Intergenerational Strategic Behavior and Crowding Out in a General Equilibrium Model

The return of large government budget deficits should encourage us to resume analysis of their effects. Two topics deserving further attention are the importance of correctly modeling the form of intergenerational relationships and clarification of the extent to which deficits crowd out private investment. This paper presents an overlapping generations model in which children seek to manipulate the size of the end-of-life bequest they receive from the parent – similar to the manipulation observed in the Samaritan’s dilemma. I first use numerical simulations to show this intergenerational strategic behavior does not negate the debt neutrality assertions of Ricardian equivalence. Then, by introducing capital gains and inheritance taxes, I show the crowding out effect of government debt is notably smaller in models with strategic behavior; manipulation by children increases the importance of bequests, which forces parents to save (and bequeath) a larger portion of a debt-financed tax cut. In spite of the neutrality of debt under lump sum taxes, including intergenerational strategic behavior can significantly influence the outcome of government tax policies. Given the restrictive nature of the conditions required for Ricardian equivalence to hold, it may be more useful to measure how near to or far from Ricardian equivalence a particular policy or economy comes rather than simply determining whether or not it holds in that environment.

A General-Equilibrium Analysis of Public Policy for Pharmaceutical Prices

Retail sales of prescription drugs totaled $154.5 billion in 2001. The National Institute for Health Care Management estimates annual sales will exceed$400 billion by the year 2010. This paper analyzes the welfare and distributional effects of two policy families that could be used to cope with high and rising pharmaceutical costs. We employ a general-equilibrium approach to contrast the current patented-monopoly system with a) a price ceiling imposed on the pharmaceutical sector of the economy; and b) a universal insurance program covering pharmaceutical purchases. We use a version of the Kelton and Wallace (1995) monopoly production environment: a two-good general-equilibrium model in which a license is required to produce one of the goods. Individuals in the model are heterogeneous with respect to preferences, but have identical production technologies and labor resources. Results indicate potential welfare gains for both the price-ceiling and universal-insurance policies, with very distinct distributional effects.

Ricardian equivalence survives strategic behavior

Robert Barro (1974) showed government debt has no real effects when generations are linked by altruistically motivated intergenerational transfers, a result now known widely as the Ricardian Equivalence Theorem. An important condition for debt neutrality is believed to be the absence of strategic interactions between members of different generations. I use a simple two-period, parent and child model in which the parent is altruistic, to show Ricardian equivalence holds in the presence of intergenerational strategic behavior for a broad class of utility functions. The intuition for this result derives from the fact that the child’s utility is a public good

Intergenerational strategic behavior and crowding out in a general equilibrium model

The return of large government budget deficits should encourage us to resume analysis of their effects. Two topics deserving further attention are the importance of correctly modeling the form of intergenerational relationships and clarification of the extent to which deficits crowd out private investment. This paper presents an overlapping generations model in which children seek to manipulate the size of the end-of-life bequest they receive from the parent – similar to the manipulation observed in the Samaritan’s dilemma. I first use numerical simulations to show this intergenerational strategic behavior does not negate the debt neutrality assertions of Ricardian equivalence. Then, by introducing capital gains and inheritance taxes, I show the crowding out effect of government debt is notably smaller in models with strategic behavior; manipulation by children increases the importance of bequests, which forces parents to save (and bequeath) a larger portion of a debt-financed tax cut. In spite of the neutrality of debt under lump sum taxes, including intergenerational strategic behavior can significantly influence the outcome of government tax policies. Given the restrictive nature of the conditions required for Ricardian equivalence to hold, it may be more useful to measure how near to or far from Ricardian equivalence a particular policy or economy comes rather than simply determining whether or not it holds in that environment

A Classroom Experiment on Exchange Rate Determination with Purchasing Power Parity

We develop a classroom experiment on exchange rate determination appropriate for undergraduate courses in macroeconomics and international economics. Students represent citizens from different countries and need to obtain currency to purchase goods. By participating in a sealed bid auction to buy currency, students gain a better understanding of currency markets and the determination of exchange rates. The implicit framework for exchange rate determination is one in which prices are perfectly flexible (in the long run) so that purchasing power parity (PPP) prevails. Additional treatments allow students to examine the impact of transport costs, nontradable goods and tariffs on the exchange rate and to explore possible deviations from PPP.

