Knowledge that Transforms

Models of economic activity with frictions in coordinating trading have been shown to be capable of generating multiple steady states. (Peter Diamond, 1982, is the pioneering work; see my 1987a paper for a general discussion.) Less work has been done on out-of-steady-state dynamics in such models, which would enable us to examine what sort of fluctuations these models may generate. The absence of dynamics leaves open the question of which steady state the economy will reach, as well as whether the comovements of key variables resemble what is observed over the cycle. In my earlier paper (1987b), I presented a model combining search and aggregate demand approaches to unemployment to show how spillovers between product and labor markets could yield multiple equilibria. Here, a highly simplified dynamic model based on this work is presented, in which (self-fulfilling) sales expectations determine to which steady state the economy converges. These expectations are summarized by the asset values of firms which are producing output relative to those that are not. Two types of dynamic paths leading to stationary solutions can arise. The first is a saddle path. In addition, for certain parameter values, stable limit cycles emerge. Interestingly, over this cycle, asset values of firms (which one could interpret as stock market values) lead economic activity. I. Model Setup

Undoubtedly, the greatest surprise in telephone industry deregulation has been the absence of deregulation, for the industry continues to be almost as highly regulated today as twenty years ago. Entry has been greatly liberalized in the equipment and most services markets, AT&T has been broken up, but the most important intrastate and interstate telephone services continue to be subject to formal rate regulation. Competitive entry has made this regulation more difficult, not politically less compelling. The major event in the telephone industry has not been deregulation, but divestiture. In 1984, AT&T was divested of its operating companies as the result of an historic 1982 antitrust decree. In this paper, I summarize some of the early effects of divestiture, including: (i) the virulence of the politics to keep the uneconomic subsidies that invited competitive entry in the first place, (ii) the preliminary evidence that AT&T is losing by winning and not vice versa, (iii) the new competition in equipment markets that may turn out to be more important than the recent developments in services competition, (iv) the misplaced concerns about the loss of system efficiency and service quality due to divestiture, and (v) the plight of the divested regional Bell holding companies (RBOCs).

Many theories of individual choice under risk and uncertainty are formu lated in terms of preferences over prospects, i.e., probability distr ibutions of consequences. By contrast, regret theory is formulated in terms of actions, i.e., n-tuples of state-contingent consequences. W hat appear from the viewpoint of prospect-based theories to be innocu ous rephrasings of choice problems are predicted by regret theory to cause people to reverse their choices. This paper follows up earlier results with a new kind of experimental test. The new evidence favors regret theory.

Recent attempts to resolve the international debt crisis have lead some countries to engage in debt-equity swaps. The paper explores conditions under which such transactions are beneficial to the debtor as well as the creditors. It identifies a market failure that may prevent the emergence of actually beneficial swaps and analyzes the effects of swaps on the investment level in the debtor country. The latter helps to evaluate the contribution of this policy to future difficulties with debt service payments.

This paper studies the welfare consequences of inflation and disinflation in a model in which monopol istic firms incur a fixed cost of price adjustment. It is shown that a moderately increasing price level is associated with higher social welfare than a perfectly stable price level, and the model therefore provides theoretical support for the widespread belief that a little bit of inflation is good for the economy. Nevertheless, it is also tr ue that the eradication of a moderate inflation leads to an increase in social welfare.

During the period from 1960 to 1973, the economic growth rate in Japan was at the rate of 10 or 11 percent per year. Japan was not the only country that grew rapidly during that period. France and Germany grew at 5.9 and 5.4 percent per year between 1960 and 1973 and Italy grew at 4.8 percent per year. Even the United Kingdom grew at a respectable 3.8 percent per year. The United States grew at 4.3 percent per year during this period. To fill out the roster of the seven major industrialized countries, Canada grew at 5.1 percent per year.' After the first oil crisis in 1973, and even more so after the second oil crisis in 197879, there was a dramatic decline of economic growth among industrialized countries. Growth in the OECD countries dipped to 2.6 percent per year between 1973 and 1979. Japanese growth dropped from the doubledigit levels of the 1960's and the early 1970's to 3.8 percent per year from 1973 to 1979. In the United States, the growth rate dropped to slightly above the OECD average at 2.8 percent per year. The rate of economic growth in Germany dropped to 2.4 percent and in France to 3.1 percent. In every major industrialized country there was a precipitous fall in the rate of economic growth. The sources of economic growth in Japan and the United States over the whole period from 1960 to 1979 are given in Table 1. If we compare Japan and the United States during the period 1960-79, we see that the growth of output over the whole period was 8.3 percent in Japan and only 3.5 percent in the United States. We can allocate this growth in output in the two countries among its three sources, namely, the contribution of capital input, the contribution of labor input and the rate of technical change. By far, the most important contributor to economic growth in both countries is the growth of capital input. This growth source accounts for about 5 percentage points of the Japanese economic growth rate and about 1.5 percentage points of the U.S. economic growth rate. This amounts to 60 percent of Japanese growth and 40 percent of U.S. growth. Labor input in the two countries is a major contributor to economic growth, accounting for 1.5 percent of the Japanese growth rate and 1.2 percent of the U.S. growth rate. The rate of technical change is an important contributor as well, at nearly 2 percent in Japan and 0.7 percent in the United States. I conclude that by far the most important contributor to economic growth in the two countries is the growth of capital input. The relative importance of capital input is much greater in Japan than in the United States. Focusing attention on the period from 1973 to 1979 after the energy crisis, we can see that capital input retained its lead as a source of economic growth in both countries. However, the decline in the growth of tDiscussants: John W. Kendrick, George Washington University; J. Randolph Norsworthy, Rensselaer Polytechnic Institute; Rolf R. Piekarz, National Science Foundation.