Money, Imperfect Information and Economic Fluctuations

This paper summarizes the macro-economic and, in particular, monetary and financial market implications of recent developments in the micro-economic theory of imperfect information. These micro-economic models which lead to credit-rationing on the one hand and limitations in the availability of equity type financing on the other can account for a wide range of observed business cycle and monetary phenomena. These include (a) unemployment, (b) the existence of Keynesian-type multiples, (c) the observed lack of production smoothing in response to cyclical fluctuations in demand, (d) the impact of monetary policy on business activity despite the absence of significant changes in real interest rates, and (e) price rigidities which arise from rational firm decisions (not as an a priori assumption).

Pareto Inefficiency of Market Economies: Search and Efficiency Wage Models

This paper shows that market economies with search and in which wages are affected by efficiency wage considerations are not constrained Pareto efficient. Wages are not set at Pareto efficient levels, nor is the level of employment (unemployment) Pareto efficient. We identify the nature of the biases and the welfare improving government interventions.

Pecuniary & Market Mediated Externalities: Towards a General Theory of the Welfare Economics & Economies with Imperfect Information & Incomplete Mrkts

This paper presents a simple but quite general framework for analyzing the impact of informational externalities. By identifying the traditional pecuniary effect of these externalities which nets out,the paper greatly simplifies the problem of determining when tax interventions can be Pareto improving. In some cases it also leads to simple tests, based on readily observable indicators of the efficacy of a particular tax policy. The framework of the paper is used to analyze adverse selection, signalling, moral hazard, incomplete contingent claim markets and queue rationing equilibria.

Financial Market Imperfections and Business Cycles

This paper develops a simple model of macroeconomic behavior which incorporates the impact of financial market "imperfections," such as those generated by asymmetric information in financial markets. These information asymmetries may lead to breakdowns in markets, like that for equity, in which risks arm shared. In particular, we analyze firm behavior in the presence of equity rationing and imperfect futures markets, in which there are lags in production. Aft a consequence, firms act in a risk-averse manner. We trace out the macroeconomic consequences, and show that they are able to account for many of the widely observed aspects of actual business cycles.

Asymmetric Information and the New Theory of the Firm: Financial Constraints and Risk Behavior

This paper summarizes recent developments in the theory of the firm that have arisen in examining the implications of imperfect information. It shows that a wide range of these models have similar implications for the likely reaction of firms to external environmental and policy changes. Two significant implications are (1) that firms behave as if they are risk averse individuals maximizing a utility function of terminal wealth (profitability) -- even when the risks involved are unsystematic -- and (2), in many circumstances, because this utility function is likely to be characterized by decreasing absolute risk aversion, firms are likely to respond significantly (and positively) to changes in cash flow and profitability. Together these two phenomena are able to account for a wide range of firm behaviors that have been empirically observed (both formally and informally) and that are difficult to explain in terms of the traditional theory of the firm. Furthermore, the responses of such firms to policy interventions are likely to differ significantly from those of neoclassical firms.

Financial Market Imperfections and Productivity Growth

This paper examines the impact of financial market imperfections on long-term productivity growth. It focuses on failures in markets for the sale of equity securities and hence on the failure of markets which help firms diversify the risks of real investment. The paper examines separately situations in which productivity growth is driven by learning-by-doing and where it results from the cumulative impact of explicit investments in technology by firms, In general, a multiplicity of steady-state growth paths exists with different growth rates along each path. The particular path followed by any single economy (and hence the growth rate of that economy) will depend significantly on policy interventions which mitigate effects of financial markets.

Informational Imperfections in the Capital Market and Macro-Economic Fluctuations

This paper describes the role that informational imperfections in capital markets are likely to play in business cycles. It then developes a simple illustrative model of the impact of adverse selection in the equity market and the way in which this may lead to large fluctuations in the effective cost of capital in response to relatively small demand shocks. The model also derives an expression for the cost of equity capital in the presence of adverse selection and provides informational explanations for several widely observed macro-economic phenomena.

The Asymmetric Effect of Diffusion Processes: Risk Sharing and Contagion

We provide a general characterization of diffusion processes, allowing to analyze both risk-sharing and contagion at the same time. We show that interdependencies are beneficial when the economic environment is favorable, and detrimental when the economic environment deteriorates. The risk of contagion increases the volatility of outcome and thus reduces the ability of the network to provide risk-sharing.Risk-sharing, Contagion, Networks.

Impact of the Changing Tax Environment on Investments and Productivity: Financial Structure and the Corporation Income Tax

This paper explores the consequences of the corporation income tax when firms face financial constraints; that is, they are either credit- or equity-rationed. (These financial constraints can, in turn, be explained as the natural consequences of informational asymmetries that are pervasive in the capital market.) The paper shows that the effect of such taxes may be more related to average tax rates than to the marginal effective tax rates on which recent literature, analyzing the incidence of such taxes in neoclassical firms, has focused. For firms that are equity- (but not credit-) constrained, the reduction in retained earnings reduces their willingness to undertake risky investments, including R-and-D expenditures which enhance productivity in the long run. More generally, the impact of the tax depends on the structure of taxes as much as it does on the level (the provisions for tax deductibility of interest, the tax treatment of capital gains, and so forth), and an analysis requires taking into account the combined effects of the corporation and individual income tax structures. For instance, for firms that are neither equity-nor credit-constrained, the fact that interest payments are tax-deductible implies that there are no marginal distortions with respect to the level of investment. Higher differential taxes on equity may induce some firms to decide not to issue equity. This financial decision will be accompanied by a discrete reduction in the level of investment