Variability in employment, prices, and money

Carnegie-Rochester Conference Series on Public Policy 19 (1983) l-4 North-Holland

VARIABILITY

IN EMPLOYMENT, PRICES, AND MONEY

Karl Brunner

of Rochester

University

and Allan 13. Meltzer Carnegie-Mellon

As economists fully elements prices,

away

from

of risk and uncertainty,

output,

increasing

move

and other

attention

variables

in theoretical

The November discussed

a number

comments

of the

1982

linear

models

to incorporate

the effects of variability

more

on employment,

come to the fore. Variability

now receives

work and in policy discussions. meeting

of aspects formal

University

of the Carnegie-Rochester

of variability.

discussants

and,

The papers in some

Conference

are followed

by the

cases, by rejoinders

from

authors. In a competitive labor

efficiently.

buy insurance manent

model

Workers

or can self-insure

value and dissaving

the permanent nomies,

with rational

income

governments

expectations,

who are concerned

by saving when

when

theory

about

unemployed.

employment

can either

is above its per-

This arrangement

of consumption.

offer unemployment

real wages allocate

unemployment

is explicit

Yet, in most developed

insurance

as a supplement

in eco-

to private

programs. Sherwin unemployment applies

Rosen

the theory

develops

and

insurance

a model

Dale Mortensen

on labor

of contracts that

markets,

to the relation

combines

the implicit

analyze

the role and effect

employment,

and welfare.

of firms to workers. contract

and search

of

Rosen

Mortensen theories

of

employment. In Rosen’s cannot

be improved

Rosen

notes

governments.

model,

private

by such collective

that large-scale The

government

employment

contracts

arrangements

unemployment programs

insurance did

not

are optimal,

as unemployment generally

displace

so they insurance.

is operated

private

by

insurance,

however. insurance.

Governments’ role arises because of macro risk, as in the case of deposit Private insurers can diversify risks of unemployment at particular

0 167-2231/83/$03.00

0 1983 Elsevier Science Publishers B.V. (North-Holland)

firms,

but

cannot

severe)

business

business

cycles

diversify

the unemployment

cycles without require

large,

insurers

paying

private

viduals

would have to save to maintain

of government fluctuations.

notes

policies

that

increase

the

cost

of aggregate

instability,

they

experience

is accurate.

When

the benefit

payment

experience

result holds whether

raise the cost

optimal

level of benefits. Mortensen

insurance

measured

rating

benefit

is inexact,

and

unemployment

evidence

then considers

inflation

relation

this literature. Cukierman

between

on this definition

or temporary. of inflation,

inflation.

of inflation.

uses the term inflation

persistent

insurance

the rate of inflation Alex

insurance between

system is optimal. A number

econo-

of studies

and the variability

Cukierman

surveys

to refer to the rate of change

He uses a Lucas-type

the relation

can result from changes

between

in the variability

the

but the differences

of the past two decades has encouraged

variability

with

be used to determine

He shows that when differences

models of steady, maintained

extends

increases

size of unemployment

mists to go beyond

or the

rating

He shows that this

cost of working,

have found

prices

in his model depends

unemployment

are sman, a single unemployment

relative

increase

even when experience

cannot

the optimal

cost are not observable.

positive

Research

are risk averse as a result of moral hazard.

econometric

The persistent

rates.

for benefits

fee (or tax rate).

Workers differ in their opportunity

types of workers

that,

of self-insurance

of these effects is not negligible.

or not workers

he concludes

price variability

the

over time. If govern-

rating and tax exemption

and the insurance

Hence,

whether

and employment,

shows that the level of unemployment

on the size of the unemployment

prices,

output

the size of

rates by as much as 15 per cent.

unemployment

in opportunity

they

that indiadvantage

rises with

consumption

increases

out that the magnitude

Mortensen

benefits.

argues,

The comparative

of self-insurance

to smooth

insurance

suggests that imperfect measured

is that (severe)

Rosen

for public programs.

Unemployment Rosen points

Hence,

consumption.

The larger the variance

create a demand

payouts.

