Volume 5, Issue 1

We examine the link between increases in housing wealth, financial wealth, and consumer spending. We rely upon a panel of 14 countries observed annually for various periods during the past 25 years and a panel of U.S. states observed quarterly during the 1980s and 1990s. We impute the aggregate value of owner-occupied housing, the value of financial assets, and measures of aggregate consumption for each of the geographic units over time. We estimate regression models in levels, first differences and in error-correction form, relating consumption to income and wealth measures. We find a statistically significant and rather large effect of housing wealth upon household consumption.

The United States relies for its government revenues more on the taxation of capital relative to the taxation of labor than countries in continental Europe do. In this paper we ask what can account for this. Our approach is to look at Markov perfect equilibria of a two-country growth model where both governments use labor, capital and corporate taxes to finance exogenously given streams of public expenditure under period-by-period balanced budget constraints. There is no commitment technology and the equilibrium policies are time-consistent. We find that differences in productivity, size, and government spending can account for the heavy American reliance on capital taxation.

This paper revisits the issue of what factors produced the macroeconomic policies that led to the Great Inflation of the 1970s. I emphasize that a satisfactory explanation should satisfy two important criteria. First, it must be consistent with the record of views on the economy, manifested in statements by policymakers and prominent financial commentators. Second, it should work for countries beside the United States. I show that the monetary policy neglect hypothesis–which claims that policymakers took a nonmonetary view of the inflation process–meets these criteria. Other explanations of the Great Inflation are ruled out, with one exception (the output gap mismeasurement hypothesis), which supplements the monetary policy neglect hypothesis. The study covers the Great Inflation in both the United Kingdom and the United States, with policymakers’ views on the economy documented using 1970s news reports.

This study examines the relationship between growth in manufacturing employment and youth outcomes in Indonesia from 1985 to 1995, a time of rapid industrialization. In comparison with cross-national studies, this study has a larger sample size of regions, defines data more consistently, and conducts better checks for causality and specification. We also distinguish between the effects of manufacturing employment in the region and in the household and explore potential causal mechanisms underlying the observed correlations. Overall, manufacturing employment in the region modestly increases enrollment and decreases labor force participation for male and female young teens. At the household level, employment of adult females in manufacturing is associated with lower enrollment and higher labor force participation for young women relative to young men.

I show that in a Ramsey growth model, where the production function is of fixed proportions type and the utility function is CRRA, the saddle path is a closed form expression. The closed form expression greatly simplifies the analysis of how the labor productivity growth, the intertemporal rate of substitution, and the discount factor affect investments and growth.

This paper examines whether taxation is effective in eliminating sunspot fluctuations by considering two separate model economies by which indeterminacy occurs for empirically plausible specification of the model parameters. In the first model where production exhibits social increasing returns to scale and private constant returns to scale, I find that i) labor income tax alone, even if the tax schedule is flat, is effective; ii) taxes on labor and capital income would be more effective with increased progressivity; iii) at each average tax rate, labor income tax is more effective than capital income tax. However, in the second model where production exhibits social constant returns to scale and private decreasing returns to scale, I find that labor and capital income taxes at all progressivity levels are ineffective in removing sunspot fluctuations.

In this paper we discuss fiscal and monetary policy issues facing heavily-indebted poor countries (HIPCs) who receive debt reduction via the enhanced HIPC initiative. This debt relief program is distinguished from previous ones by its conditionality: freed resources must be used for poverty reduction. We argue that (i) this conditionality severely limits the extent to which the initiative provides significant debt relief; (ii) depending on the response of monetary policy to an increase in social spending there could be a short-run increase in inflation in HIPC countries and (iii) the keys to long-run fiscal sustainability in the HIPCs are significant fiscal reforms by their governments, and the effectiveness of their poverty reduction programs in raising growth.

