Working papers 2023 Back to index

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  • Rich by Accident: the Second Welfare Theorem with a Redundant Asset Under Imperfect Foresight


    We consider a multiperiod (T-period) model with no uncertainty where short term bonds co-exist with a long term bond. Markets are complete with just the short term bonds so that under the usual hypothesis of perfect foresight, the long term bond is redundant by no arbitrage in that it has no allocational implications. We dispense with perfect foresight, derive appropriate no arbitrage conditions and show that the presence of the long term bond has significant allocational implications. Specifically, in the model with just the short term bond, we show that a T dimensional subset of efficient allocations can arise as Walrasian equilibria whereas the dimension of efficient allocations is one less than the number of households (assumed to be much larger than T). In the model with the both types of bonds, essentially all efficient allocations might arise as Walrasian equilibria; minute errors in forecasting prices might generate all income transfers that are consistent with efficiency. We argue that the beneficiaries of such unanticipated income transfers are determined not by the superiority of forecasts but rather by accident.



    What allocational role might a redundant financial asset play in an intertemporal Walrasian setting? Traditional wisdom would suggest none, since by definition, a redundant financial asset can be replicated by trading other assets dynamically at market prices so that any trader is indifferent between holding it and ignoring it, and so its presence in no way alters the possibilities of income transfers across periods/states. But notice that this conclusion might not be valid if the market prices are not correctly anticipated. That is, this conclusion relies entirely on the feature that the axiom of perfect foresight is built into the particular equilibrium concept, Radner equilibrium, used in the analysis. We dispense with perfect foresight and show that essentially all intertemporally efficient allocations can arise as Walrasian equilibria when a redundant asset is traded.




  • Oligopolistic Competition, Price Rigidity, and Monetary Policy


    This study investigates how strategic and heterogeneous price setting influences the real effect of monetary policy. Japanese data show that firms with larger market shares exhibit more frequent and larger price changes than those with smaller market shares. We then construct an oligopolistic competition model with sticky prices and asymmetry in terms of competitiveness and price stickiness, which shows that a positive cross superelasticity of demand generates dynamic strategic complementarity, resulting in decreased price adjustments and an amplified real effect of monetary policy. Whether a highly competitive firm sets its price more sluggishly and strategically than a less competitive firm depends on the shape of the demand system, and the empirical results derived from the Japanese data support Hotelling’s model rather than the constant elasticity of substitution preferences model. Dynamic strategic complementarity and asymmetry in price stickiness can substantially enhance the real effect of monetary policy.



    The COVID-19 pandemic has resulted in a resurgence of inflation, which some policymakers and scholars attribute to a surge in firms’ markups.1 The upward trajectory of market oligopoly and markups over the past few decades may have contributed to the inflationary upswing. In contrast, Japan’s inflation has remained low relative to other countries, with firms frequently attributing this phenomenon to the presence of other firms with inflexible pricing policies. These findings underscore the importance of considering strategic price setting in an oligopolistic market, yet macroeconomic analyses in this area are limited due to the predominance of monopolistic competition in macroeconomic models, despite strategic complementarity in price setting being a major source of real rigidity (Romer 2001, Woodford 2003). Furthermore, while markups are increasing, their development is not uniform across firms, and heterogeneity, such as the emergence of superstar firms, cannot be ignored.