Perfect Foresight Model Research Articles

Public sector layoffs, credibility and the dynamics of inflation in a simple macromodel

The impact of public sector layoffs is analyzed in a simple perfect foresight model that incorporates the main elements of the conflict between adjustment and the pursuit of long-run efficiency. Permanent layoffs are normally welfare improving even when they give rise to a lengthy phase of high unemployment. The transitional problems are much more acute, however, when doubts exist about the permanency of the layoffs. Self-fulfilling failure is frequently an equilibrium when it is known that a return of inflation to its previous level will provoke the government to reverse the reform. Moreover, reform may be most difficult to sustain precisely when it promises the greatest benefits.

A Reliable and Computationally Efficient Algorithm for Imposing the Saddle Point Property in Dynamic Models

(Anderson and Moore, 1983; Anderson and Moore, 1985) describe a powerful method for solving linear saddle point models. The algorithm has proved useful in a wide array of applications including analyzing linear perfect foresight models, providing initial solutions and asymptotic constraints for for nonlinear models. Although widely used at the Federal Reserve, few outside the central bank know about or have used the algorithm. This paper attempts to present the current algorithm in a more accessible fonnat in the hope that economists outside the Federal Reserve may also find it useful. In addition, over the years there have been many undocumented changes in approach that have improved the efficiency and reliability of algorithm. This paper describes the present state of development of this set of tools. This paper analyzes a general linear saddle point model with a unique steady state and a unique solution converging to that steady state for any set of temporally predetermined variables. We prove that any such model has a reduced form relating the solution sequence entirely to its history, and we present an efficient procedure for computing the reduced form coefficients.The procedure is a generalization of the familiar saddlepoint analysis, and it is straightforward to program. The procedure consists of efficient library routines for matrix rank determination and invariant space calculation embedded in a simple control structure.The algorithm solves linear probles with dozens of lags and leads and hundreds of equations in seconds. The technique works well for both symbolic algebra and numerical computation.

Comparative Dynamics in Perfect-Foresight Models

This paper analyzes the technique of comparative dynamics (Judd, 1982) for the computation of the impact of perturbations on a steady state in a perfect-foresight model. The accuracy of this technique is demonstrated by numerical simulation experiments. Moreover, the technique is generalized to discrete-time models.

Robust and Risk-Neutral Optimization with Linear Dynamic Perfect Foresight Models: A Field Manual

Robust and Risk-Neutral Optimization with Linear Dynamic Perfect Foresight Models: A Field Manual

Joint Production of Goods and Knowledge: Implications for Tax Reform

This paper examines the welfare impacts of tax reformin the context of a perfect-foresight two-sector model with linearendogenous growth, where new knowledge is a byproduct of productionactivities. A calibrated version of this model is used to obtainnumerical estimates of the welfare impact of equal-yield unanticipatedtax changes through transitional analysis. Simulation resultsindicate that the size of the welfare effects of income tax reformdepends crucially on the sectoral composition of final consumptionand investment demand, and on the interplay between output complementaritylinkages and factor intensities.

THE EFFECT OF DEFICIT FINANCE ON HUMAN CAPITAL

This study examines the effect of structural budget deficits on investment in human capital in a perfect-foresight model. This effect is shown to be significantly negative. This disinvestment in human capital is also shown to cause an important initial substitution toward work, consumption, and investment in physical capital. Thus the initial stimulative effect of deficits on economic activity is magnified. The long-run detrimental effects of deficits on these variables, however, are also magnified by the effect on human capital. In addition, the effect on human capital is shown to significantly increase the welfare cost of deficit finance.

Public investment, private investment, and inflation

Abstract In this paper I investigate the short- and long-run effects of cutting investment in social infrastructure in a simple perfect foresight model. Even though the equilibrium capital stock falls, private investment increases in the short run provided the intertemporal elasticity of substitution is not extremely large. When the productivity of social infra-structure is comparable to or above that of private capital, inflation is likely to increase in the long run. Furthermore, inflation may be higher throughout the adjustment process if a modest degree of intertemporal substitution is possible.

Constraints in perfect-foresight models: The case of old-age savings and public pensions

The solution of discrete-time perfect-foresight models with constrained state variables differs considerably from the solution of models without constraints. In this paper this is worked out for a simple model of decision making on public pensions.

