Julio J. Rotemberg

Monopolistic Price Adjustment and Aggregate Output

This paper studies the consequences for the behaviour of aggregate output of the perception on the part of firms that changing prices is costly. The rational expectations equilibrium of an economy with many such firms is constructed. It is shown that in this economy nominal shocks have a persistent effect on aggregate output. Furthermore, the real wage is demonstrated to move procyclically in such an economy.

Interest-Rate Rules in an Estimated Sticky Price Model

This paper evaluates alternative rules by which the Fed may set interest rates using the small model of the U.S. economy estimated in Rotemberg and Woodford (1997). Our main substantive finding is that low and stable inflation together with stable interest rates can be achieved by letting the funds rate respond positively to inflation while also responding, with a coefficient bigger than one, to the lagged funds rate itself. A rule in which the interest rate is set in this extremely simple way does almost as well as a more complicated rule which is optimal in our setting, in the sense of maximizing expected utility to the representative household. Furthermore, when the funds rate responds to inflation only with a delay, due to delay in the availability of inflation data, performance under the rule is only slightly reduced.

Oligopolistic Pricing and the Effects of Aggregate Demand on Economic Activity

We construct a dynamic general equilibrium model in which the typical industry colludes by threatening to punish deviations from an implicitly agreed-on pricing path. We use methods similar to those of Kydland and Prescott to calibrate linearized versions of both our model and an analogous perfectly competitive model. We then compute the two models predictions concerning the economys responses to a change in military spending. The responses predicted by the oligopolistic model are closer to the empirical responses estimated with postwar U.S. data than the corresponding predictions of the competitive model.

The Excess Co-Movement of Commodity Prices

This paper tests and confirms the existence of a puzzling phenomenon - the prices of largely unrelated raw commodities have a persistent tendency to move together. We show that this comovement of prices is well in excess of anything that can be explained by the common effects of past, current, or expected future values of macroeconomic variables such as inflation, industrial production, interest rates, and exchange rates. These results are a rejection of the standard competitive model of commodity price formation with storage.

Intertemporal Substitution in Macroeconomics

Modern neoclassical business cycle theories posit that the observed fluctuations in consumption and employment correspond to decisions of an optimizing representative individual. We estimate three first-order conditions that represent three tradeoffs faced by such an optimizing individual. He can trade off present for future consumption, present for future leisure, and present consumption for present leisure. The aggregate U. S. data lend no support to this model. The overidentifying restrictions are rejected, and the estimated utility function is often convex. Even when it is concave, the estimates imply that either consumption or leisure is an inferior good.

An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy: Expanded Version

This paper considers a simple quantitative model of output, interest rate and inflation determination in the United States, and uses it to evaluate alternative rules by which the Fed may set interest rates. The model is derived from optimizing behavior under rational expectations, both on the part of the purchasers of goods and upon that of the sellers. The model matches the estimates responses to a monetary policy shock quite well and, once due account is taken of other disturbances, can account for our data nearly as well as an unrestricted VAR. The monetary policy rule that most reduces inflation variability (and is best on this account) requires very variable interest rates, which in turn is possible only in the case of a high average inflation rate. But even in the case of a constrained-optimal policy, that takes into account some of the costs of average inflation and constrains the variability of interest rates so as to keep average inflation low, inflation would be stabilized considerably more and output stabilized considerably less than under our estimates of current policy. Moreover, this constrained-optimal policy also allows average inflation to be much smaller. This version contains additional details of our derivations and calculations, including three technical appendices, not included in the version published in NBER Macroeconomics Annual 1997.

The Comovement of Stock Prices

We test whether comovements of individual stock prices can be justified by economic fundamentals. This is a test of the present value model of security valuation with the constraint that changes in discount rates depend only on changes in macroeconomic variables. Then, stock prices of companies in unrelated lines of business should move together only in response to changes in current or expected future macroeconomic conditions. Using a latent variable model to capture unobserved expectations, we find excess comovement of returns. We show that this excess comovement can be explained in part by company size and degree of institutional ownership, suggesting market segmentation.

Leadership style and incentives

We study the relationship between a firms environment and its optimal leadership style. We use a model in which contracts between the firm and managers are incomplete so that providing incentives to subordinates is not straightforward. Leadership style, whether based on organizational culture or on the personality of the leader, then affects the incentive contracts that can be offered to subordinates. We show that leaders who empathize with their employees adopt a participatory style and that shareholders gain from appointing such leaders when the firm has the potential for exploiting numerous innovative ideas. By contrast, when the environment is poor in new ideas, shareholders benefit from hiring a more selfish i.e., more profit maximizing leader whose style is more autocratic.

Money, Output and Prices: Evidence from a New Monetary Aggregate

This article derives a new utility-based monetary aggregate, the currency-equivalent (CE) aggregate. It equals the stock of currency that would be required for households to obtain the liquidity services that they get from their entire collection of monetary assets. This aggregate is derived from preferences assuming that these satisfy a separability assumption in addition to satisfying the requirements for Divisia aggregation. The resulting aggregate remains valid when asset characteristics change and equals the sum of individuals CE holdings. It also predicts output movements better than simple-sum aggregates such as M1 and M2.

Inflation And Taxation With Optimizing Governments

This paper extends and evaluates previous work on the positive theory of inflation. We examine the behavior of governments concerned solely with minimizing the deadweight loss from raising revenue through inflation and tax finance. We show that both governments that can commit to future policy actions, as well as those that cannot precommit, will choose a positive contemporaneous association between inflation and the level of tax burdens. We examine the empirical validity of this prediction using data from Britain, France, Germany, Japan, and the United States. Inflation and tax rates are as likely to be negatively as positively correlated, so the results cast doubt on the empirical relevance of simple models in which governments with time-invariant tastes choose monetary policy to equate the marginal deadweight burdens of inflation and taxes.