Joseph Pearlman

Rational expectations models with partial information

Abstract This paper provides a general solution to the problem of partial information in linear discrete time stochastic rational expectations models. The full information case is first reviewed and the solution of Blanchard and Kahn [4] extended. Then we consider the problem of partial information for the special case where only the current values of some variables are unobserved. The solution can be treated as a straightforward extension to the full information case. In the general problem where in addition to some current variables being unobserved, certain variables are unobserved for all lags, we provide a solution which requires the use of Kalman filters. The paper concludes by examining the covariance properties of the rational expectations system under different informational assumptions.

Reputational and nonreputational policies under partial information

Abstract This paper analyses the effect of partial information on optimal policy design for stochastic macroeconomic models incorporating forward-looking expectations. The main theoretical result is that reputational and nonreputational policies are certainty-equivalent, as has previously been conjectured, and it is also shown that the welfare loss does not necessarily increase with decreasing information. Of particular additional interest in the analysis of reputational policy design is the issue of sustainability, and it is shown using an example that weak sustainability may be information-dependent.

North-South Models of Growth and Trade

The paper surveys the literature that combines growth and trade into models of North-South interaction. We distinguish two strands of growth theory: old (exogenous) and new (endogenous) growth. We also distinguish old trade theory which assumes constant returns to scale and perfect competition, and new trade theory which relaxes both of these assumptions. This gives us four possible combinations of growth and trade theories which provide the basis of the taxonomy employed in our survey. We address the following long-standing issues raised in the literature: first, given that one of the North-South asymmetries is that the North leads in technical progress, how does the South adjust to such changes? Second, can the models explain patterns of trade and income differentials between the regions? Third, do asymmetries mean that standard prescriptions on the mutual benefits of free trade and free movements of capital need to be modified? Finally, can our models explain why the South continues to favour protection of its manufacturing sectors at the same time that barriers within the North are being dismantled? Copyright 2002 by Blackwell Publishers Ltd

Endogenous Persistence in an Estimated DSGE Model Under Imperfect Information

A framework for estimating Dynamic Stochastic General Equilibrium (DSGE) models by Bayesian methods and validation under very general information assumptions is applied to a New Keynesian model. The standard asssumption that private agents have perfect information observing all state variables including shocks, whereas the econometrician uses only observable data, is compared with both agents having the same imperfect information (II) set. We also generalise rational expectations to a behavioural composite model that allows some households and firms to form expectations adaptively. We find significant empirical support for II as an endogenous persistence mechanism, but this is dominated by that from habit and adaptive learning.

Indeterminacy with Inflation-Forecast-Based Rules in a Two-Bloc Model

We examine the performance of forward-looking inflation-forecast-based rules in open economies. In a New Keynesian two-bloc model, a methodology first employed by Batini and Pearlman (2002) is used to obtain analytically the feedback parameters/horizon pairs associated with unique and stable equilibria. Three key findings emerge: First, indeterminacy occurs for any value of the feedback parameter on inflation if the forecast horizon lies too far into the future. Second, the problem of indeterminacy is intrinsically more serious in the open economy. Third, the problem is compounded further in the open economy when central banks respond to expected consumer, rather than producer price inflation.

The Immigration Surplus Revisited In A General Equilibrium Model With Endogenous Growth

We revisit the work of Borjas (1995) which has provided an influential positive theory of immigration policy. An important feature of his framework is the focus on the skill-composition of immigrants and we retain this feature in our paper. Our contribution to this literature is to extend his analysis in a number of directions. First, we study the immigration surplus in the context of a general equilibrium model in which capital is endogenous and the welfare of the indigenous population is set out explicitly. Second, we introduce several sectors into the model so that changing the skill composition leads to changes in sector shares. Third, related to the second development, we introduce and R&D sector and develop a model with long-term endogenous growth. The result is that growth effects on the Immigration Surplus come to dominate the purely static effects in the original analysis of Borjas, but they are not sufficient to eliminate the emergence of losers among the section of natives competing with immigrants in the labour market.

