Knowledge that Transforms

Hiroki Tsurumi, A Comparison of Alternative Optimal Models of Advertising Expenditures: Stock Adjustment Vs. Control Theoretic Approaches, The Review of Economics and Statistics, Vol. 55, No. 2 (May, 1973), pp. 156-168

R ECENT attempts to measure changes in the quality of labor inputs in production have been based either on changes in years of schooling and other quality determining factors (Denison (1967) and Jorgenson and Griliches (1967)) or on changes in occupational mix (Griliches (1967) and Raimon and Stoikov (1967)).' Both measures raise serious problems. The first, because of lack of data, has not been able to adjust for differences in ability, on-the-job training or a number of other quality determining factors so that they do not even purport to have exhausted all significant quality differences.2 On the other hand, studies using occupational data have been based essentially on Bureau of Census major occupational groups i.e., eleven groups -and as the authors themselves were aware, these are uncomfortably broad. The purpose of this paper is to discuss still another (albeit related) approach to measuring changes in the quality of labor in production and to present the results for manufacturing industries. The approach is to first develop a wage rate index which measures changes in prices of a homogeneous bundle of labor services over time. The wage rate index is then used to deflate a time series of average hourly earnings (i.e., the cost of a changing bundle of labor services per man-hour) in order to obtain the desired index of quality per manhour. This index, in effect, measures changes in labor quality by changes in occupational mix -i.e., increases in quality per man-hour are measured by shifts from lower to higher paid occupations. The major difference between the approach used here and that in the previously cited studies is that my results are based on very detailed occupational data by sex and industry. Because of limited coverage, the indexes of quality per man-hour are for production (blue collar) workers in 25 selected manufacturing industries. On the basis of these series and some additional assumptions, I also attempt to expand the results to all employees in manufacturing in order to estimate the contribution of changes in labor quality to the growth in output and output per man-hour in this sector. In particular, changes in quality per manhour are divided between those resulting from shifts among production and nonproduction (white collar) workers and those resulting from changes in quality per man-hour within these two groups.

CONTROVERSIES involving inflation, particularly inflation in developing countries, have usually focused on Latin America.1 One major point which emerges from these controversies is the distinction between a fully anticipated, fully adjusted inflation and an inflation which proceeds with such irregularity that economic agents are able neither to anticipate nor to adjust completely. To the extent that individuals can anticipate and adjust to inflation, a higher rate of inflation will cause the income velocity of money to rise, as attempts are made to exchange money for hedges against inflation.' The influence of inflation on monetary velocity is less clear, however, under the conditions of imperfect anticipation and adjustment which prevail in Latin America. Not only are the rates of inflation in most Latin American countries high, but they also tend to be highly variable. In addition, most Latin American countries have less than perfect markets for hedging against inflation, and these are further restricted by the regulations often imposed on interest rates, prices and international trade in the wake of inflationary conditions.' The present paper examines the impact of inflation on the income velocity of money for sixteen Latin American countries over the period 1950-1969. Such an examination not only indicates the sensitivity of demand for real cash balances to changes in the price level, but also reflects the extent to which economic agents under conditions prevailing in Latin America can anticipate inflation and adjust by hedging. Aside from Cagan's well-known work on hyperinflation (Friedman, 1956, pp. 25117), most empirical studies of the demand for money in individual countries conclude that inflation does not have a significant impact on velocity.4 These studies generally argue that the small changes in the price level usually observed cannot be adequately anticipated or are not large enough to cover the costs of adjustment. A recent article by Melitz and Correa (1970) on international differences in income velocity, like most studies of individual countries (but contrary to theoretical expectations), also concludes that inflation does not influence velocity. This article, like the present study, uses international comparisons, but the findings differ substantially. Melitz and Correa find that the coefficient for the impact of inflation on velocity does not have the expected sign and therefore omit the inflation variable from further consideration. They argue that price changes are important only in cases of hyperinflation and that adjusting to mild inflation is too costly and difficult to be worthwhile. Having excluded inflation as an explanatory variable, Melitz and Received for publication May 24, 1972. Revision accepted for publication January 30, 1973. * The authors wish to thank Michael C. Lovell for many helpful comments and suggestions, Francisco Chaves for assistance with data collection and computational work, and the Wesleyan Computer Center for generous use of its facilities. ' Best known is the monetarist-structuralist controversy over the causes of inflation and the impact of inflation on economic development. See, for example, Baer and Kerstenetzky (1964), Johnson (1967, pp. 281-291) and Baer (1967). 2-Johnson (1967, pp. 104-142) identifies the tax on real cash balances as the essence of the quantity theory approach to inflation, and it is the efforts to escape this tax which cause monetary velocity to rise with inflation. 'In discussions of inflation and economic growth, more costs and benefits of inflation are attributed to structural imperfections rather than to the tax on real cash balances. Structuralists emphasize the benefits of inflation in circumventing market imperfections, while monetarists focus on the costs of inflation in conjunction with inappropriate government regulations. See Johnson (1967, pp. 281-291) and Baer (1967). 4 However, some studies in a collection edited by Meiselman (1970) provide limited support for a positive influence of inflation on velocity in several less-developed countries. Deaver (Meiselman, 1970, pp. 7-67), finds the rate of inflation to be a significant variable in explaining velocity changes in Chile during the period 1932-1955, while Campbell (Meiselman, 1970, pp. 339-386) finds a positive correlation between velocity and changes in the rate of inflation in a comparative study of South Korea and Brazil. In a cross-country study Perlman (Meiselman, 1970, pp. 297337) finds nominal interest rates or inflation rates (as proxies for the opportunity cost of holding money) to be significant in explaining international differences in liquid asset portfolios.

