Intertemporal Coordination Research Articles

Determinacy Without the Taylor Principle

A long-standing issue in the theory of monetary policy is that the same path for the interest rate can be associated with multiple bounded equilibrium paths for inflation and output. We show that a small friction in memory and intertemporal coordination can remove this indeterminacy. This leaves no space for equilibrium selection by means of either the Taylor Principle or the Fiscal Theory of the Price Level. It reinforces the logical foundations of the New Keynesian model’s conventional solution (a.k.a. its fundamental or MSV solution). And it liberates feedback rules to serve only one function: stabilization.

Market-based coordination of integrated electricity and natural gas systems under uncertain supply

The interdependence between electricity and natural gas systems has lately increased due to the wide deployment of gas-fired power plants (GFPPs). Moreover, weather-driven renewables introduce uncertainty in the operation of the integrated energy system, increasing the need for operational flexibility. Recently proposed stochastic dispatch models optimally use the available flexibility and minimize the total expected system cost. However, these models are incompatible with the current sequential market design. We propose a novel method to optimally define the available natural gas volume for power production scheduling, anticipating the real-time flexibility needs. This volume-based model is formulated as a stochastic bilevel program that aims to enhance the inter-temporal coordination of scheduling and balancing operations, while remaining compatible with the sequential clearing of day-ahead and real-time markets. The proposed model accounts for the inherent flexibility of the natural gas system via the proper modeling of linepack capabilities and reduces the total expected system cost by the optimal definition of natural gas volume availability for GFPPs at the forward phase. The volume-based coordination model is compared with a price-based coordination alternative, which was recently proposed. In the latter one, the natural gas price perceived by GFPPs is similarly adjusted to enhance the temporal coordination of scheduling and balancing stages. This comparison enables us to highlight the main properties and differences between the two coordination mechanisms.

Leijonhufvud on New Keynesian Economics and the economics of Keynes

Abstract The theme that Axel Leijonhufvud has extracted from the economics of Keynes is the potential for failures in the intertemporal coordination of activities in complex market systems. In his path-breaking book of 1968, he attacked standard Keynesian Economics for its view on frictions, which reduces the causes of macroeconomic pathologies to nominal rigidities. With the rise of DSGE-based New Keynesian Economics, Leijonhufvud has pointed out that ‘standard macroeconomics’ is still stuck in the frictions view. Referring to recent financial crises, he considers DSGE modelling to be hopelessly inadequate for dealing with such macroeconomic instability. Yet, the financial frictions literature in New Keynesian Economics claims to have found ways to incorporate financial crises into DSGE frameworks. The article describes continuity and change in Leijonhufvud’s critique of Old and New Keynesians, and assesses contrary claims to progress made in the DSGE world.

Liquidity Sentiments

We develop a rational theory of liquidity sentiments in which the market outcome in any given period depends on agents’ expectations about market conditions in future periods. Our theory is based on the interaction between adverse selection and resale considerations giving rise to an intertemporal coordination problem that yields multiple self-fulfilling equilibria. We construct “sentiment” equilibria in which sunspots generate fluctuations in prices, volume, and welfare, all of which are positively correlated. The intertemporal nature of the coordination problem disciplines the set of possible sentiment dynamics. In particular, sentiments must be sufficiently persistent and transitions must be stochastic. We consider an extension with production in which asset quality is endogenously determined and provide conditions under which sentiments are a necessary feature of any equilibrium. A testable implication is that assets produced in good times are of lower average quality than those produced in bad times. (JEL D84, D82, E32, E44, G12)

Coordination and Free-Riding Problems in Blood Donations

This article theoretically and experimentally examines the twin problems of free-riding and coordination failure faced by blood banks, by investigating the effects of information provision on the efficiency of blood donation. We augment a standard linear public goods game, incorporating the following features of blood donation: multiplicity of public goods (to reflect intertemporal coordination issues), current and upcoming upper bound demands (to incorporate the perishable nature of blood and the embargo period of consecutive donations), and semi-binary choices (to account for individual options to withhold donations or make donations and when). We analyze whether a provision of deterministic information on the potential blood demand (full information) would improve the efficiency of blood when compared to the provision of probabilistic information (partial information). The theory predicts that if each individual maximizes the payoff-sum of all players, then the full information provision would achieve efficiency in equilibrium. The results of laboratory experiment show that the full information provision does not improve the efficiency of donation, on an average. We find that full information improves intertemporal coordination, but it worsens the free-riding problem. Although information helps individuals to direct donations in response to the demand, it drives individuals to withhold donations to avoid potential wastage against the risk of over the upper bound. When the predicted total demand is relatively small, that is, when strategic uncertainty about others’ matters for achieving efficiency, the provision of information about intertemporal demand in upper bounds tends to lower efficiency because the donation withholding'' effect becomes dominant.

