Consistent Targets and Optimal Monetary Policy: A Note

Kydland and Prescott (1977) develop a simple model of monetary policy making, where the central bank needs some commitment technique to achieve optimal monetary policy over time. Although not their main focus, they illustrate the difference between consistent and optimal policy in a sequential-decision one-period world. We employ the analytical method developed in Yuan and Miller (2005), whereby the government appoints a central bank with consistent targets or delegates consistent targets to the central bank. Thus, the central bank s welfare function differs from the social welfare function, which cause consistent policy to prove optimal.

Antidumping as Strategic Trade Policy Under Asymmetric Information

In the last two decades, trade liberalization under GATT/WTO has been partly offset by an increase in antidumping protection. Economists have argued convincingly that this is partly due to the inclusion of sales below cost in the definition of dumping during the GATT Tokyo Round. The introduction of the cost- based dumping definition gives regulating authorities a better opportunity to choose protection according to their liking. This paper investigates the domestic government's antidumping duty choice in an asymmetric information framework where the foreign firm's cost is observed by the domestic firm, but not by the government. To induce truthful revelation, the government can design a tariff schedule, contingent on firms' cost reports, accompanied by a threat to collect additional information for report verification (i.e., auditing) and, in case misreporting is detected, to set penalty duties. We show that depending on the concrete assumptions, the domestic government may not only be able to extract the true cost information, but also succeeds in implementing the full-information, governmental welfare-maximizing duty. In this case, the antidumping framework within GATT/WTO does not only offer the means to pursue strategic trade policy disguised as fair trade policy, but it also helps overcome the informational problems with regard to correctly determining the optimal strategic trade policy.

The Making of Optimal and Consistent Policy: An Analytical Framework for Monetary Models

This paper shows that optimal policy and consistent policy outcomes require the use of control-theory and game-theory solution techniques. While optimal policy and consistent policy often produce different outcomes even in a one-period model, we analyze consistent policy and its outcome in a simple model, finding that the cause of the inconsistency with optimal policy traces to inconsistent targets in the social loss function. As a result, the central bank should adopt a loss function that differs from the social loss function. Carefully designing the central bank s loss function with consistent targets can harmonize optimal and consistent policy. This desirable result emerges from two observations. First, the social loss function reflects a normative process that does not necessarily prove consistent with the structure of the microeconomy. Thus, the social loss function cannot serve as a direct loss function for the central bank. Second, an optimal loss function for the central bank must depend on the structure of that microeconomy. In addition, this paper shows that control theory provides a benchmark for institution design in a game-theoretical framework.

The Making of Optimal and Consistent Policy: An Implementation Theory Framework for Monetary Policy

This paper shows that optimal policy and consistent policy outcomes require the use of control-theory and game-theory solution techniques. While optimal policy and consistent policy often produce different outcomes even in a one-period model, we analyze consistent policy and its outcome in a simple model, finding that the cause of the inconsistency with optimal policy traces to inconsistent targets in the social loss function. As a result, the social loss function cannot serve as a direct loss function for the central bank. Accordingly, we employ implementation theory to design a central bank loss function (mechanism design) with consistent targets, while the social loss function serves as a social welfare criterion. That is, with the correct mechanism design for the central bank loss function, optimal policy and consistent policy become identical. In other words, optimal policy proves implementable (consistent).

Sustaining the Economic Rent of Oceanic Resources: The Case of Marine Protected Areas

This paper investigates economic aspects of marine protected areas (MPAs) that are closely related to the underlying marine biota. Many marine scientists recognize that enough is now known about the marine biology for the scientific siting of MPAs to protect marine environments that create associated economic values. Marine scientists have identified several objectives of MPAs. These include protection of genetic and biodiversity, increase in population levels and structures (e.g., age, size, fecundity), enrichment of ecosystems by promoting species interactions, and the protection of continental shelf landscapes from invasive human actions. Indeed, some marine scientists and fisheries economists view MPAs as an 'insurance policy' against over-fishing and other human uses of oceanic resources that have damaged so many of the world's fisheries. The economic analysis presented here pays attention to optimal zoning, policies to maintain sustainable economic rents, and the optimal policing of MPAs.

Monetary Policy Delegation, Contract Costs, and Contract Targets

We reconsider the optimal central banker contract derived in Walsh (1995). We show that if the government's objective function places weight (value) on the cost of the contract, then the optimal inflation contract does not completely neutralize the inflation bias. That is, a fraction of the inflation bias emerges in the resulting inflation rate after the central banker's monetary policy decision. Furthermore, the more concerned the government is about the cost of the contract or the less selfish (more benevolent) is the central banker, the smaller is the share of the inflation bias eliminated by the contract. No matter how concerned the government is about the cost of the contract or how unselfish (benevolent) the central banker is, the contract always reduces the inflationary bias by at least half. Finally, a central banker contract written in terms of output (i.e., incorporating an output target) can completely eradicate the inflationary bias, regardless of concerns about contract costs.

