The optimal choice of monetary policy instruments in a small open economy

Abstract.  This paper studies how the nature of shocks affects the optimal choice of monetary policy instruments in a small open economy. Three classic rules, fixed exchange rates, monetary targeting, and inflation targeting are studied and ranked by comparing with the optimal monetary policy under commitment. We find that the ranking of the simple rules can be mapped to the terms-of-trade variability that the rule allows relative to what a particular shock optimally calls for. It turns out that inflation targeting dominates the other two rules under productivity or velocity shocks, whereas monetary targeting is the best performer under fiscal shocks.     

The optimal sequencing of carrots

When aid organizations contract with local agents aid funds have the potential to be diverted to purposes other than the intended project. A multi-stage game is presented where the benefit from the project is cumulative, with the application of funds in each stage increasing both the agent's and the organization's benefit from the project. As the agent's utility of diversion increases, the allocation in each stage decreases and the project takes more stages to complete. When contracting with agents with high utilities of diversion the optimal contract involves bloated projects and a side payment to the agent upon completion. If the organization's commitment to the contract is not credible both the agent's and the organization's benefit is reduced.     

The optimal multi-stage contest

This paper investigates the optimal (effort-maximizing) structure of multi-stage sequential-elimination contests. We allow the contest organizer to design the contest structure using two instruments: contest sequence (the number of stages, and the number of contestants remaining after each stage), and prize allocation. When the contest technology is sufficiently noisy, we find that multi-stage contests elicit more effort than single-stage contests. For concave and moderately convex impact functions, the contest organizer should allocate the entire prize purse to a single final prize, regardless of the contest sequence. Additional stages always increase total effort. Therefore, the optimal contest eliminates one contestant at each stage until the finale when a single winner obtains the entire prize purse. Our results thus rationalize various forms of multi-stage contests that are conducted in the real world.     

The choice of innovation policy instruments

The purpose of this article is to discuss the different types of instruments of innovation policy, to examine how governments and public agencies in different countries and different times have used these instruments differently, to explore the political nature of instrument choice and design (and associated issues), and to elaborate a set of criteria for the selection and design of the instruments in relation to the formulation of innovation policy. The article argues that innovation policy instruments must be designed and combined into mixes in ways that address the problems of the innovation system. These mixes are often called “policy mix”. The problem-oriented nature of the design of instrument mixes is what makes innovation policy instruments ‘systemic’.     

The political economy of urban transport-system choice

This paper analyzes the political economy of transport-system choice, with the goal of gaining an understanding of the forces involved in this important urban public policy decision. Transport systems pose a continuous trade-off between time and money cost, so that a city can choose a fast system with a high money cost per mile or a slower, cheaper system. The paper compares the socially optimal transport system to the one chosen under the voting process, focusing on both homogeneous and heterogeneous cities, while considering different landownership arrangements. The analysis identifies a bias toward underinvestment in transport quality in heterogeneous cities.     

The role of risk in contract choice

Structuring contracts to share risk in light of incentive problemsis the central premise of contract theory, yet the risk-sharingimplications have rarely been thoroughly tested using micro-levelcontract data. In this article we test the major implicationsof a principal-agent model of contracts using detailed dataon more than 4000 individual contracts from modern North Americanagriculture. On a case-by-case basis, our evidence fails tosupport the standard principal-agent model with risk aversionas an explanation of contract choice in modern North Americanfarming. At the same time, we find some support for models thatassume risk-neutral contracting parties and stress multiplemargins for moral hazard and enforcement costs.     

The best choice problem under ambiguity

We model and solve best choice problems in the multiple prior framework: An ambiguity averse decision maker aims to choose the best among a fixed number of applicants that appear sequentially in a random order. The agent faces ambiguity about the probability that a candidate—a relatively top applicant—is actually best among all applicants. We show that our model covers the classical secretary problem, but also other interesting classes of problems. We provide a closed form solution of the problem for time-consistent priors using backward induction. As in the classical case, the derived stopping strategy is simple. Ambiguity can lead to substantial differences to the classical threshold rule.     

The existence of optimal consumption policies in optimal economic growth models with nonconvex technologies

An existence theorem for a class of continuous time infinite horizon optimal growth models is developed. The underlying technology set is not assumed to be convex, instead the “slices” of the technology set corresponding to a fixed capital stock vector are assumed convex and compact in the consumption and net investment variables. This allows consideration of the case of increasing returns to scale. Existence of an optimal capital stock and consumption policy is proved directly without consideration of the underlying Hamiltonian dynamical system that arises from applying Pontryagin's maximum principle.     

