Christopher J. Waller

Money, credit and banking

We use a modified version of the Lagos-Wright model to introduce an essential role for banks. Due to preference shocks, agents have excess demand for or supply of money balances. Banks arise to reallocate excess cash by taking deposits from sellers and making loans to buyers. We consider two variations of the model: one in which buyers borrow to finance consumption and another in which they borrow to finance investment. We show that for any positive nominal interest rate, the existence of banks leads to a higher level of steady state output and welfare. We also derive conditions under which borrowers voluntarily repay loans. Finally, we examine how monetary injections into the banking system affect the economy. The effects are very similar to limited particiption models and gives rise to a liquidity effect on nominal interest rates

A bargaining model of partisan appointments to the central bank

Abstract In this paper, a bargaining model is developed to analyze the appointment of central bankers in a two-party political system. The major results of the paper are: 1) The party in power will appoint partisans early on but later appointments will be increasingly moderate in their views concerning monetary policy. 2) Changing the timing of the appointment of the board chairman from the end of a presidents term in office to the first period of the presidents term will lead to more partisan monetary policy. 3) In equilibrium, nominations to the board are not rejected, thus confirmation hearings appear to be nothing more than a ‘rubber stamp’ process. 4) Lengthening the terms on the board relative to the electoral cycle will lead to more moderate appointments to the central bank and a reduction in partisan policymaking.

Policy Boards and Policy Smoothing

Partisan politics and random election outcomes generate policy uncertainty and partisan business cycles. To reduce policy uncertainty, society must design the policy-making environment to overcome electoral uncertainty and partisanship. I show that delegating policy to an independent policy board with discretionary powers will produce substantial policy smoothing and lower policy uncertainty relative to a simple model in which elected officials set policy. Board members are chosen in a partisan, noncooperative environment; yet in the benchmark model, policy variability is eliminated, and the cooperative bargaining solution is replicated.

A search-theoretic model of legal and illegal currency

Using a search theoretic model of money, we explore the conditions under which two currencies, domestic and foreign, will co-exist depsite legal restrictions on the use of foreign currency for internal trade. We then study how changes in government policy regarding enforcement of currency laws affects the equilibrium value of both currencies, the exchange rate and goverment seigniorage revenues. In our one country, two currency model, we show that there are multiple monetary equilibria.

Central Bank Design in General Equilibrium

We study the effects of alternative institutional arrangements for the determination of monetary policy in the context of a capital-theoretic, general equilibrium economy. We consider three institutional arrangements for determining monetary policy. The first, unconditional majority voting, always leads to a substantial inflation bias. The second, a simple form of bargaining which we interpret as a policy board, generally improves on the unconditional majority voting outcome. Finally,we consider a constitutional rule which always achieves the social optimum.

Discretionary Monetary Policy and Socially Efficient Wage Indexation

It is not uncommon for policy-makers, especially when they are trying to reduce inflation, to create incentives or restrictions that change individual decisions regarding nominal wage indexation. This raises a very interesting question for economists: if indexation of nominal contracts is the result of utility-maximizing behavior, why would policy-makers try to alter private indexation decisions? The usual rationale for governmental involvement in markets provided by microeconomic theory is that individual decisions may cause externalities that create a conflict between individual and social optima. Extending this logic to the case of indexation suggests that private indexation decisions may create an inflation externality and, thus, are not socially efficient. Blanchard [1979] and Ball [1988] have investigated the social efficiency of private decisions to index to the price level. They find that the equilibrium degree of wage indexation to the price level is socially inefficient if indexation to other relevant variables is costly. Since indexation costs do not appear to be empirically significant, these models do not provide a very convincing argument for governmental involvement in the indexation process. Furthermore, these models do not tie the degree of indexation to the trend inflation rate, which seems to be the crucial element for justifying governmental intervention. Thus, in order to pinpoint the exact nature of this externality, a model is required that considers endogenous wage indexation but links indexation to the trend inflation rate. Devereux [1987, 1989] uses such a model to examine the relationship between indexation and mean inflation. By combining a Gray [1976] indexation model with a Barro-Gordon [1983] inflation model, he shows that wage indexation affects the mean inflation rate, but he does not address the issue of indexation efficiency. In this paper we use a synthesis of Ball and Devereuxs models to demonstrate that individual indexation decisions are, in general, socially inefficient. However, in contrast to Blanchard and Balls

Money and Capital: A Quantitative Analysis

We study the effects of money (anticipated inflation) on capital formation. Previous papers on this topic adopt reduced-form approaches, putting money in the utility function or imposing cash in advance, but use otherwise frictionless models. We follow a literature that is more explicit about the frictions making money essential. This introduces several new elements, including a two-sector structure with centralized and decentralized markets, stochastic trading opportunities, and bargaining. We show how these elements matter qualitatively and quantitatively. Our numerical results differ from findings in the reduced-form literature. The analysis reduces the previously large gap between mainstream macro and monetary theory.

Price‐Level Targeting and Stabilization Policy

The authors construct a dynamic stochastic general equilibrium model to study optimal monetary stabilization policy. Prices are fully flexible and money is essential for trade. The authors’ main result is that if the central bank pursues a price-level target, it can control inflation expectations and improve welfare by stabilizing short-run shocks to the economy. The optimal policy involves smoothing nominal interest rates that effectively smooths consumption across states. (This abstract was borrowed from another version of this item.)

Outside Versus Inside Bonds: A Modigliani-Miller Type Result for Liquidity Constrained Economies

When agents are liquidity constrained, two options exist — sell assets or borrow. We compare the allocations arising in two economies: in one, agents can sell government bonds (outside bonds) and in the other they can borrow (issue inside bonds). All transactions are voluntary, implying no taxation or forced redemption of private debt. We show that any allocation in the economy with inside bonds can be replicated in the economy with outside bonds but that the converse is not true. However, the optimal policy in each economy makes the allocations equivalent.

Optimal disclosure policy and undue diligence

While both public and private financial agencies supply asset markets with large quantities of information, they do not necessarily disclose all asset-related information to the general public. This observation leads us to ask what principles might govern the optimal disclosure policy for an asset manager or financial regulator. To investigate this question, we study the properties of a dynamic economy endowed with a risky asset, and with individuals that lack commitment. Information relating to future asset returns is available to society at zero cost. Legislation dictates whether this information is to be made public or not. Given the nature of our environment, nondisclosure is generally desirable. This result is overturned, however, when individuals are able to access hidden information - what we call undue diligence - at sufficiently low cost. Information disclosure is desirable, in other words, only in the event that individuals can easily discover it for themselves.