In the mid 80's, many European countries liberalized the use of fixed-term (temporary) contracts in order to lower firm's non-wage labor costs, instead of reducing firing costs associated with indefinite duration (permanent) contracts. This policy generated segmented labor markets. The Spanish case is the most striking, with a share of temporary employment of 33% by the mid 90's. Since then, several reforms have been suggested and in this paper I quantify some of their effects. First, I build a model of job creation and destruction of the search and matching type that is able to generate the main properties of a segmented labor market like the Spanish one. Then, I use his model to quantify the effects of removing procedural wages, and further reductions in firing costs associated with permanent contracts. The main results are: (i) a small increase in permanent job destruction, (ii) a significant reduction in temporary job destruction, mainly driven by the increase in job conversions from temporary contracts into permanent ones, and (iii) a significant reduction in labor market segmentation measured as the reduction in the wage gap of temporary versus permanent workers.

Credit-constrained households must use savings both to smooth consumption and to finance productive investments. This non-separability between consumption and production decisions is ignored in the standard intertemporal buffer-stock consumption model where income growth is exogenous. This paper develops an intertemporal model of household consumption and investment in the presence of credit constraints and income uncertainty. Investment options are modelled as irreversible, indivisible, and non-stationary, allowing for endogenous income growth. The resulting behaviour is markedly different from that of the standard buffer-stock model.

The relative demand for skills has increased considerably in many OECD countries during recent decades. This development is potentially explained by capital-skill complementarity and high growth rates of capital equipment. When production functions are characterized by capital-skill complementarity, relative wages and employment of skilled labor are countercyclical because capital equipment is a quasi-fixed factor in the short run. The exact behavior of the two variables depends on relative wage flexibility. Relative wages are rigid in Denmark, implying that the employment share of skills should be countercyclical. The labor market is competitive in the United States and therefore relative wages of skilled labor are expected to be countercyclical. We find that the business cycle development of the two economies is consistent with capital-skill complementarity.

We examine stability under learning of sunspot equilibria in Real Business Cycle type models with indeterminacies. Our analysis emphasizes the importance of examining alternative representations of sunspot solutions. A general bivariate reduced form contains parameter regions in which sunspots are stable under learning. However, for parameters restricted to those generated by standard models of indeterminacy, we find, under one information assumption, that no stable sunspots exist, and under another information assumption, that they exist only for a very small part of the indeterminacy region. This leads to the following puzzle: why does indeterminacy almost always imply instability in RBC-type models?

This paper analyzes some unnoticed predictions of the two-sector AK model in line with the recent literature on embodied technical change. Firstly, by confining constant returns to capital to the investment sector, the AK model generates endogenously the secular downward trend of the relative price of equipment investment and the rising real investment rate observed in US NIPA data. Secondly, Jones' (1995) claim that the AK model fails to reconcile the empirical facts of trending real investment rates and stationary output growth vanishes in the two-sector version. Thirdly, consistent with the evidence from cross-country studies, the model predicts a negative relation between GDP per capita and the relative price of equipment. Hence, in spite of its overly simplistic structure, the two-sector AK model provides important intuition on the implications of a trending relative price of equipment investment in endogenous growth environments.

A number of hypotheses have been proposed to account for the role of lagged inflation in the New Keynesian price-adjustment model: (1) In the aftermath of abrupt structural change, rational learning may appear adaptive. (2) The model may have a serially correlated error term. (3) Estimating the model conditional on labor costs may remove or reduce the need for lagged inflation. I address the empirical support for these hypotheses and find that none eliminates the need for lagged inflation. In particular, lagged inflation enters with a coefficient in the range of 0.4 to 0.5, regardless of whether labor's share or detrended output is the measure of real marginal cost, or whether a serially correlated error term is allowed. Also, eliminating the period 1980-83 from the sample does not reduce the coefficient on lagged inflation.

