James Peery Cover

Asymmetric Effects of Positive and Negative Money-Supply Shocks

This paper examines whether positive and negative money-supply shocks have symmetric effects on output. The results are consistent with the hypothesis that positive money-supply shocks do not have an effect on output, while negative money-supply shocks do have an effect on output. This finding is independent of whether or not expected money is assumed to affect output. The results reported in this paper imply that the Fed could increase the growth rate of real output by reducing the standard deviation of unexpected changes in the money supply.

Time Series, Homicide, and the Deterrent Effect of Capital Punishment*

Erlich [5; 6] presents regression results showing that the U.S. time-series data supports the deterrent effect of capital punishment (the deterrence hypothesis). Other researchers [9; 10; 16] criticize Erlichs findings on a number of grounds-including the possibility of simultaneity bias, and the sensitivity of the results to the choice of sample period, control variables, and functional form. Layson [11] extends Erlichs U.S. sample to the 1936-1977 period and, taking account of these criticisms, concludes that the U.S. time-series evidence provides robust support for the deterrence hypothesis. This paper contributes to the debate on the deterrence hypothesis by analyzing the time-series properties of the homicide rate; the U.S. homicide rate is a nonstationary time series. It is well known that the use of nonstationary series in regression analysis leads to inconsistent coefficient estimators, biases estimators of coefficient standard errors toward zero, and invalidates standard statistical-inference procedures [2; 8; 13; 14; 15; 17; 18]. Nonstationarity may be due to a linear trend (trend nonstationarity) or may be a property of the underlying stochastic process (difference nonstationarity). If the time series is difference nonstationary then use of a linear trend does not correct these problems and may be misleading [13; 14; 15]. We explicitly test for the source of the nonstationarity of the homicide rate, difference or trend nonstationarity, using the tests recently developed by Dickey and Fuller [3; 4; 7]. We find that the homicide rate is difference nonstationary. This implies that the data must be first differenced to achieve stationarity, and that use of a linear trend (as in [5; 6; 9; 10; 11; 16]) is inappropriate. The regression results obtained using the first-differenced, stationary data do not provide robust support for a deterrence effect of capital punishment.

Identifying Sources of Macroeconomic and Exchange Rate Fluctuations in the UK

Using quarterly data for the period 1985:1–2011:1, this paper uses a stylised, open economy, structural VAR model to identify the types of shocks responsible for macroeconomic fluctuations in the UK economy. The stylised model implies a set of short-run restrictions that allow for the identification of the shocks. The importance of each shock is determined by examining forecast-error variance decompositions, impulse response functions, and implied long-run (or permanent) effects. The results presented here imply that two shocks (called the technology and IS shocks) are relatively more important than other shocks. Monetary shocks do exhibit long-run monetary neutrality, but clearly monetary policy is not responsible for a meaningful share of output and employment fluctuations during the sample period. The estimated VAR and structural disturbances imply that the model accurately reflects the UK economy. There is little evidence of a price puzzle or an exchange rate puzzle (evidence against uncovered interest rate parity) in response to an unexpected monetary policy tightening.

Price and Output Stability under Price-Level Targeting

It is commonly believed that a monetary policy that targets the price level reduces the long-term variability of the price level, but only at the cost of increased variability of both inflation and output. We develop a model in which the one-step-ahead variance of output and the price level are lower under price-level targeting than under inflation targeting. This increased stability under price-level targeting works through an interest-rate channel that, to our knowledge, has not previously been emphasized in the literature. Surprisingly, if the sensitivity of demand to the real rate of interest is high enough, then the variance of inflation can also be lower under price-level targeting than under inflation targeting.

The Correlation Between Shocks to Output and the Price Level:Evidence from a Multivariate GARCH Model

Previous research indicates that the price-output correlation is time varying. This paper therefore estimates a vector autoregression (VAR) model with a bivariate generalized autoregressive conditional heteroskedasticity (GARCH) error process to obtain quarterly estimates of the price-output correlation for the United States for the period 1876:IV–1999:IV. The estimated correlation is usually positive before 1945 and zero during 1945–1963. Negative correlations become important only after 1963 but do not become obviously more important than zero correlations. Prior to 1945, the estimated correlation typically is positive during both recessions and expansions. After 1945, the estimated correlation remains largely positive during recessions but becomes mainly negative during expansions, suggesting that changes in the sign of the price-output correlation are the result primarily of changes in its sign during expansions.

