Volume 3, Issue 1

New growth theories suffer from their counterfactual prediction that a higher (rate of) population (growth) generally implies a higher growth rate of per capita income. This population puzzle is solved by introducing imported intermediates and an exogenously growing world export demand creating a Keynesian balance of payments constraint in a neoclassical model of non-scale growth. It is shown among other things that the growth rate of per capita consumption may decline or increase in the rate of population growth depending on the relative magnitudes of particular elasticities. The growth rate of per capita income measured in terms of the intermediate produced abroad will fall in the population growth rate if world export demand is price-inelastic. This elasticity is also decisive in whether the implications of the model are more Keynesian or more neoclassical.

If technological innovations in the North can be costlessly imitated by educated workers in the South, and if education decisions are endogenous, why aren't all countries well-educated and rich? This paper explores a possible answer: if technologically advanced sectors, operating under increasing returns to scale, need a minimum pool of educated workers to commence production, then coordination failure can arise in the choice of education. A simple two-sector model is shown to yield multiple equilibria: countries that perform well educationally and adopt technology successfully can co-exist with countries that fail in both endeavors.

The Federal Reserve Act calls upon the newly created Banks "... to furnish an elastic currency..." since such action was thought to be welfare improving during times of high currency demand. This paper considers the welfare implications of an "elastic currency" regime within the context of an overlapping generations model of fiat money that includes banks that face aggregate risk. Although in the economy's stationary equilibrium the bank chooses to hold both fiat currency and illiquid capital in its portfolio, it would prefer to hold additional amounts of currency (were they available) during periods of high withdrawal demand. To remedy this problem, a central bank is introduced that offers zero-interest, intraperiod loans of currency via a discount window. When the central bank optimally chooses the size of the loan, it is shown that the resulting stationary equilibrium supports the economy's "golden rule" allocation.

The empirical analysis of precautionary savings based on household level has long suffered from the assumption of no risk-sharing behavior and measurement errors. Using a unique dataset from China Health and Nutrition Survey (CHNS), we provide an explicit estimate of the relative prudence coefficient of a representative consumer in the Chinese community. As the main innovation of this paper, focusing our estimation on the community, rather than individual household level, is motivated by two salient features of Chinese communities: the virtual isolation between the communities and a significant amount of risk-sharing within each community. Averaging consumption growth across individual households in the same community in China’s context can reduce measurement errors. We show that the relative prudence coefficient for a community representative consumer is dramatically greater than that of an individual household, which is consistent with the widely agreed belief about the magnitude of risk-aversion in the life-cycle model.

We consider an economy with symmetric buyers and symmetric sellers. The sellers are in locations and post prices simultaneously. The buyers observe the prices, and each buyer visits one location. The buyers act independently and employ symmetric mixed strategies. We show that when there are several sellers in a location, the Nash equilibrium features price dispersion, i.e. the sellers post different prices. The equilibrium strategy of the sellers is a non-atomic distribution.

This paper develops a simple model to study the impact of stock markets on the current account. The model allows for an arbitrary number of risky assets, which form an incomplete market, as well as a risk-free bond. A closed-form solution for the current account is derived from the optimal portfolio and consumption/saving choices of a representative agent. Formally, the model can be seen as a stock-market-augmented version of the “fundamental equation of the current account” popularized by Sachs. In order to make the main points of the model clear, I first solve it taking prices as given. A general equilibrium is analyzed in a companion paper.I suggest that the model sheds light on the recent US current account deficit. Some claim that this current account deficit reflects over-optimistic -“irrationally exuberant”- expectations of future stock market performance. The model, however, suggests that it is optimal for a country to run a current account deficit even if people do not expect the stock market boom to last. Another insight afforded by the model is that the current account may help predict future stock market performance and/or future endowments streams. This forecasting property can be formally expressed by a set of Granger causality and Granger causal priority propositions.

I study the dynamics of shiftwork when the demand for the output of the firm is stochastic and adjusting the number of shifts entails irreversible costs. The analysis reveals the existence of a gap between the level of demand that triggers activation of a shift and the level of demand that triggers shutting it off. The higher the uncertainty about future demand, the wider this gap. I also analyze in detail the pro-cyclical labor productivity created by the use of shiftwork.