This paper investigates whether monetary and exchange rate policies are important for the success of major fiscal adjustments. We assess their role controlling for other determinants of success identified in the literature, including the size and composition of the deficit cut, the level of public debt and the rate of economic growth. We find that successful adjustments are preceded by exchange rate depreciations. Empirically, a depreciation of the nominal effective exchange of one standard deviation of the sample mean in the two years before an adjustment increases the probability of success by 2 percentage points. The size and composition of the deficit cut are also important determinants of success: an increase of one standard deviation of the sample mean raises the probability of success by 3 and 4 percentage points, respectively. One implication of our results is that it may be more difficult to attain persistent fiscal adjustments within the Economic and Monetary Union of Europe, since the adoption of a single currency rules out the use of exchange rate policy among member countries.

The technology growth trends that underlie recent productivity patterns are investigated in a framework that incorporates investment-specific technological progress. Structural-break tests and regime-shifting models reveal the presence of a downward shift in total factor productivity growth in the late 1960s and an upward shift in investment-specific technology growth in the mid-1980s. In both cases, these breaks precede the generally recognized dates of labor productivity growth shifts. Simulations of technology growth shocks in a basic neoclassical model show that induced patterns of capital accumulation are generally consistent with the observed lags between technological advances and changes in productivity growth.

We develop a graphical 3-equation New Keynesian model for macroeconomic analysis to replace the traditional IS-LM-AS model. The new graphical IS-PC-MR model is a simple version of the one commonly used by central banks and captures the forward-looking thinking engaged in by the policy maker. Within a common framework, we compare our model to other monetary-rule based models that are used for teaching and policy analysis. We show that the differences among the models centre on whether the central bank optimizes and on the lag structure in the IS and Phillips curve equations. We highlight the analytical and pedagogical advantages of our preferred model. The model can be used to analyze the consequences of a wide range of macroeconomic shocks, to identify the structural determinants of the coefficients of a Taylor type interest rate rule, and to explain the origin and size of inflation bias.

Transparency has become one of the key features of monetary policy. This paper analyzes the reputational incentives related to transparency, focusing on the publication of central bank forecasts. A simple dynamic monetary policy game shows how transparency reduces inflation, as has been found empirically. Furthermore, the endogenous choice of transparency is analyzed. Although transparency exposes weak central banks, the negative market feedback in response to secrecy could provide a sufficiently strong inducement to become transparent. Thus, reputational concerns could lead to transparency, even without formal disclosure requirements.

Technology adoption in follower countries can be accomplished by local R&D activities, but it can also be achieved without formal R&D, for example, by foreign direct investment. Empirical evidence suggests that current R&D activities often expand local knowledge for future R&D, while adoption without R&D does not seem to have this effect. We formalize this idea in a quality-ladder growth model and find that this biased externality results in multiple steady states: In the long run, countries with sufficient initial knowledge and human capital converge to a state in which R&D is locally undertaken and thus become relatively rich, while other countries fully rely on technology adoption without R&D and stay poor. Switching regression using cross-country data supports the presence of multiple steady states in R&D expenditures.

The market solution of a general R&D-based endogenous growth model is developed. The model is general in two respects: First, general formulations are used and restrictions are only introduced provided that these become necessary. Second, each factor of production (labour, capital and technological knowledge) is allowed to be productive in each sector (final output, capital goods and R&D). Since the resulting R&D-based growth model encompasses a large number of specific models, it can be viewed as a summary of this strand of the literature. The complete dynamic system as well as the balanced growth rates are derived. By employing numeric techniques, the gap between the decentralised and the centralised balanced growth path as well as the transitional dynamics implications are investigated.

This paper starts from the observation that parameter instability and model uncertainty are relevant problems for the analysis of monetary policy in small macroeconomic models. We propose to deal with these two problems by implementing a novel "thick recursive modelling" approach. At each point in time we estimate all models generated by the combinations of a base-set of k observable regressors for aggregate demand and supply. We compute optimal monetary policies for all possible models and then consider alternative ways of summarizing their distribution. Our main results show that thick recursive modelling delivers optimal policy rates that track the observed policy rates better than the optimal policy rates obtained under a constant parameter specification with no role for model uncertainty.

