Net Rate Of Return Research Articles

Postretirement Adjustments of Pension Benefits

This paper examines why pension plans increased their liabflities by giving benefit increases to persons no longer working even though almost al lof them were not required to do so by any legally enforceable contract. In our model workers and firms have implicit contracts under which post-retirement increases in benefits are purchased by workers through lower wages or initial benefits. Such arrangements permit both plans and workersto share the risk of uncertain rates of return. They also allow beneficiaries to invest at a higher net rate of return than they could obtain elsewhere because of tax advantages and, in large plans, economies of scale. We also discuss how post-retirement adjustments can be used to influence turnover. Some empirical implications of the model are tested over a sample of beneficiaries of defined benefit plans. The major empirical findings are:(1) There is strong evidence of compensating differentials in final salary and initial pension benefits for beneficiaries receiving post-retirement adjustments.(2) Regardless of how the size of pension plans is measured(beneficiaries, participants, amount of benefits paid), large pension plans provide larger post-retirement benefit increases.(3) Beneficiaries of collectively bargained plans are more likelyto receive benefit increases and, among those receiving benefit increases, receive larger increases.(4) Benefit increases are larger in percentage terms for those who have been retired the longest and for those with the most years of service.

Banking Structure and the National Capital Market, 1869–1914: A Comment

Marie E. Sushka and W. Brian Barrett's study evaluating postbellum development of American capital market makes a number of interesting points, but their use of inappropriate data and their methods of analysis call into question their conclusions. ' Sushka and Barrett proxy regional interest rates by regional net rates of return derived by Lance E. Davis in his 1965 study.2 The Davis data afford them a longer time period than would other series, but Davis's net rates of return on earning assets are not satisfactory proxies for interest rates.3 This point has been made elsewhere, but it needs to be reemphasized and further defended.4 In his 1965 study Davis presented gross and net rates of return on earning assets for country and city bank regions. The net rates covered years 1869 through 1914, but gross rates could only be calculated for years 1888 through 1914. The gross rates were calculated as ratio of gross earnings of banks divided by level of income earning assets at a call date in middle of year. However, gross earnings were not reported prior to 1888. Since net earnings were reported back to 1869, net rates of return could be calculated from 1869 to 1914. Net earnings were gross earnings less operating expenses, taxes paid, and premiums and losses charged off against gross earnings. Davis suggested that, the net rates of return are a fairly good proxy for long-

Banking Structure and the National Capital Market, 1869–1914: A Reply

In Gene Smiley's comment on our study of nineteenth-century American financial markets several issues are discussed. ' We group them into three areas. First, he argues that Davis's net rates of return on earning assets are not satisfactory estimates of the return on investment in loans. Second, he argues that our theoretical model of bank behavior is too simplistic to justify our empirical specifications and our conclusion that the New York Stock Exchange had an important impact on financial integration. Third, he argues that the relationship between the yield on securities of the New York Stock Exchange and the regional quantity of loans, which we estimated as a loan-demand relationship, could be explained in terms of the loan-supply behavior of regional banks. However, it is our contention that none of Professor Smiley's suggestions is warranted and that the results of our analysis remain valid. It should be emphasized that Professor Smiley had access to the longer, original version of our article which contained a more extensive treatment of the theoretical model, numerous references to the relevant literature, and an extensive amount of empirical results that were reviewed but not reported in the condensed published version.2 Smiley argues that Davis's net rates of return on earning assets are not satisfactory estimates of interest rates and that gross returns (although not available prior to 1888) are more useful.3 Although more refined data are always desirable, there are ample justifications for using net returns in our analysis of the integration of nineteenthcentury capital markets. In a well-integrated market expected rates of return (adjusted for risk) are equated by movements in the flow of capital. But this is distinct from the notion that stated rates of interest are equated for two reasons. First, investors recognize that a promised (stated) rate is not necessarily the rate actually realized given business and financial risk.4 Thus, the expected yield will be less than the promised yield on all but risk-free debt. In other words, if all ex ante rates were realized ex post, then all securities would be risk free. Clearly, riskier loans require higher promised returns to compensate bankers for the higher probability of default. Second, operating costs (monitoring costs and collection costs, for example) must be absorbed by bankers in their lending operations. If operating costs were not important factors, bankers would have shifted their entire portfolios into consumer loans and

DO IRAS AND KEOGHS INCREASE SAVING?