The impact of prudence on optimal prevention

Summary. What are the determinants of the optimal level of effort to reduce the probability of a loss to occur? Whereas most of the literature on this question focused on risk aversion, we show that the concept of prudence (i.e., a positive third derivative of the utility function) is essential to answer this question. We explain in this paper that prudence and prevention tend to be opponents rather than allies contrary to the intuition attached to everyday language.Received: 7 November 2003, Revised: 3 August 2004, JEL Classification Numbers: D61, D81. Correspondence to: Christian Gollier     

The optimal use of fines and imprisonment

This paper examines the use of fines and imprisonment to deter individuals from engaging in harmful activities. These sanctions are analyzed separately as well as together, first for identical risk-neutral individuals and then for two groups of risk-neutral individuals who differ by wealth. When fines are used alone and individuals are identical, the optimal fine and probability of apprehension are such that there is some ‘underdeterrence’. If individuals differ by wealth, then the optimal fine for the high wealth group exceeds the fine for the low wealth group. When imprisonment is used alone and individuals are identical, the optimal imprisonment term and probability may be such that there is either underdeterrence or overdeterrence. If individuals differ by wealth, the optimal imprisonment term for the high wealth group may be longer or shorter than the term for the low wealth group. When fines and imprisonment are used together, it is desirable to use the fine to its maximum feasible extent before possibly supplementing it with an imprisonment term. The effects of risk aversion of these results are also discussed.     

The labor market effects of employer recruitment choice

I analyze employer recruitment decisions using a dynamic, discrete-choice structural model that I estimate on a sample of clerical workers from the MCSUI, a large cross section of establishments in four metropolitan areas of the US. In the model, employers choose either informal recruitment methods (which generate a small but select applicant pool from which the employer can hire quickly) or formal methods (which create a large but less select applicant pool which the employer must screen intensively, delaying hiring times). I study the effects of three counterfactual simulations on recruitment strategies, starting wages, and vacancy durations: A wage subsidy, a policy designed to improve information about prospective matches, and an increase in the heterogeneity of prospective matches. I show that the effects of exogenous policy or environmental changes can be decomposed into “pure wage effects” that affect the wage offers employers post, holding constant their recruitment strategies, and “recruitment-wage effects” that involve changes in recruitment methods. The results show that changes in recruitment strategies represent an important channel through which changes in the economic environment affect the starting wages and vacancy duration for new hires.     

The effect of sequential entry on choice of location

An important aspect of economics arises when entry into a market of differentiated products is sequential and essentially irrevocable. An approach to the investigation of this problem is offered by the theory of spatial competition. We consider a market consisting of a line segment or its equivalent and assume irrevocable location choices for all sellers, each of whom pursues a ‘maximin’ strategy in selecting a location, and negative elasticity of demand for all buyers. Results for small N are generalised to any finite N and the patterns are evaluated on a criterion of ‘Buyers' Welfare’.     

The extent of the market and optimal specialization

Summary. In this paper I examine how the socially optimal allocation, and specialization in particular, depends on the extent of the market. I interpret the societys ability to keep transaction records as the extent of the market and measure it by a probability with which the society can update agents past transactions into the public record. The society uses this record to detect potential defections from the optimal allocation and to punish the defectors with autarky. I show that when is small, increasing increases optimal specialization. However, when is close to 1, increasing further has no effect on the optimal allocation. I also show that optimal specialization is gradual over time when there is cost to reduce specialization. Even for small , the process converges to the unconstrained optimum that would occur under .JEL Classification Numbers: D60, C78.An earlier version of this paper was presented at the Society for Economic Dynamics meetings in Stockholm (2001). I thank a referee and the editor for useful comments and suggestions. For financial support, I gratefully acknowledge the Social Sciences and Humanities Research Council of Canada, and the Bank of Canada Fellowship. The opinion expressed here is my own and does not reflect the view of the Bank of Canada.     

The impact of prudence on optimal prevention revisited

We re-examine the link between absolute prudence and self-protection activities. We show that the level of effort chosen by an agent with decreasing absolute prudence is larger than the optimal effort chosen by a risk-neutral agent if the degree of absolute prudence is less than a threshold that is utility-independent and empirically verifiable.     

The robustness of optimal equilibrium among overlapping generations

Summary. We combine and strengthen optimality and robustness theorems for the overlapping-generations model of money. Roughly, we find a Pareto-optimal monetary equilibrium of a generic stationary economy that is near an optimal monetary equilibrium of each nearby non-stationary economy. Since the nearby equilibria are monetary, the general problem of macroeconomic stabilization reduces to maintaining the money supply. And since the nearby equilibria are optimal, stabilization is socially desirable. Received: October 27, 1997; revised version: March 25, 1998     

The role of optimal threats in auction design

This paper studies revenue-maximizing auctions when buyers' outside options depend on their private information and are endogenously chosen by the seller. We show that the revenue-maximizing assignment of the object can depend crucially on the outside options that the seller can choose as threats. Depending on the shape of outside options, sometimes an optimal mechanism allocates the object in an ex-post efficient way, and, other times, buyers obtain the object more often than is efficient.     

The optimality of optimal punishments in Cournot supergames

The result of Colombo and Labrecciosa [Colombo, Luca and Labrecciosa, Paola (2006). ‘The suboptimality of optimal punishments in Cournot supergames’, Economics Letters 90, pp. 116–121.] that optimal punishments are inferior to Nash-reversion trigger strategies with decreasing marginal costs is shown to be due to the output when a firm deviates from the punishment path becoming negative.     

The sunk-cost effect and optimal two-part pricing

This paper examines how the sunk-cost effect on consumers’ purchasing behavior may reset the optimal two-part pricing. It shows that the sunk-cost effect of a membership fee provides the firm an incentive to raise the unit price and/or to increase the market coverage by charging a lower membership fee.