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Intertemporal issues in international macroeconomics
Journal
of Economic
Dynamics
and Control
15 (1991) l-3.
North-Holland
Intertemporal issues in international macroeconomics Stephen
J. Turnovsky
University of Washington, Seattle, WA 98195, USA National Bureau of Economic Research
Recent work in macroeconomics in general, and in international macroeconomics in particular, has emphasized the need to base such models on firm microeconomic underpinnings. Essentially, this has come to mean that the underlying behavioral relationships are derived from some form of intertemporal optimization by representative agents, with particular attention being devoted to ensuring that the equilibrium is consistent with the intertemporal resource constraints facing the individual and the economy. While it is fair to say that macroeconomic theory is increasingly being carried out within this type of framework, there are eminent economists who remain skeptical of what this approach has to offer. This view is expressed most forcibly by Riidiger Dornbusch, who in the introduction of his recent collection of essays writes: ‘Although much of policy-oriented open-economy macroeconomics stands unproved, I am impressed with near-complete sterility of the intertemporal approach in the face of actual policy issues. Perhaps as it matures in the hands of some of the excellent scholars now working in that mode, it will come to yield a richer harvest.’ This special issue of the Journal of Economic Dynamics and Control is devoted to studying intertemporal issues in international macroeconomics. There are two features to the intertemporal approach which those who adopt this framework find to be attractive. First, by deriving the model from underlying microeconomic principles, much of the arbitrariness associated with macroeconomic modeling is eliminated. But the extent to which this is accomplished should not be overstated, since a good deal of arbitrariness inevitably still remains. The nature of the objective function, the range of decision variables, the specification of the constraints, all typically remain subject to choice. Secondly, by explicitly introducing some intertemporal measure of welfare, the intertemporal approach provides a natural frame01651889/91/$03.500
1991-Elsevier
Science
Publishers
B.V. (North-Holland)
2
S.J. Tumousky, Introduction
work for performing macroeconomic welfare analysis and optimal macroeconomic policy. The collection of papers in this special issue all share this common approach and can be divided into two parts. Part I, which deals with positive aspects, analyzes various sorts of disturbances, in some cases originating with policy and in others being external to the economy. Part II discusses issues pertaining to optimal policy and is therefore more normative. In spite of the fact that authors were unconstrained in their choice of specific topic, the set of papers has turned out to be remarkably cohesive. Hopefully, after reading through this special issue, skeptics will be persuaded as to the merits of this approach. In the first paper in Part I, Matsuyama analyzes the effects of a reduction in the rate of devaluation on the macrodynamic adjustments in the economy. An important aspect he emphasizes is how the dynamic process exhibits hysteresis. That is, the steady state depends upon the starting point, so that a temporary policy has a permanent effect. The papers by Gavin and Turnovsky focus on tariffs and the sectoral adjustments to which they give rise. Gavin assumes a given aggregate capital stock and focuses on the behavior of the current account, emphasizing the adjustment costs to moving capital between sectors. Turnovsky introduces gradual aggregate capital accumulation and shows how the qualitative dynamic adjustment in response to a tariff depends crucially upon sectoral capital intensities. The shock analyzed by Sen is that of an oil price increase. When no borrowing is permitted he shows how an unanticipated permanent shock worsens the current account, in contrast to models which assume perfect capital mobility. Most of the intertemporal optimizing models in international macroeconomics assume perfect capital mobility, although as just noted, the Sen paper treats the other polar case. Murphy’s contribution takes an intermediate case and considers an economy which faces an imperfect capital market. Alternative arrangements are considered and Murphy shows how a situation where the interest rate at which an economy can borrow or lend is tied to its trade balance, is likely to be unstable. In the final paper in Part I, Brock uses stochastic control methods to analyze the effects of export instability on savings and investment rates. He shows that while an increase in export instability will cause the investment-output ratio to decline, the corresponding savings ratio may either rise or fall depending upon the relative magnitudes of the income risk and capital risk it generates. Part II deals with normative issues. Obstfeld studies currency depreciation and fiscal policy as the outcome of a dynamic game between the government and rational households. He emphasizes the diverse pattern of macroeconomic behavior which may result from differences in government objectives. Kimbrough discusses optimal taxes and emphasizes the inflation tax as part of the overall package. He shows how, with a sufficiently rich tax structure,
S.J. Tumouky, Introduction
3
the Friedman optimal monetary growth rule is a component of the optimal tax policy. Calvo analyzes the effects of a temporary slowdown in the rate of expansion of the money supply and shows how this may be welfaredeteriorating. As he notes, his analysis provides an example of how half-baked stabilization programs may have negative effects on welfare. The final paper by Buiter and Kletzer studies the welfare consequences of cooperative and noncooperative fiscal policy. Using an overlapping-generations framework, the optimal choice of distortionary and lump-sum taxes under alternative scenarios is examined.
of Economic
Dynamics
and Control
15 (1991) l-3.