Setting Reserve Requirements to Approximate the Efficiency of the Stochastic Dispatch

This paper deals with the problem of clearing sequential electricity markets under uncertainty. We consider the European approach, where reserves are traded separately from energy to meet exogenous reserve requirements. Recently, proposed stochastic dispatch models that co-optimize these services provide the most efficient solution in terms of expected operating costs by computing reserve needs endogenously. However, these models are incompatible with existing market designs. This paper proposes a new method to compute reserve requirements that bring the outcome of sequential markets closer to the stochastic energy and reserves co-optimization in terms of cost efficiency. Our method is based on a stochastic bilevel program that implicitly improves the inter-temporal coordination of energy and reserve markets, but remains compatible with the European market design. We use two standard IEEE reliability test cases to illustrate the benefit of intelligently setting operating reserves in single and multiple reserve control zones.

Sentiment, Liquidity and Asset Prices

We study a dynamic market for durable assets, in which asset owners are privately informed about the quality of their assets and experience occasional productivity shocks that generate gains from trade. An important feature of our environment is that asset buyers must worry not only about the quality of assets they are buying, but also about the prices at which they can re-sell the assets in the future. We show that this interaction between adverse selection and resale concerns generates an inter-temporal coordination problem and gives rise to multiple self-fulfilling equilibria. We find that there is a rich set of sentiment driven equilibria, in which sunspots generate large fluctuations in asset prices, output and welfare, resembling what one may refer to as “bubbles.”

Adaptation on Multiple Landscapes: Relatedness, Complexity, and Inter-Temporal Coordination Costs

We introduce and examine the concept of inter-temporal coordination costs, i.e., the reduction in a firm’s ability to adapt within businesses as a result of its attempts to capture synergies across businesses. Using a modified NK model of search across two landscapes, we show that these costs have an inverted-U relationship with the relatedness between landscapes, and this relationship is moderated by complexity. We further extend the model to examine entry into new markets, and use it to define conditions under which diversifying entrants may be at an advantage relative to either de novo start-ups or entrepreneurial spin-outs. Our study complements and extends recent work on inter-temporal economies of scope, while offering new insights for the literature on diversification, new market entry, and firm adaptation.

The International Business Cycle as Intertemporal Coordination Failure

Where investments are irreversible and future uncertain, people in two countries can make investment decisions that turn out to be mutually inconsistent. I argue that this intertemporal coordination failure explains international business cycles in a two-currency-area setting. The sequence of events starts with a domestic expansionary monetary shock, which decreases the domestic real interest rate. Facing low transactions costs, people spend the new money relatively early in the foreign exchange market and in the foreign market for loanable funds. Domestic monetary expansion thereby changes the relative prices of domestic and foreign goods and also of goods of earlier and later stages of production. The relative price changes lead to intertemporal and international coordination failures once the monetary expansion ends and relative prices change. Domestic monetary policy thereby causes the comovement we observe of business cycles across different currency areas.

The international business cycle as intertemporal coordination failure

Where investments are irreversible and the future is uncertain, people in two countries can make investment decisions that turn out to be mutually inconsistent. I argue that this intertemporal coordination failure explains international business cycles in a two-currency-area setting with a floating foreign exchange rate. The sequence of events starts with an expansionary domestic monetary shock, which decreases the domestic real interest rate. Facing low transactions costs, people spend the new money relatively early in the foreign exchange market and in the foreign market for loanable funds. Domestic monetary expansion thereby changes the relative prices of domestic and foreign goods and also of goods of earlier and later stages of production. The relative price changes lead to intertemporal and international coordination failures once the monetary expansion ends and relative prices change. Domestic monetary policy thereby causes the comovement across different currency areas we observe of business cycles.