In this paper we build up a theoretical continuous time model to study how future constraints affect current investment decisions. We show that firms constrained in the future, but currently unconstrained, select an optimizing investment trajectory different from that of an identical firm that will never be constrained. We provide a complete characterization of the formal solution to the constrained problem: in particular, we show that two simple conditions allow us to compute the trajectory for the (potentially) constrained firm. A basic result of our analysis is that the effect of future financing constraints are captured by the current q value of the firm.

Is it politically feasible for governments to engineer endogenous growth? This paper illustrates two reasonable political decision mechanisms by which fiscal policy generates endogenous growth with a single accumulable factor, and a constant returns to scale production technology without production externalities. In the first mechanism, policies are chosen by the government to maximize constituent support by raising aggregate income. In the second mechanism, policies are determined in a voting equilibrium where agents are concerned only with their own incomes. We demonstrate that policies that target aggregates generate balanced growth and are Pareto optimal. Policies chosen by the median voter also produce balanced growth, but result in public investment 50 percent below the socially optimal level. However, we identify a plausible restriction under which median voting replicates the socially optimal level. This shows that both mechanisms are linked through their effects on asset distribution.

Price-setting models with monopolistic competition and costs of changing prices exhibit coordination failure: in response to a monetary policy shock, individual agents lack incentives to change prices even when it would be Pareto-improving if all agents did so. The potential welfare gains are in part evaluated relative to a benchmark equilibrium of perfect, costless coordination; in practice, since agents will still have incentives to deviate from the benchmark equilibrium, coordination is likely to require enforcement. We consider an alternative benchmark equilibrium in which coordination is enforced by punishing deviators. This is formally equivalent to modeling agents as a cartel playing a punishment game. We show that this new benchmark implies that the welfare losses from coordination failure are smaller. Moreover, at the new benchmark equilibrium, prices are upwards-flexible but downwards-sticky. These last results suggest that the dynamic behavior of sticky-price models may more generally depend on the kind of imperfect competition assumed.

The annual structure of real output in the G7 countries is investigated in this article by means of fractional integration techniques. However, instead of using the classical ARMA specifications for describing the short-run components of the series, we use an approach due to Bloomfield (1973). The results reject the null hypothesis of a unit root in all series in favour of higher orders of integration. This indicates that the standard approach of taking first differences to obtain I(0) stationary residuals may lead to series still with a component of long memory behaviour. The possibility of a structural change corresponding to World War II is also examined, and the results confirm that fractional integration is difficult to distinguish from structural break/regime switching models.

In an environment of low inflation, the Federal Reserve faces the possibility that it may not have provided enough monetary stimulus even though it had pushed the short-term nominal interest rate to its lower bound of zero. Assuming the nominal Treasury-bill rate had been lowered to zero, this paper considers whether further open market purchases of Treasury bills could spur aggregate demand through increases in the monetary base. Such action may be stimulative by increasing liquidity for financial intermediaries and households; by affecting expectations of the future paths of short-term interest rates, inflation, and asset prices; through distributional effects; or by stimulating bank lending through the credit channel. This paper also examines the alternative policy tools that are available to the Federal Reserve in theory, and notes the practical limitations imposed by the Federal Reserve Act. The tools the Federal Reserve has at its disposal include open market purchases of Treasury bonds and certain types of private-sector credit instruments; unsterilized and sterilized intervention in foreign exchange; lending through the discount window; and, in some circumstances, may include the use of options.

In this paper we show that the richest countries are investing proportionally less than middle income countries in engineering and technical human capital. We generalize this result, controlling for country-specific effects, cross-time error correlations, heteroskedasticity, the presence of outliers and the introduction of other explanatory variables. Thus, we establish an unexpected stylized fact (about human capital composition): the proportion of high-tech human capital in tertiary education presents an inverted U-shaped relationship with GDP per capita. This is interesting because Research and Development (R&D) endogenous growth models predict and most evidence show that investment in R&D increases with economic development.

Two-country applications of equilibrium business cycle methodology have succeeded in matching some key features of international fluctuations. However, discrepancies between theory and data remain. This paper identifies an anomaly related to a basic property of typical models: The prediction of countercyclical net exports is fundamentally related to a counterfactual implication for negative cross-country investment correlations. The introduction of investment adjustment costs can induce positive investment comovement; however, this has the side-effect of reversing the cyclical behavior of net exports. The calibration of a low elasticity of substitution between domestic goods and imports is shown to be a more robust specification with regard to this and other puzzles that have arisen in the international business cycle literature.

