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Department of Economics

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Economics Department
Kansas State University
327 Waters Hall
1603 Old Claflin Place
Manhattan, KS 66506
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Dr. Steven Cassou | Publications

"Optimal monetary policy revisited: Does considering real-time data change things?"

Abstract: Yes, it does. This paper extends a variant of the asymmetric preference model suggested by Ruge-Murcia (2003a) to investigate the use of real-time data available to policy makers when making their decisions and revised data which more accurately measure economic performance (Croushore, 2011). In our extended model, the central banker targets a weighted average of revised and real-time inflation together with a weighted average of revised and real-time output. Moreover, we allow for an asymmetric central bank response to real-time data depending on whether the unemployment rate is high or low. Our model identifies several new potential sources of inflation bias due to data revisions. Our empirical results suggest that the Federal Reserve Bank focuses on targeting revised inflation during low unemployment periods, but it weighs heavily real-time inflation during high unemployment periods. The inflation bias due to data revisions is comparable in magnitude to the bias from asymmetric central banker preferences with the bias being somewhat larger during high unemployment.
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"Do US government tax revenues and expenditures respond to debt levels and economic conditions asymmetrically over the business cycle?"

Abstract: This paper empirically investigates whether there are asymmetries in the responses of US government tax revenues and expenditures to debt levels and economic conditions over the business cycle. State of the art regime switching models, including Threshold Regression and Markov Switching, are investigated. Both sides of the government budget show asymmetries, but the asymmetries for tax revenue show greater statistical significance. The results show that fiscal authorities take weaker action in response to debt during poor economic times. In addition, the asymmetric responses to economic conditions for both sides of the government budget shows that stronger countercyclical policy is taken during poor economic times.
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"Fiscal policy asymmetries and the sustainability of US government debt revisited,"

Abstract: This paper empirically investigates US fiscal policy sustainability and cyclicality in an empirical structure that allows fiscal policy responses to exhibit asymmetric behavior. We investigate this over two quarterly intervals, both of which begin in 1955:1. The short sample ends in 1995:2 and is most similar to the one used by Bohn (1998), whereas the full sample ends in 2013:3. Our estimation results show that the full sample period is sufficiently different from the short sample period, that the asymmetric (non-linear) empirical models used in this paper are important and that the sustainability of US government debt topic needed to be revisited. Indeed, the short sample provides evidence of fiscal policy sustainability in line with Bohn's (1998) findings. However, when considering the full sample, US fiscal policy is found sustainable during good economic times only according to the best fitting nonlinear model, but unsustainable for all specifications studied during times of distress. With regard to cyclicality, both samples show policy is asymmetric. Moreover, both samples show countercyclical policy during times of distress and the full sample results show some evidence that policy may be procyclical during good economic times.
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"Threshold cointegration between inflation and US capacity utilization,"

Abstract: An analogue to the Phillips curve shows a positive relationship between inflation and capacity utilization. Some recent empirical work has shown that this relationship has broken down when using data after the mid 1980s. We empirically investigate this issue using several threshold error correction models. We find, in the long run, a 1% increase in the rate of inflation leads to approximately a 0.004% increase in capacity utilization. The asymmetric error correction structure shows that changes in capacity utilization show significant corrective measures only during booms while changes in inflation correct during both phases of the business cycle with the corrections being stronger during recessions. We also find that, in the short run, changes in the inflation rate do Granger cause capacity utilization while changes in capacity utilization do not Granger cause inflation. The Granger causality from inflation to capacity utilization can be interpreted as supporting recent calls made in the popular press by some economists that it may be desirable for the Fed to try to induce some inflation. The lack of Granger causality from capacity utilization to inflation casts doubt on the older view that capacity utilization could be a leading indicator for future inflation.
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"Does consumer confidence affect durable goods spending during bad and good economic times equally?"

