Knowledge that Transforms

Despite the fact that the most theoretical analyses (with the notable exception of the Ricardian equivalence approach) indicate that increased deficits cause interest rates to rise, the empirical evidence is at best inconclusive.1 In this note the relationship between interest rates and deficits is examined with the announcement effect methodology which has not previously been used in this context. We find evidence of a positive relationship between unanticipated announcements of the projected Federal government deficit and interest rates. In an efficient market, information about any determinant of interest rates should be quickly incorporated into observed rates. Thus, when information about the size of the deficits is released, a relatively quick impact on interest rates can be anticipated. More specifically, if an increase in the deficit is, in fact, associated with higher interest rates, then an unanticipated announcement of a larger deficit should lead to a response in financial markets, which increases interest rates. This paper provides evidence on the announcement effects of information on the deficit. The advantage of the announcement effect approach is that it precludes the necessity of specifying a structural model for interest rates.2 Projections of current and future Federal government deficits are made on a regular basis by both the Office of Managementand Budget (OMB) and the Congressional Budget Office (CBO), and receive wide attention in the financial press. These projections provide data that are related to the change in interest rate on government securities from the day before the announcement to the end of the announcement day. The macroeconomic hypothesis underlying this investigation is simply that an increase in the current or future deficit leads to an increase in yields on government securities in anticipation of higher levels of debt financing. In a rational expectations framework, an announcement of higher future deficits will lead to a current increase in interest rates in anticipation of future financing. Thus, the examination of announcement effects enables us to substantiate a relationship between interest rates and deficits without encountering the econometric problems of reduced form modeling. Section I begins with a description of the data. This is followed by a discussion of the methodology in Section II. Section III presents the empirical results. This is followed by our conclusions in Section IV.

This paper argues that the empirical disagreement as to whether capital and energy are complements or substitutes is not likely to be reconciled with aggregate data. It demonstrates that price-induced changes in the composition of output can cause either outcome in the aggregate, even if no technical substitution is possible. Substitution by consumers and changes in the relative incomes of consumers and foreigners are identified as key factors in determining which outcome arises.

The family is distinguished from other social institutions, such as firms, by its crucial role in the production and nurture of children and its rationale is ultimately to be found in the preferences of individuals for own children. Sexual reproduction means that the production of one's own child requires the participation of another person of the opposite sex. The production of a child who will survive, become a successful adult, and produce his or her own children requires the expenditure of both personal and purchased resources over a lengthy period of time. Although interesting insights on the family can be culled from the classics, systematic development of the economics of the family is a recent phenomenon, beginning in the late 1950's when Harvey Leibenstein (1957) and Gary Becker (1960) attempted to address the determinants of fertility behavior within the framework of consumer theory. In this paper, I provide a brief overview of the history of family economics since 1960 and, along the way, offer a selective assessment of what has been learned from it. I attempt this assessment by asking how far we have progressed in answering a few of the larger theoretical, empirical, and policy questions that have motivated economists' interests in an area customarily studied by sociologists and demographers, or that have caused economists dealing with more traditional subject matter to incorporate the family into their work. Among the set of questions that have been addressed within the literature during the past twenty-five years are: 1) What are the causes of the historical association between economic growth and development and demographic transition from high to low levels of fertility and mortality? Of what relevance is the historical experience of currently developed countries to contemporary LDCs? Should fertility reduction be a primary goal of policy in the developing countries? Are the developed countries in danger of extinction because of fertility below replacement levels? 2) What was the cause of the post-World War II and subsequent bust? Was the baby boom a one-time aberration from a secular decline in fertility, or can we expect substantial fluctuations in the birth rate in the future? What are the consequences of the baby boom for the economic welfare of cohorts born during and after the boom? 3) Is the traditional family dead in the United States and other developed countries? Why did the divorce rate double in a decade? Why the growth in female-headed households? Why do so many divorced fathers fail to support their children? Has the sexual division of labor within the family changed as a consequence of the growth of female labor supply? To what extent are these changes in the family caused by social policy, and to what extent are they a product of basic market forces associated with modern economic development? What are the consequences of these changes for the welfare of future generations? I attempt to touch on some issues from each of the three areas in which the questions are grouped. However, constraints imposed by limitations of space, time, and most imtDiscussants: Kenneth Wolpin, Ohio State University; Robert Pollak, University of Pennsylvania; T. Paul Schultz, Yale University.

The study of discrimination received a major impetus in the 1960's when increasing social attention focused upon race and gender differentials in market outcomes. Gary Becker's The Economics of Discrimination (1957) strongly influenced empirical research by providing a definition of wage discrimination and suggesting a specific way in which it might operate. During the following years new theories were developed and refined in an attempt to explain why there appears to be continued discrimination in spite of market forces presumably operating against it. Similarly, a large amount of empirical work has been done to determine whether and how much discrimination actually exists, and to a lesser extent to test the implications of the various theories. Even so, the hope expressed by Becker in the preface of the second edition (1971) that our understanding of discrimination would increase so rapidly that the materials in his book would become obsolete before another decade began has clearly not been fulfilled. Here, we review what has been learned in the intervening years and suggest some fruitful directions for future research.1 The focus of this paper, like that of most of the empirical research in this area, is on determining the extent of discrimination rather than on testing alternative models of discrimination.

This paper describes an environment in which government-issued currency is dominated in rate of return and in which there obtains a Modigliani-Miller theorem for government open market operations. Earlier Modigliani-Miller theorems for government finance have been stated for environments in which government-issued currency is not dominated in rate of return in equilibrium. Since government-issued currency is widely observed to be dominated in return, it is useful to study how Modigliani-Miller theorems hinge on absence of rate of return dominance.

Those schooled in the shifting curves of static and steady-state macro models may not fully appreciate the dynamic nature of fiscal policy. Simple blackboard models can convey neither the timing nor the magnitude of responses to shortand intermediate-term fiscal policies, nor can they isolate the impact of fiscal policies on transitional generations. There is also a range of issues, such as deficit finance and the relative efficiency of alternative tax structures, that cannot be properly addressed without solving for the economy's transition path. Recent experience has provided several experiments in dynamic fiscal policy, including the accumulation of large amounts of official government debt, expected future changes in the level of social security benefits, shifts in the tax structure, and increases and then reductions in investment incentives. Each of these policies has important transitional as well as long-term effects. The analysis of these effects is possible using a dynamic general equilibrium numerical simulation model.

It is traditional in a discussion piece to organize the material in one of two ways. The writer can either take a historical perspective and attempt to explain how it is we got where we are today and where we are likely to go from here, or the writer can describe the current state of the art, dwelling on particular points of interest or promise in the prevailing research. Having quite recently done both, I thought I would take a somewhat different approach. I would like to try to briefly describe the main characteristics of a neoclassical theory of finance that captures the essential themes of modern finance and relate these characteristics to the general themes of economics. Finance uses the modeling framework constructed in economics but, within this scaffolding, finance has taken a different methodological perspective. It is wrong to characterize finance, or financial economics to be formal, as simply another of the specialty areas of economics-not unlike, for example, labor economics or development economics or public finance. While finance is specialized in its focus on the financial markets, the differences between economics and finance only begin there. The principal distinction is one of methodology rather than of focus. If labor markets behaved like financial markets, the theories of finance would be used to study them. Indeed, the line where financial theoretic analysis leaves off and more conventional patterns of economic reasoning begin is an active research issue.