Aggregation, State Dependence, and Dynamics
Much individual behavior is characterized by long periods of inertia interrupted by occasional large scale revisions in behavior. Work on state dependence and aggregation explores macroeconomic implications. In my view the most important aspect of this is the manner in which inertia can hide important information from view and induce market crashes. John Leahy and I modeled these forces a full 30 years ago. To this day no one has built a data set rich enough to operationalize our theory. This is an area much in need of economic data engineering.
Economic Theory and the World of Practice: A Celebration of the (S, s) Model
An article written in celebration of the (S,s) model that Kenneth Arrow, Theodore Harris, and Jacob Marschak developed in 1951. This shows how this model not only answered important practical questions but also opened the door to a quite startling range of important and challenging follow-up questions, many of great practical importance and analytic depth.
Mass layoffs and unemployment
Mass layoffs give rise to groups of unemployed workers who possess similar characteristics and, therefore, may learn from one another’s experience searching for a new job. We model social learning incentives that slow their reabsorption into the labor force and imply that in equilibrium the natural rate of unemployment is socially excessive.
Monetary policy as a process of search
Monetary policy makers are uncertain about the state of the economy and learn from the economy’s reaction to policy. Private agents, however, anticipate any systematic attempt to incorporate this information into future policy. We analyze this feedback in the context of a monetary authority’s attempt to stimulate an economy in recession. We show that modest stimuli may prove ineffectual. If small reductions in interest rates are unlikely to promote a response, then they may be followed by further cuts. A vicious circle develops in which the expectation that the policy couldfail leads investors to delay investment thereby promotingfailure.
Business as usual, market crashes, and wisdom after the fact
We present a three-stage model of market crashes. In the first stage, routine behavior tends to keep information of common interest trapped in private hands. In the second stage, private information reaches a threshold that triggers some agents to alter their behavior; these actions release information to the market. The final stage involves the market’s response to this news as other participants react to the initial departure from routine behavior. We present an application to industry investment.
Sectoral shocks, learning, and aggregate fluctuations
We present a model in which sectoral shocks have aggregate consequences. The model relies on irreversible investment and imperfect information to slow the adjustment of expanding industries. We show that this gradual expansion is sub-optimal.
State-dependent pricing and the dynamics of money and output
Identifies a special case in which state-dependent (S,s) pricing policies give rise to non-neutrality of money. The model produces a positive money-output correlation and an empirical Phillips curve. The impact of monetary shocks depends crucially on the current level of output, which points to a natural connection between state-dependent microeconomics and state-dependent macroeconomics.
Aggregation and Imperfect Competition: On the Existence of Equilibrium. Econometrica, 59, 1-23
Provides new conditions guaranteeing the existence of pure strategy pricing equilibria in models of imperfect competition. These have played a significant role in subsequent developments in applied industrial organization.
Aggregation and social choice: a mean voter theorem
Provides conditions under which the mean voter’s most preferred outcome is unbeatable according to a 64%-majority rule. In doing so introduces generalized concavity measures due to Prékopa (1971, 1973) and Borell (1975). which have broad applications in economics.
On 64%-majority rule
Without some restriction on preferences, the majority rule has paradoxical properties, for example allowing cyles. Perhaps for this reason many electoral rules (such as those governing the U.S. Constitution) require a super-majority vote to change the status quo. We provide conditions defining a form of social consensus under which there exists an unbeatable proposal according to 64%-majority rule.
Menu costs and the neutrality of money
Presents the first model of monetary policy state dependent pricing. In the aggregate, price stickiness disappears, and money is neutral in stark contrast with time dependent pricing.
The variability of aggregate demand with (S, s) inventory policies
Presents a simple theory of the aggregate implications of (S, s) inventory policies. It is shown that (S, s) policies add to the variability of demand, with the variance of orders exceeding the variance of sales.