Bharat Trehan

Testing Intertemporal Budget Constraints: Theory and Applications to U.S. Federal Budget and Current Account Deficits

This paper extends previous tests of intertemporal budget balance and present value relationships by expanding the set of allowable deficit processes and by deriving a testable condition that is sufficient to ensure intertemporal budget balance as long as the expected discount rate is strictly positive. Using these tests, the authors find that both the postwar federal budget deficit process and the process governing accumulation of U.S. assets by foreigners are consistent with intertemporal budget balance. Copyright 1991 by Ohio State University Press.

Common trends, the government's budget constraint, and revenue smoothing

Abstract The requirement that the governments budget be balanced in present value terms is shown to be equivalent to the condition that government expenditures inclusive of interest, tax receipts and seignorage be cointegrated. The condition is in fact stronger, requiring that the deficit inclusive of interest be stationary. Stationarity of the net-of-interest deficit is neither necessary nor sufficient for intertemporal budget balance. However, it does have implications for Barros tax smoothing hypothesis. Data for the period 1890–1986 are consistent with intertemporal budget balance but not with tax smoothing.

Location and the Growth of Nations

Does a country‘s long-term growth depend on what happensin countries that are nearby? Such linkages could occur for avariety of reasons, including demand and technology spillovers.We present a series of tests to determine the existence of suchrelationships and the forms that they might take. We find thata country‘s growth rate is closely related to that of nearbycountries and show that this correlation reflects more than theexistence of common shocks. Trade alone does not appear responsiblefor these linkages either. In addition, we find that being neara large market contributes to growth.

Seigniorage and tax smoothing in the United States 1914-1986

Models in which fiscal and monetary authorities cooperate to minimize the distortionary costs of raising revenue to finance an exogenous stream of government expenditures are shown to have implications for the long-run relationships between government expenditures, tax revenues and seigniorage. First, tax and seigniorage revenue should be cointegrated. Second, the cointegrating vector linking taxes and seigniorage should be only one of the cointegrating vectors linking expenditures, tax revenues and seigniorage. Third, the deficit net-of-interest should be nonstationary. These implications are tested using annual U.S. data from the period 1914 to 1986. The data reject all three implications of the theory.

New Evidence on Cyclical and Structural Sources of Unemployment

We provide cross-country evidence on the relative importance of cyclical and structural factors in explaining unemployment, including the sharp rise in U.S. long-term unemployment during the Great Recession of 2007-09. About 75% of the forecast error variance of unemployment is accounted for by cyclical factors-real GDP changes (?Okun‘s Law?), monetary and fiscal policies, and the uncertainty effects emphasized by Bloom (2009). Structural factors, which we measure using the dispersion of industry-level stock returns, account for the remaining 25 percent. For U.S. long-term unemployment the split between cyclical and structural factors is closer to 60-40, including during the Great Recession.

Survey Measures of Expected Inflation and the Inflation Process

The accuracy of inflation forecasts obtained from household and professional surveys has deteriorated noticeably of late, to the extent that a simple autoregressive specification outperforms survey forecasts. The decline in (absolute and relative) accuracy has taken place at about the same time as an apparent change in the inflation process. Projections of household forecasts on realized inflation suggests that households have not recognized this change. For the professionals, projections of expected inflation on headline inflation have changed, but on core inflation have not. By contrast, projections of realized headline inflation on core have changed sharply.

Forward-looking behavior and optimal discretionary monetary policy

This paper derives a closed-form solution for the optimal discretionary monetary policy in a small macroeconomic model that allows for varying degrees of forward-looking behavior. We show that a more forward-looking aggregate demand equation serves to attenuate the response to inflation and the output gap in the optimal interest rate rule. In contrast, a more forward-looking real interest rate equation serves to magnify the response to both variables. A more forward-looking Phillips curve serves to attenuate the response to inflation but magnifies the response to the output gap. ; Original title: Forward-looking behavior and the optimality of the Taylor rule.

On Using Relative Prices to Measure Capital-specific Technological Progress

Recently, Greenwood, Hercowitz and Krusell (GHK) have identified the relative price of (new) capital with capital-specific technological progress. In a two-sector growth model, however, the relative price of capital equals the ratio of the productivity processes in the two sectors. Restrictions from this model are used with data on wages and prices to construct measures of productivity growth and test the GHK identification, which is easily rejected by the data. This raises questions about various measures of the contribution that capital-specific technological progress might make to the economy. This identification also induces a negative correlation between the resulting measures of capital-specific and economy-wide technological change, which potentially explains why papers employing this identification find that capital-specific technological change accelerated in the mid-1970s. We impose structure on the productivity measures based on their long run behavior and find evidence of a slowdown in productivity in the 1970s that is common to both sectors and an acceleration in the mid-1990s that is exclusive to the capital sector.

Accounting for the Secular "Decline" of U.S. Manufacturing

The share of employment in manufacturing as well as the relative price of manufactures has declined sharply over the postwar period, while the share of manufacturing output relative to GDP has remained roughly constant. Household preferences turn out to play a key role in reconciling this behavior with a closed-economy, two-sector model with differential rates of productivity growth. We show that the data imply that households are not willing to substitute between the two goods at all and also that this inference is independent of whatever the income elasticity of demand for services might be. Because we are unable to account for the entire decline in employment over this period, we expand the model to allow for manufactured exports. While this does not change our estimate of the elasticity of substitution, it does improve the model’s ability to explain the decline in relative employment in the 1990s. However, larger errors in the 1970s remain unexplained.

Cyclical or Structural? Evidence on the Sources of U.S. Unemployment

We provide evidence on the relative importance of cyclical and structural factors in explaining unemployment, including the sharp rise in U.S. long-term unemployment during the Great Recession of 2007–09. About 75 % of the forecast error variance of unemployment is accounted for by cyclical factors—real GDP changes (“Okun’s Law”) and monetary and fiscal policies. Structural factors, which we measure using the dispersion of industry-level stock returns, account for the remaining 25 %. For long-term unemployment the split between cyclical and structural factors is closer to 60–40, including during the Great Recession. Examination of the industry-level stock returns suggests that adverse shocks to the construction sector and, to a lesser extent, the finance sector were responsible for the increase in structural unemployment. The Great Recession appears similar to the recession of 1973–75, as sectoral shocks played a large role at that time as well.