On Public Inefficiencies in a Mixed Duopoly

The aim of this paper is to investigate the welfare effect of a change in the public firms objective function in oligopoly when the government takes into account the distortionary effect of rising funds by taxation (shadow cost of public funds). We analyze the impact of a shift from welfare- to profit-maximizing behaviour of the public firm on the timing of competition by endogenizing the determination of simultaneous (Nash-Cournot) versus sequential (Stackelberg) games using the game with observable delay proposed by Hamilton and Slutsky (1990). Differently from previous work that assumed the timing of competition, we show that, absent efficiency gains, instructing the public firm to play as a private one never increases welfare. Moreover, even when large efficiency gains result from the shift in public firm's objective, an inefficient public firm that maximizes welfare may be preferred.

Local Currency Pricing, Foreign Monetary Shocks and Exchange Rate Policy

The implications of local currency pricing (LCP) for monetary regime choice are analysed for a country facing foreign monetary shocks. In this analysis expenditure switching is potentially welfare reducing. This contrasts with the existing LCP literature, which focuses on productivity shocks and thus analyses a world where expenditure switching is welfare enhancing. This paper shows that, when home and foreign producers follow LCP, expenditure switching is absent and a floating rate is preferred by the home country. But when only home producers follow LCP, expenditure switching is present and a fixed rate can be welfare enhancing for the home country.

Expectations Traps and Coordination Failures with Discretionary Policymaking

Discretionary policymakers cannot manage private-sector expectations and cannot coordinate the actions of future policymakers. As a consequence, expectations traps and coordination failures can occur and multiple equilibria can arise. To utilize the explanatory power of models with multiple equilibria it is first necessary to understand how an economy arrives to a particular equilibrium. In this paper we employ notions of learnability and self-enforceability to motivate and identify equilibria of particular interest. Central among these criteria are whether the equilibrium is learnable by private agents and jointly learnable by private agents and the policymaker. We use two New Keynesian policy models to identify the strategic interactions that give rise to multiple equilibria and to illustrate our methods for identifying equilibria of interest. Importantly, unless the Pareto-preferred equilibrium is learnable by private agents, we find little reason to expect coordination on that equilibrium.

How Optimal is US Monetary Policy?

Most of the literature estimating DSGE models for monetary policy analysis assume that policy follows a simple rule. In this paper we allow policy to be described by various forms of optimal policy - commitment, discretion and quasi-commitment. We find that, even after allowing for Markov switching in shock variances, the inflation target and/or rule parameters, the data preferred description of policy is that the US Fed operates under discretion with a marked increase in conservatism after the 1970s. Parameter estimates are similar to those obtained under simple rules, except that the degree of habits is significantly lower and the prevalence of cost-push shocks greater. Moreover, we find that the greatest welfare gains from the ‘Great Moderation’ arose from the reduction in the variances in shocks hitting the economy, rather than increased inflation aversion. However, much of the high inflation of the 1970s could have been avoided had policy makers been able to commit, even without adopting stronger anti-inflation objectives. More recently the Fed appears to have temporarily relaxed policy following the 1987 stock market crash, and has lost, without regaining, its post-Volcker conservatism following the bursting of the dot-com bubble in 2000.

Choice, Deferral and Consistency

In this paper we study decision making in situations where the individual’s preferences are not assumed to be complete. First, we identify conditions that are necessary and sufficient for choice behavior in general domains to be consistent with maximization of a possibly incomplete preference relation. In this model of maximally dominant choice, the agent defers/avoids choosing at those and only those menus where a most preferred option does not exist. This allows for simple explanations of conflict-induced deferral and choice overload. It also suggests a criterion for distinguishing between indifference and incomparability based on observable data. A simple extension of this model also incorporates decision costs and provides a theoretical framework that is compatible with the experimental design that we propose to elicit possibly incomplete preferences in the lab. The design builds on the introduction of monetary costs that induce choice of a most preferred feasible option if one exists and deferral otherwise. Based on this design we found evidence suggesting that a quarter of the subjects in our study had incomplete preferences, and that these made significantly more consistent choices than a group of subjects who were forced to choose. The latter effect, however, is mitigated once data on indifferences are accounted for.

Perceiving Prospects Properly

When an agent chooses between prospects, noise in information processing generates an effect akin to the winner’s curse. Statistically unbiased perception systematically overvalues the chosen action because it fails to account for the possibility that noise is responsible for making the preferred action appear to be optimal. The optimal perception patterns share key features with prospect theory, namely, overweighting of small probability events (and corresponding underweighting of high probability events), status quo bias, and reference-dependent S-shaped valuations. These biases arise to correct for the winner’s curse effect.