Abstract: Recent econometric analysis shows that consumer confidence innovations have long lasting effects on economic activities like consumption. Using US data, we show this conclusion is more nuanced when considering an economy that has different potential states. In particular, using regime-switching models, we show that the connection between consumer confidence to some types of consumer purchases is important during good economic times, but is relatively unimportant during bad economic times. Our regime-switching models use the unemployment rate as the indicator distinguishing bad and good economic times and investigate impulse responses, Granger Causality and variance decompositions. We consistently find that the impact of consumer confidence is dependent on the state of the economy for durable goods purchases. We also use this type of model to investigate the connection between news and consumer confidence and this connection is also state dependent. These findings have important implications for recent policy debates which consider whether confidence boosting policies, like raising inflation expectations on big-ticket items such as automobiles or business equipment would lead to a faster recovery.
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 "New Keynesian Model Features that can Reproduce Lead, Lag and Persistence Patterns,"

Abstract: This paper uses a new method for describing dynamic comovement and persistence in economic time series which builds on the contemporaneous forecast error method developed in den Haan (2000). This data description method is then used to address issues in New Keynesian model performance in two ways. First, well known data patterns, such as output and inflation leads and lags and inflation persistence, are decomposed into forecast horizon components to give a more complete description of the data patterns. These results show that the well known lead and lag patterns between output and inflation arise mostly in the medium term forecasts horizons. Second, the data summary method is used to investigate a small-scale New Keynesian model with some important modeling features to see which of these features can reproduce lead, lag and persistence patterns seen in the data. We show that a general equilibrium model with habit formation, persistent IS curve shocks and persistent supply shocks can reproduce the lead, lag and persistence patterns seen in the data.
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"Did asymmetric monetary preferences for the output gap disappear during recent economic times?"

Abstract: Surico (2007) showed that the Fed asymmetric preferences for the output gap disappeared during recent times.  We show that this result is sensitive to the starting date chosen for the regressions.  Using a starting date of 1984:1 or later, we find that the hypothesis of the Fed exhibiting symmetric preferences is consistently rejected.
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"Employment Comovements at the Sectoral Level over the Business Cycle,"

Abstract: This paper implements the technique suggested by den Haan (2000) to investigate contemporaneous as well as lead and lag correlations among economic data for a range of forecast horizons.  The lead/lag approach provides a richer picture of the economic dynamics generating the data and allows one to investigate which variables lead or lag others, and whether the lead or lag pattern is short term or long term in nature.  This technique is applied to monthly sectoral level employment data for the U.S. and shows that among the ten industrial sectors followed by the U.S. Bureau of Labor Statistics, six tend to lead the other four.  These six have high correlations indicating that the structural shocks generating the data movements are mostly in common.  Among the four lagging industries, some lag by longer intervals than others and some have low correlations with the leading industries. These low correlations may indicate that these industries are partially influenced by structural shocks beyond those generating the six leading industries, but they also may indicate that lagging sectors feature a different transmission mechanism of shocks.
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"Time Variation in an Optimal Asymmetric Preference Monetary Policy Model."

Abstract: This paper considers a time varying parameter extension of the Ruge-Murcia (2003, 2004) model to explore whether some of the variation in parameter estimates seen in the literature could arise from this source. A time varying value for the unemployment volatility parameter can be motivated through several means including variation in the slope of the Phillips curve or variation in the preferences of the monetary authority. We show that allowing time variation for the coefficient on the unemployment volatility parameter improves the model fit and it helps to provide an explanation of inflation bias based on asymmetric central banker preferences, which is consistent across subsamples.
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"Policy Effects of the Elasticity of Substitution between Skilled and Unskilled Labor in Life Cycle Models," 

Abstract: This paper investigates how the production function elasticity of substitution across different labor types impacts the results of policy analysis in multiperiod lived agent overlapping generations models.  We critique and investigate the popular structure that simply assumes that workers with different age, experience or education are perfectly substitutable in production.  This structure is inconsistent with empirical evidence of production complementarities.  We couch our findings in the context of two types of policy reforms: a social security reform and a tax reform. These reforms were chosen in part because of the large interest in them, but also because of their differing effects on life cycle decisions.  We find that ignoring production complementarity may influence the conclusions of policy analysis.
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"Optimal Monetary Policy with Asymmetric Preferences for Output,"

Abstract: We extend Ruge-Murcia (2003, 2004) to weigh inflation and output and show that empirical evidence supports an asymmetric preference hypothesis for output. We also find evidence that the monetary authority targets potential output in parallel to Barro and Gordon (1983).
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Industry estimates of the elasticity of substitution and the rate of biased technological change between skilled and unskilled labour.

