Federal Reserve Bank of Minneapolis Quarterly Review

Periodical covering business and financial issues.

Articles

Vol. 36, No. 1, March

An Attractive Monetary Model with Surprising Implications for Optima Two Examples
The work of Ostroy (1973), Townsend (1989), and Kocherlakota (1998) helped initiate the mechanism-design approach to monetary theory. The goal of that approach is to find settings in which money helps to achieve good outcomes--or, in Hahn's (1973)...
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Vol. 35, No. 2, October

Aggregate Labor Supply
Fifty years ago, the labor supply decision was thought of as virtually irrelevant for macroeconomic analysis. The view was that in the aggregate, labor supply was not determined by the same factors that determined individual labor supply. Lucas and...
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Vol. 35, No. 1, February

Negative Equity Does Not Reduce Homeowners' Mobility
The decline in housing prices over the past several years has left many homeowners owing more on their mortgages than their houses are worth. As of mid-2011, about 10 percent of all housing units were occupied by owners who had negative equity. (1)...
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Vol. 34, No. 1, February

Facts on the Distributions of Earnings, Income, and Wealth in the United States: 2007 Update
This article is largely a description of inequality in the United States in 2007 as measured by the Survey of Consumer Finances (SCF). Essentially we report, organize, and discuss a series of snapshots of inequality taken at a point in time in the...
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Vol. 33, No. 1, July

Measurement with Minimal Theory
Applied macroeconomists interested in identifying the sources of business cycle fluctuations typically have no more than 40 or 50 years of data at a quarterly frequency. With sample sizes that small, identification may not be possible even if the analyst...
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Asset Prices, Liquidity, and Monetary Policy in the Search Theory of Money
Many financial assets are held not only for the intrinsic value of the stream of consumption that they yield, but also for their usefulness in facilitating exchange. Consider a buyer who cannot commit or be forced to honor debts, and who wishes to...
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Vol. 32, No. 1, July

If Exchange Rates Are Random Walks, Then Almost Everything We Say about Monetary Policy Is Wrong *
The key question asked of standard monetary models used for policy analysis is, How do changes in short-term interest rates affect the economy? The standard answer built into these models is that such policy changes affect the economy by changing the...
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Back to the Future with Keynes *
In the early stages of the Great Depression, John Maynard Keynes took time out from his role as a policy adviser, research economist, and economic journalist to write "Economic Possibilities for our Grandchildren," an essay presenting his forecasts...
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Vol. 31, No. 1, November

On the Needed Quantity of Government Debt
We need to change our way of thinking regarding government debt. First, the government debt that a country owes to its citizens is not debt in the usual sense of the word. This form of government debt is a mechanism that facilitates intergenerational...
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Modeling Great Depressions: The Depression in Finland in the 1990s *
The general equilibrium growth model is the workhorse of modern economics. It is the accepted paradigm for studying most macroeconomic phenomena, including business cycles, tax policy, monetary policy, and growth. The collection of papers edited by...
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Vol. 29, No. 1, October

Optimal Monetary Policy: What We Know and What We Don't Know
Abstract In this article, I examine the current state of knowledge about optimal monetary policy. I distinguish between two literatures, basic and applied. The basic literature is explicit about the frictions that generate a positive value for money...
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Introduction to "Models of Monetary Economies II: The Next Generation"
Abstract This article is a summary of the papers presented at the Models of Monetary Economies II conference, hosted in May 2004 by the Federal Reserve Bank of Minneapolis and the University of Minnesota. It focuses on several themes in the papers,...
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Vol. 28, No. 2, December

Avoiding Significant Monetary Policy Mistakes
With low inflation now a reality, the Federal Open Market Committee (FOMC) has achieved one of its primary objectives. Nevertheless, some have asked if this result is a product more of good fortune than of good policy. (See, for instance, Ihrig and...
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The Evolution of U.S. Earnings Inequality: 1961-2002 *
This article summarizes the main trends in the earnings and employment distribution in the United States during the last four decades, using data drawn from the March Current Population Surveys (March CPS) covering the period between 1961 and 2002,...
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Vol. 28, No. 1, July

Changes in Hours Worked, 1950-2000
Abstract This article describes changes in the number of average weekly hours of market work per person in the United States since World War II. Overall, this number has been roughly constant; for various groups, however, it has shifted dramatically--from...
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Why Do Americans Work So Much More Than Europeans?
Abstract Americans now work 50 percent more than do the Germans, French, and Italians. This was not the case in the early 1970s, when the Western Europeans worked more than Americans. This article examines the role of taxes in accounting for the...
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Vol. 27, No. 3, Summer

