Knowledge that Transforms

In this paper, I demonstrate how Bayesian information may be analyzed as a bona fide input in determining the optimal level of precautionary balances to hold. I first examine the impact of information in revising the expected total cost function and the effect of information on optimal precautionary cash balances. I then derive the optimal demand for information, and the comparative statics of θ^* are developed. Finally, I examine the elasticity of precautionary balances to scale under the assumption that the degree of uncertainty of cash needs is a decision variable for the firm or household to determine. Surprisingly, monetary balances demonstrate significant economies of scale with endogenous information.

Traditional dumping theory consists of an analysis of monopolistic price determination between national markets. The present paper develops an alternative theory motivated by contemporary experience. This theory views dumping as an integral part of the relationship between domestic factor markets and international commodity markets in a world of uncertainty and sluggish adjustment. Key determinants identified by the theory include the pattern of demand uncertainty, alternatives available to the unemployment of factors, and relative endowments of factors with distinct contractual arrangements. The balance of the paper isolates the role of each determinant.

A simple stochastic model is developed which demonstrates that information on the nominal value of money conveys sufficient information about the disturbance to currency and deposit demand so that monetary prices, such as adjusting the level of bank reserves, have no impact on the dispersion of price level forecast errors. However, if information on monetary aggregates is obtained only with a lag, then reserve requirements can reduce the disturbances to the demand for high-powered money and hence prices. Such a reserve ratio depends critically on the variance-covariance matrix of shocks to the monetary demands.

[It has often been argued that prices are sticky in the United States. However, the empirical papers that have claimed to support this view have not reflected any formal behavioral theory. This paper presents a theory that justifies price stickiness, namely, that firms, fearing to upset their customers, attribute a cost to price changes. The rational expectations equilibrium of an economy with many such firms is presented, estimated with postwar U.S. data, and tested against alternative hypotheses. The results largely support the model. Furthermore, the hypothesis that prices are not sticky is rejected by U.S. data.]

This model treats the exchange rate as an "asset price" that depends on expectations concerning exogenous real and monetary factors that will affect relative prices and absolute price levels in future periods. Changes in exchange rates reflect both expected changes in these exogenous factors and changes in expectations occasioned by new information. The model explains the random component in exchange rate behavior, the source of divergences from purchasing power parity, the anticipatory response of exchange rates to future expected disturbances, and the causes of exchange rate overshooting.

Nominal wages have less variation about a trend than the money supply does, and the variation is more persistent. This inertia in the nominal wage is often cited as the principal source of stagflation. This paper explains the phenomenon by appealing to temporary wage inflexibility in an environment where agents cannot directly disentangle permanent versus transitory movements in key state variables. A wage equation results that is a distributed lag of previous values of the state variables, including money. Nominal wage variation becomes less sensitive to the money supply as agents' ability to detect the permanent evolution of the money supply declines.

This paper estimates a general equilibrium model of suppressed inflation using quarterly U.S. data for the sample period 1942:IV-48:II. It finds that the pricelevel was reduced by at least 30.4 percent and that this suppression of inflation reduced employment by at least 11.7 percent and output by at least 7.1 percent. It also finds that monetary policy could have been equally successful in combating inflation but would not have had the side effect of reducing employment and output.