Adjustment costs and indeterminacy in perfect foresight models

Abstract This paper suggests a method for resolving indeterminacy of equilibrium in perfect foresight models and applies it to several existing models. Quadratic adjustment costs are introduced into models with multiple equilibria, and the limiting behavior of the resulting solutions is studied as the adjustment costs go to zero. The method is shown to be useful in selecting among feasible equilibria in examples in which there is local indeterminacy.

On Perfect Foresight Models of a Stochastic World

Long-run analysis is often based on perfect foresight equilibrium relationships arbitrarily augmented to incorporate stochastic shocks. This paper examines whether perfect foresight models admit interpretations as limits of stochastic economies and reflect long-run behavior and policy effects. It provides a novel interpretation of such models, specifies consistency criteria for long-run analysis, and proposes metrics for model convergence. Analytical and calibration exercises are conducted to show that convergence to perfect foresight need not occur and even when it occurs it does not ensure that relationships between long-run averages or low-frequency components are captured by perfect foresight models. Copyright 1994 by Royal Economic Society.

Quotas v. Devaluation in the Small Open Economy

Only one attempt has been made in the existing literature to evaluate the validity of the claim that quotas are less inflationary than devaluation. Cornes and Dixit (1982) contrast the impact of the two policies upon the price of non-tradables in a static three-sector model (importables, exportables and non-tradables) of the small open economy in which free trade prevails initially and nominal money balances enter the private utility function. After showing that the price of the non-traded good may rise more or less under the quota that produces the same improvement in the trade balance as devaluation, they conclude that the issue as to which instrument is more 'inflationary' can only be resolved empirically. In this paper I take up the issue in an optimizing perfect-foresight model of the small open economy that differs in a number of important respects from the model of Cornes and Dixit. The time horizon is longer, extending beyond the short run to encompass the entire transition path for domestic prices; real, (?) The London School of Economics and Political Science 1993

Modern Business Cycle Theory

This paper extends Sidrauski's approach to two currencies in a small open economy. Following Sidrauski's solution procedure, we derive a macroeconomic model that is usually found in some ad hoc models of perfect foresight. It turns out that an implicit assumption of fixed future expectations on the future price inflation is imposed on the household's behavior. We also show that unexpected and permanent increases in government expenditure cause the exchange rate to rise. Whether there is initial overshooting in the exchange rate depends on the relative shifts of m = 0 and F = 0 schedules. Furthermore, it is shown that when the government announces its future increases in the government expenditure, the domestic currency depreciates immediately and the foreign exchange accumulates thereafter. [F 41]

Technological Progress in a Model of the Housing – Land Cycle

A stationary-state perfect foresight model is developed in which housing and land are treated as investment assets convertible to each other at some cost. Investors hold either land or housing and are heterogeneous in the i.i.d. idiosyncratic shocks to their conversion costs in every time period. Hence, there are endogenously determined probabilities that a unit of land will be converted to housing ("construction probability") and that a unit of housing will be converted to land ("demolition probability") in any given time period. This model is used to analyze the effects of a decrease in construction cost on the asset prices of land and housing, on housing rent and on the stationary stocks of land and housing. A decrease in construction cost always raises land values, may either raise or lower housing values, and increases both the construction and demolition probabilities. The housing stock increases (decreases) if the construction probability increases proportionally more (less) than the demolition probability. Since housing rent is inversely related to the stock of housing, the fall in construction costs may cause rents to rise. Thus, paradoxically, technological progress may hurt renters. The moral of the model is important: in contrast to models of the housing market without land or to models in which land price is exogenous, the long-run supply price of housing is not fully determined by construction cost, but depends as well on demolition cost and on the endogenous value of land.

A Simple Model of Sectoral Adjustment

Despite the significance of limited labour mobility across sectors, few attempts have been made to produce dynamic models of sectoral adjustment which are consistent with perfect foresight and, yet, flexible enough to allow for a variety of dynamic experiments. This paper proposes a simple perfect-foresight model of two-sector economies, in which aggregate sectoral movement of labour takes place through the process of demographic change. The model is tractable enough that one can easily examine the effects of intertemporally complicated relative price shocks (both exogenous and endogenous) under a variety of assumptions on technology.

