Financial Innovation and Monetary Substitution with an Application to a Century of Data on the M1-Income Ratio [March 2009]
Abstract: I study a DSGE model incorporating a monetary transactions technology in which a representative household invests time to improve its skill (human capital) in making transactions. The model is designed to reconcile salient short- and long-run features of the relationship between money, income, and the opportunity cost of holding money. An econometric reduced form, derived analytically, is revealing for the nature of pathologies perceived by the empirical money demand literature; particularly interesting is the possibility of a moving average root close to the unit circle. The impact elasticity of the M1-income ratio to an innovation to the opportunity cost is about -0.1, whereas the long-run response to a unit permanent shift is -1. In comparison to less parsimonious models, parametric restrictions are not rejected, and out-of-sample forecasts are improved. The theory also yields implications for the welfare cost of inflation vastly different from those of standard shopping time models. JEL: E41
Technical Appendix: A Theory of Financial Innovation and Monetary Substitution with an Application to a Century of Data on the M1-income Ratio: Technical Notes
Sharing Risk Efficiently under Suboptimal Punishments for Defection [November 2007]
Abstract: I study the efficient risk-sharing in an endowments economy when enforcement is achieved by the threat of reversion to punishments that may be less severe than autarkic consumption. I characterize (up to a technical condition) the set of allocations that may be interpreted as efficient with respect to some punishment convention. The conditions rationalizing such efficiency are very weak; they are (i) resource exhaustion, (ii) satisfaction of individual rationality constraints at each continuation, and (iii) finiteness of the value of the allocation under the implicit decentralizing price system. I show how efficient allocations may be decentralized, and I state versions of the Welfare Theorems for these economies. JEL: D61, E21
The Elastic Provision of Liquidity by Private Agents [December 2007, forthcoming in JMCB]
Abstract: I study a model of investment by financially
constrained firms that are heterogeneous with respect to their exposure to an
aggregate liquidity shock. A firm that is susceptible to the shock will mitigate
its exposure by purchasing claims issued by a firm that is not. Liabilities of
an unaffected firm may earn a liquidity premium due to their fungibility; and,
because they are backed by productive investment, their supply is elastic to the
demand. This segmentation implies that an aggregate liquidity shock has
different consequences across sectors of the economy.
JEL: E44, E51, E22.