EVER since the publication of Rachel Carson's famous book, Silent Spring (1962), insecticide pollution has been an important public issue. As well as naturalists and medical researchers, economists have joined the discussion. They have rightly claimed that insecticide usage is an economic phenomenon, and they have proceeded to estimate the costs and production losses from total or partial bans.' In this paper, we consider the possibility of reducing United States insecticide usage through an efficient relocation of agricultural activities. We find that if agricultural activities were located so as to minimize the production and transportation costs to satisfy the demand for agricultural products, there would be a substantial reduction in insecticide requirements. Our argument is organized as follows. In section II, we describe United States insecticide usage, emphasizing regional differences. Section III is a discussion of studies of efficient crop relocation, i.e., studies concerned with the location of crops under cost minimizing conditions and without the influence of government price support and land retirement schemes. In section IV, we estimate the insecticide requirements for an efficient agricultural sector. The estimates are repeated in section V with alternative measures of insecticide usage, and our conclusions are summarized in section VI.

T HE traditional aid-and-development literature assumes that, under most relevant circumstances, aid and other capital flows to developing countries induce an expansion of economic activity and output in these countries. In the underlying models such capital finances an equivalent amount of net imports of either (a) capital goods of an unspecified nature (thereby relaxing the saving constraint) or (b) specific required inputs obtainable only from abroad (thereby relaxing the foreign-exchange constraint).' A number of writers have estimated the effects of past capital inflows and capital requirements on the basis of 'this assumption, without seriously questioning its validity (Rosenstein-Rodan 1961; Chenery and Bruno 1962; Manne 1963). Several recent writers, however, have criticized this view, both because of its formal incompatibility with other aspects of the theoretical models employed and because of its inconsistency with empirical observation (Rahman 1968, Areskoug 1969, Chenery and Eckstein 1970, Griffin 1970, Griffin and Enos 1970, Weisskopf 1972).2 It seems that a considerable portion of these capital inflows have in fact been allocated to consumption and that ties and other creditor (donor) restrictions designed to channel them into investment have been largely ineffective. The traditional aid-and-development models must therefore be deficient.

