Do Expected Shifts in Inflation Affect Estimates of the Long-Run Fisher Relation?

Recent empirical studies suggest that nominal interest rates and expected inflation do not move together one-for-one in the long run, a finding at odds with many theoretical models. This article shows that these results can be deceptive when the process followed by inflation shifts infrequently. We characterize the shifts in inflation by a Markov switching model. Based upon this model's forecasts, we reexamine the long-run relationship between nominal interest rates and inflation. Interestingly, we are unable to reject the hypothesis that in the long run nominal interest rates reflect expected inflation one-for-one.     

ECONOMIC PERSPECTIVES ON EDUCATIONAL POLICY: INTRODUCTION

The two papers that follow both deal with prospects for achieving efficiency in education. Psacharopoulos identifies the extent of government-induced distortions directly or indirectly related to education, and assesses the likely effects of such distortions on social welfare. He concludes that, among other things, governments should not attempt directly to provide or manage schooling services. Levin's article focuses upon one particular management decision…namely, extending the length of the school day and increasing the number of school days per year. He argues that mechanically increasing school sessions through legislative acts or through administrative mandates does not appear, in itself, to be a promising use of scarce resources.     

PRICE DISPERSION AND COMPETITION WITH DIFFERENTIATED SELLERS*

I measure price dispersion among differentiated retail gasoline sellers and study the relationship between dispersion and the local competitive environment. Significant price dispersion exists even after controlling for differences in station characteristics, and price differences between sellers change frequently. The extent of price dispersion is related to the density of local competition, but this relationship varies significantly depending on the type of seller and the composition of its competitors. These findings are consistent with interactions between seller and consumer heterogeneity that are not well understood in the existing price dispersion literature.     

An Incentive Approach to Banking Regulation

We examine the optimal design of a risk-adjusted deposit insurance scheme when the regulator has less information than the bank about the inherent risk of the bank's assets (adverse selection), and when the regulator is unable to monitor the extent to which bank resources are being directed away from normal operations toward activities that lower asset quality (moral hazard). Under a socially optimal insurance scheme: (1) asset quality is below the first-best level, (2) higher-quality banks have larger asset bases and face lower capital adequacy requirements than lower-quality banks, and (3) the probability of failure is equated across banks.     

Budget Allocation Patterns of African Americans

The Consumer Expenditure Survey (1980–1992), Consumer Price Index (1980–1992), and ACCRA Cost of Living Index (1990) are used to construct annual household expenditure data from 1980 to 1992 to compare household budget allocation patterns of African Americans to Asian Americans, Caucasian Americans, and Hispanic Americans. Using the LA/AIDS demand system, researchers found that African American households have statistically significantly different budget allocation patterns in more than half of the 13 expenditure categories investigated in this study, after controlling for other socioeconomic and demographic characteristics.     

Fiscal Sustainability in a New Keynesian Model

Recent work on optimal monetary and fiscal policy in New Keynesian models suggests that it is optimal to allow steady‐state debt to follow a random walk. In this paper we consider the nature of the time inconsistency involved in such a policy and its implication for discretionary policymaking. We show that governments are tempted, given inflationary expectations, to utilize their monetary and fiscal instruments in the initial period to change the ultimate debt burden they need to service. We demonstrate that this temptation is only eliminated if following shocks, the new steady‐state debt is equal to the original (efficient) debt level even though there is no explicit debt target in the government's objective function. Analytically and in a series of numerical simulations we show which instrument is used to stabilize the debt depends crucially on the degree of nominal inertia and the size of the debt stock. We also show that the welfare consequences of introducing debt are negligible for precommitment policies, but can be significant for discretionary policy. Finally, we assess the credibility of commitment policy by considering a quasi‐commitment policy, which allows for different probabilities of reneging on past promises.     

A Simple Algorithm for the Portfolio Selection Problem

The author presents a rapidly convergent algorithm to solve the general portfolio problem of maximizing concave utility functions subject to linear constraints. The algorithm is based on an iterative use of the Markowitz critical line method for solving quadratic programs. A simple example, taken from the theory of state-contingent claims, is worked out in detail. For technical convergence results, the reader is referred to the appropriate mathematical programming literature.