Fair (2002) argues that New Keynesian models are wrong in predicting that an inflation shock has contractionary effects only if it raises the real interest rate, and that a coefficient on inflation higher than one in the Taylor rule is a necessary condition for stability. While Fair uses his macroeconometric model as a benchmark to evaluate the predictions of the standard New Keynesian framework, we adopt a VAR supported by models in that framework, and the model of Rudebusch and Svensson (1999). The findings are broadly in line with Fair's.

Several empirical papers have established the fact of a negative price-output correlation for the United States in the post WWII era. Much of this work appears to interpret the sign of this correlation under the assumption that monetary policy is passive. This paper uses a simple aggregate supply and demand model to examine how an optimizing monetary policy affects the price-output correlation. The model is capable of explaining why the price-output correlation in the United States is positive with prewar data but negative with postwar data. The model implies that a negative price-output correlation can emerge under an optimal policy only if policymakers are concerned with both inflation and output and the underlying economy is one in which both demand and supply shocks affect output. The model implies that a negative price-output correlation is inconsistent with real business cycle models, while a positive correlation does not necessarily support the use of neo-Keynesian models.

Some argue that central banks can improve monetary policy by including confidential supervisory assessments of banking organizations in their forecasts of inflation and unemployment. In this study we examine the extent to which forecasts of these variables would have been improved with the inclusion of supervisory data. We begin by reproducing the earlier results used to support the claim. We critically examine them and extend the analysis from in-sample to out-of-sample testing. Finally, we check the robustness of our findings by extending the analysis period, using a different methodology to determine the contribution to forecasts, and substituting a different measure of supervisory information. Our analysis does not support claims that confidential supervisory information would have improved forecasts of inflation. Confidential supervisory information improved forecasts of unemployment in some periods. It is unclear, however, if the frequency or level of improvement would have altered monetary policy in a nontrivial way.

A closed-form solution for quantity and asset-price movements in a dynamic general equilibrium model with non-state-separable preferences shows that the welfare cost of fluctuations and the equity premium can be large in such a model. But a large welfare loss from cycles does not imply a large gain from good monetary policy. Although monetary policy can implement the optimal allocation in a sticky-price version of the model, the gain from such activism is trivial because the optimal allocation continues to imply volatile consumption in response to productivity shocks. This highlights a distinction between recent models and older Keynesian-style models: In recent models, fluctuations are largely an efficient response to shocks and inefficiencies stem from price distortions associated with price rigidity, i.e., Harberger triangles. In the older literature, fluctuations were viewed as inherently inefficient with large costs, i.e., Okun's gaps.

Many researchers have found that the lagged interest rate enters estimated monetary policy rules with overwhelming significance, suggesting that policy adjusts gradually to changes in economic conditions. However, Rudebusch (2002) argues that the lagged interest rate is not a fundamental component of the U.S. policy rule, and that its significance arises from the omission of serially correlated variables from the policy rule. This paper considers the possibility that policy rules may be characterized by both partial adjustment and serially correlated omitted variables. Our findings indicate that even if one allows for serially correlated errors, partial adjustment plays an important role in describing the behavior of the federal funds rate.

This paper examines the joint determination of long-run income per worker and capital utilization. Comparatively low (optimal) rates of capital utilization may arise in poor economies in response to weak underlying structural characteristics. The quantitative implications of variable capital utilization are also explored. It is demonstrated that adding endogenous capital utilization to the Solow model implies a rate of convergence in line with empirical estimates and that controlling for capital utilization has important consequences for the results stemming from cross-country growth and levels accounting.

The paper presents a general theory of the aggregation of prices and quantities that unifies the field and relates topics that in the past have been treated separately and unsatisfactorily, or not at all. The theory does without the common but unrealistic assumptions of homotheticity, or representative agents and is valid with or without an explicit utility maximization assumption. Two different derivations are given, one in continuous time, using Divisia integrals, and one employing more traditional discrete arguments. The unifying concept is the money metric, which is interpreted as a partial welfare indicator, rather than as a comprehensive welfare measure. On this basis, a consistent set of chained price and quantity indexes for a set of additive time series, such as those in the national income and product accounts, is derived. All variants of the theory lead to Törnqvist indexes defined on the appropriate data set. A numerical example confirms that in the non-homothetic case, these indexes are superior both to Fisher’s ‘ideal’ index and to the consumer surplus approximation.

