Standard Neoclassical Model Research Articles

Government size and the effectiveness of fiscal policy: the bigger the better?

Abstract This study investigates the effect of government size, as measured by the tax revenue to gross domestic product (tax-GDP) ratio, on output responses to increases in government purchases. First, we show that in a standard static neoclassical model, the stimulus effect of fiscal expansion on output increases with the tax-GDP ratio. This finding is quantitatively confirmed using a dynamic neoclassical model with standard functional forms and parameter values. To empirically test the theoretical findings, we analyze the responses of macroeconomic variables to an unanticipated increase in government purchases for 12 Organisation for Economic Cooperation and Development (OECD) countries during 1985–2019 using a state-dependent local projection method. The estimation results reveal that while output responses to an unanticipated fiscal expansion are significantly positive when the tax-GDP ratio is high, they are statistically indistinguishable from zero when the ratio is low. Overall, our findings suggest that fiscal expansion can stimulate output more effectively at high tax rates, unlike the well-known predictions of the traditional Keynesian model.

Does economic liberalization foster corporate investment? Theory and evidence from US and Canadian firms

Prior studies have largely debated and demonstrated the positive effect of economic liberalization on economic growth, but they have not clarified how and to which extent economic liberalization affects corporate investment, the main driver of a country's economic growth. This paper investigates the relationship between economic liberalization and corporate investment by modelling the microeconomic channels through which economic liberalization affects corporate investment. Our theoretical framework extends the standard neoclassical model of firm value maximization to incorporate the effect of economic liberalization on corporate investment via several microeconomic channels. We test the theoretical predictions of our model by using a large and heterogeneous sample of non-financial US firms for the period 2000–2019. The empirical results support our hypotheses that economic liberalization positively affects corporate investment both directly and indirectly through different channels. These effects hold, although with different intensity, for all dimensions of economic liberalization.

A mathematical contribution to the economic growth theory. Evidence on the relationship between wages and output from the Italian region

In this manuscript, the authors empirically assess the impact of an increase in the wage per worker on the GDP per capita of the Italian regions. To achieve this research aim, the authors carry out a panel data regression analysis, relying on an identification strategy based on the standard Neoclassical model of economic growth. The authors’ results suggest that, on average, the output effect of an increase in the wage per worker is positive, with a substantial difference between the Northern and Center-Southern regions. The authors’ policy implication is that wage moderation does not represent a remedy to the economic stagnation that the Italian regions have been experiencing since the second half of the 1990s.

Impact of Social Preferences, Trust and Behavioural Norms on Cooperation: Experimental Evidence from Prisoner’s Dilemma Game

The main objective of the study is to evaluate the impact of social preferences, trust and behavioural norms on strategic choices made by economic agents using the framework of a one-shot Prisoner’s Dilemma (PD) game. The standard neoclassical economics model predicts that all players will choose a strategy of non-cooperation, establishing it as the Nash equilibrium. We examine how social preferences and behavioural norms influence the player’s expectations from others and their own choices, by experimentally testing for the same using a 2 × 2 factorial design with the following three levels of partner selection arrangements: (i) game playing with stranger, (ii) face-to-face game playing with peer, and (iii) game playing with friend. The experimental results reveal significant deviations from the standard predictions of the one-shot PD game. The experimental data revealed that (i) players while interacting with a peer cooperated significantly more than playing with a stranger and (ii) players playing with a friend cooperated significantly more than playing with a peer. These changes in the social preferences of the players were further investigated in terms of trust/distrust and four behavioural norms—positive reciprocity, negative reciprocity, exploitation and altruism, and how these factors interact in influencing decision-making with respect to cooperation. JEL Codes: C72, C91, D01, D91

Handbook of Behavioral Economics and Climate Change

The past three decades have witnessed an exponential increase in academic literature pertaining to the behavioural economics discipline (Mesa-Vázquez et al., 2021). This comes in the wake of increasing systematic evidence of the potential for behavioural economics—with its underpinnings in psychology—to significantly improve standard neoclassical economics models and predictions of human behaviour in varying economic contexts (Thaler and Sunstein, 2008; Thaler, 2015). In tandem, a similar revolutionary trend has been seen in climate change research, motivated by an increasingly urgent concern for self-preservation of current and future generations. Whilst the two fields are now well-established strands in academic literature, the extent and nature of recent advancements at the intersection of behavioural economics and climate change research are less clear. The Handbook of Behavioral Economics and Climate Change (Seo, 2022a) (the Handbook henceforth) is a timely edited collection of frontier research that attempts to fill this gap, confronting the complex relationship amongst anthropogenic climate change, climate policy and decision-making behaviours of economic agents.