How Severe Is the Time-Inconsistency Problem in Monetary Policy?
Abstract This study analyzes two monetary economies, a cash-credit good model and a limited-participation model. In these models, monetary policy is made by a benevolent policymaker who cannot commit to future policies. The study defines and analyzes...
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Interbank Payments Relationships in the Antebellum United States: Evidence from Pennsylvania
Abstract This article investigates U.S. interbank relationships before the Civil War using previously unknown data for Pennsylvania banks from 1851 to 1859 that disaggregate the amounts due from other banks by debtor bank. It finds that country...
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Vol. 27, No. 2, Spring

Accounting for the Great Depression *
The Great Depression is not yet well understood. Economists have offered many theories for both the massive decline and the slow recovery of output during 1929-39, but no consensus has formed on the main forces behind this major economic event. Here...
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Competitive Pressure and Labor Productivity: World Iron Ore Markets in the 1980s *
Does the extent of competitive pressure industries face influence their productivity? While a widespread view says that competitive pressure does influence productivity, and some theoretical reasons to expect gains exist, the amount of evidence to...
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Vol. 27, No. 1, Winter

Sticky Prices and Monetary Policy Shocks *
A large literature in macroeconomics holds that, because of sticky prices, changes in monetary policy temporarily affect the real quantifies of goods and services produced. The magnitude and persistence of the effects should vary across goods in relation...
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Measuring Consumption Growth: The Impact of New and Better Products *
Official government data put growth in real (that is, inflation-adjusted) consumption per capita at 2.4 percent per year in the United States from 1960 to 2000. (1) If consumers bought a fixed set of constant-quality goods and services over time, then...
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Vol. 26, No. 4, Fall

In This Issue
This issue of the Quarterly Review is dedicated to Bruce D. Smith, our close friend and colleague, who died of colon cancer on July 9, 2002, at the age of 47. Bruce spent about five years early in his professional career as an economist in the Research...
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Money and Inflation in Colonial Massachusetts
A view common to nearly all economists is that, over a sufficiently long period of time, the rate of growth of the money supply is the key determinant of the rate of inflation. An extreme (but not uncommon) version of this view is that inflation can...
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The Relationship between Money and Prices: Some Historical Evidence Reconsidered
Bruce D. Smith * [James] Madison entertained an intelligent view of the causes affecting the value of paper money. "It depends on the credit of the State issuing it, and on the time of its redemption; and is no otherwise affected by the quantity...
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Lessons from a Laissez-Faire Payments System: The Suffolk Banking System (1825-58)
Warren E. Webert + Should the Federal Reserve maintain its strong presence in the U.S. payments system? Or should the Federal Reserve exit and allow the market to produce its own mechanism for making payments? While U.S. history is replete with...
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Vol. 26, No. 3, Summer

Updated Facts on the U.S. Distributions of Earnings, Income, and Wealth
The purpose of this article is to report facts on the distributions of earnings, income, and wealth in the United States. Specifically, we update the 1997 report published in the Quarterly Review (Diaz-Gimenez, Quadrini, and Rios-Rull 1997) that used...
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Vol. 26, No. 2, Spring

Inequality and Fairness
While conceding that normative issues like fairness or justice may be appropriate considerations when discussing social policies informally, economists have a strong tradition of shying away from such considerations when they evaluate policies formally....
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Why Did Productivity Fall So Much during the Great Depression? (*)
The Great Depression brought a striking short-run productivity change to the U.S. economy. Between 1929 and 1933 in the United States, real output per adult fell more than 30 percent, and total factor productivity (TFP)--changes in output not accounted...
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Vol. 26, No. 1, Winter

In This Issue
In October 2000, the Minneapolis Federal Reserve Bank hosted a conference to discuss current research on "Great Depressions of the 20th Century," including the worldwide Depression of the 1930s and Japan's and Latin America's prolonged downturns in...
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Decades Lost and Found: Mexico and Chile since 1980 (*)
Chile and Mexico, like most of the other countries in Latin America, experienced severe economic crises in the early 1980s that led to large drops in output. For these two countries, the paths of recovery from these crises differed markedly. Chart...
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Vol. 25, No. 4, Fall