Information, expectations and monetary policy: Keynes’s and Friedman’s complementary lessons for today

This paper considers what lessons there might be for our contemporary ‘monetary consensus’ in Keynes’s and Friedman’s respective policy principles. I focus first on the expectations issue. For both Keynes and Friedman, monetary policy aims at the stabilisation of expectations; and in both cases, major issues arise for knowledge and uncertainty, although each conceives this in a different manner. Next I deal with the core of monetary policy principles: while Keynes’s approach is at odds with our modern strategy of inflation-targeting, Friedman would warn us that, even in this case, interest-rate manipulation might not be the appropriate approach. The analysis concludes with the issue of interest rate determination—the issue of intertemporal coordination and financial stability. Policy principles are always rooted in theoretical investigation: Keynes’s approach is based upon an analysis of intertemporal coordination failures, whereas Friedman’s policy schemes require that financial markets be made perfectly competitive.

The fiscal benefits of repeated cooperation: coalitions and debt dynamics in 36 democracies

AbstractDo coalition governments really suffer from short time horizons in fiscal policymaking, as posited by standard political-economy models? This article focusses on coalitions that have created high levels of familiarity through shared governing experiences in the past and that are likely to cooperate again in future governing coalitions. I argue that such coalitions have incentives to internalise the future costs of debt accumulation and reach credible agreements to balance their constituencies’ fiscal preferences. Moreover, sustaining broad coalitions should have electoral advantages to implementing controversial economic reforms, thus resulting in lower debt increases compared not only with less durable coalitions but also with single-party governments. Comparing 36 economically advanced democracies between (up to) 1962 and 2013, I estimate the effects of coalitions’ cooperation prospects on the dynamics of public debt. The findings indicate that long time horizons can help coalitions to overcome intertemporal coordination problems and to reach specific policy goals.

Новото динамично равновесие

The series of financial crises shook seriously the new consensus between neoclassical and new Keynesians on dynamic stochastic general equilibrium (DSGE) models. The criticisms were directed mainly to inadequate policy of monetary institutions and the inability of these models to foresee similar crises. In the ensuing debate on the future of macroeconomic theory two approaches were outlined: (1) Combination of alternative economic theories in new, free framework that ignores DSGE models; and (2) Critical analysis of the shortcomings of the DSGE models that enrich them with new ideas and methodological instruments. This article belongs to the second approach and presents DSGE models through the lens of new, non-Walrasian's version of the dynamic disequilibrium. Unlike neo-Walrasian disequilibrium, not the natural equilibrium prices of Smith and Marshall, but the natural rate of Wicksell are put in the role of a gravity center. Endogenezation of capital allows the model to involve the problem of intertemporal coordination, which is pathological for the economy and leads to financial crises.

Intertemporal coordination with delay options

This paper studies equilibrium selection in intertemporal coordination problems with delay options. The risk-dominant action of the underlying one-shot game is selected when frictions are arbitrarily small. Larger frictions introduce real option effects in the model and inhibit coordination.

Capital Theory and the Process of Inter Temporal Coordination: The Austrian Contribution to the Theory of Economic Growth

An appreciation of the necessity of the inter-temporal coordination of heterogeneous capital goods is the chief contribution of Austrian economics to the theory of economic growth. Austrian theory illustrates why an institutional environment of freely formed prices predicated on private property is essential for economic growth. This leads Austrians to have a unique take on Solow growth theory, the financing gap model, national economic planning, and aggregative development measures.

Capital Theory and the Process of Inter-Temporal Coordination: The Austrian Contribution to the Theory of Economic Growth

Appreciation of the necessity of the inter-temporal coordination of heterogeneous capital goods is the chief contribution of Austrian economics to the theory of economic growth. Austrian theory illustrates why an institutional environment of freely formed prices predicated on private property is essential for economic growth. This leads Austrians to have a unique take on Solow growth theory, the financing gap model, national economic planning, and aggregative development measures.

