Knowledge that Transforms

We characterize and measure a long-term risk-return trade-off for the valuation of cash flows exposed to fluctuations in macroeconomic growth. This trade-off features risk prices of cash flows that are realized far into the future but continue to be reflected in asset values. We apply this analysis to claims on aggregate cash flows and to cash flows from value and growth portfolios by imputing values to the long-run dynamic responses of cash flows to macroeconomic shocks. We explore the sensitivity of our results to features of the economic valuation model and of the model cash flow dynamics. (c) 2008 by The University of Chicago. All rights reserved.

In this article, we analyze the implications of price‐setting restrictions for the conduct of cyclical fiscal and monetary policy. We consider standard monetary economies that differ in the price‐setting restrictions imposed on the firms. We show that, independently of the degree or type of price stickiness, it is possible to implement the same efficient set of allocations and that each allocation in that set is implemented with policies that are also independent of the price stickiness. In this sense, environments with different price‐setting restrictions are equivalent.

We study the optimal inflation tax in an economy with heterogeneous agents subject to nonlinear taxation of labor income. We find that the Friedman rule is Pareto efficient when combined with a nondecreasing labor income tax. In addition, the optimum for a utilitarian social welfare function lies on this region of the Pareto frontier. The welfare costs from inflation are bounded below by the area under the demand curve.

We develop an analytically tractable Phillips curve based on state‐dependent pricing. We consider a local approximation around a zero inflation steady state and introduce infrequent idiosyncratic shocks. The resulting Phillips curve is a simple variant of the conventional time‐dependent Calvo formulation with important differences. First, the model is able to match the micro evidence on the magnitude and timing of price adjustments. Second, our state‐dependent model exhibits greater flexibility in the aggregate price level than the time‐dependent model. With real rigidities present, however, our model can exhibit nominal stickiness similar to a conventional time‐dependent model.