Money and Interest Rates
Cyril Monnet (*) Warren E. Weber (*) Central banks routinely state monetary policies in terms of interest rates. For example, in October 2001, the European Central Bank stated that it had not changed interest rates recently because it considered...
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Some Monetary Facts
George T. McCandless Jr. (*) Warren E. Weber (+) The Federal Reserve System was established in 1913 to provide an elastic currency, discount commercial credit, and supervise the banking system in the United States. Congress changed those purposes...
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Vol. 25, No. 3, Summer

Dollarization and the Conquest of Hyperinflation in Divided Societies [*]
This article studies the effects of political institutions on inflation. In our view, hyperinflation is the manifestation of a tragedy of commons in a divided society with a weak central monetary authority. Economies with fiat money are inherently...
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Looking for Evidence of Time-Inconsistent Preferences in Asset Market Data
Narayana R. Kocherlakota [*] Jan is about to go out to her neighborhood bar. Before drinking anything there, Jan would like to sign a legally binding contract stating that she is allowed to drink only four beers that night. Why does she want to...
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Vol. 25, No. 2, Spring

Competition at Work: Railroads vs. Monopoly in the U.S. Shipping Industry [*]
By their nature, water transportation industries are often subject to monopolization. In some places, for example, geography produces ports through which all water traffic must flow. If groups can take control of those ports, they can charge traffic...
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Vol. 25, No. 1, Winter

Are Phillips Curves Useful for Forecasting Inflation?[*]
A Phillips curve is an equation that relates the unemployment rate, or some other measure of aggregate economic activity, to a measure of the inflation rate. Modern specifications of Phillips curve equations relate the current rate of unemployment...
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Thoughts on the Fed's Role in the Payments System[*]
Technological and institutional innovations, including the growth of the Internet and of interstate banking, have enhanced the prospect for rapid evolution of the U.S. payments system. The Federal Reserve is collaborating with other payments system...
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Vol. 24, No. 4, Fall

In This Issue
One of the most exciting economic phenomena of the last decade has been the exceptional strength of the U.S. stock market. Between 1990 and 2000, the value of U.S. corporate equities rose 425 percent, representing an increase in the value of U.S. corporations...
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The Declining U.S. Equity Premium [*]
Ellen R. McGrattan [+] Historically, investors holding corporate equities have earned a premium, or an extra return for holding equities instead of bonds, which have more predictable returns. Estimates of this equity premium in the United States...
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Is the Stock Market Overvalued? [*]
Ellen R. McGrattan [+] As the 20th century drew to a close, the U.S. stock market boomed. Between 1994 and 2000, the value of corporate equity relative to gross national income, or equivalently, gross national product (GNP), nearly doubled. In the...
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Vol. 24, No. 3, Summer

Creating Business Cycles through Credit Constraints
Narayana R. Kocherlakota [*] Over the past two centuries, aggregate output in the United States has grown steadily, but not in a straight line; it has fluctuated around its upward trend. These output fluctuations have had three key properties: ...
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Knowledge of Individual Histories and Optimal Payment Arrangements [*]
Not so many years ago, when I used a credit card at some retail outlets, the clerk would consult a printed document that contained the numbers of cards which were not to be accepted. From the well-worn look of the document, it seemed that an updated...
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Vol. 24, No. 2, Spring

The Suffolk Bank and the Panic of 1837 [*]
Warren E. Weber [+] Before the establishment of federal deposit insurance in 1933, the U.S. economy was subject to periodic banking panics. During such panics, banks suspended payments; that is, they refused to pay specie (gold or silver) at par...
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Learning to Be Unpredictable: An Experimental Study
David E. Runkle [*] Sometimes it pays to be unpredictable. Tennis players know this. So does the Internal Revenue Service. If a tennis player always served to the same part of the court, the player's opponent would know where to be in order to easily...
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Vol. 24, No. 1, Winter

Diamond and Dybvig's Classic Theory of Financial Intermediation: What's Missing?
Edward J. Green [*] Ping Lin [*] History is replete with instances in which a seemingly healthy economy has plunged into difficulty, investors have become suddenly insistent on exercising contractual options to mitigate their individual risks,...
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Bank Runs, Deposit Insurance, and Liquidity [*]
Douglas W. Diamond [+] Philip H. Dybvig [+] This article develops a model which shows that bank deposit contracts can provide allocations superior to those of exchange markets, offering an explanation of how banks subject to runs can attract...
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In This Issue
One of the most disturbing features of monetary history is systemwide bank runs. In the United States, for example, before the creation of federal deposit insurance in 1933, the nation's banking system endured numerous bank panics, periods when depositors...
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Vol. 23, No. 4, Fall