Government retirement saving policies influence household saving. This paper considers the impact on household saving of tax-favored individual retirement savings plans—Keogh accounts and Individual Retirement Accounts (IRAs). One presumption behind the change in policy toward a more liberalized tax treatment of individual retirement saving is that higher net rates of return will encourage saving. Here, the focus is on the extent to which access to higher net rates of return afforded by IRAs and Keoghs leads to increased saving. As a basis for analysis, an extended life-cycle model of saving is used; the model is estimated using cross-section data. The results indicate that contributions to IRAs and Keogh plans stimulate saving and that the increase depends positively on the marginal tax rate, implying an interest sensitivity of saving.

The Financial Feasibility of Tax-Sheltered Individual Retirement Plans

Current literature on the financial feasibility of tax-sheltered individual retirement plans (TSAs) is scanty. One reason is that most observers believe the results are intuitively obvious since the tax shelter under TSAs allows the accumulation of greater funds at retirement. At that time, the retirement income will be fully taxable and TSAs prove to be a viable investment only when the projected investor's marginal tax rate after retirement is lower than the corresponding tax rate before retirement when savings are made. The study introduces a cash flow model to measure the net cash flows per one dollar annual savings under TSA and the taxed investment alternative for an investor of a certain age, opportunity net rate of return after tax and expense, and marginal tax rates before and after retirement.

Inflation, Tax Rules and the Accumulation of Residential and Nonresidential Capital

The present paper analyses the effect of the interaction between tax rules and inflation on the size and allocation of the capital stock with particular emphasis on the role of owner-occupied housing. The analysis is developed in the framework of an economy that is in equilibrium and in which a constant fraction of disposable income is saved. In this model, I show that, with current U.S. tax laws, an increase in the rate of inflation reduces the equilibrium amount of business capital employed in the economy and raises the amount of housing capital. The analysis also shows that a higher rate of inflation lowers the real net-of-tax rate of return to the provider of business capital. In a richer model than the current one, i.e., in a model in which the rate of personal saving was an increasing function of the net rate of return, a higher inflation rate would therefore lower the rate of saving. The present analysis also shows that permitting firms to depreciate investments more rapidly for tax purposes increases the accumulations of business capital but that, unless firms are permitted to expense all in- vestment immediately, an increase in in£ lat ion continues to depress the accumulation of business capital.

On an algorithm for combined system optimisation and parameter estimation

The paper is concerned with the determination of optimum steady-state operation of industrial plant where the optimisation is performed using a mathematical model with parameters whose values are estimated by comparing model and real plant measurements. The two associated problems of system optimisation and model parameter estimation are discussed and an algorithm is examined whose purpose is to accomplish the correct steady-state optimum operating condition on the real plant in spite of inaccuracies in the structure of the mathematical model. The aim of the paper is to investigate the performance of the algorithm which is accomplished through a theoretical analysis of its application to a linear process, where the optimisation is performed using a quadratic performance index and a mathematical model of incorrect structure. Particular emphasis is given to the stability and convergence properties of the algorithm and to the effect of real process measurement errors. Simulation results are also presented illustrating the effectiveness of the technique when applied to nonlinear optimisation problems including a study concerned with determining optimum controller set points to maximise the net rate of return from a chemical reactor plant.

Saving and the Rate of Interest: A Clarifying Note

Is the compensated interest elasticity of saving necessarily positive? In a classic paper in this Journal, MartinJ. Bailey (1957) argues that it is. This result has been controversial, as is indicated by James Buchanan's subsequent comment (1959) and Martin Feldstein's (1978) recent rejection of Bailey's point. Feldstein (1978, p. S30) states that although a compensated price increase unambiguously reduces the demand for a good (or increases its supply), this is not sufficient to establish that savings are increased by a rise in the net rate of This is incorrect. Feldstein has not and cannot show that Bailey's argument is wrong. What Feldstein can show is that he prefers a definition of income different from Bailey's and that the compensated interest elasticity of saving need not be positive using Feldstein's definition. As a corollary to his analysis of the compensated interest elasticity of saving, Feldstein rejects Harberger's (1964) measure of the welfare cost of an interest rate distortion (e.g., as a result of an income tax) because this measure makes the existence of such a welfare cost dependent on the compensated supply of saving being responsive to changes in the net rate of return. Specifically, Feldstein (1978, p. S36) states that Harberger's approach is incorrect. A capital income tax can impose a substantial annual or generational welfare cost even if the compensated effect on net saving is zero. Again Feldstein is incorrect for precisely the same reason that he was incorrect about the sign of the compensated interest elasticity of saving. If Harberger were using Feldstein's definition of income and hence saving, Har-