Martin Feldstein and Otto Eckstein (1970) have set out and estimated a model of interest rate determination which they claim represents an integration of Keynes's liquidity preference theory with Irving Fisher's theory of the impact of expected inflation on interest rates. They achieve their integration by first inverting a Keynesian demand function for real balances, solving it for the nominal rate of interest. Then to incorporate Fisher's effect, they simply add to the right side of this equation a distributed lag in current and past actual rates of inflation, the same proxy for expected inflation that Irving used. Feldstein and Eckstein interpret sizable and statistically significant estimated coefficients on the elements of that distributed lag as confirming the presence of an effect of anticipated inflation on the interest rate. It is questionable whether Keynes's and Fisher's theories stand in need of any integration at all, since they are in principle compatible in the first place. The two theories are on very different footings. Keynes's liquidity preference theory is a theory about one particular structural equation relating real money balances, income, and the nominal rate of interest. On the other hand, Fisher's theory is one about how the whole economy is put together; that is, it is a statement about the reduced form equation for the nominal interest rate. In Fisher's theory, an exogenous increase in the anticipated rate of inflation is asserted to work its way through the economy in such a fashion that the nominal interest rate rises by the amount of the increase in anticipated inflation.1 In this note, I suggest that Feldstein and Eckstein's equation does not successfully synthesize Keynes and Fisher. Furthermore, I suggest that Feldstein and Eckstein's econometric procedure is not a good one for estimating the dimensions of the Fisher effect. In particular, the effect may be present in full force but still not be detected by Feldstein and Eckstein's procedure. On the other hand, it is possible to construct examples of economies in which there is really no effect but in which Feldstein and Eckstein's test would point to the presence of one. Finally, I show that in a model that includes both Keynes's liquidity preference schedule and a reduced form for the interest rate like the one posited by Fisher, Feldstein and Eckstein's equation is not statistically identifiable.

T HE response of government policy variables to the targets or objectives of policy has received increasing attention in the literature. All of the published studies have limited their investigations to the behavior of the monetary authority.1 This concern with the reaction function of the monetary authority can be traced to three factors: (1) Since the monetary authority is independent (or semiindependent) of the government, investigators have been concerned with whether the central bank has responded to the appropriate social objectives such as price stability and full employment; (2) Central banks have often expressed concern with short-run objectives (such as interest rate stability) and investigators have examined whether the pursuit of such objectives has hindered the implementation of the social goals; and (3) Econometric modelbuilders have become concerned with the statistical problems arising from the endogeneity of policy.2 This paper reports on an attempt at estimating the reaction function of the Federal Home Loan Bank System (FHLBS) and the Federal National Mortgage Association (FNMA). Both FNMA and the FHLBS are governmentsponsored agencies (the FHLBS being under more government control than FNMA) whose major objective concerns the mortgage market and housing activity. FHLBS makes loans (advances) to savings and loan associations which, in turn, use the funds for mortgage loans. FNMA buys (or sells) mortgages in the secondary market. During the 1960's these operations were aimed primarily at stabilizing the volume of mortgage credit with the implicit view towards stabilizing housing activity.3 There were a number of factors during the 1960's which might have prevented the FHLBS and FNMA from pursuing their objective of minimizing the variability in mortgage flows and housing starts. First, before 1968, FNMA purchases and sales of mortgages appeared in the United States budget, hence mortgage purchases, in particular, were carefully examined since such purchases added to the deficit. After 1968 this was no longer true since FNMA was made a private corporation and taken out of the federal budget. During the credit squeeze of 1966 the Johnson Administration placed severe restrictions on the debt issues of various government agencies, including the FHLBS. In effect, this meant that the FHLBS was not free to decide to raise funds to lend to savings and loan associations without severe scrutiny. In the next section, two alternative models of FHLBS behavior are derived within a utility function framework. Empirical estimates of the alternative reaction functions are presented. same is done for FNMA behavior in a subsequent section. remainder of the paper presents the implications of the results for a number of issues, including: (1) whether FNMA and the FHLBS have, indeed, used Received for publication June 29, 1972. Revision accepted for publication December 13, 1972. * author wishes to acknowledge the financial support of the Federal Home Loan Bank System. views expressed are not necessarily shared by the FHLBS. He also thanks M. J. Hamburger, S. M. Goldfeld, and an anonymous referee for their comments. 1See, for example, H. G. Johnson and W. G. Dewald, Analysis of the Objectives of in D. Carson (ed.), Banking and Studies, Irwin Inc., 1963; and J. H. Wood, Model of Federal Reserve Behavior, in George Horwich (ed.), Process and Policy, Irwin Inc., 1967. 2See F. de Leeuw and J. Kalchbrenner, Monetary and Fiscal Actions: A Test of Their Relative Importance in Economic Stabilization-Comment, in Review, Federal Reserve Bank of St. Louis, April, 1969, and the Reply by L. C. Anderson and J. L. Jordon in same issue. 3See Harry Schwartz, The Role of Government-Sponsored Intermediaries in the Mortgage Market, in Housing and Policy, Federal Reserve Bank of Boston, Boston, 1970; and Ernest Bloch, The Federal Home Loan Bank System, in Federal Credit Agencies, Commission on Money and Credit, Prentice-Hall, Englewood Cliffs, N.J., 1963.