Is public capital productive? A review of the evidence

An examination of the empirical evidence regarding the productive effects of public capital on the U.S. economy, concluding that although boosting infrastructure investment might have a positive impact on private output, the magnitude of the effect is unclear.Infrastructure (Economics) ; Investments

Dynamic optimal fiscal and monetary policy in a business cycle model with income redistribution

An estimation of an optimal program of distortionary taxes, money growth, and borrowing to finance a stream of expenditures based on a real business cycle model in which distribution issues between the rich and poor play a fundamental role in policy decisions.Business cycles ; Monetary policy ; Income distribution

Optimal fiscal policy when public capital is productive: a business cycle perspective

A presentation of a dynamic general-equilibrium model with productive public capital to help account for differences in the business cycle characteristics of public- versus private- sector expenditures in postwar U.S. data.Business cycles ; Fiscal policy

Speculative growth and overreaction to technology shocks

This paper develops a stochastic endogenous growth model that exhibits “excess volatility” of equity prices because speculative agents overreact to observed technology shocks. When making forecasts about the future, speculative agents behave like rational agents with very low risk aversion. The speculative forecast rule alters the dynamics of the model in a way that tends to confirm the stronger technology response. For moderate levels of risk aversion, the forecast errors observed by the speculative agent are close to white noise, making it difficult for the agent to detect a misspecification of the forecast rule. In model simulations, I show that this type of behavior gives rise to intermittent asset price bubbles that coincide with improvements in technology, investment and consumption booms, and faster trend growth, reminiscent of the U.S. economy during the late 1920s and late 1990s. The model can also generate prolonged periods where the price-dividend ratio remains in the vicinity of the fundamental value. The welfare cost of speculation (relative to rational behavior) depends crucially on parameter values. Speculation can improve welfare if actual risk aversion is low and agents underinvest relative to the socially-optimal level. But for higher levels of risk aversion, the welfare cost of speculation is large, typically exceeding one percent of per-period consumption.Asset pricing ; Technology

Time-Varying U.S. Inflation Dynamics and the New Keynesian Phillips Curve

This paper introduces a form of boundedly-rational expectations into an otherwise standard New-Keynesian Phillips curve. The representative agent's forecast rule is optimal (in the sense of minimizing mean squared forecast errors), conditional on a perceived law of motion for inflation and observed moments of the inflation time series. The perceived law of motion allows for both temporary and permanent shocks to inflation, the latter intended to capture the possibility of evolving shifts in the central bank's inflation target. In this case, the agent's optimal forecast rule defined by the Kalman filter coincides with adaptive expectations, as shown originally by Muth (1960). I show that the perceived optimal value of the gain parameter assigned to the last observed inflation rate is given by the fixed point of a nonlinear map that relates the gain parameter to the autocorrelation of inflation changes. The model allows for either a constant gain or variable gain, depending on the length of the sample period used by the agent to compute the autocorrelation of inflation changes. In the variable-gain setup, the equilibrium law of motion for inflation is nonlinear and can generate time-varying inflation dynamics similar to those observed in long-run U.S. data. The model's inflation dynamics are driven solely by white-noise fundamental shocks propagated via the expectations feedback mechanism; all monetary policy-dependent parameters are held constantInflation Expectations, Phillips Curve, Time-Varying Persistence & Volatility

Some new variance bounds for asset prices: a comment

Engel (2005) derives a theoretical variance inequality involving the change in equilibrium stock prices Var ( p) : Assuming that stock prices are "cum-dividend" and that investors are risk neutral, he shows that Var ( p) must be greater than or equal to the variance of the "perfect foresight" (or "ex post rational") price change Var ( p*) ; where p* is computed from the discounted stream of subsequent realized dividends. This paper expands the analysis to consider "ex-divdend" prices and risk aversion in a standard Lucas-type asset pricing model. I show that the direction of the price-change variance inequality can be reversed, depending on the values assigned to some key parameters of the model, namely the dividend AR(1) parameter, the investor's subjective time discount factor, and the coefficient of relative risk aversion. Overall, the results demonstrate that the present-value model of stock prices does not impose theoretical bounds on price-change volatility except in some special cases.Asset pricing