Using NAICS to Identify National Industry Cluster Templates for Applied Regional Analysis

Whereas FESER and BERGMAN, 2000, developed the concept of national-level cluster templates and introduced a systematic methodology to identify such clusters, their technique and results were based on the now-outdated Standard Industrial Classification (SIC) system for categorizing industries. We update their results using the 1997 Benchmark Input-Output Accounts for the United States, which are based on the North American Industry Classification System (NAICS). Since the treatment of services is much more comprehensive under NAICS, we are able to expand on the Feser and Bergman manufacturing templates to identify more comprehensive mixed-sector templates. The cluster templates we determine can provide a foundation for regional economic development strategies.

The Effect of Strategic Behavior on Ricardian Equivalence

The presence of strategic behavior is often believed to be sufficient to negate the neutrality assertions of the Ricardian Equivalence Theorem. I present a two-period, two-consumer (parent and child) model with one-sided altruism. The child behaves strategically in the sense that he seeks to manipulate the size of the parent's second period transfer. The parent behaves strategically as he seeks to minimize this manipulation. I show that, for general utility functions, this form of strategic behavior does not alter the effects of a change in the timing and incidence of a lump-sum tax. The intuition for this result derives from the fact that the child's utility is a public good. Under certain conditions (present in this model) wealth redistributions have no effect on total voluntary contributions to a public good

A Goldsmith Exercise for Learning Money Creation A Goldsmith Exercise for Learning Money Creation