Abstract: We estimate the elasticity of substitution between skilled and unskilled labour and the pace of skill-biased technological change at the industry level. The data is compiled from the March extract of the Current Population Survey (CPS) from 1968 to 2006. Industry information provided by the survey is used to group workers into 13 industry categories and education levels are used to dichotomize workers as skilled or unskilled. We construct measures of the ratio of skilled to unskilled employment and the ratio of skilled to unskilled wages in each industry. Using a relationship implied by profit maximizing behaviour on the part of representative firms, this data generates estimates of structural parameters. We find considerable differences across industries in the elasticity of substitution between skilled and unskilled labour. Furthermore, while most industries have experienced skill-biased technological change, the pace of this change has varied widely across industries.
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Barriers to Technological Adoption in Spain and Portugal.

Abstract: Since 1945, both Spain and Portugal have experienced significant market transformations. These countries were both led by dictators for many years until the mid 1970s when each moved toward more democratic governments and more open markets. As a result, each experienced significant changes in output with Spain’s becoming a model for proper market based transformations. Although Portugal’s transformation has been less impressive it experienced improvements too. This paper uses a Parente and Prescott (J Polit Econ 102(2), 298–321, 1994; 2000) type model to investigate the recent transformations in each of these countries and quantify the extent to which barriers to technological adoption may have played for these two development experiences. Our results indicate that from 1945 to 2003 these barriers have fallen considerably but remain high, and are somewhat higher in Portugal than in Spain.
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Second-best Tax Policy in a Growing Economy with Externalities

Abstract: This paper investigates the exploitation of environmental resources in a growing economy within a second-best fiscal policy framework. Agents derive utility from two types of consumption goods -- one which relies on an environmental input and one which does not -- as well as from leisure and from environmental amenity values. Property rights for the environmental resource are potentially incomplete. We connect second best policy to essential components of utility by considering the elasticity of substitution among each of the four utility arguments. The results illustrate potentially important relationships between environmental amentity values and leisure. When amenity values are complementary with leisure, for instance when environmental amenities are used for recreation, taxes on extractive goods generally increase over time. On the other hand, optimal taxes on extractive goods generally decrease over time when leisure and environmental amenity values are substitutes. Unders some parameterizations, complex dynamics leading to nonmonotonic time paths for the state variables can emerge.
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Industrial dynamics and the neoclassical growth model

Abstract: This paper studies industry level dynamics and demonstrates the ability of a modified neoclassical growth model to capture a range of empirical facts. The paper begins by using U.S. data to document skilled and unskilled labor trends within industry sector classifications as well as industry sector output trends. Using CPS data from 1968 to 2004, it is shown that the ratio of skilled workers to unskilled workers employed has risen in all industries. The absolute increase in this ratio was larger in the more skilled industries while the growth rate was larger in the less skilled industries. Furthermore, using national income account data it is shown that relatively high skilled industries have accounted for an increasing share of output over time. A version of the neoclassical growth model is then constructed to match these observations. One important feature of this model is a structure which introduces new goods into the economy at each moment of time. The model is able to capture a rich set of labor market movements between sectors and between skill levels as well as changes in the relative output shares across industries, yet preserves many nice features of the neoclassical growth model.
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Optimal fiscal policy in a multisector model: The price consequences of government spending.

Abstract: This paper investigates optimal fiscal policy in a static multisector model. A Ramsey type planner chooses tax rates on each good type as well as spending levels on each good type subject to an exogenous total expenditure constraint. It is shown that, like taxes, government spending policy has price effects and that these price effects have significant implications for optimal policy. These price effects imply a U shape to the government's objective function and this U shape results in boundary values for the choice of the spending allocation. In particular, it is shown that the optimal allocation of government spending tends to be concentrated on one good rather than spread among many goods.
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Allocating Government Education Expenditures across K-12 and College Education

Abstract: As of the late 1990s, public spending on education in the U.S. comprised approximately 7.1% of GDP; about 60% of that support was directed at K-12 education and the remainder at college education. We investigate the welfare and output implications of this spending in a theoretical model in which agents of differential innate ability choose whether to pursue higher education. Higher-ability agents support greater expenditures at both the K-12 and college levels. When public education expenditures are low, all agents prefer that spending be directed solely to K-12 education; when expenditures are high, all prefer that some spending be allocated to college education.
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Labor Market Trends with Balanced Growth.

Abstract: Well-known stylized facts have led to widespread use of the balanced growth concept. Recently, labor market trends including rising educational attainment and share of the labor force considered skilled have cast doubt upon balanced growth as an appropriate baseline. This paper develops a version of the neoclassical growth model that allows these labor market dynamics to occur jointly with balanced growth in output. Along the balanced growth path, skill-biased technological change drives rising skill and education levels. Relative prices of goods adjust so that growth in the value of total output is unaffected by these labor market changes. Several plausible foundations for skill-biased technological change are offered.
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Tax Reform with Useful Public Expenditures.