Asset pricing with concentrated ownership of capital

This paper investigates how concentrated ownership of capital influences the pricing of risky assets in a production economy. The model is designed to approximate the skewed distribution of wealth and income in U.S. data. I show that concentrated ownership significantly magnifies the equity risk premium relative to an otherwise similar representative-agent economy because the capital owners' consumption is more strongly linked to volatile dividends from equity. A temporary shock to the technology for producing new capital (an "investment shock") causes dividend growth to be much more volatile than aggregate consumption growth, as in long-run U.S. data. The investment shock can also be interpreted as a depreciation shock, or more generally, a financial friction that affects the supply of new capital. Under power utility with a risk aversion coefficient of 3.5, the model can roughly match the first and second moments of key asset pricing variables in long-run U.S. data, including the historical equity risk premium. About one-half of the model equity premium is attributable to the investment shock while the other half is attributable to a standard productivity shock. On the macro side, the model performs reasonably well in matching the business cycle moments of aggregate variables, including the pro-cyclical movement of capital's share of total income in U.S. data.Asset pricing ; Capital

Optimal fiscal policy when public capital is productive: a business- cycle perspective

An examination of the business cycle implications of productive public capital in a two-sector, dynamic general-equilibrium model with optimal fiscal policy. In simulations, public investment and public consumption move procyclically, and the capital tax is more variable than the labor tax--features also observed in annual U.S. data.Capital ; Fiscal policy

Time-Varying U.S. Inflation Dynamics and the New Keynesian Phillips Curve

This paper introduces a form of boundedly-rational expectations into an otherwise standard New Keynesian Phillips curve. The representative agent's forecast rule is optimal, conditional on a perceived law of motion for inflation and observed moments of the inflation time series. The perceived law of motion allows for both temporary and permanent shocks, the latter intended to capture the possibility of evolving shifts in the central bank's inflation target. In this case, the agent's optimal forecast rule defined by the Kalman filter coincides with adaptive expectations, as shown originally by Muth (1960). I show that the perceived optimal value of the Kalman gain parameter is given by the fixed point of a nonlinear map that relates the gain to the autocorrelation of inflation changes. The model allows for either a constant gain or variable gain, depending on the length of the sample period used by the agent to compute the autocorrelation of inflation changes. In the variable-gain setup, the law of motion for inflation is nonlinear and can generate time-varying inflation dynamics similar to those in long-run U.S. data. The model's inflation dynamics are driven solely by white-noise fundamental shocks propagated via the expectations feedback mechanism; all monetary policy-dependent parameters are held constantInflation Expectations, Phillips Curve, Time-Varying Persistence and Volatility

Fiscal policy, increasing returns, and endogenous fluctuations

We examine the quantitative implications of government fiscal policy in a discrete-time one-sector growth model with a productive externality that generates social increasing returns to scale. Starting from a laissez-faire economy that exhibits an indeterminate steady state (a sink), we show that the introduction of a constant capital tax or subsidy can lead to various forms of endogenous fluctuations, including stable 2-, 4-, 8-, and 10- cycles, quasi-periodic orbits, and chaos. In contrast, a constant labor tax or subsidy has no effect on the qualitative nature of the model's dynamics. We also show that the use of local steady-state analysis to detect the presence of multiple equilibria in this class of models can be misleading. For a plausible range of capital tax rates, the log-linearized dynamical system exhibits saddle-point stability (suggesting a unique equilibrium) while the true nonlinear model exhibits global indeterminancy. Finally, we explore the use of a state-contingent capital subsidy/tax scheme for stabilization purposes. We show that a local control policy designed using the log-linearized model can rule out sunspot equilibria near the steady state but may not prevent fluctuations arising from global indeterminacy. We proceed to use the nonlinear model to design a policy that can stabilize the economy against all forms of endogenous fluctuations and select a globally unique equilibrium.Fiscal policy ; Business cycles ; Chaotic behavior in systems