This paper uses the neoclassical growth model to examine the extent to which a tax cut pays for itself through higher economic growth. The model yields simple expressions for the steady-state feedback effect of a tax cut. The feedback is surprisingly large: for standard parameter values, half of a capital tax cut is self- nancing. The paper considers various generalizations of the basic model, including elastic labor supply, general production technologies, departures from in nite horizons, and non-neoclassical production settings. It also examines how the steady-state results are modi ed when one considers the transition path to the steady state.
This paper is a contribution to the analysis of optimal monetary policy. It begins with a critical assessment of the existing literature, arguing that most work is based on implausible models of inflation-output dynamics. It then suggests that this problem may be solved with some recent behavioral models, which assume that price setters are slow to incorporate macroeconomic information into the prices they set. A specific such model is developed and used to derive optimal policy. In response to shocks to productivity and aggregate demand, optimal policy is price level targeting. Base drift in the price level, which is implicit in the inflation targeting regimes currently used in many central banks, is not desirable in this model. When shocks to desired markups are added, optimal policy is flexible targeting of the price level. That is, the central bank should allow the price level to deviate from its target for a while in response to these supply shocks, but it should eventually return the price level to its target path. Optimal policy can also be described as an elastic price standard: the central bank allows the price level to deviate from its target when output is expected to deviate from its natural rate.
Analyzing 50 years of inflation expectations data from several sources, we document substantial disagreement among both consumers and professional economists about expected future inflation. Moreover, this disagreement shows substantial variation through time, moving with inflation, the absolute value of the change in inflation, and relative price variability. We argue that a satisfactory model of economic dynamics must speak to these important business cycle moments. Noting that most macroeconomic models do not endogenously generate disagreement, we show that a simple “sticky-information” model broadly matches many of these facts. Moreover, the sticky-information model is consistent with other observed departures of inflation expectations from full rationality, including autocorrelated forecast errors and insufficient sensitivity to recent macroeconomic news
This paper assumes that a central bank commits itself to maintaining an inflation target and then asks what measure of the inflation rate the central bank should use if it wants to maximize economic stability. The paper first formalizes this problem and examines its microeconomic foundations. It then shows how the weight of a sector in the stability price index depends on the sector’s characteristics, including size, cyclical sensitivity, sluggishness of price adjustment, and magnitude of sectoral shocks. When a numerical illustration of the problem is calibrated to U.S. data, one tentative conclusion is that a central bank that wants to achieve maximum stability of economic activity should use a price index that gives substantial weight to the level of nominal wages.
This paper examines a model of dynamic price adjustment based on the assumption that information disseminates slowly throughout the population. Compared to the commonly used sticky-price model, this sticky-information model displays three related properties that are more consistent with accepted views about the effects of monetary policy. First, disinflations are always contractionary (although announced disinflations are less contractionary than surprise ones). Second, monetary policy shocks have their maximum impact on inflation with a substantial delay. Third, the change in inflation is positively correlated with the level of economic activity.
This paper explores a model of wage adjustment based on the assumption that information disseminates slowly throughout the population of wage setters. This informational frictional yields interesting and plausible dynamics for employment and inflation in response to exogenous movements in monetary policy and productivity. In this model, disinflations and productivity slowdowns have a parallel effect: They both cause the path of employment to fall below the level that would prevail under full information. The model implies that, in the face of productivity change, a policy of targeting either nominal income or the nominal wage leads to more stable employment than does a policy of targeting the price of goods and services. Finally, we examine U.S. time series and find that, as the model predicts, unemployment fluctuations are associated with both inflation and productivity surprises.
This paper discusses the short-run tradeoff between inflation and unemployment. Although this tradeoff remains a necessary building block of business cycle theory, economists have yet to provide a completely satisfactory explanation for it. According to the consensus view among central bankers and monetary economists, a contractionary monetary shock raises unemployment, at least temporarily, and leads to a delayed and gradual fall in inflation. Standard dynamic models of price adjustment, however, cannot explain this pattern of responses. Reconciling the consensus view about the effects of monetary policy with models of price adjustment remains an outstanding puzzle for business cycle theorists.
This paper discusses the conduct and performance of U.S. monetary policy during the 1990s, comparing it to policy during the previous several decades. It reaches four broad conclusions. First, the macroeconomic performance of the 1990s was exceptional, especially if judged by the volatility of growth, unemployment, and inflation. Second, much of the good performance was due to good luck arising from the supply-side of the economy: Food and energy prices were well behaved, and productivity growth experienced an unexpected acceleration. Third, monetary policymakers deserve some of the credit by making interest rates more responsive to inflation than was the case in previous periods. Fourth, although the 1990s can be viewed as an example of successful discretionary policy, Fed policymakers may have been engaged in "covert inflation targeting" at a rate of about 3 percent. The avoidance of an explicit policy rule, however, means that future policymakers inherit only a limited legacy.
The macroeconomic analysis of fiscal policy is usually based on one of two canonical models--the Barro-Ramsey model of infinitely-lived families or the Diamond-Samuelson model of overlapping generations. This paper argues that neither model is satisfactory and suggests an alternative. In the proposed model, some consumers plan ahead for themselves and their descendants, while others live paycheck to paycheck. This model is easier to reconcile with the essential facts about consumer behavior and wealth accumulation, and it yields some new and surprising conclusions about fiscal policy.
This paper surveys the literature on the macroeconomic effects of government debt. It begins by discussing the data on debt and deficits, including the historical time series, measurement issues, and projections of future fiscal policy. The paper then presents the conventional theory of government debt, which emphasizes aggregate demand in the short run and crowding out in the long run. It next examines the theoretical and empirical debate over the theory of debt neutrality called Ricardian equivalence. Finally, the paper considers the various normative perspectives about how the government should use its ability to borrow.
Average incomes in the world's richest countries are more than ten times as high as in the world's poorest countries. It is apparent to anyone who travels the world that these large differences in income lead to large differences in the quality of life. Less apparent are the reasons for these differences. What is it about the United States, Japan, and Germany that makes these countries so much richer than India, Indonesia, and Nigeria? How can the rich countries be sure to maintain their high standard of living? What can the poor countries do to join the club?
After many years of neglect, these questions are again at the center of macroeconomic research and teaching. Long-run growth is now widely viewed to be at least as important as short-run fluctuations. Moreover, growth is not just important. It is also a topic about which macroeconomists, with their crude aggregate models, have something useful to say.
My goal here is to assess what we now know about economic growth. The scope of this paper is selective and, to some extent, idiosyncratic. The study of growth has itself grown so rapidly in recent years that it would take an entire book to discuss the field thoroughly.' In this paper, I do not try to lay out the many different views in the large literature on economic growth. Instead, I try to present my own views, as cogently as I can, on what we know about the growth of nations.
This paper proposes a theory of supply shocks, or shifts in the short-run Phillips curve, based on relative-price changes and frictions in nominal price adjustment. When price adjustment is costly, firms adjust to large shocks but not to small shocks, and so large shocks have disproportionate effects on the price level. Therefore, aggregate inflation depends on the distribution of relative-price changes: inflation rises when the distribution is skewed to the right, and falls when the distribution is skewed to the left. We show that this theoretical result explains a large fraction of movements in postwar U. S. inflation. Moreover, our model suggests measures of supply shocks that perform better than traditional measures, such as the relative prices of food and energy.