Winners and Losers in a North-South Model of Growth, Innovation and Product Cycles

The paper examines the welfare gains from North-South trade and their distribution. We construct an endogenous growth North-South model with four Southern stages of development as possible equilibria: specialisation in a traditional good; the South in addition copies Northern high-tech manufactured goods; the South begins to innovate in its own right and finally a stage in which the South only innovates, as in the North. We use this model to show that dynamic gains from trade and from Southern development through the stages can create new winners, unskilled workers in the North and possibly skilled workers in the South.

European monetary union or hard EMS

This paper contributes to the debate engendered by the Delors Report on the issue of European Monetary Union. It focuses on the options of a strengthened (or hard-) EMS, with a commitment to a fixed exchange rate relative to the Deutschmark, or a European central bank with full monetary union (EMU). Under hard-EMS, an anti-inflationary reputation is acquired by all as a result of Bundesbank credibility. As regards EMU, it is possible that too rapid a move through the latter stages of the Delors process will produce a central bank with little or no anti-inflation credibility. Here we make starkest assumption of no credibility under EMU, and compare it with hard-EMS for various supply and demand shocks using a two-bloc model, the latter exhibiting short-run wage/price stickiness but with long run natural rate properties. A non-EMS regime with floating exchange rates is used to examine the incentive compatibility of hard-EMS and EMU, with a cooperative reputational regime acting as a benchmark.

Monetary Union: The Ins and Outs of Strategic Delegation

This paper addresses the conduct of monetary and fiscal policy in a closed trading bloc consisting of ‘ins’ forming a monetary union and ‘outs’ who retain monetary sovereignty. All governments can opt for a particular choice of institutional arrangement for their central bank (CB), however, and delegate monetary policy to it with varying degrees of independence or, equivalently, ‘conservatism’. This paper examines the outcome when these decisions are individually rational for governments and are taken strategically, taking in to account the intra-country interactions between fiscal authorities and their own central bank, and the inter-country interactions between the same players.

Fiscal and monetary policy in a monetary union: Credible inflation targets or monetized debt?

Fiscal and Monetary Policy in a Monetary Union: Credible Inflation Targets or Monetized Debt? —The paper examines the interrelationship between fiscal and monetary policy in a two-country monetary union. The worst scenario occurs when an independent central bank sets the nominal interest rate and responds to rising government debt/GDP ratios by monetization. The result is high inflation, high debt/GDP ratios and a large public sector. Government debt and inflation are contained if the governments bear sole responsibility for solvency, but the public sector remains excessively large. The best scenario occurs if the central bank removes the incentive for the governments to engineer surprise inflation by credible inflation targeting.ZusammenfassungFinanz-und Geldpolitik in einer Währungsunion -Glaubhafte Inflationsziele oder monetisierte Staatsverschuldung? —Die Verfasser untersuchen die Beziehung zwischen Finanz-und Geldpolitik in einer Währungsunion von zwei Ländern. Das schlechteste Szenario liegt vor, wenn eine unabhängige Zentralbank den nominalen Zinssatz festlegt und auf einen Anstieg der Staatsverschuldung (im Verhältnis zum BIP) mit Monetisierung reagiert. Das Ergebnis ist hohe Inflation, ein ungünstiges Verhältnis zwischen Staatsschulden und BIP und ein aufgeblähter öffentlicher Sektor. Staatsschulden und Inflation werden gebremst, wenn die Regierungen die alleinige Verantwortung für die Solvenz tragen, aber der öffentliche Sektor übertrieben groß bleibt. Das beste Szenario ist gegeben, wenn die Zentralbank den Regierungen den Anreiz nimmt, überraschende Inflationen zu inszenieren, indem sie in ihrer Politik glaubwürdige Inflationsziele verfolgt.