The Optimal Capital Structure of Banks: Balancing Deposit Insurance, Capital Requirements and Tax-Advantaged Debt

The capital structure and regulation of financial intermediaries is an important topic for practitioners, regulators and academic researchers. In general, theory predicts that firms choose their capital structures by balancing the benefits of debt (e.g., tax and agency benefits) against its costs (e.g., bankruptcy costs). However, when traditional corporate finance models have been applied to insured financial institutions, the results have generally predicted corner solutions (all equity or all debt) to the capital structure problem. This paper studies the impact and interaction of deposit insurance, capital requirements and tax benefits on a bankÇs choice of optimal capital structure. Using a contingent claims model to value the firm and its associated claims, we find that there exists an interior optimal capital ratio in the presence of deposit insurance, taxes and a minimum fixed capital standard. Banks voluntarily choose to maintain capital in excess of the minimum required in order to balance the risks of insolvency (especially the loss of future tax benefits) against the benefits of additional debt. Because we derive a closed- form solution, our model provides useful insights on several current policy debates including revisions to the regulatory framework for GSEs, tax policy in general and the tax exemption for credit unions.

Do Labor Market Imperfections Increase Trade Protection? A Theoretical Investigation

Labor market imperfections are commonly believed to be a major reason for imposing trade impediments. In this paper, I introduce labor market rigidities that are prevalent in continental European countries into the well-known protection for sale model proposed by Grossman and Helpman (1994). I show that contrary to commonly held views, imperfections in the labor market do not necessarily increase equilibrium trade protection. A testable equilibrium trade protection equation is also derived. The findings in this paper are hence particularly relevant for empirical tests of trade policy determinants in economies with more regulated labor markets.

Total Factor Productivity and Monetary Policy: Evidence from Conditional Volatility

This paper empirically assesses whether monetary policy affects real economic activity through its affect on the aggregate supply side of the macroeconomy. Analysts typically argue that monetary policy either does not affect the real economy, the classical dichotomy, or only affects the real economy in the short run through aggregate demand new Keynesian or new classical theories. Real business cycle theorists try to explain the business cycle with supply-side productivity shocks. We provide some preliminary evidence about how monetary policy affects the aggregate supply side of the macroeconomy through its affect on total factor productivity, an important measure of supply-side performance. The results show that monetary policy exerts a positive and statistically significant effect on the supply-side of the macroeconomy. Moreover, the findings buttress the importance of countercyclical monetary policy as well as support the adoption of an optimal money supply rule. Our results also prove consistent with the effective role of monetary policy in the Great Moderation as well as the more recent rise in productivity growth.

Optimal Central Banker Contracts and Common Agency

This paper considers the contacting approach to central banking in the context of a simple common agency model. The recent literature on optimal contracts suggests that the political principal of the central bank can design the appropriate incentive schemes that remedy for time-inconsistency problems in monetary policy. The effectiveness of such contracts, however, requires a central banker that attaches a positive weight to the incentive scheme. As a result, delegating monetary policy under such circumstances gives rise to the possibility that the central banker may respond to incentive schemes offered by other potential principals. We introduce common agency considerations in the design of optimal central banker contracts. We introduce two principals - society (government) and an interest group, whose objectives conflict with society's and we examine under what circumstances the government-offered or the interest-group-offered contract dominates. Our results largely depend on the type of bias that the interest group contract incorporates. In particular, when the interest group contract incorporates an inflationary bias the outcome depends on the principals' relative concern of the incentive schemes' costs. When the interest group contract incorporates an expansionary bias, however, it always dominates the government contract. A corollary of our results is that central banker contracts aiming to remove the expansionary bias of policymakers should be written explicitly in terms of the perceived bias.

A General Schema for Optimal Monetary Policymaking: Objectives and Rules

This paper examines four equivalent methods of optimal monetary policymaking, committing to the social loss function, using discretion with the central bank long-run and short-run loss functions, and following monetary policy rules. All lead to optimal economic performance. The same performance emerges from these different policymaking methods because the central bank actually follows the same (similar) policy rules. These objectives (the social loss function, the central bank long-run and short-run loss functions) and monetary policy rules imply a complete regime for optimal policy making. The central bank long-run and short-run loss functions that produce the optimal policy with discretion differ from the social loss function. Moreover, the optimal policy rule emerges from the optimization of these different central bank loss functions.