Optimal Inflation Policy

This paper considers the problem of optimal long run monetary policy. It shows that optimal inflation policy involves trading off two quite different considerations. First, increases in the rate of inflation tax the holding of many balances, leading to a deadweight loss as excessive resources are devoted to economizing on cash balances. Second, increases in the rate of inflation raise capital intensity. As long as the economy has a capital stock short of the golden rule level, increases in capita intensity raise the level of consumption. Ignoring the second consideration leads to the common recommendation that the money growth rate be set so that the nominal interest rate is zero. Taking it into account can lead to significant modifications in the "full liquidity rule." Inter-actions of inflation policy with financial intermediation and taxation are also considered. The results taken together suggest that inflation can have important welfare effects, and that optimal inflation policy is an empirical question, which depends on the structure of the economy.

Estimating the Long-Run Relationship Between Interest Rates and Inflation: A Response to McCallum

This note demonstrates that Bennett McCallum's recent critique of low frequency estimates of macro-economic relationships is of little empirical significance. It also demonstrates that readily available and frequently used techniques can be used to diagnose the problem McCallum raises. Finally, it shows that the standard critique of expectational distributed lags is not warranted once the role of learning by economic agents is recognized.

The After Tax Rate of Return Affects Private Savings

This paper reviews theoretical argumrents and empirical evidence regarding the interest elasticity of savings. It concludes that there are strong theoretical reasons to expect an increase in after tax rates of return to increase private savings. Moreover, the empirical rrethods used in most previous studies are likely to produce underestimates of the interestelasticity of savings. New evidence based on direct estimation of utility function parameters suggests that savings are likely to be highly interest elastic. The paper concludes by noting that too little time has passed to evaluate the effects of the savings incentives contained in recent tax legislation.

Do We Really Know That Financial Markets Are Efficient?

This paper examines the power of statistical tests commonly used to examine the efficiency of speculative markets. It shows that for markets with "long horizons" such as the stock markets, or the market for long term bonds, these tests have very low power. Market valuations can differ substantially and persistently from the rational expectation of the present value of cash flows without leaving statistically discernible traces in the pattern of ex-post returns. This observation also suggests that speculation is unlikely to insure rational valuations, since similar problems of identification plague both financial economists and would-be speculators.

Relative Wages, Efficiency Wages, and Keynesian Unemployment

While modern economic theorists have produced a variety of explanations for the failure of wages to fall in the face of unemployment, Keynes emphasis on relative wages has not been reflected in most contemporary discussions. This short paper suggests that relative wage theories in which workers' productivity depends primarily on their relative wage provide the best available apparatus for understanding actual unemployment and its fluctuations. Such theories are very closely related to the efficiency wage theories that have received widespread attention in recent years.