The Secret Life of Mundane Transaction Costs

Transaction costs, one often hears, are the economic equivalent of friction in physical systems. Like physicists, economists can sometimes neglect friction in formulating theories; but like engineers, they can never neglect friction in studying how the system actually does let alone should work. Interestingly, however, the present-day economics of organization also ignores friction. That is, almost single-mindedly, the literature analyzes transactions from the point of view of misaligned incentives and (especially) transaction-specific assets. The costs involved are certainly costs of running the economic system in some sense, but they are not obviously frictions. Stories about frictions in trade are not nearly as intriguing as stories about guileful trading partners and expensive assets placed at risk. But I will argue that these seemingly dull categories of cost what Baldwin and Clark (2003) call mundane transaction costs actually have a secret life. They are at least as important as, and quite probably far more important than, the more glamorous costs of asset specificity in explaining the partition between firm and market. These costs also have a secret life in another sense: they have a secret life cycle. I will argue that these mundane transaction costs provide much better material for helping us understanding how the boundaries among firms, markets, and hybrid forms change over time.

Monetary Policy, Exchange Rate Overshooting, and Endogenous Physical Capital

We develop an open economy macroeconomic model with real capital accumulation and microeconomic foundations. We show that expansionary monetary policy causes exchange rate overshooting, not once, but potentially twice; the secondary repercussion comes through the reaction of firms to changed asset prices and the firms' decisions to invest in real capital. The model sheds further light on the volatility of real and nominal exchange rates, and it suggests that changes in corporate sector profitability may affect exchange rates through international portfolio diversification in corporate securities.

Monetary Policy in a Portfolio Balance Model with Endogenous Physical Capital

We develop a portfolio balance model with real capital accumulation. The introduction of real capital as an asset as well as a good produced and demanded by firms enriches extant portfolio balance models of exchange rate determination. We show that expansionary monetary policy causes exchange rate overshooting, not once, but twice; the secondary repercussion comes through the reaction of firms to changed asset prices and the firms' decisions to invest in real capital. The model sheds further light on the volatility of real and nominal exchange rates, and it suggests that changes in corporate sector profitability may affect exchange rates through portfolio diversification in corporate securities.