If workers anticipate a technological innovation, some workers may decide to quit their job and retrain themselves to acquire the skills which are needed by this new technology. However, this may facilitate the innovation and make it a self-fulfilling prophecy. This self-fulfilling mechanism is reinforced if the anticipated innovation causes job insecurity for workers who do not retrain themselves and keep their current job, but realize that the innovation may make their job obsolete. If these workers engage in precautionary saving and cut their consumption expenditures, aggregate output contracts. This gives the other workers an extra incentive to quit their job and acquire new skills, and therefore facilitates even more the innovation which consumers were worried about. This paper formalizes this idea. It also provides an illustration of how a first-order Taylor-approximation of the Euler equation yields an effect of precautionary saving.

The Federal Reserve Act authorizes the Federal Reserve to undertake various types of discount window loans and open market operations. While the Federal Reserve generally has not found it necessary to use all types of such authority, there could be circumstances in which the Federal Reserve might need to consider utilizing its statutory authority more broadly than it has in the past.We examine the limits imposed by the Federal Reserve Act along two dimensions: those types of counterparties and financial instruments with which the Federal Reserve may conduct monetary policy. In doing so, we develop a theme not commonly pursued in the literature -- the ways and extent to which the Federal Reserve Act limits the Federal Reserve from taking credit risk onto its balance sheet.We also provide some historical perspective on how the current powers of the Federal Reserve came to be authorized.

This paper studies the growth effects of productive public expenditures on education and public capital in an endogenous growth model of overlapping generations. The model is calibrated to Latin American data, and the effects of raising government expenditures on education and public capital are computed. Results show that increases in these public expenditures have moderate, positive effects on per capita growth and income under different scenarios. In addition, re-allocating expenditures from public capital to education while keeping the budget constant can raise growth up to a threshold.

The growth literature has not yet fully established how data on educational attainment should be introduced in theories involving human capital. This paper examines alternative specifications of human capital within the Mincerian class that once incorporated in standard growth models may generate predictions that match up with the existing data on education. First, we analyze predictions in the Bils and Klenow (2000) model and show that although they behave correctly under some parameterizations, they are also subject to some shortcomings. Next, we present a standard neoclassical two-sector growth model that adopts a human capital specification in which the fraction of individual's time endowment in school is viewed as an investment rate. We show that the optimally chosen educational attainment predicted by the calibrated model does not correspond to the data as it is unrealistically high. Finally, we propose an alternative specification of human capital based on a law of motion of educational attainment that successfully matches up with the data.

We use a simple growth model with public capital to examine the evolution of the US macroeconomy and to discuss the implications of the public infrastructure decline for the productivity slowdown over the last four decades. The main difference of the model to other papers in the related literature is that public investment is actively managed as a non-linear function of the state of the economy, and is not a constant fraction of output in every period. The active management policy delivers transition dynamics that reproduce the public capital downsizing episode, but that accounts for only a minor fraction of the observed productivity slowdown. However, taking into consideration higher rates of returns to public capital or the reallocation of public resources from productive to unproductive expenditures, which is consistent with the US experience in the 70s and 80s, the model simulation accounts for most of the observed productivity slowdown.

The dollarization of bank deposits and credit is widespread in developing countries, resulting in varying degrees of currency mismatches in domestic financial intermediation. It is argued that flexible exchange rate regimes generally encourage banks to match dollar-denominated liabilities with a corresponding amount of dollar-denominated assets. Does this argument apply to the behavior of dollar deposits and credits in financially dollarized economies? A new database on deposit and credit dollarization in developing and transition countries is assembled and used to address this question. Empirical results suggest that, if anything, floating regimes are positively associated with deposit dollarization more strongly than they are associated with credit dollarization. As a consequence, currency mismatches in domestic financial intermediation seem to be greater under floating regimes.