Maintenance and Repair: Too Big to Ignore
Ellen R. McGrattan [*] James A. Schmitz, Jr. [*] Most models of aggregate economic activity, like the standard neoclassical growth model, ignore the fact that equipment and structures are maintained and repaired. Once physical capital is purchased...
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Explaining the Fiscal Theory of the Price Level
Narayana Kocherlakota [*] Christopher Phelan [*] How can governments influence inflation rates? Economists' standard answer is that the central bank controls the inflation rate through its ability to control the money supply. In particular, if...
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Vol. 23, No. 3, Summer

Taxing Capital Income: A Bad Idea
Corporate profits. Capital gains. Dividend and interest income. These are just a few of the types of capital income that are taxed in the United States - and, some would say, taxed heavily. This situation is quite different from what recent economic...
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Aggregate Returns to Scale: Why Measurement Is Imprecise
The value of aggregate returns to scale - the percentage change in output from a given percentage change in factor inputs - has important implications for the sources of shocks that lead to business cycle fluctuations. With constant or decreasing returns...
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Vol. 23, No. 2, Spring

Nobel Laureate Robert E. Lucas, Jr.: Architect of Modern Macroeconomics
In the late 1960s and early 1970s, Robert E. Lucas, Jr., wrote a number of papers which have rightly been revered as modem classics. For this body of work, Lucas received the Nobel Prize in Economic Sciences in the fall of 1995. The purpose of this...
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Money and Debt in the Structure of Payments
An aphorism in economics is that money exchanges for goods, and goods for money, but goods do not exchange for goods. However, if one interprets money to mean base money or other outside money (such as balances held at a central bank), then the aphorism's...
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Vol. 23, No. 1, Winter

The Great Depression in the United States from a Neoclassical Perspective
Between 1929 and 1933, employment fell about 25 percent and output fell about 30 percent in the United States. By 1939, employment and output remained well below their 1929 levels. Why did employment and output fall so much in the early 1930s? Why...
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Some Observations on the Great Depression
The prosperity of the 1920s in the United States was followed by the Great Depression in the 1930s. Will the prosperity of the 1980s and 1990s be followed by another great depression in the coming decade? This question is not that far-fetched. Depressions...
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Vol. 22, No. 2, Spring

Money, Inflation, and Output under Fiat and Commodity Standards
Recently, Lucas (1996, p. 661) argued that the question of how "changes in the conduct of monetary policy can influence inflation, employment, and production . . . has not been given anything like a fully satisfactory answer." A shift in monetary standards...
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Vol. 22, No. 1, Winter

Changes in Hours Worked since 1950
The number of weekly hours of market work per person in the United States has been roughly constant since World War II. At the same time, the amount of real compensation per hour worked has more than doubled. Economists have used these two facts in the...
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A Dictum for Monetary Theory
Since this is a volume about methodology and since my long-standing concern is monetary theory, I will take this opportunity to propose and defend a dictum, or role, that monetary theory ought to satisfy. The dictum can be put quite simply: Money should...
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Vol. 21, No. 4, Fall

Money
Observations written(1) posterior to the circular Address of Congress in Sept. 1779, and prior to their Act of March, 1780.(2) It has been taken for an axiom in all our reasonings on the subject of finance, that supposing the quantity and demand of...
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The Debasement Puzzle: An Essay on Medieval Monetary History
Sometimes, lest worse befall and to avoid scandal, a community tolerates dishonorable and evil things, like brothels. Sometimes also, by necessity or convenience, vile business is tolerated, like money-changing, or evil business, like usury. But there...
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Vol. 21, No. 1, Winter

Reviving Reputation Models of International Debt
Unlike lenders in domestic credit markets, lenders in the international credit market have little recourse if borrowers do not repay debt. There are few direct legal sanctions that can be used against such borrowers, especially when they are sovereign...
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Vol. 20, No. 4, Fall

