Knowledge that Transforms

The concept of "economically rational" expectation formation is developed for a regime in which the acquisition and use of some information sets are nonnegligible. The concept provides a middle ground between "autoregressive" expectation formation and "rational" expectation formation. A necessary condition for the use of nonnegligible cost information sets is that such sets serve as leading indicators or more formally satisfy the causality conditions of Granger (1969). Using a time series modeling identification methodology developed by Box and Jenkins (1970) and Haugh (1972), we test the causal relationship between the rate of inflation and various monetary and fiscal aggregates. Surprisingly, we cannot reject the hypothesis that the rate of inflation is independent of the monetary and fiscal aggregates considered. Since the proposed leading indicator series contain no incremental predictive power once the information contained in the past history of inflation is efficiently utilized, we conclude that autoregressive expectation models may indeed represent economically rational price expectation formation.

The joint determination of work and investment in human capital over the life cycle is analyzed. At low rates of impatience investment is decreasing throughout life, as in simpler models which assume hours of work to be fixed. The demand for leisure over the life cycle is "U shaped." Wages rise to a single peak which occurs after the peak in hours of work. Distinctly different patterns arise when the rate of impatience is high. Such individuals may prefer an increasing hours of work profile, and schooling need not be concentrated at the beginning of life. Conditions are provided to determine a critical level of time preference which is sufficient to induce a "normal" life-cycle pattern for investment and work.

The paper develops a theory of exchange rate movements under perfect capital mobility, a slow adjustment of goods markets relative to asset markets, and consistent expectations. The perfect foresight path is derived and it is shown that along that along that path a monetary expansion causes the exchange rate to depreciate. An initial overshooting of exchange rates is shown to derive from differential adjustment speed of markets. The magnitude and persistence of the overshooting is developed in terms of the structural parameters of the model. To the extent that output responds to a monetary expansion in the short run, this acts a a dampening effect on exchange depreciation and may, in fact, lead to an increase in interest rates.

The shape of the earnings-age function and the way education affects it can explain all the empirically observed relations of migration measures to distance moved, age, and education. No other assumptions (which are often made)--such as attributing lower risk aversion and higher efficiency of job search to more-educated persons, or higher psychic cost of moving to older persons--are needed. The individual's search for jobs and the firm's search for employees are affected by the shape of the earnings function--and, thus, by age and education in a predictable way. In turn, the observed systematic behavior of the migration measures with respect to age and education is responsive to the search behavior.

This paper presents a model of price stabilization applicable to less-developed economies. Distinctive features of the model are: (i) its explicit incorporation of a commercial banking system, (ii) its specification that the actual rate of inflation depends on inflationary expectations and on excess demand for output, and (iii) endogeneity of the growth rate of real output. Numerical simulations are also conducted. We demonstrate that stabilization through an initial increase in the average nominal interest rate paid on money holdings has significantly more favorable short-run effects on real output than does stabilization through an initial reduction in the rate of monetary expansion.

The theory of exhaustible resources is modified to take account of the industrial organization of the world oil market. The cartel is viewed as a unified enterprise which dominates other extractors because of its larger reserves. Equilibrium price and sales paths are derived giving neither the dominant extractor nor the competitive fringe any incentive to change its intertemporal behavior. Under standard but simplified cost assumptions, it is shown that a disproportionate share of the increased profits results from the formation of the cartel goes to non-members and that the cartel's restriction on sales eventually leaves it the sole supplier of oil.