Comments on the Public-Sector Discount Rate: Response to Jenkins

Despite the length of his commentary, Jenkins (1980) fails to answer the criticisms of the Treasury Board's Guide outlined by Sumner (1980). Indeed, many of his apparent answers are addressed to questions which were never raised in the first place. His discussion of risk is a classic example of ignoratio elenchi. His convincing rebuttal of the argument that no allowance for risk need be incorporated in the appraisal of public sector projects is irrelevant. The point at issue was not whether such an allowance should be made, but that it should not be made twice. The Treasury Board's recommendations are therefore inconsistent; if its preferred procedure, of making an explicit allowance for risk, is to be retained, a matter on which, incidentally, an opinion was not expressed, then the discount rate derived from observed returns in the private sector is too high for the purpose. In similar fashion, Jenkins then argues that the marginal rate of return in the private sector is not measured by the return on the set of least profitable projects observed. It would be difficult to disagree with this observation, but it is equally difficult to see its relevance to the distinction that was being made between marginal and average rates of return. That distinction relates to the distribution of expected returns across all potential projects, and not to the distribution of actual returns around their expected yields. Certainly 'there will be a tendency for marginal expected rates of return on new investment and the average expected rates of return to converge'; the substantive question is whether the convergence is so rapid as to render the distinction between average and marginal rates of return unimportant. Notice that if convergence occurred so quickly, Jenkins would not be able to argue that his calculated average understated the marginal rate of return by overrepresenting comparatively unprofitable sectors. More significantly, his implicit judgement that convergence takes place rapidly is inconsistent not only with his own estimates of dispersion in the average private rates of return across industries, but also with the substantial lags in adjustment identified in studies of investment behaviour. Jenkins' remaining arguments reiterate the view that divergencies between private and social returns are attributable solely to taxation. His dismissal of imperfections in the competitive process as a contributory factor leaves as open questions both the adequacy of national indices of concentration as proxies for barriers to entry, and the source of dispersion in private rates of return. The proposition that 'real corporation income tax rates will increase as a result of an inflationary situation' is, yet again, not in dispute. What is in dispute is the assertion that the increase in inflation has more than offset the lower effective tax rates resulting from more generous write-off provisions. The assertion does not apply to the manufacturing and processing incentives. More importantly, its validity or otherwise cannot be established from a simple scrutiny of the historical record, because the benefits of investment credits or more liberal capital cost allowances are typically not extended to existing assets: what matters is the social rate of return on new investment, which depends on current tax provisions. That is why an alternative procedure was recommended, of calculating social rates of return on different assets at the prevailing tax structure, for a given net rate of return. This procedure would eliminate the confusing influence of irrelevant history. By abstracting from other determinants, it would also serve the valuable purpose of throwing into sharper relief the

G4.2: Overcoming Optimising Model Uncertainties in Supervisory Control

The paper is concerned with on-line computer determination of optimum steady state operating conditions of industrial plant, where the optimal solution is computed using a mathematical model whose parameters are periodically updated by comparing model and real process measurements. A method is employed which, by iterating between parameter estimation and a modified system optimisation, attains the correct optimum steady state operating condition on the real process in spite of structural inaccuracies in the mathematical model. Results of computer simulation studies are presented on the application of the iterative technique to on-line determination of maximum net rate of return from an exothermic chemical reactor in which optimum raw material input flow and reaction temperature controller set points are computed using a simplified steady state mathematical model. Particular attention is given to the effects of real process dynamics and measurement errors, and the simulation results illustrate the robust nature of the technique despite the requirement to obtain first-order derivatives of real process steady state measurements with respect to controller set point values.