Are Checks Overused?
Despite the growing availability and acceptance of electronic payment instruments - such as credit cards, debit cards, and automated clearinghouse (ACH) payments - by far the most popular noncash payment instrument used in the United States is the paper...
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Delayed Financial Disclosure: Mexico's Recent Experience
After several years of strong economic performance, Mexico suddenly suffered a financial crisis at the end of 1994. Within one month, the value of the peso fell by more than 35 percent and Mexican international reserves were depleted to the point that...
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Vol. 20, No. 3, Summer

Will the New $100 Bill Decrease Counterfeiting?
Earlier this year, the Federal Reserve System and the U.S. Treasury introduced $100 bills that are printed in a new style. These new-style bills are much more difficult and expensive to counterfeit convincingly than the old-style bills, and the main...
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Vol. 20, No. 2, Spring

The Role Played by Public Enterprises: How Much Does It Differ across Countries?
In this article, I study one aspect of national industrial policy: the extent to which governments decide that they will produce and sell goods and services. The article's theme is that many low-productivity countries have pursued a much more aggressive...
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Using Monthly Data to Improve Quarterly Model Forecasts
The time periods in most forecasting models of the national economy are quarters, not months or weeks or days. This choice of model frequency is natural since many of the most reliable data series on national economic activity - including the gross domestic...
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Vol. 20, No. 1, Winter

Narrow Banking Meets the Diamond-Dybvig Model
The current version of the 100 percent-reserve banking proposal, called the narrow banking proposal, begins with an observation: The magnitude of safe short-term assets outside the banking system exceeds the magnitude of banks' demand deposit liabilities....
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Proposition Proofs
Here I develop the proofs for the three propositions discussed in the pr-eceding paper. Proposition 1. Any solution to the upper bound problem is such that all date 1 consumption is supported by investment in the short-term technology and all date...
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Time to Plan and Aggregate Fluctuations
A major goal of macroeconomic research for the three decades has been the integration of macroeconomics and microeconomics. Work aiming to reach that goal has taken two related paths. One type of work has tried to give theoretical macroeconomic models...
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Vol. 19, No. 4, Fall

The CAPM Debate
Most large U.S. companies have built into their capital budgeting process a theoretical model that economists are now debating the value of. This is the capital asset pricing model (the CAPM) developed 30 years ago by Sharpe (1964) and Lintner (1965)....
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The Growth Effects of Monetary Policy
For years, scholars have recognized the key role government policies play in the process of development. The recent availability of quality data has led to quantitative analyses of the effect such policies have on development. Most of the renewed...
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Vol. 19, No. 3, Summer

Some Monetary Facts
The Federal Reserve System was established in 1913 to provide an elastic currency, discount commercial credit, and supervise the banking system in the United States. Congress changed those purposes somewhat with the Employment Act of 1946 and the Full...
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Incorporating Concern for Relative Wealth into Economic Models
A standard, often implicit, assumption in economics is that people only accumulate wealth to fund consumption by themselves and their families. In this article, we will argue that, in many circumstances, people have other motivations for wealth acquisition....
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Vol. 19, No. 2, Spring

A New Idea for Welfare Reform
Welfare reform is now a top priority on the U.S. agenda.(1) A broad consensus has emerged that the current welfare system discourages the very type of behavior it should encourage: the system discourages people who participate in welfare programs from...
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Analyzing a Proposal to Ban State Tax Breaks to Businesses
$150 million from South Carolina to BMW, $200 million from Utah to Micron Technology, $240 million from Illinois to Sears, Roebuck, . . . The list is long and includes most states and most major industries in the United States (Schweke, Rist, and Dabson...
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Vol. 19, No. 1, Winter

Resistance to New Technology and Trade between Areas
The theme of this article is that competition, here modeled as the movement of goods between two areas, reduces resistance to new technology and, hence, leads to increased technology adoption and wealth. The article develops a model in which the extension...
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A Fine Time for Monetary Policy?
Almost everyone would agree - even we in the Federal Reserve System - that monetary policy can be improved. But improving it requires accurate empirical descriptions of the current policy and the relationship between that policy and the economic variables...
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Vol. 18, No. 4, Fall

A Progress Report on Business Cycle Models
Before using a specific model to analyze economic data or policies, economists must have confidence that the model will fit the data along certain dimensions. One of the goals of modem business cycle research has been to develop economic models that...
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Another Attempt to Quantify the Benefits of Reducing Inflation
Over the last several years, the U.S. inflation rate has dropped below 4 percent per year - to levels common in the mid-1960s. This is widely regarded as a good thing. But would further reductions in the inflation rate make a good thing even better?...
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