This paper examines income convergence across U.S. regions for the period 1929-2002 using unit root and cointegration techniques. The findings suggest it is difficult to reject non-convergence in per capita incomes across regions even when endogenous breakpoints are included. Interestingly, we also find evidence of cointegration among technology and incomes in the leading regions, but not in the lagging ones, identifying technology as a factor that contributes to the lack of convergence.

An economy is considered in which new firms require time to learn whether they will grow in size and profitability in the long run. The labor market is imperfectly competitive. I show that inefficient levels of firm entry will generally exist. Whether under or over entry occurs is tightly related to the bargaining power of labor, but the logic behind my result differs dramatically from other work which has identified a similar link. The theory may shed some light on the continuing debate over the contribution of small firms to economic growth, and suggests that, in some cases, subsidizing small firms may be socially beneficial.

This paper studies the issue of price stability in a continuous time optimizing general equilibrium model with overlapping generations. It is shown that fiscal policy has effects on nominal variables. Fiscal expansions are inflationary even when the government intertemporal budget constraint is respected for any prices sequence and there is no recourse to money financing. Our results shed new light on the interaction between fiscal policy and nominal prices.

This paper employs a stochastic endogenous growth model with productive government expenditure to analyze the macroeconomic effects of income taxation. We demonstrate that in the presence of capital and income risk the impact of taxation on consumption choice as well as on economic growth is ambiguous as it affects the mean as well as the variance of disposable income. It is possible to solve for welfare-maximizing policies, but contrary to the deterministic framework, welfare-, consumption- and growth-maximizing policies do not necessarily coincide. Multiple solutions for optimal tax rates can be found. The risk premium turns out to be a key factor in explaining the effects. In fact, growth-maximizing policies also maximize the risk premium. This may entail too much risk for risk-averse agents, thereby minimizing welfare and the propensity to consume.

This paper studies the business cycle dynamics of income and wealth distributions in the context of the neoclassical growth model where agents are heterogeneous in initial wealth and non-acquired skills. Our economy admits a representative consumer which enables us to characterize distributive dynamics by the evolution of aggregate quantities. We show that inequality in both wealth and income follow a countercyclical pattern: the former is countercyclical because labor income is more sensitive to the business cycle than capital income, while the latter is countercyclical due to the wealth-distribution effect. We find that the predictions of the model about the income distribution dynamics accord well with the U.S. data.

This paper conducts a Ramsey analysis within an endogenous growth cash-in-advance economy with policy commitment. Credit and money are alternative payment mechanisms that act as inputs into the household production of exchange. The credit is produced with a diminishing returns technology with Inada conditions that implies along the balanced-growth path a degree one homogeneity of effective banking time. This tightens the restrictions found within shopping time economies while providing a production basis for the Ramsey-Friedman optimum that suggests a special case of Diamond and Mirrlees (1971).

This paper studies the implications for the optimal policy of introducing an exogenous minimum wage into a standard public finance model. I present a dynamic general equilibrium model with a Ramsey planner deciding about public spending, labor income taxes and debt. I find that for sufficiently high minimum wages, equilibria in which the labor supply is rationed and involuntary unemployment arises may be optimal in bad times. For a minimum wage not too high, the government will set taxes to reduce the labor supply and avoid non desirable rationing. This implies increasing taxes in bad times. As regards the cyclical properties of the optimal policy, state contingent returns on debt are used as shock absorbers so as to smooth private consumption over time and across states of nature.