(relatively

to avoid these costs.

larger the stock of assets required ments’

during

to save and hold assets for the same reason

arises from its ability

Rosen

occurs

large costs. The reason

correlated

require

that

of and of

model to show

inflation

and relative

of aggregate

demand

and supply or from changes in the variaiblity of relative demands and supplies. In a later section, Cukierman extends his model to permit permanent and transitory changes. He finds that inability to distinguish permanent from transitory

changes

tween variability

as they

of inflation

occur

explains

many

and the variability

2

of the observed

of relative prices.

relations

be-

Hans-Jiirg changes

Biittler and Kurt Schiltknecht

in the rule guiding

empirical

observation.

money

growth

money

to a policy

of foreign increase

in autumn

Btittler which

appreciation

base to increase

develop

by transaction

growth

to control

of controlling rate. Purchases

by 50 per cent. The

rate of change reduced

a model

long- and

banks

rates depends

(or market

The money

stock

of bank asset allocation

costs. They use the model

on interest

They then show that the response

to which

permanent.

from a policy

of the exchange

stock and its reported

and Schiltknecht

assets differ

degree

gave up efforts

rates.

effect of money participants.

policy. They start from an

Bank

1978. The bank shifted

caused the monetary

in the money interest

of monetary

Swiss National

of preventing

exchange

short-term

the conduct

The

discuss the effect of temporary

responds

to show that the

on the expectations of interest

participants)

of market

rates depends

regard

the policy

less to changes

in

that

on the

change

as

are perceived

as

transitory. The reason is that a transitory change in the monetarv base is offset to a greater extent than a permanent change by an opposite change in the money multiplier. Banks adjust their reserve ratio to absorb perceived in the monetary base. The interest

authors

conclude

rates controlling

stock over a period deviations

of months.

of money

rates fluctuate

that

central

the monetary

growth

more and variability

The two remaining

can reduce

base to achieve

If central from

banks

changes

variability

control

banks, instead,

the planned

transitory

of

of the money

respond

to short-term

(or announced)

path,

interest

increases.

papers

in the volume

take up two issues of con-

tinuing interest. lierschel Grossman’s paper is a critique of current research Benjamin Eden proposes a method of indexing strategies in macroeconoinics. the economy

to reduce the costs of inflation.

We are now librium nomics this

models

into

the second

of aggregates.

Yet, Grossman

relies on the assumption

situation

opportunities assumptions.

it

of rational notes,

expectations,

most work

in macroeco-

are not in “equilibrium.”

implies

that

there

equiHe finds

are unexplored

to gain from trade.

Grossman to current

that markets because

“remarkable”

decade

offers

two

reasons

The first is empirical; and past changes

clearing

models.

rational

expectations

Second, and

for the survival

evidence

in monetary the natural

of the response

aggregates

non-market-clearing rate

of non-market-clearing

models

with market-

have appeared

hypothesis.

neutrality of monetary change arises because expectations slowly than is required by market clearing. Grossman’s

3

of real aggregates

is inconsistent

that

In these models,

use non-

form and decay more paper, and Frederic

Mishkin’s

discussion,

suggest

reasons

for

non-neutrality

without

endorsing

any single explanation. One reason variables

for the observed

is the high cost of acquiring

AS the paper by Biittler

effect

information

and Schiltknecht

central

bank often

fails to follow a policy

consistent,

costs

errors

of forecast

monetary

policy

of acquiring

occurs

than

do not adjust

on real

monetary

policy.

other works) suggests, the

rule consistently.

information

about

their attainable

if prices

aggregates

about current

(and many

is not

are larger

of monetary

If the central monetary

minimum. to transitory

bank

policy

A real effect changes

and of

of this

kind. One variables.

way

to reduce

Benjamin

effects of indexing

Eden’s

costs paper,

real variables

Eden develops

of anticipating and Alvin

inflation

Marty’s

to the money

is to index

discussion,

analyze

real the

stock.

a model in which pricing contracts

replace the Walrasian

auctioneer. The contracts can be fixed in nominal value or contingent on the stock of money. The choice of contract has aspects of a public good; the contract contingent requiring

on money indexing

move to the indexed

is optimal

in some

nomy

against

a government

his paper.

the political

that chooses

the effect of inflation?

but their relevance

people choose

the government

this contract.

helps the economy

By to

contract.

Eden does not address Why should

only if other

contracts,

issue that lies close to the surface.

to inflate

also choose

to index the eco-

Issues of this kind are, typically,

for the design of policy

rules or institutions

neglected,

is illustrated

by