Abstract: The paper outlines a classroom exercise involving goldsmiths designed to improve undergraduate students' understanding of how banks create money. This concept is important to Macroeconomics and Money and Banking courses, yet students frequently struggle with it, largely due to the non-physical nature of deposits and reserves. In contrast, gold-based banking systems tend to be more intuitive due to the physical nature of gold. By simulating interactions between a Goldsmith, a Depositor, a Merchant and a Borrower in a gold-based system students gain a deeper understanding of reserves and money creation. In particular the exercise illuminates the intricate link between lending and the creation of new money, and highlights the importance of fractional reserve banking and reserve deposits. Keywords: Classroom experiments, medium of exchange, money creation, banking JEL Codes: A22, E40, E51 3 This paper outlines a classroom exercise involving Goldsmiths designed to improve undergraduate students' understanding of how banks create money and the role of monetary policy in that process. These concepts are important components of many Introductory Macroeconomics and Money and Banking courses, yet students frequently struggle with them. One key reason is that in modern banking systems the money created by banks and the reserves created by central banks are electronic. The lack of physical form makes money creation seem abstract and enhances the misconception that the process is arbitrary. In contrast, specie-based banking systems are rooted in a commodity -usually gold -whose physical aspects are well known. By simulating money creation in a gold-based banking system students gain a more intuitive understanding of money creation, the importance of the reserve ratio and total reserves to this process, and, by extension, the ability of central banks to effect changes in the money supply. The exercise is inspired by several textbooks that introduce banks with a brief discussion of Goldsmiths, who were the first bankers (e.g., It builds on the insight that gold-based banking systems are more intuitive than fiat-based ones due to the physical nature of gold. In the exercise students pretend they are in the 18 th century and simulate interactions between a Goldsmith, a Gold Depositor, a Merchant and a Borrower. Through the interactions students establish how paper notes linked to a commodity are created (gold notes), how those notes become a medium of exchange, and how, through the lending process, Goldsmiths can create new money. They also see that money created in this manner can be linked to the purchase of a good or service and, therefore, to an increase in economic activity. 1 Through the exercise students also discover that Goldsmiths' ability to make new loans and create new money depends on the backing ratio maintained by the Goldsmith and the 4 amount of gold deposits held by the Goldsmith. In particular, students see that fractional reserve banking is necessary for money creation to occur. Students also discover that in order for Goldsmiths to create more money while keeping the backing ratio the same, they must increase their holdings of gold reserves. After understanding that electronic reserves are similar to gold holdings and that central banks control both the backing ratio of bank liabilities and the level of electronic reserves, students can better understand the important role that modern central banks play in determining banks' ability to make new loans and create new money. Finally, by asking students to create their own deposit and loan agreements, the exercise raises issues of adverse selection and moral hazard in credit markets and the mechanisms used in financial contracts to mitigate them. These topics can be explored in detail if the course and level of student preparation make it appropriate. It is not necessary to do so, however, for the main objectives of the exercise to be successful. The exercise also is similar to The paper is based on experiences running the exercise in a liberal arts college with classes between 20 and 35 students. It proceeds as follows. We first outline the necessary tools students should have for the exercise to be successful and the set-up of the exercise. We next describe each of four stages of the exercise and the final discussion. Finally, we offer some possible extensions. PRE-REQUISITES A main goal of the exercise is for students to establish the counterpart of modern deposits, loans, and reserves in a specie-based system. Therefore, for the exercise to be successful, students must have familiarity with the following concepts: the functions of money; the evolution of payment systems (specifically why economies moved from using commodity money to using representative paper money); the basic functions of a bank; and a basic bank balance sheet. Without this background it is difficult for students to discover the subtleties of the money creation process through the interactions modeled here. In particular, it is important that students track the Goldsmith's transactions in a balance sheet. This usually necessitates experience outlining modern bank transactions in a balance sheet. It is not necessary, however, for students 6 to have familiarity with central banks or the tools of monetary policy. Indeed, this exercise provides a logical lead into these topics. THE SET-UP The exercise takes a full class period and requires the materials described below. 2 The number of students needs to be sufficiently small such that they can form groups of four, engage in various interactions within the group, and discuss the outcomes with the entire class. If the number of students is not divisible by four, the instructor can allow for groups of five that include more than one Merchant. To start the exercise, students form groups of four in whatever way the instructor deems optimal. 3 Each group is given the items described below. We have developed examples of all of these items, particularly the student record sheets, which incorporate many of the questions we suggest instructors ask during this exercise. These examples are available on the websites of both authors

A general-equilibrium analysis of public policy for pharmaceutical prices

Retail sales of prescription drugs totaled $154.5 billion in 2001. The National Institute for Health Care Management estimates annual sales will exceed$400 billion by the year 2010. This paper analyzes the welfare and distributional effects of two policy families that could be used to cope with high and rising pharmaceutical costs. We employ a general-equilibrium approach to contrast the current patented-monopoly system with a) a price ceiling imposed on the pharmaceutical sector of the economy; and b) a universal insurance program covering pharmaceutical purchases. We use a version of the Kelton and Wallace (1995) monopoly production environment: a two-good general-equilibrium model in which a license is required to produce one of the goods. Individuals in the model are heterogeneous with respect to preferences, but have identical production technologies and labor resources. Results indicate potential welfare gains for both the price-ceiling and universal-insurance policies, with very distinct distributional effects

Using NAICS to identify national industry cluster templates for applied regional analysis

Whereas FESER and BERGMAN, 2000, developed the concept of national-level cluster templates and introduced a systematic methodology to identify such clusters, their technique and results were based on the now-outdated Standard Industrial Classification (SIC) system for categorizing industries. We update their results using the 1997 Benchmark Input-Output Accounts for the United States, which are based on the North American Industry Classification System (NAICS). Since the treatment of services is much more comprehensive under NAICS, we are able to expand on the Feser and Bergman manufacturing templates to identify more comprehensive mixed-sector templates. The cluster templates we determine can provide a foundation for regional economic development strategies