The time path of productivity convergence and the international allocation of capital

Can cross-country heterogeneity in the time path of technological convergence account for observed allocation of international capital? The time path of technological convergence varies significantly across countries, whereas previous studies assume a common cross-country convergence path and one that is linear. We show that the time path of a country’s technological convergence has important implications for the predicted size of capital inflows from the rest of the world. Accounting for this observed heterogeneity accounts for around 20 percent of the puzzling allocation of capital across developing economies relative to neoclassical predictions, without the introduction of additional distortions common in the existing literature. Cross country differences in convergence paths are not powerful enough to account for capital outflows observed in particularly fast-growing Asian economies, but go a long way in explaining why the fastest developing and converging economies are not receiving capital inflows in the magnitude predicted by the standard neoclassical model.

Dynamic Effects of Changes in Government Spending in Pakistan’s Economy.

This study analyses the effects of changes in government spending on aggregate economic activity and the way these effects are transmitted in case of Pakistan for the period 1971-2008. To analyse the transmission mechanism of government spending innovations, the Vector Autoregressive Model is estimated for following five variables: government spending per capita, GDP per capita, consumption per capita, debt to GDP ratio, long term interest rate and real exchange rate. The consumption and output respond negatively to the innovation in government spending which is consistent with the standard neoclassical model. The interest rates increase in the face of expansionary fiscal spending. As government debt builds up with fiscal expansion, the rising risk of default or increasing inflation risk reinforce crowding out through interest rates. The real exchange rate tends to appreciate in response to rise in government spending. This finding is according to the open economy literature and also with the conventional literature. JEL classification: E21, E62, E63 Keywords: Government Spending, Vector Autoregressive Model, Impulse Response Function, Neoclassical Model

The circular economy and the optimal recycling rate: A macroeconomic approach

This paper studies the economic implications of the circular economy and recycling activities from a macroeconomic perspective. The paper incorporates the circular economy into an otherwise standard neoclassical dynamic general equilibrium linear economy model, in which the production function depends on capital, labor, and raw materials. Raw materials are a composite of natural resources (the linear economy) and recycled material (the circular economy). Waste is a function of consumption but can be incorporated back into production activities through recycling. We find the existence of a positive S-shaped relationship between the optimal recycling rate and economic development, indicating that increasing the circularity of the economy is a necessary condition to augment social welfare in a growing economy. The optimal recycling rate depends positively on the pollution damage and waste content of final consumption goods. Simulation of the model supports the existence of a steady-state Environmental Kuznets Curve (EKC) relationship between the stock of waste and the output in the presence of a circular economy. Finally, we find that while a permanent improvement in recycling technology has positive effects on output, expanding the circularity of the economy, an increase in the cost of natural material has harmful effects on output, increasing waste accumulation and reducing recycling.

Public Health Federalism?

Abstract This paper develops a general equilibrium model of competitive jurisdictional choice that provides insights into what is being coined 'public health federalism'. Using a standard neoclassical model of production combined with a utility maximization hypothesis, jurisdictions choose both tax rates and a level of local public health quality. Incorporating the joint determination of both tax decisions and the choice of public health standards can give rise to some interesting interrelationships between local tax revenues and public health considerations. Additionally, the model is extended to address the fiscal realities of sub-state jurisdictions in the United States. Beleaguered in a second-best setting, devolved efficiency becomes a target difficult to hit. We show that when jurisdictions rely on taxing mobile factors and mobile factor productivity is enhanced by relaxing public health mitigation, jurisdictions will choose lower levels of public health quality. JEL classification numbers: H73, I18, R13. Keywords: Federalism, Decentralized authority, COVID - 19, Public health mandates.

Public Health Federalism?

Abstract This paper develops a general equilibrium model of competitive jurisdictional choice that provides insights into what is being coined 'public health federalism'. Using a standard neoclassical model of production combined with a utility maximization hypothesis, jurisdictions choose both tax rates and a level of local public health quality. Incorporating the joint determination of both tax decisions and the choice of public health standards can give rise to some interesting interrelationships between local tax revenues and public health considerations. Additionally, the model is extended to address the fiscal realities of sub-state jurisdictions in the United States. Beleaguered in a second-best setting, devolved efficiency becomes a target difficult to hit. We show that when jurisdictions rely on taxing mobile factors and mobile factor productivity is enhanced by relaxing public health mitigation, jurisdictions will choose lower levels of public health quality. JEL classification numbers: H73, I18, R13. Keywords: Federalism, Decentralized authority, COVID - 19, Public health mandates.

