree of product differentiation.     

Horizontal Mergers Under Asymmetric Information About Synergies

This paper analyses a situation in which there are three quantity‐setting firms, two of which are considering whether or not to merge. When these two firms have private information about the potential cost‐saving synergies of the merger, they may have an incentive to overstate them. This is because if they succeed in making the non‐merging rival firm believe that the synergies are high, the rival firm reduces output and the merger becomes more profitable. Under some conditions, anticipating that the rival will form such a belief, low‐synergy firms that would never merge under complete information will mimic high‐synergy firms by merging. Such pooling behaviour by the merging firms can have a negative impact on social welfare.     

Rationality,rules of thumb,and R&D

A model of Schumpeterian growth is compared under rational expectations (RE) and under a simple rule of thumb (RT) in which firms invest a constant fraction of their current profits in R&D. The analysis generates a scenario in which the RE and RT equilibria are observationally equivalent, yet the interpretations of the two equilibria differ in ways which are critical for the appropriate design of technology policy. The RE model dictates that the largest government transfers for R&D support should be given to high-technology (high-R&D) firms. The observationally equivalent RT model indicates that low-R&D firms should receive the largest incentives to stimulate R&D. The paper also provides some new analytical results on the limiting distribution of firm size, and these may be of independent interest.     

Optimal Hedging Under Forward-Looking Behaviour*

The study focuses on the production and hedging behaviour of forward-looking risk-averse competitive firms. It is shown that there is separation between production and hedging. Optimal productin for a forward-looking firm is identical to that of an otherwise equivalent myopic firm. However, the optimal forward-looking hedge differs from the optimal myopic hedge. If forward prices are unbiased, full hedging is suboptimal when the firm is forward looking and output and material input prices are contemporaneously related. Furthermore, under certain conditions, the optimal forward-looking hedge under unbiased forward prices is strictly smaller than the full hedge.