An Austrian view of expectations and business cycles

Austrian economists have contributed several important concepts to business cycle theory including: inter-temporal coordination of production and consumption, heterogeneous specificity of capital, non-neutrality of money, and the capital structure of production. Noticeably lacking, however, is a clear theory of expectations. Recent Austrian responses to rational expectations critiques—such as positing a prisoner’s dilemma, heterogeneous entrepreneurs, and adverse selection—try to fill this gap. But much work remains to be done developing an Austrian theory of expectations, one where they are endogenous to the market process and market institutions. This paper explores how people adapt their expectations to changing market phenomena based upon their perceived costs and benefits of doing so. It then applies endogenous expectations to the 2008 financial crisis.

An Austrian View of Expectations and the Business Cycles

Austrian economists have contributed several important concepts to business cycle theory including: inter-temporal coordination of production and consumption, heterogeneous specificity of capital, nonneutrality of money, and the capital structure of production. Noticeably lacking, however, is a clear theory of expectations. Austrians should develop such a theory, one where expectations are endogenous to the market process and market institutions, because it will improve our understanding of business cycles. An endogenous theory of expectations explores how people adapt their expectations to changing market phenomena based upon their perceived costs and benefits of doing so. It supplants, to some extent, recent Austrian responses to rational expectations critiques such as positing a prisoner's dilemma, heterogeneous entrepreneurs, and adverse selection. This paper sketches a framework for thinking about endogenous expectations and uses it to examine the 2008 financial crisis.

An Exploration of the Nature of Equilibria in the Colombian Electricity Wholesale Market

In the last two decades many countries in the world have implemented across the board reforms seeking to increase the reliability and efficiency of their electric power sectors. These reforms have often included the introduction of hourly/half-hourly multiple- generation-units electricity auctions as the core electricity supply and demand clearing mechanism. Thorough economic analyses indicate that by and large these market mechanisms have yielded significant efficiency improvements, however the experiences have been quite varied. In particular, the level of competitiveness among electricity generators that they are able to induce seems to be very sensitive to 1) The precise details of the mechanism 2) The technological composition of the country’s energy sector. These concerns have spawned individual country studies to measure in detail the market power of the participants, the precise ways in which they exercise that market power and the features of the economic environment and the market’s design which explain them. The standard models of these markets, represent them as sequences of independent Cournot competition encounters between the electricity generating firms. That is, a key assumption of the model is that the markets do not exhibit any forms of inter-temporally sustained tacit collusion. However, the details of these market mechanisms seem to match very well the broad conditions which the theory of repeated games has identified as conducive towards tacit collusion: 1) The interaction is very frequent and occurs at regular intervals. 2) Information about competitors’ fundamentals is public and easily available 3) There are a number predictable, naturally focal variables in the environment which can serve as correlating devices. This paper is the first part of a project studying the Colombian wholesale electricity market. The main objective of the project is to formulate an explicit model of tacit collusion for this market with three specific goals in mind: 1) That it matches the data better than the standard Cournot models 2) That it can be used to explicitly test hypotheses asserting that generating firms are tacitly colluding 3) That it can provide concrete policy recommendations to increase this market’s efficiency by reducing the amounts of tacit collusion. Concretely, I have in mind a very simple kind of tacit collusion: The weather (specifically the amount of rainfall) serves as an intertemporal coordination mechanism, indexing how aggressive each participant “can be” at any given time. Given the transparency of the environment and visibility of the actions of all participants, no “punishments phases” ever occur on the equilibrium path. This means that in the data, the behaviors of the generators should be fully driven by a (small) finite partition of the periodic rainfall levels. In this paper I begin this exploration by studying the conjecture that the behavior of participants in this particular market, is driven by a small partition of a set of publicly observable variables, not including past behaviors.

Viennese kaleidics: Why it’s liberty more than policy that calms turbulence

The idea of a kaleidic economy or society is strongly associated with George Shackle and his vision of Keynesian kaleidics. This essay asserts that the central thrust of the Austrian tradition in economic analysis can be described by the term Viennese kaleidics. In either version of kaleidics, the analytical stress is placed on treating time seriously and not just notionally. Either version of kaleidics leads to recognition that economic processes are better treated as turbulent than as equilibrated. While that turbulence is a natural feature of the unavoidable incompleteness of intertemporal coordination, it is subject to mitigation. This essay explains how it is that individual liberty and private ordering is generally superior to state policy and public ordering in calming the turbulence that naturally characterizes a kaleidic economy.