In this paper we challenge Parente and Prescott's (1999) theoretical framework, which establishes that unions use their control of "work practices" to thwart the efficient use of technology in the firms. We argue instead that unions, despite endowing monopoly rights over a technology, should tend to impose its efficient use. In fact if union members care about labor disutility, along with wage incomes, they will dictate "work practices" consistent with operating technology at full efficiency, in order to allow workers to enjoy more leisure. Our result is more general than Parente and Prescott's and does not rely on the particular specification of preferences.

In this paper we study the evolution of the labor share in the OECD. We show it is essentially related to the capital-output ratio; that this relationship is shifted by factors like the price of imported materials or capital-augmenting technological progress; and that discrepancies between the marginal product of labor and the real wage ---due to, e.g., labor adjustment costs or union wage bargaining--- cause departures from it. We also provide empirical evidence on the determinants of the labor share with panel data on 13 industries and 12 countries for 1972-93.

This paper presents an endogenous growth model with intertemporally dependent preferences and "Ak" technology. We derive sufficient conditions for a balanced growth path to be an equilibrium, provide a full characterization of the equilibrium dynamics of the economy, and explore the implications of habit formation for the patterns of cross-country growth and convergence. Finally, we show that the alternative departure from the standard assumption of isoelastic preferences represented by the use of a Stone-Geary utility function can be interpreted as a special case of the model with habit formation. Our results highlight the importance of preferences in the dynamics of growth, a point neglected in most of the literature.

This paper studies the validity of the Friedman rule in a search model with divisible money and divisible goods in which the terms of trades are determined endogenously. We show that ex post bargaining generates a holdup problem similar to the one emphasized in the labor-market literature. Buyers cannot obtain the full return that an additional unit of money provides to the match, which makes the purchasing power of money inefficiently low in equilibrium. Consequently, even though the Friedman rule maximizes the purchasing power of money, it fails to generate the first-best allocation of resources unless buyers have all the bargaining power.

In recent years, a number of studies have found in favour of a causal link between finance and growth. This paper examines the empirical foundations of such studies, performing some additional econometric tests using the datasets and methodologies of Rajan and Zingales (1998a) and Levine and Zervos (1998). First, we consider the stability of published results across countries at different stages in their economic development, re-estimating Rajan and Zingales’ specification to allow separate coefficients for OECD and non-OECD member countries. We find that finance has a greater impact upon growth in non-OECD countries, with bank finance of particular importance. Second, we explore the issue of identification, concluding that it is difficult to disentangle the effect of financial development from that of other correlated factors. In particular, we show that the results of these authors depend heavily on the strong performance of the ‘Tiger’ economies during the 1980s.

Empirical research has shown that there is large uncertainty concerning the value of the natural rate of unemployment at any point in time. I incorporate this feature in a model of monetary policy where the policymaker targets an inflation rate and the natural rate of unemployment and solve for the optimal policy. Two interesting results emerge. First, under a realistic shock profile, the model generates long-lasting deviations of inflation from target, providing an alternative (but also a complement) to the popular Barro-Gordon framework. Second, the economy exhibits large inflation persistence and can have very rich inflation dynamics. The model is able to account for approximately one third of the increase in inflation in the United States in the late 1970s, and suggests an explanation for the low inflation of the late 1990s. Moreover, I present empirical evidence for the United States and other countries that support the model including a new empirical finding: across countries there is a positive statistical relation between the persistence of unemployment and the persistence of inflation.

We examine the extent of downward nominal wage rigidity using the microdata underlying the BLS’s employment cost index. This dataset has two significant advantages over those used previously. It is an extensive, nationally representative dataset based on establishment records and is thus free from much of the reporting error that has plagued earlier work. Even more important, the data are unique in containing detailed information on benefit costs, allowing a first look at the rigidity of total compensation (that is, wages plus benefits). In general, we find significantly stronger evidence of downward nominal wage rigidity than did studies using panel data on individuals. Although total compensation appears somewhat more flexible than wages and salaries alone, we still find a significant amount of rigidity for compensation. Furthermore, the greater flexibility of compensation does not seem to reflect the deliberate attempt by firms to use benefits to circumvent wage and salary rigidity.