On an Algorithm for Combined System Optimisation and Parameter Estimation

The paper is concerned with the determination of optimum steady state operation of industrial plant where the optimisation is performed using a mathematical model with parameters whose values are estimated by comparing model and real plant measurements. The two associated problems of system optimisation and model parameter estimation are discussed and an algorithm is examined whose purpose is to accomplish the correct steady state optimum operating condition on the real plant in spite of inaccuracies in the structure of the mathematical model. The aim of the paper is to investigate the performance of the algorithm which is accomplished through a theoretical analysis of its application to a linear process, where the optimisation is performed using a quadratic performance index and a mathematical model of incorrect structure. Particular emphasis is given to the stability and convergence properties of the algorithm and to the effect of real process measurement errors. Simulation results are also presented illustrating the effectiveness of the technique when applied to non1inear optimisation problems including a study concerned with determining optimum controller set points to maximise the net rate of return from a chemical reactor plant.

An algorithm for steady-state system optimization and parameter estimation

In this paper an algorithm is described which uses a steady-state mode! to determine the optimum operating point of a process. The model, which is not required to be an accurate representation of the real process, contains parameters to be estimated and the algorithm involves an iterative procedure between the two problems of system optimization and parameter estimation. Lagrangian analysis is employed to account for the interaction between the two problems, resulting in a procedure which may be regarded as a modified two-step approach in which the optimization objective index includes an extra term. The extra term contains a comparison between model and real process output derivatives and ensures that the optimal steady-state operating condition is achieved in spite of model inaccuracies. The algorithm is shown to perform satisfactorily in a digital simulation study concerned with determining food flow rate and temperature controller set points to maximize the net rate of return from an exothermic chemical reactor using a simplified non-linear model for system optimization and parameter estimation. The simulation is employed to investigate the convergence properties of the algorithm and to study the effects of measurement errors.

Inflation and Taxes in a Growing Economy with Debt and Equity Finance

Our tax system was designed for an economy with little or no inflation. The current paper shows that inflation causes capricious changes in the effective rate of tax on capital income and therefore in the real net rate of return that savers receive. This is not only a temporary disequilibrium effect but one which persists in steady-state equilibrium. Unlike earlier papers by Feldstein and by Green and Sheshinski, the current study recognizes that firms finance investment by both debt and equity in a ratio that depends on the tax rates and on the rate of inflation.

Is the Rate of Profit Falling?

THE PRETAX net rate of return on corporate capital reached a thirty-year low in 1974 of only 6.4 percent, according to the estimates that we develop in this paper. Although profits have rebounded substantially since then, there is still a widespread suspicion that the rate of profit may have been declining over a number of years. A primary purpose of this paper is to use the new official estimates of profits, capital consumption, and the capital stock to assess whether such a decline has in fact occurred. In a widely cited paper written a few years ago, William Nordhaus concluded that the rate of profit has been falling and attributed this decline to the higher capital intensity that resulted when investors shifted funds into the corporate sector because their perception of the risk of such investment declined.' Important revisions in the national income accounts data on profits and in the corresponding estimates of the capital stock have become available since Nordhaus did his work. Moreover, Nordhaus' conclusion was based on his visual inspection of the data and not on any for-

THE ACCOUNTING TREATMENT OF HUMAN INVESTMENT AND CAPITAL

Defining investment as outlays that increase income‐ and output‐producing capacity, the author presents estimates of human investment in the United States 1929–69, comprising rearing costs, education, training, health, safety and mobility outlays. He develops an economic accounting framework to accommodate human investments and research and development in national and sector capital accounts, with appropriate adjustments to the current accounts to provide consistency. The associated balance sheets and wealth statements are also developed.The wealth and corresponding income estimates are used to compute rates of return on human, non‐human, and total capital. In the business economy the average net rate of return on total capital was 10.6 percent in 1969, compared with 10.0 percent in 1929. The average and marginal rates of return on human capital were generally somewhat higher than on non‐human capital throughout the period.