Kaldor and Piketty’s facts: The rise of monopoly power in the United States

The macroeconomic data of the last fifty years have overturned at least two of Kaldor’s famous stylized growth facts: constant interest rates, and a constant labor share. At the same time, the research of Piketty and others has introduced several new and surprising facts: an increase in the financial wealth-to-output ratio in the US, an increase in measured Tobin’s Q, and a divergence between the marginal and average returns on capital. In this paper, we argue that these trends can be explained by an increase in market power and pure profits in the US economy—that is, the emergence of a non-zero-rent economy—along with forces that have led to a persistent long-term decline in real interest rates. We make three parsimonious modifications to the standard neoclassical model to explain these trends. Using recent estimates of the increase in markups and the decrease in real interest rates, we show that our model can quantitatively match these new stylized macroeconomic facts.

HOW LONG DOES ECONOMIC INJUSTICE LAST?

This article assesses whether economic injustices that took place in the past still have significant implications for the material welfare of people many years later. That issue is central to the question of how fair is the distribution of wealth and income today. It is also relevant to issues of reparations for past wrongs. I find that in standard neoclassical models of economic growth the lingering effects of injustice from more than 70 years ago are generally small. But effects can last much longer once we allow for impacts of past injustices to be transmitted through human capital accumulation as well as physical capital.

Nonconvex consumer preferences, compulsive eating, and food addiction

PurposeEpisodes of compulsive eating may lead to addiction. Changing relative prices does not always work for many food addicts turned overweight or obese individuals. This paper points to when such situations may arise and how they can be remedied.Design/methodology/approachWe modify the standard neoclassical economics model assumption of indifference curves being convex to the origin. It becomes violated in situations when compulsive eaters become food addicts. As a result of that, the assumption of the concave (quasi-concave) utility function is violated too. We also introduce the possibility that compulsive eaters may have stable but nonconstant preferences.FindingsMost important finding of our model is that a smooth dynamic path to addiction, caused by habit, disappears. Hence, the ability for smooth adjustment to relative price changes due to policies targeting obesity may not be applicable for a compulsive addict. We postulate the existence of thresholds past in which irreversible harm to addicted overeaters may occur. Reaching such states implies that no economic tools at our disposal could reverse the harm, which, in turn, deem that many policies directed at altering relative prices are ineffective in correcting overeating addiction and its consequences.Social implicationsEven if we believe in consumer sovereignty, it is possible to shape consumer behavior via policy actions, including the behavior of extremum seekers turned addicts. The public policy of obesity should consider, in this case, its social cost.Originality/valueNo prior research has considered food addiction in light of compulsive eating caused by extremum-seeking behavior. Addiction correcting food policies always relied on either rational or myopic addiction models.

Circular Regulations (CR) for Bioeconomy Development

The term Circular Regulations (CR) is introduced to describe a broad regulatory framework, designed with a circular understanding of the economy. Central in this discussion is the transition towards bioeconomy, a term that is not always used consistently, and sometimes treated in the same way as circular economy (CE), although these terms are not necessarily equivalent. In this article we endorse a systemic interpretation of CE, where a continuum of approaches, extending from reusing/recycling/upcycling to refuse/rethink/reduce, gradually replace existing linear “end-of-life” concepts. CE is a key prerequisite for the bioeconomy shift, a transition that further builds on CE, where circular design and processes are further augmented with increased resource utilization and intensive applications of innovative science and technology. The prevailing regulatory arrangements in CE, however, remain either fragmented or largely based on pre-existing policies, drafted to address issues of the linear economy, thus presenting several limitations when dealing with the underlying paradigm shift: complex market relationships that go beyond the standard neoclassical model. CR adopts an encompassing approach to regulatory design; it is not meant to be a rigid set of rules, but rather a regulatory framework where institutions, market rules, and business practice explicitly account for environmental and socially responsible activities, while securing an enabling environment for innovation. CR directly reflects on CE, where bioeconomy growth is informed by science, enabled by technology, driven by business, and supported by relevant policies and institutional frameworks. The article presents a conceptual setting towards CR and a practical example for its development.

