Inflation and output dynamics with firm-owned capital

We model firm-owned capital in a stochastic dynamic New-Keynesian general equilibrium model à la Calvo. We find that this structure implies equilibrium dynamics which are quantitatively di¤erent from the ones associated with a benchmark case where households accumulate capital and rent it to firms. Our findings therefore stress the importance of modeling an investment decision at the firm level–in addition to a meaningful price setting decision. Along the way we argue that the problem of modeling firm-owned capital with Calvo price-setting has not been solved in a correct way in the previous literature.Monetary policy shocks, sticky prices, investments

Firm-Specific Investment, Sticky Prices, and the Taylor Principle

According to the Taylor principle a central bank should adjust the nominal interest rate by more than one for one in response to changes in current in?ation. Most of the existing literature supports the view that by following this simple recommendation a central bank can avoid being a source of unnecessary ?uctuations in economic activity. The present paper shows that this conclusion is not robust with respect to the modelling of capital accumulation. We use our insights to discuss the desirability of alternative arrangements for the conduct of monetary policy.international banking, portfolio diversification, international integration

Pitfalls in the Modelling of Forward-Looking Price Setting and Inverstment Behavior

We discuss some di?culties in a dynamic New-Keynesian model with staggered price setting à la Calvo and a convex capital adjustment cost at the firm level, as considered by Woodford (2003, Ch. 5). It is shown that the implied simultaneous price setting and investment decision has not been analyzed properly. Our work fills that gap by proposing a tractable solution to the key problem of describing the inflation dynamics associated with that structure. We use our framework to assess to what extent capital accumulation matters for inflation and output dynamics. JEL Classification: E22, E31Sticky Prices; Investments

Firm-specific capital, nominal rigidities, and the Taylor principle

In the presence of firm-specific capital the Taylor principle can generate multiple equilibria. Sveen and Weinke (2005b) obtain that result in the context of a Calvo-tyle sticky price model. One potential criticism is that the price stickiness which is needed for our theoretical result to be relevant from a practical point of view is somewhat to the high part of available empirical estimates. In the present paper we show that if nominal wages are not fully flexible (which is an uncontroversial empirical fact) then the Taylor principle fails already for some minor degree of price stickiness. We use our model to explain the consequences of both nominal rigidities for the desirability of alternative interest rate rules.Nominal Rigidities, Aggregate Investment, Monetary Policy.

Is lumpy investment really irrelevant for the business cycle?

New-Keynesian (NK) models can only account for the dynamic effects of monetary policy shocks if it is assumed that aggregate capital accumulation is much smoother than it would be the case under frictionless firm-level investment, as discussed in Woodford (2003, Ch. 5). We find that lumpy investment, when combined with price stickiness and market power of firms, can rationalize this assumption. Our main result is in stark contrast with the conclusions obtained by Thomas (2002) in the context of a real business cycle (RBC) model. We use our model to explain the economic mechanism behind this difference in the predictions of RBC and NK theory.Lumpy investment, Sticky prices

Distinct patterns of neural activity during memory formation of nonwords versus words

Research into the neural underpinnings of memory formation has focused on the encoding of familiar verbal information. Here, we address how the brain supports the encoding of novel information that does not have meaning. Electrical brain activity was recorded from the scalps of healthy young adults while they performed an incidental encoding task (syllable judgments) on separate series of words and "nonwords" (nonsense letter strings that are orthographically legal and pronounceable). Memory for the items was then probed with a recognition memory test. For words as well as nonwords, event-related potentials differed depending on whether an item would subsequently be remembered or forgotten. However, the polarity and timing of the effect varied across item type. For words, subsequently remembered items showed the Usually observed positive-going, frontally distributed modulation from around 600 msec after word onset. For nonwords, by contrast, a negative-going, spatially widespread modulation predicted encoding success from 1000 rnsec onward. Nonwords also showed a modulation shortly after item onset. These findings imply that the brain supports the encoding of familiar and unfamiliar letter strings in qualitatively different ways, including the engagement of distinct neural activity at different points in time. The processing of semantic attributes plays an important role in the encoding of words and the associated positive frontal modulation

Firm-specific investment, sticky prices and the Taylor principle

According to the Taylor principle a central bank should adjust the nominal interest rate by more than one-for-one in response to changes in current inflation. Most of the existing literature supports the view that by following this simple recommendation a central bank can avoid being a source of unnecessary fluctuations in economic activity. The present paper shows that this conclusion is not robust with respect to the modelling of capital accumulation. We use our insights to discuss the desirability of alternative interest rate rules. Our results suggest a reinterpretation of monetary policy under Volcker and Greenspan: The empirically plausible characterization of monetary policy can explain the stabilization of macroeconomic outcomes observed in the early eighties for the US economy. The Taylor principle in itself cannot.Sticky prices, aggregate investment, monetary policy

Pitfalls in the modeling of forward-looking price setting and investment decisions

The present paper makes progress in explaining the role of capital for inflation and output dynamics. We followWoodford (2003, Ch. 5) in assuming Calvo pricing combined with a convex capital adjustment cost at the firm level. Our main result is that capital accumulation affects inflation dynamics primarily through its impact on the marginal cost. This mechanism is much simpler than the one implied by the analysis in Woodford's text. The reason is that his analysis suffers from a conceptual mistake, as we show. The latter obscures the economic mechanism through which capital affects inflation and output dynamics in the Calvo model, as discussed in Woodford (2004).Sticky prices, investments

Firm-specific capital and welfare

What are the consequences for monetary policy design implied by the fact that price setting and investment takes typically place simultaneously at the firm level? To address this question we analyze simple (constrained) optimal interest rate rules in the context of a dynamic New Keynesian model featuring firm-speci.c capital accumulation as well as sticky prices and wages à la Calvo. We make the case for Taylor type rules. They are remarkably robust in the sense that their welfare implications do not appear to hinge neither on the speci.c assumptions regarding capital accumulation that are used in their derivation nor on the particular definition of natural output that is used to construct the output gap. On the other hand we find that rules prescribing that the central bank does not react to any measure of real economic activity are not robust in that sense.Monetary policy, Sticky prices, Aggregate investment

Savers, Spenders and Fiscal Policy in a Small Open Economy

This paper analyzes the effects of fiscal policy in an open economy. We extend the savers-spenders theory of Mankiw (2000) to a small open economy with endogenous labor supply. We first show how the Dornbusch (1983) consumption-based real interest rate for open economies is modified when labor supply is endogenous. We then turn to the effects of fiscal policy when there are both savers and spenders. With this heterogeneity taken into account, tax cuts have a short-run contractionary effect on domestic production, and increased public spending has a short-run expansionary effect. Although consistent with recent empirical work, this result contrasts with those of most other theoretical models. Transitory changes in demand have permanent real effects in our model, and we discuss the implications for real exchange-rate dynamics. We also show how "rational" savers may magnify or dampen the responses of "irrational" spenders, and show how this is related to features of the utility functions.rule-of-thumb consumers;fiscal policy;open economy.