Blogging has been a bit light around here. In lieu of a blog post, here are a few papers of mine have recently been accepted for publication that might be of interest to regular readers:
1. “Money, Liquidity, and the Structure of Production” (with Alexander Salter), Journal of Economic Dynamics and Control. This paper is a little bit of Hayek, Hirshleifer, Tobin, and Dixit all rolled into one. Here is the abstract:
We use a model in which media of exchange are essential to examine the role of liquidity and monetary policy on production and investment decisions in which time is an important element. Specifically, we consider the effects of monetary policy on the length of production time and entry and exit decisions for firms. We show that higher rates of inflation cause households to substitute away from money balances and increase the allocation of bonds in their portfolio thereby causing a decline in the real interest rate. The decline in the real interest rate causes the period of production to increase and the productivity thresholds for entry and exit to decline. This implies that when the real interest rate declines, prospective firms are more likely to enter the market and existing firms are more likely to stay in the market. Finally, we present reduced form empirical evidence consistent with the predictions of the model.
2. “An Evaluation of Friedman’s Monetary Instability Hypothesis“, Southern Economic Journal. This paper examines two elements of Milton Friedman’s work within the context of a relatively standard structural model. The first element is the idea that deviations between the money supply and money demand are a significant source of business cycle fluctuations. The second element is the idea that shocks to the money supply are much more empirically significant that shocks to money demand. Here is the abstract:
In this paper, I examine what I call Milton Friedman’s Monetary Instability Hypothesis. Drawing on Friedman’s work, I argue that there are two main components to this view. The first component is the idea that deviations between the public’s demand for money and the supply of money are an important source of economic fluctuations. The second component of this view is that these deviations are primarily caused by fluctuations in the supply of money rather than the demand for money. Each of these components can be tested independently. To do so, I estimate an otherwise standard New Keynesian model, amended to include a money demand function consistent with Friedman’s work and a money growth rule, for a period from 1875-1963. This structural model allows me to separately identify shocks to the money supply and shocks to money demand. I then use variance decompositions to assess the relative importance of shocks to the supply and demand for money. I find that shocks to the monetary base can account for up to 28% of the fluctuations in output whereas money demand shocks can account for less than 1% of such fluctuations. This provides support for Friedman’s view.
3. “Interest Rates and Investment Coordination Failures“, Review of Austrian Economics. This paper examines the role of interest rates in influencing both production time and entry decisions of firms. The paper therefore examines coordination problems similar to those emphasized in the Austrian business cycle theory and the business cycle theory of Fischer Black. I show that in low interest rate environments firms are more likely to preempt the entry of their competitors at lower levels of demand than when interest rates are high. When firms enter simultaneously at these levels of demand, it is a coordination failure. Low interest rates also produce changes in the length of production that are consistent with the ABCT. This provides some support for business cycle theories such as the ABCT, which have been criticized as violating the assumption of rational expectations.
The theory of capital developed by Bohm-Bawerk and Wicksell emphasized the roundabout nature of the production process. The basic insight is that production necessarily involves time. One element of the production process is to determine the period of production, or the length of time from the start of production to its completion. Bohm-Bawerk and Wicksell emphasized the role of the interest rate in determining the period of production. In this paper, I develop an option games model of the decision to invest. Two firms have an opportunity to enter a market, but production takes time. Firms face a two-dimensional decision. Along one dimension, they determine the period of production and the prospective profit therefrom. Along another dimension, they determine whether or not they want to enter the market given the amount of time it will take to start generating revenue from production. Within this option games approach, the period of production can be understood as an endogenous time-to-build and I argue that this framework provides a tool for evaluating the claims of Bohm-Bawerk and Wicksell against the backdrop of competition and uncertainty. I evaluate the period of production decision and the option to enter decision when the real interest rate changes. I show that investment coordination failures are more likely to occur at lower levels of profitability when real interest rates are low. I conclude by discussing the implications of low interest rates for boom-bust investment cycles.