The Roles of Money in an Economy and the Optimum Quantity of Money

What is the optimum quantity of money in a society? This paper answers this question both from the perspective of a utility maximizing model with real balances in the utility function, and employing an inventory theoretic model which focuses attention on the costs of transacting in different markets and on the storage costs of holding money. We find that socially optimal transactions patterns and inventory holdings can be induced by paying interest on money and bonds equal to the net rate of return on capital. This conclusion is however only valid if it is costless for the society to institute and operate such an interest payment mechanism. In a world where it is costly to institute and operate an interest payment mechanism, a social optimum requires that the rate of return on money and bonds must equal the net rate of return on capital minus the social cost of inducing individuals to hold optimal quantities of financial assets. It is therefore necessary to take account of both the potential gains in welfare from instituting interest payments on money and the real potential costs of such a policy. Reference: Economica, November, 1973 pp. 416-431

Une tentative d'explication de l'offre de monnaie en France

The french money supply: an attempted explanation ; ; A sfudy of the French money supply reveals that the French banks neutralize as a minimum .70, and probably doser to .80, of movements in fhe unborrowed reserve base. Second, changes in borrowed reserves intensif y the impact of changes in the ratio of money to the reserve base, or the money multiplier. Third, the marginal net yield on bank credit, therefore implicitly the aggregate demand for bank credit, exercise an extremely important influence on the level of borrowed reserves. Fourth, the monetary authorities depend highly on their ability to vary the net rate of return on bank credit.

Une tentative d'explication de l'offre de monnaie en France

The french money supply: an attempted explanation A sfudy of the French money supply reveals that the French banks neutralize as a minimum .70, and probably doser to .80, of movements in fhe unborrowed reserve base. Second, changes in borrowed reserves intensif y the impact of changes in the ratio of money to the reserve base, or the money multiplier. Third, the marginal net yield on bank credit, therefore implicitly the aggregate demand for bank credit, exercise an extremely important influence on the level of borrowed reserves. Fourth, the monetary authorities depend highly on their ability to vary the net rate of return on bank credit.

The Role of Interest Rates and Inflation in the Consumption Function

MOST OF THE ANALYSIS of the effects of interest rate changes on consumption has been concerned with (1) the relative importance of income and substitution effects in determining how households will allocate their resources over time, and (2) the substitution effect at a moment of time determining the demands for durable versus nondurable consumption goods. But two other types of interest rate effects on consumption-effects that have received little attention in the literature-may be of some importance and are the subject of this report. The rate of inflation enters the analysis because of the wedge it drives between the nominal and real rates of interest. One of the effects to be considered is a consequence of the fact that the real rate of interest helps determine the services yielded by the stock of consumer durables. Following a common practice in econometric work on consumption, the services of durables are included in consumption and purchases of consumer durables are excluded. Services of durables must also be added to disposable income. Since the value of such services cannot be ascertained from market transactions, it must be imputed. The stock of consumer durables is first estimated, and then multiplied by a depreciation rate and a net rate of return to obtain the gross yield on the stock. Since

DEPOSIT COMPOSITION AND COMMERCIAL BANK EARNINGS

THE PURPOSE of this study is to provide quantitative estimates of the marginal net rates of return which commercial banks realize on their demand deposits, time deposits, and capital stock. To estimate these rates of return, multiple regression analysis is applied to balance sheet data on earnings, costs, deposits, and capital. The data consist of a cross section of 295 member banks in the state of Ohio for each year of the period from 1963 to 1966.1 Marginal rates of return are estimated for each of these four years. To test the possibility that net rates of return may be influenced by bank size, separate regressions are estimated for banks with total deposits of under and over 10 million dollars. Commercial banks earn a return on their deposits and capital by investing deposit-funds and capital-funds in assets. This process, of course, involves costs. Marginal rates of return are estimated net of the costs of servicing and managing assets. However, the model is specified so that the estimated coefficients on the time deposit categories do not reflect the interest costs of acquiring these deposits. For reasons discussed below, the interest costs of time deposits are presented separately. Estimated net rates of return on deposits and capital reflect the structural characteristics that prevailed during the period from 1963 to 1966. Obviously, interest rates on bank assets are an important determinant of net rates of return on deposits and capital. During this period, interest rates rose gradually.2 Covariance analysis is used below to test for year-to-year variations in net rates of return caused by increases in interest rates. In section II, the theoretical model used to estimate marginal net rates of return is developed. In sections III and IV, the data and statistical assumptions of the model are discussed. The empirical results are presented in section V. Section VI summarizes the principle findings of this paper.