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Author: Scott Freeman
Publisher:
ISBN:
Category : Contracts
Languages : en
Pages : 44
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Book Description
Why do we see nominal contracts in the presence of price level risk? To answer this question, this paper studies an overlapping generations model in which the equilibrium contract form is optimal, given the contracts elsewhere in the economy. Nominal contracts turn out to be optimal in the presence of aggregate price level risk under two circumstances. First, if individuals have the same constant degree of relative risk aversion. The reason is that in this case nominal contracts (eventually coupled with equity contracts) lead to optimal risk sharing. Second, nominal contracts can be optimal, even if the first condition is not met, if the repayment of contracts is subject to a binding cash in advance constraint. The reason is that a contingent contract, while reducing purchasing power risk, also increases the cash flow risk. Under a binding cash in advance constraint on the repayment of contracts, this second risk is costly, and it is minimized by a nominal contract. Finally, the paper also identifies some symmetry conditions under which nominal contracts are optimal even in the presence of relative price risk.
Author: Scott Freeman
Publisher:
ISBN:
Category : Contracts
Languages : en
Pages : 44
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Book Description
Why do we see nominal contracts in the presence of price level risk? To answer this question, this paper studies an overlapping generations model in which the equilibrium contract form is optimal, given the contracts elsewhere in the economy. Nominal contracts turn out to be optimal in the presence of aggregate price level risk under two circumstances. First, if individuals have the same constant degree of relative risk aversion. The reason is that in this case nominal contracts (eventually coupled with equity contracts) lead to optimal risk sharing. Second, nominal contracts can be optimal, even if the first condition is not met, if the repayment of contracts is subject to a binding cash in advance constraint. The reason is that a contingent contract, while reducing purchasing power risk, also increases the cash flow risk. Under a binding cash in advance constraint on the repayment of contracts, this second risk is costly, and it is minimized by a nominal contract. Finally, the paper also identifies some symmetry conditions under which nominal contracts are optimal even in the presence of relative price risk.
Author: Scott Freeman
Publisher:
ISBN:
Category :
Languages : en
Pages : 0
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This paper presents a model in which agents choose to use money as a medium of exchange, a means of payment, and a unit of account. The paper defines conditions under which nominal contracts, promising future payment of a fixed number of units of fiat money, prove to be the optimal contract form in the presence of either relative or aggregate price risk. When relative prices are random, nominal contracts are optimal if individuals have ex ante similar preferences over future consumption. When the aggregate price level is random, whether from shocks to the money supply or aggregate output, nominal contracts (perhaps coupled with equity contracts) lead to optimal risk-sharing if individuals have the same degree of relative risk aversion. Finally, nominal contracts may be optimal if the repayment of contracts is subject to a binding cash-in-advance constraint. In this case, a contingent contract increases the risk of holding excessive cash balances.
Author: Nils Gottfries
Publisher:
ISBN:
Category :
Languages : en
Pages : 46
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Author: Antoine Martin
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Category :
Languages : en
Pages : 0
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We propose a theory to explain the choice between nominal and indexed labor contracts. We find that contracts should be indexed if prices are difficult to forecast and nominal otherwise. Our analysis is based on a principal-agent model developed by Jovanovic and Ueda (1997) in which renegotiation can take place once the nominal value of the agent's output is observed. Their model assumes that agents use pure strategy, with the strong result that only nominal contracts can be written without being renegotiated. But, in reality, we do observe indexed contracts. We resolve this weakness of their model by allowing agents to choose mixed strategies, and find that the optimal contract is indeed nominal for certain parameters. For other parameters, however, we show that the optimal contract is indexed. Our findings are consistent with two empirical regularities: that prices are more volatile with higher inflation, and that countries with high inflation tend to have indexed contracts.
Author: R. Glenn Hubbard
Publisher:
ISBN:
Category : Prices
Languages : en
Pages : 48
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Book Description
The search for microeconomic foundations of non-Walrasian outcomes in labor and product markets has spawned many studies of contracting. This paper emphasizes the role of contracts for market equilibrium -- for many raw materials and basic industrial commodities -- in which long-term contractual arrangements and spot markets coexist. Our principal goals are two -- (i) to explain the existence of contracts and the equilibrium fraction of trades carried out under contract, and (ii) to consider the impact of demand and supply shocks on spot prices when market trades also take place through long-term contracts. We find that the relative importance of contracting depends on, inter alia, the variance of the spot price and the sources of underlying fluctuations. Consistent with the findings of previous macroeconomic studies, we find that contracting and price rigidity are more likely the more important demand shocks are relative to supply shocks. We adapt our static model of contract price and quantity determination to discuss the adjustment of contract prices. Finally, we discuss three important applications of our multiple-price modeling structure -- to (i) analyses of the effects of changes in vertical market structure on market equilibrium in commodity markets (with specific reference to petroleum and copper), (ii) models of the optimal degree of contract indexation, and (iii) aggregate studies of "sticky prices" in macroeconomics
Author: Césaire Assah Meh
Publisher:
ISBN:
Category : Contracts
Languages : en
Pages : 46
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We study a model with repeated moral hazard where financial contracts are not fully indexed to inflation because nominal prices are observed with delay as in Jovanovic and Ueda 1997. More constrained firms sign contracts that are less indexed to inflation and, as a result, their investment is more sensitive to nominal price shocks. We also find that the overall degree of nominal indexation increases with price uncertainty. An implication of this is that economies with higher inflation uncertainty are less vulnerable to a price shock of a given magnitude. The micro predictions of the model are tested empirically using macro and firm-level data from Canada.
Author: Christopher J. Erceg
Publisher:
ISBN:
Category : Employment (Economic theory)
Languages : en
Pages : 50
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We formulate an optimizing-agent model in which both labor and product markets exhibit monopolistic competition and staggered nominal contracts. The unconditional expectation of average household utility can be expressed in terms of the unconditional variances of the output gap, price inflation, and wage inflation. Monetary policy cannot replicate the Pareto-optimal equilibrium that would occur under completely flexible wages and prices; that is, the model exhibits a tradeoff between stabilizing the output gap, price inflation, and wage inflation. The Pareto optimum is attainable only if either wages or prices are completely flexible. For reasonable calibrations of the model, we characterize the optimal policy rule. Furthermore, strict price inflation targeting is clearly suboptimal, whereas rules that also respond to either the output gap or wage inflation are nearly optimal.
Author: Daron Acemoglu
Publisher:
ISBN:
Category : Contracts
Languages : en
Pages : 32
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Author: Stephen Hurst Wright
Publisher:
ISBN:
Category : IS-LM model (Macroeconomics)
Languages : en
Pages : 35
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Author: Jeffrey C. Fuhrer
Publisher:
ISBN:
Category : Monetary policy
Languages : en
Pages : 68
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