Evaluation of municipal water supply operating rules using stochastic dominance

A procedure for evaluating and selecting among alternative rules for operating a municipal water supply system is outlined in this study. It is assumed that monthly water demands and supplies are random. The total cost, however, is affected by both current month and future water allocation decisions with respect to the operation of facilities. A perfect foresight model using mixed integer programming is developed and applied to 36 years of historical demand and supply data. Using the solutions to this model, several simple operating rules are derived. These rules are applied to the historical data to simulate system operation, and cumulative distribution of net revenue for each rule is derived. Based on first‐ and second‐degree stochastic dominance criteria, the performance of alternative rules are evaluated. The procedure is also repeated with a set of generated data sequences to check the consistency of the solutions. Average reductions of up to 11% in annual net revenues from those of a perfect foresight model are observed, for various operating rules. Using stochastically dominant rules, annual revenues can be increased by 5% on the average from a commonly used rule based on unit cost.

Current-Account Effects of a Temporary Change in Government Expenditure

A perfect-foresight model of intertemporal utility maximization is used to analyze the current-account effects of a temporary increase in government spending. The relationship between the marginal utility of private consumption and the supply of public goods in the economy is shown to play a crucial role in determining the qualitative nature of the optimal current-account response. The link between the timing of the policy change and the magnitude of the current-account effect is also examined.

ON THE INTERACTION BETWEEN MONETARY AND FISCAL POLICIES UNDER PERFECT FORESIGHT

THE COMPOSITION of money/bond finance of the government's budget deficit will in general affect the rate of inflation in long run perfect foresight models. It has been shown however that the nature of the analysis depends crucially on the type of deficit which is being held constant while its composition varies. McCallum (1984) has shown, for example, that a policy of pure bond finance of the deficit is not possible if the deficit is defined of interest payments, while this policy is possible, without inflation, if the deficit is gross of (i.e. includes) interest payments. Liviatan (1982) has shown that an increase in money finance of the deficit is deflationary when deficit is held constant and inflationary when gross deficit is held constant. The distinction between the two types of deficit is crucial to almost every problem of monetary policy in long run perfect foresight models. For example, it was brought up recently in relation to the analysis of the effect of tight money on inflation, following the work of Sargent and Wallace (1981). Liviatan has (1984) shown that the result that tight money may have an inflationary effect even in the short run is reversed when the definition of the deficit is changed from net to gross. Although there seems to be, in recent papers, some preference for holding constant deficit [a new example is provided by Calvo (1985)], there is no theoretical justification for this procedure. If we hold constant deficit, we assume implicitly an inflationary attitude by the government, which seems to prefer financing additional interest payments by printing money and selling bonds rather than by additional taxes. If alternatively, we hold gross deficit constant, we assume that the government has an anti-inflationary philosophy which calls for an increase in taxation when interest payments rise. The choice among these approaches should presumably reflect the government's evaluation of the cost of inflation as compared with the cost of raising taxes. In principle, there is no particular reason why we should confine ourselves only to a choice between the extreme attitudes mentioned above. It seems more reasonable to assume that the government can adopt a convex combination of the extreme cases. We shall therefore define a fiscal policy parameter in the form of the proportion (0) of the interest on government bonds which is financed by taxes. The parameter of monetary policy will be defined as the ratio (ar) of money finance to bond finance of the deficit.

Collapsing exchange rate regimes and exchange rate dynamics: Some further examples

This paper extends some recent perfect foresight models of balance of payments crises and exchange rate realignments to a world of smart speculators, sticky prices and restricted international capital movements. The likelihood and timing of a regime collapse are shown to depend upon initial foreign reserve endowments, monitary policy, speeds of market adjustment and future exchange rate policy. These factors are also shown to influence the dynamic behavior of the exchange rate and prices during a transitional period of floating.

A procedure for differentiating perfect-foresight-model reduced-from coefficients

Anderson and Moore (1985) present a fail-safe method for analyzing any linear perfect-foresight model. They describe a procedure which either computes the reduced-form solution or indicates why the model has no reduced form. This paper presents formulae for differentiating singular vectors and vectors spanning an invariant space, and shows how to use these formulae to differentiate Anderson and Moore's structural-model to reduced-form-model transformation.

The Welfare Cost of Factor Taxation in a Perfect-Foresight Model

This paper examines the marginal efficiency cost of various factor taxes in a dynamic general-equilibrium model. The au thor solves for the excess burden of anticipated and unanticipated, t emporary and permanent, tax policies. Using a range of estimates for taste and technology parameters, he finds excess burdens larger than those indicated by previous studies that use static models. These exc ess burdens are sensitive to parameter values and timing. However, th e rankings of alternative tax policies turn out to be insensitive to structural parameter values. Copyright 1987 by University of Chicago Press.