Owing to lags in the transmission mechanism of monetary policy, central banks put much weight on forecasts of the future paths of output and inflation. So there has been considerable recent interest in forward-looking Taylor-type reaction functions. Using publicly available data on the Monetary Policy Committee’s forecasts for UK inflation and output growth, 1997-2003, we examine how the coefficients in such reaction functions changed as we switched between ex post forecasts – those published after, and incorporating, the preceding interest rate decision – and ex ante forecasts – those presented to the MPC before that decision – and also as we vary the (forecast) horizon, out to eight quarters ahead. In our data set, the coefficients vary sensitively as the horizon/forecast basis changes. Our results are consistent with the hypothesis that the MPC tried aggressively to eliminate any predicted, ex ante, deviation of inflation from target immediately it emerged, with no apparent indication of intended inertia, or gradualism, in response. Nevertheless the time path of official short term interest rates during these years shows the usual record of consecutive similarly-signed small steps.

The paper analyzes the question why the U.S. economy in the 2000:4--2004:3 period was sluggish in light of the large expansionary fiscal and monetary policies that took place. The answer does not appear to be that there were large structural changes in the economy or systematic bad shocks. This paper tests for such changes and shocks, and the results are generally negative. Instead, the main culprits seem to be large negative effects from declines in the stock market and exports. Although not tested in this paper, some of the decline in exports may be the result of the stock market decline, in which case most of the explanation is simply the stock market decline itself.

This paper re-examines the importance of human capital in explaining economic growth. Previous studies are extended by including schooling investments of both time and goods within the school year, a human capital externality, and imperfect substitution between white collar and manual tasks. The model of worker productivity used to conduct the growth accounting is consistent with (1) rates of return to time and goods investment in education, (2) white collar wage premia, and (3) trendless worker productivity growth rates in the United States over the 20th century. The analysis suggests that about one third of United States growth over this period was related to human capital accumulation, accounting for an average annual growth rate of 0.6 to 0.7 percent. The model also implies that neoclassical inputs can account for 5.5 to 8.5-fold differences in worker productivity across rich and poor countries.

Labor market outcomes such as turnover and earnings are correlated with employer characteristics, even after controlling for observable differences in worker characteristics. We argue that this systematic relationship constitutes strong evidence in favor of models where workers choose how much to invest in future productivity. Because employer characteristics are correlated with firm survival, returns to these investments vary across firm types. We describe a dynamic general equilibrium model where workers employed in firms more likely to survive choose to devote more time to productivity-enhancing activities, and therefore have a steeper earnings-tenure profile. Our model also predicts that quit rates should be lower in firms more likely to survive, and should tend to fall during slow times, while job destruction rates should rise. These predictions, we argue, are borne out by the existing empirical evidence.

This paper examines the effect of vertical diversity in workers' skill on the long-run growth rate of an economy. It uses a two-sector model where the technology of the consumption-good sector is supermodular and that of the R&D sector is submodular. By adopting Grossman and Maggi's (2000) model to a framework of growth, it shows first that diversity is conducive to growth. As the main innovation, a notion of communication gap is introduced among workers. It is shown that if vertical diversity is sufficiently high relative to the communication gap, the growth rate may not increase with diversity; there may be an inverse-U shaped relationship.

This paper evaluates the welfare consequences of implementing intellectual property rights in developing countries. The protection of intellectual property in poor countries promises to increase world innovation, but this would not come without costs. Higher prices for consumers in that part of the world are the negative side of this policy.We present a general equilibrium model with two regions (the North and the South) to compare these two effects. Our main contribution is to show that the results will depend on the difference in economic development (represented by labor productivity) between the two regions. The South might suffer a net welfare loss if its productivity level is very low with respect to the North.

This paper provides a general methodology for introducing capital accumulation into economies with private information and heterogeneous agents. The agents operate a stochastic neoclassical production technology with capital and labor input. I study a moral hazard economy with unobservable input (hidden action). I characterize the efficient allocation of capital, labor, and consumption in a stationary recursive competitive equilibrium. The economy is decentralized by the component planner approach developed by Atkeson and Lucas (1995). Accumulation of capital is facilitated by a "capital planner" who serves as a financial intermediary for the component planners. In the unique, feasible and non-degenerate stationary equilibrium, private information lowers the market-clearing interest rate below agents' discount rate.