Kent P. Kimbrough

The optimum quantity of money rule in the theory of public finance

This paper examines optimal tax policy in a monetary economy in which money serves as an intermediate good that helps facilitate the conversion of scarce resources into tinal consumption goods by enabling consumers to economize on the costs of transacting. It is shown that in such an environment, even though distorting taxes must be levied for revenue purposes, the optimal tax structure calls for abstaining from inflationary finance and adopting the optimum quantity of money rule.

Inflation, Employment, and Welfare in the Presence of Transactions Costs

FOR SOME TIME NOW TWO ISSUES OF PRIMARY IMPORTANCE in macroeconomics and monetary theory have been the relation between inflation and unemployment (the Phillips curve) and the optimum rate of inflation (the optimum quantity of money). In both of these areas the work of Friedman and Phelps has been influential. Friedman (1968) and Phelps (1970) emphasized the role of inflationary expectations in generating a short-run Phillips curve-like tradeoff, but argued that in the long run the Phillips curve is vertical. That is, Friedman and Phelps claimed that in the long run, defined as the time period within which expectations fully adjust to actual circumstances, inflation and employment should be uncorrelated. More recently, Friedman (1977) has argued that since the rate of inflation and its variability tend to be positively related, inflation and employment may be negatively related in the long run. This is the positively sloped Phillips curve phenomenon. In recent years the link between inflation and employment has continued to receive considerable attention. The vast rational expectations literature on the role of monetary policy and the equilibrium approach to the business cycle are, in large part, an outgrowth of the earlier Phillips curve controversy. The notion that there is an inverse long-run relation between inflation and employment has recently received theoretical support from Barro and Santomero (1976), Stockman (1981), and Aschauer and Greenwood (1983). Related studies concerning the real effects of inflation have been undertaken by Jovanovic (1982), Stockman (1984), and Abel (1985). The common element running through all of these papers is that the real effects of inflation arise from the transactions technology that underlies money demand. l

An Investigation in the Theory of Foreign Exchange Controls

A choice-theoretic, cash-in-advance model is constructed to examine foreign-exchange controls. While foreign-exchange controls improve the trade balance and the balance-of-payments (or exchange rate) they reduce welfare for a distortion-free, small, open economy. This is because foreign-exchange controls essentially place a quota on imports. Shocks to the terms-of-trade are shown to be transmitted negatively to the domestic economy when exchange controls are in effect. Devaluations are found not to have real effects. Finally, it is argued that foreign-exchange controls are not the optimal policy for attaining trade-balance objectives.

Aggregate Information and the Role of Monetary Policy in an Open Economy

A model of a small open economy in which agents trade in local goods markets and an economy-wide asset market is developed. Purchasing-power parity is assumed to hold at the aggregate level. However, because of local deviations from purchasing-power parity, agents possess differential information. Using this framework, it is shown that when the exchange rate is flexible monetary policy can influence the distribution of real output by altering the information content of the exchange rate. However, when monetary policy is committed to fixing the exchange rate (by a feedback rule) the distribution of real output is independent of the particular exchange rate rule chosen. The stability of real output under the two regimes is compared, and it is demonstrated that regardless of the stability of domestic monetary policy a flexible exchange rate regime is superior in this respect. Possible qualifications and extensions of these results are also discussed.

