Model fit and model selection

This paper uses an example to show that a model that fits the available data perfectly may provide worse answers to policy questions than an alternative, imperfectly fitting model. The author argues that, in the context of Bayesian estimation, this result can be interpreted as being due to the use of an inappropriate prior over the parameters of shock processes. He urges the use of priors that are obtained from explicit auxiliary information, not from the desire to obtain identification.Econometric models ; Macroeconomics

Inflation and growth - commentary

Inflation (Finance)

Creating business cycles through credit constraints.

Business cycles appear to be large, persistent, and asymmetric relative to the shocks hitting the economy. This observation suggests the existence of an asymmetric amplification and propagation mechanism, which transforms the shocks into the observed movements in aggregate output. This article demonstrates, in a small open economy, how credit constraints can be such a mechanism. The article also shows, however, that the quantitative significance of the amplification which credit constraints can provide is sensitive to the quantitative specification of the underlying economy (especially factor shares).Business cycles

Looking for evidence of time-inconsistent preferences in asset market data.

This study argues that strong evidence contradicting the traditional assumption of time-consistent preferences is not available. The study builds and analyzes the implications of a deterministic general equilibrium model and compares them to data from the U.S. asset market. The model implies that (1) because of dynamic arbitrage, the prices of retradable assets cannot reveal whether preferences are time-inconsistent; but (2) the prices of commitment assets, investments which must be held for their lifetime, can. These prices will be higher than the present values of their future payoffs only when preferences are time-inconsistent. And (3) when preferences are time-inconsistent, people will not hold both retradable and commitment assets. Empirical observations on two examples of commitment assets—education and individual retirement accounts—are not consistent with these model implications.Asset pricing ; Equilibrium (Economics) - Mathematical models

Building blocks for barriers to riches

Total factor productivity (TFP) differs greatly across countries. In this paper, I provide a novel rationalization for these differences. I consider two environments, one in which enforcement is full and the other in which enforcement is limited. In both settings, manufactured goods can be produced using a high-TFP technology or a low-TFP technology; there is a fixed cost associated with adoption of the former. I suppose that the fixed cost is sufficiently small that adoption takes place in a symmetric Pareto optimum in the limited-enforcement setting. Under this condition, I prove two results. First, adoption takes place in all Pareto optima in the full-enforcement setting. Second, adoption may not take place in a Pareto optimum in the limited-enforcement setting, if the division of social surplus is sufficiently unequal. I conclude that limited enforcement and high inequality interact to create particularly strong barriers to riches (in the language of Parente and Prescott (1999, 2000).Productivity ; Technology - Economic aspects

Money and bonds: an equivalence theorem

This paper considers four models in which immortal agents face idiosyncratic shocks and trade only a single risk-free asset over time. The four models specify this single asset to be private bonds, public bonds, public money, or private money respectively. I prove that, given an equilibrium in one of these economies, it is possible to pick the exogenous elements in the other three economies so that there is an outcome-equivalent equilibrium in each of them. (The term ?exogenous variables? refers to the limits on private issue of money or bonds, or the supplies of publicly issued bonds or money.)Money - Mathematical models ; Bonds

Societal benefits of nominal bonds

In this paper, I provide a possible explanation of why nominally risk-free bonds are essential in monetary economies. I argue that the role of nominal bonds is to serve as record-keeping devices in intertemporal exchanges of money. I show that bonds can only serve this role if they are illiquid (costly to exchange for goods). Finally, I show that in economies in which nominal bonds are essential, welfare and nominal interest rates are both positively associated with the supply of illiquid bonds (if that supply is small).Bonds ; Money

Risky collateral and deposit insurance

This paper provides a new rationalization for deposit insurance and systemic disintermediations. I consider an environment in which borrowers face no penalty for failing to repay obligations except the loss of their collateral. I assume that this collateral has aggregate risk. For a subset of the exogenous parameters, I demonstrate that an optimal arrangement features deposit insurance. For a strictly smaller set of parameters, it is optimal in some states of the world to have systemic disintermediation and concomitant falls in real output.Deposit insurance ; Contracts