Bureaucratic Advice and Political Governance

This paper studies the conflict of interest between politicians and better-informed bureaucrats when they have differing preferences over a public project. We start with a baseline model where a bureaucrat advises a single decision maker (politician) whether to adopt a project. The bureaucrat can be punished if his misrepresentation of the project is detected. We extend this to multiple projects and multiple bureaucrats, and compare the level of Type I and Type II errors generated with centralized and decentralized decision making. This typically depends on the form of the distribution function that determines the bureaucrats' expectation of being disciplined.     

RECURRENT BUBBLES*

We study rational bubbles in a standard linear asset price model. We first consider a class of bubble processes driven by multiplicative i.i.d. shocks. We show that a bubble process in this class either diverges to infinity with probability one, converges to zero with probability one, or keeps fluctuating forever with probability one, depending on investors' “confidence” in expected bubble growth. We call a bubble process having the last property “recurrent.” We develop sufficient conditions for a bubble process to be recurrent when it is driven by non‐i.i.d. shocks, when the risk‐free interest rate is not constant, and when the process is driven by non‐i.i.d. shocks and the risk‐free interest rate is not constant. In the last case we demonstrate via simulation that there can be a prolonged period in which both the bubble and the interest rate stay close to zero.     

TRADE IMPACTS ON SKILL ACQUISITION VIA VARIETY EXPANSION*

We show that trade enhances skill formation through gains from trade via variety expansion à la Krugman. Although workers are identical as unskilled labour, they differ in productivity as skilled labour. Workers become skilled by incurring training costs. By introducing these settings into a trade model with monopolistic competition, we show that, although trade makes all agents better off, its effect is stronger for skilled than unskilled workers, which stimulates skill acquisition. As a result of less productive workers becoming skilled, the wage dispersion among skilled workers increases.     

QUANTITY OR QUALITY: THE IMPACT OF LABOUR SAVING INNOVATION ON US AND JAPANESE GROWTH RATES, 1960–2004*

This article deals with both theoretical and empirical analyses of the post‐war (1960–2004) growth for the USA and Japan. We investigated three factors contributing to growth: the growth rates of capital, labour and labour saving innovation. In Japan, the growth rate of the labour force has been much less important than its quality improvement—i.e. labour saving technical change—while in the USA, the growth rates of labour and population have contributed more than their quality improvement. The policy implication is that Japan's declining population can be compensated for by additional quality improvement of the existing labour force.     

Exchange Rates and Fundamentals: A General Equilibrium Exploration

Engel and West (2005) show that the observed near random‐walk behavior of nominal exchange rates is an equilibrium outcome of a partial equilibrium asset approach when economic fundamentals follow exogenous first‐order integrated processes and the discount factor approaches one. In this paper, I argue that the unit market discount factor creates a theoretical trade‐off within a two‐country general equilibrium model. The unit discount factor generates near random‐walk nominal exchange rates, but it counterfactually implies perfect consumption risk sharing and flat money demand. Bayesian posterior simulation exercises, based on post‐Bretton Woods data from Canada and the United States, reveal difficulties in reconciling the equilibrium random‐walk proposition within the canonical model; in particular, the market discount factor is identified as being much smaller than one. A relative money demand shock is identified as the main driver of nominal exchange rates.     

Optimal Income Taxation with Risky Earnings: A Synthesis

We study optimal nonlinear income taxation when earnings can differ because of both ability and luck, so the income tax has both a redistributive role and an insurance role. A substantial literature on optimal redistribution in the absence of risk has evolved since Mirrlees's original contribution. The literature on the income tax as a social insurance device is more limited. It has largely assumed that households are ex ante identical so unequal earnings are due to risk alone. We provide a general treatment of the optimal income tax under risk when households differ in ability. We characterize optimal marginal tax rates and interpret them in terms of redistribution, insurance, and incentive effects. The case of ex ante identical households and the no‐risk case with heterogeneous abilities come out as special cases.     

Economic Growth,Terms of Trade and Welfare in an Open Monetary Economy*

The authors investigate the impact of growth on terms of trade, absolute prices and welfare using a two-country, monetary model. Under flexible exchange rates export-biased growth would lead to a decline in the terms of trade if the two countries are ‘similar’. Under fixed exchange rates a weaker condition than the barter condition of export-biased growth is sufficient, namely, for the import commodity the demand creating effect of growth dominates the supply effect while for the exported commodity the opposite holds. Secondly, substitutability between money and commodities indicates that no necessary relation holds between the terms of trade and the trade balance. Thirdly, the introduction of money creates a real balance effect so that decline in terms of trade is no longer a necessary (or sufficient) condition for immiserization. Finally, the paper concludes by questioning two policy conclusions drawn in earlier models: one, that the declining terms of trade of less developed countries was due to a bias in the growth strategy and, two, that monetary models of trade support the ‘monetarist’ proposition that growth and a deteriorating trade balance can only co-exist if the domestic monetary policy is nonneutral.     

INFLATION HISTORY AND THE SACRIFICE RATIO: EPISODE-SPECIFIC EVIDENCE

This article examines whether episode-specific analysis can show a negative relationship between inflation and the slope of the Phillips curve that has been found in cross-country analysis. While the relationship between inflation and the Phillips curve slope is widely accepted from cross-country analysis, it has remained unproven in previous episode-specific studies. By defining inflation history as a weighted average of past inflation, this study finds a negative effect of inflation history on the sacrifice ratio, which is what is expected from the cross-country analysis. The negative relationship does not disappear even after including other conventional determinants of the sacrifice ratio. ( JEL E52, E31)