Abstract: We examine the effects of tax reform in an endogenous growth with two types of useful public expenditures. The optimal fiscal policy shifts the tax base to private consumption tax and generally requires a change in the size of government. If a tax reform holds the size of government fixed to satisfy a revenue-neutrality constraint, then the reform will be suboptimal; theory alone cannot tell us if welfare will be improved. For some model calibrations, we find that a revenue-neutral consumption tax reform can result in large welfare gains. For other quite plausible calibrations, the exact same reform can result in tiny or even negative welfare gains as the revenue-neutrality constraint becomes more severely binding. Overall, our results highlight the uncertainty surrounding the potential welfare benefits
of fundamental tax reform.
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The Transition from Dirty to Clean Industries: Optimal Fiscal Policy in a Two-Sector Model of Endogenous Growth.

Abstract: We examine the effects of tax reform in an endogenous growth with two types of useful public expenditures. The optimal fiscal policy shifts the tax base to private consumption tax and generally requires a change in the size of government. If a tax reform holds the size of government fixed to satisfy a revenue-neutrality constraint, then the reform will be suboptimal; theory alone cannot tell us if welfare will be improved. For some model calibrations, we find that a revenue-neutral consumption tax reform can result in large welfare gains. For other quite plausible calibrations, the exact same reform can result in tiny or even negative welfare gains as the revenue-neutrality constraint becomes more severely binding. Overall, our results highlight the uncertainty surrounding the potential welfare benefits of fundamental tax reform.
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Growth Effects of Shifting from a Graduated- Rate Tax System to a Flat Tax.

Abstract: We compute the growth effects of adopting a revenue-neutral flat tax for both a human capital-based endogenous growth model and a standard neoclassical growth model. Long-run growth effects are decomposed into the parts attributable to the flattening of the marginal tax schedule, the full expensing of physical-capital investment, and the elimination of double taxation of business income. The most important element of the reform is the flattening of the marginal tax schedule. Without this element, the combined effects of the other parts of the reform can actually reduce long-run growth. In the years immediately following the reform, the transition dynamics implied by the neoclassical growth model are quite similar to that of the endogenous growth model.
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Fiscal Policy and Productivity Growth in the OECD.

Abstract: We use a simple endogenous growth model with productive public capital to investigate the degree to which observed fiscal policies in eights OECD countries can account for slowdowns in the growth rates of aggregate labour productivity since 1970. In model simulations, we find that none of the observed public capital policies can generate slowdowns of sufficient magnitude to match those in the data. For most countries in our sample, a simulation that combines the observed public capital policy with the observed tax policy does a better job of accounting for the slowdown than either policy in isolation. JEL Classification: E62, O41
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Uniform Two-Part Tariffs and Below Marginal Cost Prices: Disneyland Revisited.

Abstract: This paper completely characterizes the demand and cost parameters which induce a constant cost monopolist charging a uniform two-part tariff to choose a marginal price less than marginal cost when selling to two types of consumers with different linear demands. It also provides a quantitative assessment of the potential significance of such pricing. Pricing below marginal cost maximizes profits in large regions of the model parameter space, contrary to widely held beliefs. If fixed costs are zero, pricing below marginal cost can increase profits by a factor of the square root of 2, although for most parameters the profit increase is much smaller.
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Optimal Fiscal Policy, Public Capital, and the Productivity Slowdown.

Abstract: This paper develops a quantitative theoretical model for the optimal provision of public capital. We show that the ratio of public to private capital in the US economy since 1925 evolves in a manner that is broadly consistent with an optimal transition path derived from a simple growth model. The model is used to quantify the conditions under which an increase in the stock of public capital is desirable and to investigate the degree to which nonoptimal fiscal policies can account for the US productivity slowdown.
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On Public Capital Analysis with State Data.

Abstract: Based on state production models with fixed effects, recent studies have argued public capital is not productive. We show multicollinearity is a potential problem and caution is warranted in interpreting estimation results for models with public capital and fixed effects.
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The Link Between Tax Rates and Foreign Direct Investment.

