Knowledge that Transforms

Employing continuous arbitrage pricing principles, closed-form expressions for the term structure of interest rates as functions of two specific rates are developed. Model restrictions to the two one-dimensional submodels are tested and rejected, thereby supporting the hypothesis that the term structure is at least two-dimensional. Evidence is also presented that supports the view that the informational content of the term structure lies in its longer maturities.

Permanent sector-specific productivity shocks alter the relative marginal products of capital and labor across sectors, such that the existing factor allocations are suboptimal. The subsequent factor reallocations may involve the costly movement and redeployment of capital and labor across sectors. To proxy the magnitude of these disturbances, this paper focuses on capital, rather than labor, allocative disturbances, since firms can make temporary adjustments in employment levels in response to transitory sectoral shocks. Empirical evidence is provided that these costs reduce output from what it otherwise would have been and that this effect persists for up to three quarters.

The hypothesis that consumption evolves over time as a martingale process is tested on household panel data for three villages in south India. A novel feature of the methodology is that it gives consistent estimates of dynamic effects in short panels. The estimated coefficients of lagged consumption are generally smaller than unity and a number of the lagged income and wealth variables are statistically significant. The results are inconsistent with the proposition that consumption equals permanent income. This is also true when the data are disaggregated by household wealth.

Economic models of politics typically use the expected value of a candidate's vote share to proxy electoral probability. In this paper, the authors introduce a risk calculation to augment the evaluation of a candidate's (or party's) expected vote share and they divide this risk element into its systematic and unsystematic components. For the same reason that systematic risk is a primary focus of portfolio management, the authors discover that an analogous systematic risk component is central to presidential elections. Their approach accounts for correlations in vote swings among states, piercing the fiction of a state-by-state or 'local' campaign strategy.

A popular theory of optimal tax policies suggests that tax rates should follow a random walk. This paper extends the existing empirical literature in three ways. First, the impact on the marginal utility of consumption when the government chooses a tax plan to smooth the distorting impact of taxes is considered. Second, exogenous changes in the real rate of interest are incorporated into the government's optimal tax plan. Finally, the tax elasticity of output is not constant over time. Allowing for these changes, there is evidence that the government discounts the future, attempts to smooth the distorting impact of taxes on the marginal utility of consumption, and that the tax elasticity of output moves predictably during wars.

Using Canadian data (1965-86), the author confirms and extends Thomas M. Stoker's (1986) results on the rule of distributional effects in demand systems. The confirmation consists of evidence from the linear expenditure system model showing that distributional effects are statistically significant and can displace AR(1) dynamics in the disturbances. The extension is made to the quadratic expenditure system model and an argument is advanced that standard habit formation dynamics may reflect omitted distributional effects. The evidence supports this conjecture. This suggests that the author may have been drawing the wrong conclusions from expenditure studies. Rather than inferring dynamic behavior, he should have been concluding that these models are misspecified.

In this paper, the author obtains and interprets estimates of short- and long-run demand for money in the United King dom in the period 1871-1913 utilizing high-quality data on broad money and its determinants and applying recent econometric techniques. A unique, theoretically consistent long-run function is estimated as well as a short-run dynamic demand function that is formally superio r to a number of previous estimates.

This paper examines the influence of credit conditions on private investment under financial repression in Greece. Three flexible accelerator investment specifications are estimated. Alternative measures are tried for the dependent and independent variables. The reported equations are selected by a simple sequential specialization procedure. The empirical results confirm the existence of an important, but lagged, effect of bank finance on investment. This reflects credit rationing, due to interest rate controls, in the Greek banking system. Various arguments from the financial repression literature are invoked to justify the finding of a positive sign on the user cost variables in the investment equations.

Maxwell L. King, Thomas S. Shively, Locally Optimal Testing When a Nuisance Parameter is Present Only Under the Alternative, The Review of Economics and Statistics, Vol. 75, No. 1 (Feb., 1993), pp. 1-7

The demand for two custom calling services is investigated. The services may be bought individually or in a discounted package. A micro-theory based on discrete choice model is formulated that explicitly accounts for these purchase options. The model is estimated assuming both dependence and independence of the unobservable choice-influencing variables. The estimated parameters are used to simulate the revenue impact of price and discount changes.