A nonnormative theory of inflation and central bank independence

A Nonnormative Theory of Inflation and Central Bank Independence. — The authors study monetary policy under different central bank constitutions when the labor-market insiders set the minimal wage so that the outsiders are involuntarily unemployed. If the insiders are in the majority, the representative insider will be the median voter. The authors show that an independent central bank, if controlled by the median voter, does not produce a systematic inflation bias, albeit equilibrium employment is too low from a social welfare point of view. A dependent central bank, in contrast, is forced by the government to collect seigniorage and to take the government’s re-election prospects into account. The predictions of their theory are consistent with the evidence that central bank independence decreases average inflation and inflation variability, but does not affect employment variability.     

Ruling Out Multiplicity and Indeterminacy: The Role of Heterogeneity

It is well known that economies of scale that are external to the individualdecision makers can lead to self-fulfilling prophecies and the multiplicityor even indeterminacy of equilibrium. We argue that the importance of thissource of multiplicity and indeterminacy is overstated in representativeagent models, as they ignore the potential stabilizing effect ofheterogeneity. We illustrate this in a version of Matsuyama's (1991)two-sector model with increasing returns to scale. Two main results areshown. First, sufficient homogeneity with respect to individual productivityleads to the instability and non-uniqueness of a given stationary state andthe indeterminacy of the corresponding stationary state equilibrium. Second,sufficient heterogeneity leads to the global saddle-path stability and theuniqueness of a given stationary state and the global uniqueness ofequilibrium.     

Time Consistent Collection of Optimal Seigniorage: A Unifying Framework

This paper reviews the existing literature on the time consistency problem of seigniorage collection when monetary policy is determined by optimal taxation considerations. It develops a unifying accounting framework and suggests a general measure for seigniorage, which encompasses the standard measures employed in the literature. In addition, the ex ante optimal solution to the optimal taxation problem is derived and interpreted in relation to the Ramsey principle. We show that the different recommendations of the public finance literature, i.e. the Friedman rule of optimal deflation, [moderately] positive inflation, and seigniorage maximizing inflation, are specific solutions to the optimal taxation problem. The paper continues with a formal illustration of the time consistency problem of the ex ante optimal policy and the characterization of the time consistent solution under discretion. As possible solutions to the time consistency problem, we consider reputational forces, institutional reforms that establish central bank independence, and specific ways of asset and debt management. In particular, it is formally shown that a modified version of the asset and debt management scheme suggested by Persson, Persson, and Svensson is not only necessary but also sufficient for optimality, although this did not hold in their model.     

Inflation targeting as a way of precommitment

This paper considers an institutional arrangement in which thegovernment assigns a publicly-announced inflation target toan instrument-independent central bank, but retains the discretionto revise the inflation target after wages have been set. Weargue that since this arrangement is transparent, it solvesCanzonen's private information problem, ensures perfect monitoringof the government, and makes reputauonal forces more effectiveCases are characterized in which, for this reason, inflationtargeting mitigates the inflationary bias of monetary policy.     

THE ROLE OF TRANSPORTATION IN U.S. ECONOMIC DEVELOPMENT: 1840–1860*

We return to two questions concerning the 19th century U.S. transportation revolution. First, to what extent were transportation improvements responsible for the large changes in the regional distribution of population in the United States and, within regions, for the changes in industry structure? Second, how important were transportation improvements for welfare gains? We find that transport improvements were the key factor driving where people lived and what industry they worked in. We also find that transport improvements were important for welfare gains: Gains over 1840–1860 would have been only half as large if there had been no transportation improvements.     

How barriers to international trade affect TFP

We ask how barriers to international trade affect TFP when there are monopoly rights in the import-competing industries. Holmes and Schmitz [1995. Resistance to new technology and trade between areas. Federal Reserve Bank of Minneapolis Quarterly Review 19, 2–17] show that without barriers to trade TFP in these industries is as large as possible. We study the general case of finite barriers to trade. We find that binding quotas lead to the use of inefficient technology in the import-competing industries. In addition, finite quotas or tariffs imply that the import-competing industries produce larger than efficient quantities, if they produce at all. For both of these reasons, barriers to international trade reduce TFP.     

BARRIERS TO ENTRY AND DEVELOPMENT*

We ask whether barriers to entry are a quantitatively important reason for the income gap between developing countries and the United States. We develop a tractable general equilibrium model that captures the effects of barriers to entry and the other main distortions typically considered in the development literature. We carry our model to the data and ask it to match the main development facts from the Penn World Table. We find that this requires large barriers to entry in developing countries, which account for about half of the income gap with the United States.