Abstract: This paper investigates the impact of tax policy on foreign direct investment flows between the US and other countries using a panel data empirical approach. Using panel data is an attractive alternative to using single time series data because it provides greater statistical power and offers greater flexibility in terms of explanatory variables. This study finds many significant factors influencing the transfer of funds component of foreign direct investment. Most noteworthy is that, in addition to host and home country corporate tax rates having a significant effect on investment flows, the host and home country income tax rates are also significant.
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Welfare, Stabilization or Growth: A Comparison of Different Fiscal Objectives.

Abstract: This paper investigates a variety of objectives that are commonly used to motivate government fiscal action. These include, welfare maximization, stabilization and growth maximization. The policies are compared on the basis of their implications for welfare, volatility and growth. We show that stabilization policies can produce welfare levels that are nearly identical to those of welfare maximization policies and that both welfare maximization and stabilization policies yield large welfare gains and modest growth losses relative to growth maximization policies. We also show that there are side issues to stabilization polices. In particular: (1) It is not possible to stabilize all macroeconomic variables simultaneously, even when the number of policy instruments is equal to the number of shocks; (2) stabilizing a particular variable requires increased volatility of some other variable; (3) stabilization requires some flexibility regarding the government's budget constraint; and, (4) stabilization requires the government to respond in a precise and immediate way to exogenous shocks which hit the economy.
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Equivalence of the Standard and Modified Switching Regression Models.

Abstract: Ophem (1993) employed a switching regression model with earnings entering the choice equation to investigate earnings differentials between the public and private sectors. Ophem also described a "modified switching regression model" in which only the equation for unknown earnings is substituted into the choice equation. He argued the coefficients in the choice equation can be identified in the modified switching regression model without exclusion restrictions and estimates from the modified switching regression model are more efficient than estimates from the standard switching regression model. We show that there are flaws in Ophem's analysis which invalidate his claims.
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A Normative Analysis of Public Capital.

Abstract: A normative analysis of short-term public capital investments is carried out using cost benefit analysis. This cost benefit approach explicitly incorporates the durability of capital into the computation and thus includes an aspect of public capital omitted from previous studies which focus on productivity. Estimation methods used elsewhere have been improved by properly handling several concerns that have been raised . In addition, this behavioural model yields many structural equations suitable for estimation which results in highly efficient parameter estimates. Although a small elasticity is found for public capital, the benefit is greater than the cost.
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Optimal Tax Rules in a Dynamic Stochastic Economy with Capital.

Abstract: This paper investigates optimal taxation in a disaggregated neoclassical growth model. Optimal tax rules for a government, which must finance an exogenous stochastic stream of spending, are investigated. Many locally optimal rules are found and two principles, which provide useful guidance into interpreting them, are described. These principles state that high steady state investment and small investment volatility are desired. A persistent income tax policy suggested by Judd (1989) is found to be among the best policies. Although some policies with complicated dynamic implications have similar welfare levels, because of its simplicity, the persistent income tax rule is recommended.
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A Diagnostic Test Without Numerical Integration.

Abstract: This paper describes a testing procedure for non-nested hypotheses for models requiring high-dimensional integration. Independent and unbiased simulators replace the integrals. The procedure is computationally simple and is not influenced by the asymptotic distribution of the parameter estimates.
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Backward Solving Quarterly Models with Seasonal or Annual Shocks.

Abstract: A method for simulation of dynamic general equilibrium models which include shocks whose magnitude depends on the time of year is described. An example of a real business cycle model with annual tax shocks is provided.
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Health Plan Choice and the Utilization of Health Care Services.

Abstract: The effect of health plan membership on the utilization of health care services is of interest to both consumbers and policy makers. Often, estimation of that effect is difficult because data are non-experimental and the dependent variable exhibits a high proportion of zeros. We propose a model of utilization that addresses both problems. After controlling for chronic illness and other observed variables, we find no evidence of further selectivity bias in equations for physician contacts and inpatient days. Our estimates of the effect of health plan membership on utilization of services are similar to those from experimental data.
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The Demand for Employment-Based Health Insurance Plans.

Abstract: We estimate the demand for health plans by employees in 17 Minneapolis firms. The data set has approximately 900 employees who chose a single-coverage health plan and 2,100 employees who chose family coverage. A nested logit model is empirically shown to be the right approach for modeling health plan choice, with freedom to choose your own doctor being the variable that distinguishes health plan nests. Our estimates show that employees are very sensitive to the out-of-pocket premium for each plan, controlling for other plan characteristics. These results are important both for public policy and for employers who offer multiple health plans.
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