North-Holland
Intertemporal issues in international macroeconomics Stephen
J. Turnovsky
University of Washington, Seattle, WA 98195, USA National Bureau of Economic Research
Recent work in macroeconomics in general, and in international macroeconomics in particular, has emphasized the need to base such models on firm microeconomic underpinnings. Essentially, this has come to mean that the underlying behavioral relationships are derived from some form of intertemporal optimization by representative agents, with particular attention being devoted to ensuring that the equilibrium is consistent with the intertemporal resource constraints facing the individual and the economy. While it is fair to say that macroeconomic theory is increasingly being carried out within this type of framework, there are eminent economists who remain skeptical of what this approach has to offer. This view is expressed most forcibly by Riidiger Dornbusch, who in the introduction of his recent collection of essays writes: ‘Although much of policy-oriented open-economy macroeconomics stands unproved, I am impressed with near-complete sterility of the intertemporal approach in the face of actual policy issues. Perhaps as it matures in the hands of some of the excellent scholars now working in that mode, it will come to yield a richer harvest.’ This special issue of the Journal of Economic Dynamics and Control is devoted to studying intertemporal issues in international macroeconomics. There are two features to the intertemporal approach which those who adopt this framework find to be attractive. First, by deriving the model from underlying microeconomic principles, much of the arbitrariness associated with macroeconomic modeling is eliminated. But the extent to which this is accomplished should not be overstated, since a good deal of arbitrariness inevitably still remains. The nature of the objective function, the range of decision variables, the specification of the constraints, all typically remain subject to choice. Secondly, by explicitly introducing some intertemporal measure of welfare, the intertemporal approach provides a natural frame01651889/91/$03.500
1991-Elsevier
Science
Publishers
B.V. (North-Holland)
2
S.J. Tumousky, Introduction
work for performing macroeconomic welfare analysis and optimal macroeconomic policy. The collection of papers in this special issue all share this common approach and can be divided into two parts. Part I, which deals with positive aspects, analyzes various sorts of disturbances, in some cases originating with policy and in others being external to the economy. Part II discusses issues pertaining to optimal policy and is therefore more normative. In spite of the fact that authors were unconstrained in their choice of specific topic, the set of papers has turned out to be remarkably cohesive. Hopefully, after reading through this special issue, skeptics will be persuaded as to the merits of this approach. In the first paper in Part I, Matsuyama analyzes the effects of a reduction in the rate of devaluation on the macrodynamic adjustments in the economy. An important aspect he emphasizes is how the dynamic process exhibits hysteresis. That is, the steady state depends upon the starting point, so that a temporary policy has a permanent effect. The papers by Gavin and Turnovsky focus on tariffs and the sectoral adjustments to which they give rise. Gavin assumes a given aggregate capital stock and focuses on the behavior of the current account, emphasizing the adjustment costs to moving capital between sectors. Turnovsky introduces gradual aggregate capital accumulation and shows how the qualitative dynamic adjustment in response to a tariff depends crucially upon sectoral capital intensities. The shock analyzed by Sen is that of an oil price increase. When no borrowing is permitted he shows how an unanticipated permanent shock worsens the current account, in contrast to models which assume perfect capital mobility. Most of the intertemporal optimizing models in international macroeconomics assume perfect capital mobility, although as just noted, the Sen paper treats the other polar case. Murphy’s contribution takes an intermediate case and considers an economy which faces an imperfect capital market. Alternative arrangements are considered and Murphy shows how a situation where the interest rate at which an economy can borrow or lend is tied to its trade balance, is likely to be unstable. In the final paper in Part I, Brock uses stochastic control methods to analyze the effects of export instability on savings and investment rates. He shows that while an increase in export instability will cause the investment-output ratio to decline, the corresponding savings ratio may either rise or fall depending upon the relative magnitudes of the income risk and capital risk it generates. Part II deals with normative issues. Obstfeld studies currency depreciation and fiscal policy as the outcome of a dynamic game between the government and rational households. He emphasizes the diverse pattern of macroeconomic behavior which may result from differences in government objectives. Kimbrough discusses optimal taxes and emphasizes the inflation tax as part of the overall package. He shows how, with a sufficiently rich tax structure,
S.J. Tumouky, Introduction
3
the Friedman optimal monetary growth rule is a component of the optimal tax policy. Calvo analyzes the effects of a temporary slowdown in the rate of expansion of the money supply and shows how this may be welfaredeteriorating. As he notes, his analysis provides an example of how half-baked stabilization programs may have negative effects on welfare. The final paper by Buiter and Kletzer studies the welfare consequences of cooperative and noncooperative fiscal policy. Using an overlapping-generations framework, the optimal choice of distortionary and lump-sum taxes under alternative scenarios is examined.