Political Influences on Monetary and Fiscal Policy



Human capital theory states that resources embodied in people, such as knowledge, skills and health, contribute to increases in earnings in the same way that physical capital raises output and income. Activities such as education, on-the-job training and medical care affect individuals’ future earnings through the accumulation of human capital and are thus called investments in human capital. Although human capital theory originally was focused on explaining the substantial income growth in the U.S. even after controlling for growth in physical capital and labor, it also helps explain many aspects of workers' earnings over their lifetimes. Workers’ earnings increase with age at a decreasing rate. This positive and concave ae-earnings profile can be explained by a lifetime human capital accumulation process in which investments are mostly concentrated at workers’ younger ages. Investments in human capital when workers are young provide a longer period to recoup the returns, and such investments are less costly earlier in life because the opportunity costs of investing in human capital are lower when earnings are lower.

Human capital theory also provides important insights into the patterns and changes in the distribution of earnings across workers. Differences in schooling and labor market experience explain a significant fraction of the inequality in earnings. The explanatory power of the human capital model is even stronger when quality of schooling and the amount of on-the-job training are included in the analysis An important dimension of human capital theory is its distinction between general and specific human capital. General training increases a worker’s marginal productivity by the same amount in the firm providing the training as in other firms. By contrast, specific training increases productivity more in the firm providing the training than when the worker is employed by another firm. For example, a training program of communication skills is general training because it raises trainees’ productivity in all firms that require a similar level of communication at work; on the other hand, a course in a specific software used only by firm X is specific training because it does not contribute much, if any, to the trainee’s productivity increase in firms other than X.

The distinctions between generl training and specific training depend on the nature of training and on the extent to which employers require specific skills and training. For example, medical skill is specific human capital to the medical industry but general human capital to all hospitals. A mastery of Danish language is specific human capital to the Danish labor market but general human capital to all the firms in Denmark. If different countries are considered separate labor markets, even schooling, a typical general human capital in most cases, could become specific human capital. Knowledge about a country’s language, history and institutions is often of little value in another country.

The question of what is the optimal institutional design of an independent Central Bank (CB) has been of great interests to legislators, central bankers, and academics alike. One of the sticky points is how much independence should the CB be given. Although the importance of CB independence is widely recognized, there is also ample agreement around the idea that the CB should not be completely isolated from the government. This is in part due to the need for harmony between monetary and fiscal policy, but also because the participation of publicly elected officials in all policy decisions is at the core of democratic systems. The dilemma is how to maintain the desired link with the government, while giving the CB enough independence to alleviate ties between monetary policy and the electoral cycle, and to reduce inflation bias. In practice, such dilemma is frequently addressed by placing the design of monetary policy in the hands of a committee of central bankers, and giving the government some power over the appointment of its members. The idea is that, while these appointment powers create a tie between the government and the CB, the larger set of decision-making mechanisms and appointment rules available under a committee arrangement can be exploited to make policy more independent from government’s pressures than it would be under a single central banker. In other words, for any given position of each individual member, the mechanisms through which positions are aggregated can be optimally designed to reduce the influence of the government.

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Reference : Copyright by Marcela Eslava, Doctor of Philosophy, 2004







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