Asymmetric wage indexation

Models of wage indexation uniformly have been based on the simplifying assumption that nominal wages adjust upward or downwrd symmetrically with unexpected price increases or decreases. Indexation typically is asymmetric in actual contracts, however. Wages are indexed to price increases but not to price reductions. This paper analyzes a macroeconomic model with asymmetric indexation. On the one hand, this paper finds that when stable equilibria supporting use of such asymmetrically indexed contracts exist, the result is an unambiguous downward bias in the base contract wage, because workers must pay a premium for insurance against real wage reductions that unexpected inflation otherwise would induce. On the other hand, the paper concludes that the likelihood of existence of stable equilibria supporting positive wage indexation generally declines as aggregate demand variability rises relative to the variability of aggregate supply. This may help explain why relatively low levels of wage indexation actually are observed in nations with relatively contained aggregate demand volatility.

Optimal Monetary Policy and the Correlation between Prices and Output

Several empirical papers have established the fact of a negative price-output correlation for the United States in the post WWII era. Much of this work appears to interpret the sign of this correlation under the assumption that monetary policy is passive. This paper uses a simple aggregate supply and demand model to examine how an optimizing monetary policy affects the price-output correlation. The model is capable of explaining why the price-output correlation in the United States is positive with prewar data but negative with postwar data. The model implies that a negative price-output correlation can emerge under an optimal policy only if policymakers are concerned with both inflation and output and the underlying economy is one in which both demand and supply shocks affect output. The model implies that a negative price-output correlation is inconsistent with real business cycle models, while a positive correlation does not necessarily support the use of neo-Keynesian models.

Estimating Money Demand in Log-First-Difference Form*

The purposes of this paper are to recommend a certain form for the estimation of demandfor-money functions and to examine some fundamental issues using the form. We provide an estimate of the demand for money that achieves a reduction in the instability so characteristic of recent estimates. Through examination of the time-series properties of the variables in the function, and adjustments to produce stationarity in them, an improved form of the demand-for-money function is possible. Evidence of its greater stability is offered by a comprehensive comparison of short- and long-term forecasts for demand for money in loglevel and log-first-difference forms. Finally, several issues are explored using the more stable form including the contribution of an interest-rate-ratchet variable, the speed of adjustment, the adjustment mechanism and the appropriate scale variable. We conclude that estimation in log-first-difference form (1) is preferable to the log-level form because of its stable time series properties; (2) is superior to log-level form for long-term forecasts; (3) implies a faster and more reasonable speed of adjustment than does the log-level form; and (4) suggests that the nominal adjustment mechanism and real GNP as a scale variable are appropriate. Section II of the paper reviews the proolem of stationarity for a regression model of the demand for money. Section III presents the demand-for-money equation and the adjustment mechanisms. Section IV compares the forecasts of log-level and log-first-difference forms. Section V explores the issues of the interest-rate-ratchet variable, speed of adjustment, adjustment mechanism and the scale variable. A summary and conclusions are offered in section VI.

Political pressures and the choice of the optimal monetary policy instrument

Abstract This paper extends Cukierman’s (1992) model of monetary policy discretion, private information, and credibility to an environment in which the quantity of money is endogenous and in which a monetary authority must choose between bank reserves or an interest rate as its instrument of monetary policy. This model is used to explore the determinants of credibility for the alternative policy instruments and to evaluate the manner in which political pressures on a monetary authority can influence the authority’s instrument choice. A key implication of the model is that such political pressures can influence the credibility of monetary policy differentially depending upon the choice of policy instrument, thereby inducing a monetary authority to choose an instrument that otherwise would fail to meet standard Poole (1970) criteria. Keywords: Optimal monetary policy; Monetary policy instruments; Monetary politics JEL classification: E52; E58

The Political Economy of Unsustainable Fiscal Deficits

This paper uses an intertemporal model of public finances to show that political instability can cause taxes to be tilted to the future, resulting in a fiscal deficit that is suboptimal and only weakly sustainable (in the sense of Quintos). This occurs because political instability gives the government an incentive to implement a myopic fiscal policy in order to increase its chances of remaining in office. The government achieves this by delaying taxes (or advancing spending) in order to buy political support, which in turn causes an upward trend in the deficit process and a financial crisis. Using annual data for Chile for the 1833-1999 period, we present statistical test results that support the model.