An examination of the effects of government purchases in an open economy

This paper examines the effects of permanent and transitory changes in government purchases in the context of a model of a small open economy that produces and consumes both traded and nontraded goods. The model incorporates an equilibrium interpretation of the business cycle that emphasizes the responsiveness of agents to intertemporal relative price, changes. It is demonstrated that transitory increases in government purchases lead to an appreciation of the real exchange rate and an ambiguous change (although a likely worsening) in the current account, while permanent increases have an ambiguous impact on the real exchange rate and no effect on the current account. When agents do not know whether a given increase in government purchases is permanent or transitory the effect is a weighted average of these separate effects. The weights depend on the relative variances of the transitory and permanent components of government purchases. In the past few years a considerable amount of effort has been devoted to examining the effects of macroeconomic policy in an open economy. Such issues as exchange rate overshooting, deviations from purchasing power parity, sterilization and monetary control, the effectiveness of monetary policy, and the choice between alternative exchange rate regimes have been at center stage. The models that have been employed to study these issues have run the spectrum from variants of the Mundell-Fleming model such as Dornbusch (1976), Turnovsky (1981), and Kimbrough (1983a), to wage contracting and indexing models like Bhandari (1982b) and Flood and Marion (1982), to equilibrium models of the business cycle along the lines of Bhandari (1982a), Saidi (1982), and Kimbrough (1983b), to the closely related intertemporal utility maximization models with money of Helpman (1981) and Stockman (1980,1983). One common thread that, in a sense, unifies all of these, and other, recent contributions is that they are concerned primarily with the effects of alternative monetary and exchange rate policies that the central bank might enact. In light of the development and refinement during this period of the monetary approach to the balance of payments and the exchange rate, it is not surprising *I would like to thank Phil Brock, Jeremy Greenwood, Gary Zarkin, and two anonymous

The information content of the exchange rate and the stability of real output under alternative exchange-rate regimes

Abstract When the exchange rate is flexible, and thus responds to market forces, it provides agents with useful information, while when it is fixed (by a feedback rule) it does not. The implications of this asymmetry for the stability of real output under the two regimes is discussed. It is shown that whenever shocks are predominantly of one variety, or when domestic monetary shocks accompanied by one real shock, a flexible exchange rate does a better job of stabilizing real output than does a fixed exchange rate. These results undermine arguments favoring fixed exchange rates because they ‘discipline’ monetary policy. In addition, it is demonstrated that managed floating rules and exchange rate feedback rules are irrelevant for the distribution of real output.

Foreign exchange controls in a black market economy

Abstract An investigation of the impact of foreign exchange controls in a black market economy is undertaken within the context of a choice-theoretic cash-in-advance general equilibrium model. While such controls may improve a ‘distortion-free’ economys trade balance and balance of payments they are found to increase the domestic price of imports and lower the countrys welfare. The ramifications of black market for economic welfare turn out to be ambiguous, depending crucially on the governments reaction to the leakage of foreign exchange into the economy via illegal activity.

TARIFFS, INTEREST-RATES, AND THE TRADE BALANCE IN THE WORLD-ECONOMY

Abstract A two-commodity intertemporal framework is used to show that, in contrast to the conventional wisdom, both permanent and temporary tariffs may worsen the trade balance of a large country. For a temporary tariff the key condition for this result is a low intertemporal elasticity of substitution in consumption. When a temporary tariff worsens the trade balance the world real interest rate must fall if the tariff-imposing country is running a deficit and rise if it is running a surplus. Temporary tariffs can only worsen the trade balance of a surplus country when international differences in tastes are important.

Tax Regimes, Tariff Revenues and Government Spending

This paper develops a model that describes the role of tariffs as a source of government revenue. The model takes a public finance perspective and treats as part of the optimum revenue-raising tax package, relating the behavior of tariff rates and revenues to observable macroeconomic variables such as income and government spending. Although the approach is quite general, the model is constructed to fit the stylized facts concerning the changing role of the tariff in U.S. history. It is shown that relative collection costs for tariffs and other forms of taxes interact with changes in macroeconomic variables to explain the regime shifts (qualitative changes in the relative importance of tariffs and other taxes) found in U.S. tariff history. Copyright 1992 by The London School of Economics and Political Science.

Optimal taxation and inflation in an open economy

Abstract This paper examines the role of the inflation tax in the optimal revenue-raising tax package for a small open economy where money is held because it serves to reduce transacttions costs associated with purchasing goods. Consumers choose whether domestic money or foreign money will serve as the medium of exchange for various goods purchases so as to minimize such costs. Results are derived regarding the appropriate role of taxes on domestic and foreign money in the optimal tax structure. It is demonstrated that with a sufficiently rich tax structure Friedmans rule, which calls for a monetary policy that drives the nominal interest rate to zero, is a component of the optimal tax policy.