Knowledge that Transforms

In this paper, we derive principles of optimal cyclical monetary policy in an economy without capital, with a cash-in-advance restriction on household transactions, and monopolistic firms that set prices one period in advance. The only distortionary policy instruments are the nominal interest rate and the money supply. In this environment it is feasible to undo both the cash-in-advance and price setting restrictions, but not the distortion due to monopolistic competition. We show that it is optimal to follow the Friedman rule, and thus offset the cash-in-advance restriction. We also find that, in general, it is not optimal to undo the price setting restriction, so that a simple criterion of eliminating gaps is not optimal. Sticky prices provide the planner with tools to improve upon a distorted flexible price allocation.

Venture capital financing is characterized by extensive use of convertible securities and stage financing. In a model where a venture capitalist provides staged financing for a project, we illustrate an advantage of convertible debt (or warrants) over a mixture of debt and equity. Essentially, when the venture capitalist retains the option to abandon the project, the entrepreneur has an incentive to engage in window dressing and bias positively the short-term performance of the project, reducing the probability that it will be liquidated. An appropriately designed convertible security prevents such behaviour because window dressing also increases the probability that the venture capitalist will exercise the conversion option becoming the owner of a substantial fraction of the project's equity.

A bivariate simultaneous discrete response model which is a stochastic representation of equilibria in a two-person discrete game is studied. The presence of multiple equilibria in the underlying discrete game maps into a region for the exogenous variables where the model predicts a nonunique outcome. This is an example of an incomplete econometric structure. Economists using this model have made simplifying assumptions to avoid multiplicity. I make a distinction between incoherent models and incomplete models, and then analyse the model in the presence of multiple equilibria, showing that the model contains enough information to identify the parameters of interest and to obtain a well defined semiparametric estimator. I also show that the latter is consistent and √n normal. Moreover, by exploiting the presence of multiplicity, one is able to obtain a more efficient estimator than the existing methods. Copyright 2003, Wiley-Blackwell.

This paper studies the theoretical conditions under which price stability is the optimal policy in a two-country open-economy model with imperfect competition and price stickiness. Special conditions on the levels of country-specific distortionary taxation and the intratemporal and intertemporal elasticities of substitution need to be satisfied. These restrictions apply to both cooperative and non-cooperative settings. Importantly, we show that cooperative and non-cooperative solutions do not coincide despite market completeness and producer currency pricing. We study the conditions under which quadratic approximations of single countries' welfare can be correctly evaluated by relying only on log-linear approximations of the equilibrium conditions.

During the 1980's, all Japanese automobile producers opened assembly plants in North America. Industry analysts and previous research claim that these transplants are more productive than incumbent plants and that they produce with a substantially different production process. I compare the production processes by estimating a model that allows for heterogeneity in technology and productivity, both of which are intrinsically unobservable. The model is estimated on a panel of assembly plants, controlling for capacity utilization and price effects. The results indicate that the more recent technology uses capital more intensively and it has a higher elasticity of substitution between labour and capital. Hicks-neutral productivity growth is estimated to be lower, while capital-biased (labour-saving) productivity growth is higher for the new technology. Using the estimation results, I decompose industry-wide productivity growth and find plant-level changes in lean plants to be the most important contributor. Plant-level productivity growth is further decomposed to reveal the importance of capital-biased productivity growth, increases in the capital-labour ratio, and returns to scale.

We add to the methods for conditioning out serially correlated unobserved shocks to the production technology. We build on ideas first developed in They show how to use investment to control for correlation between input levels and the unobserved firm-specific productivity process. We show that intermediate inputs (those inputs which are typically subtracted out in a value-added production function) can also solve this simultaneity problem. We discuss some theoretical benefits of extending the proxy choice set in this direction and our empirical results suggest these benefits can be important.

This paper analyses the interactions between growth and the contracting environment in production. With incompleteness in contracting, viable production relationships between firms and workers, and therefore the profitability of industries, depend on the rates of innovation and growth. The speed at which new innovations arrive in turn depends on the profitability of production, for the usual reasons examined in the endogenous growth literature. We show that these interactions can have important implications which are consistent with observed phenomena in both the micro and macro environments. In particular, we demonstrate that a technological shock (increasing productivity of research) can, through this interaction, lead to a productivity slowdown and a shift in labour market contracts away from firms providing implicit guarantees of lifetime employment and towards shorter-term “contractor” type arrangements. We show the consistency of an increase in the proportion of the labour force under short-term employment, increased relative returns of workers in high-productivity sectors, and increased income inequality, with a productivity slowdown of finite duration.