Modelling the Relation between Managers, Shadow Cost of External Finance and Corporate Investment

This paper provides a theoretical framework for studying the impact of self-interested managers on the level of corporate investment. I extend the standard neoclassical model of firm value maximization to incorporate the effect of misaligned managers on corporate investment via a firm’s profit, adjustment costs of capital and shadow cost of external finance. Under some assumptions, commonly made by the relevant literature, the model shows that the intensity of agency conflicts between misaligned managers and outside shareholders affects a firm’s investment decisions generating either under or overinvestment with respect to a perfect capital market and driving a higher cost of external finance.

Macroeconomic implications of dynamically inconsistent preferences

Despite the widespread use of models of intertemporal choices in economics, previous studies have assumed that intertemporal preferences are dynamically consistent. This paper provides a fresh perspective on propagation mechanisms of a typical macroeconomic shock in a model with dynamically inconsistent preferences. To this end, I develop a prototypical neoclassical model that features dynamically inconsistent preferences to explore dynamic responses of key macro-aggregates, discounted cumulative effects and some characteristics of aggregate fluctuations in response to a technology shock. The main findings reveal that (a) consumption and investment in the proposed model show a larger increase than those in a standard neoclassical model; (b) unlike the standard model, the proposed model yields a short-run decline in labor, which is corroborated by previous studies; (c) all of these dynamic responses in the proposed model deliver smaller cumulative output effects; (d) the proposed model does a reasonably good job of matching key characteristics of aggregate fluctuations with the counterparts observed in the postwar U.S. data. The present-bias and sophistication effects are the linchpin of these main results. Various analyses on a set of different parameter values are also discussed.

Economic fluctuations, volatility changes and the role of government spending in China: A structural analysis

AbstractWe study the economic fluctuations in China by using a standard neoclassical general equilibrium model to provide a structural analysis. We have carefully constructed measurements for economic variables from Chinese data to be consistent with the literature. We show that the government spending behaviour plays an important role in accounting for the changes in the pattern of both absolute and relative volatilities. Although we find that a general moderation in economic fluctuations after 1978 can be largely explained by the total factor productivity (TFP) process, TFP itself cannot explain the change in the pattern of relative volatilities. We show that policy changes in government spending can account for the relative volatility divergency. Counterfactual experiments are also provided to discover the role of each factor in explaining the economic fluctuations in China.

Health Expenditures, Institutional Quality and Economic Growth

The study aims to determine the effect of health expenditures on economic growth while taking into account the quality of health institutions, keeping in view the fact that it’s not just the level, rather quality of expenditures or institutions that matters. Our hypothesis was where institutions are better health investment in health brings more economic growth as compared to those with low quality institutions. To attain that objective the standard neo-classical Solow Growth Model at steady-state level was taken as theoretical framework and made a production function adding institutional quality proxied by government effectiveness along with other variables like health expenditure, primary education completion rate, population growth etc. For estimation purposes, data for the sample of 20 South, East Asian and Pacific developing countries was used for the period 1995-2017. It was found that if health expenditures adjusted for the quality of government expenditures increase by 100%, then the economic growth will increase by 5%.

Investment Dynamics and Earnings‐Return Properties: A Structural Approach

ABSTRACTWe propose the standard neoclassical model of investment under uncertainty with short‐run adjustment frictions as a benchmark for earnings‐return patterns absent accounting influences. We show that our proposed benchmark generates a wide range of earnings‐return patterns documented in accounting research. Notably, our model generates a concave earnings‐return relation, similar to that of Basu [1997], and predicts that the earnings‐return concavity increases with the volatility of firms’ underlying shock processes and decreases with the level of firms’ investments. We find strong empirical support for these predictions. Overall, our evidence suggests that our proposed benchmark is useful for understanding the joint dynamics of variables of interest to accounting research (e.g., earnings, returns, investment, market‐to‐book) absent accounting influences, a necessary precondition for inferring the effects of accounting from these dynamics.

Productivity enhancing trade through local fragmentation

Abstact Mechanisms linking trade and productivity are rarely discussed in well accepted trade-theoretic literature although such a link is critical especially for understanding how trade helps developing countries. We restructure the standard neo-classical model of trade to provide a clear mechanism that leads to productivity enhancement in the export sector. As trade in labor-abundant countries reduces the real return to capital due to Stolper-Samuelson hypothesis, entrepreneurs find it easier to establish new businesses as capital costs decline. A section of workers becomes entrepreneurs producing and supplying cheaper intermediate goods to the export sector. Expanding export sector helps such a process, whereas contracting import-competing sector does not. New entrepreneurs boost the productivity of the export sector by supplying low-cost input. Here a boost in entrepreneurship induced by a decline in capital cost increases productivity of the export sector. Thus, this paper establishes a different and novel link between trade and productivity.