Volume 8, Issue 1

We extend the class of quality-ladder growth models (Grossman and Helpman, 1991, Segerstrom, 1998 and others), to encompass an economy with asymmetric fundamentals. In contrast to the standard framework, in our model industries may differ in terms of their innovative potential (quality jumps and arrival rates) and consumers' preferences. This extension allows us to bring industrial policy back into the realm of the growth policy debate. We first show that it is always possible to raise the long-run growth rate and the social welfare of the economy through a costless tax/subsidy scheme reallocating resources towards the relatively more promising industries. We then prove that, in certain economies, even a mere profit taxation policy increases economic growth and social welfare above the laissez-faire.

This article presents a group of exercises of level and growth decomposition of output per worker using cross-country data from 1970 to 2000. It is shown that in the early seventies factors of production (capital and education) were the main source of output dispersion across economies and that productivity variance was considerably smaller than in later years. Only after the mid-eighties did the prominence of productivity start to show up in the data, as the majority of the literature has found. The growth decomposition exercises show that the reversal of relative importance of productivity vis-à-vis factors is explained by the very good (bad) performance of productivity of fast- (slow-) growing economies. Although growth in the period, on average, is mostly due to factor accumulation, its variance is explained by productivity.

We carry out a meta-analysis on the frequency of unit-roots in macroeconomic time series with a dataset covering 249 variables for the G7 countries. We use linear tests and the three popular non-linear tests (TAR, ESTAR and Markov Switching). In general, the evidence in favour of the random walk hypothesis is weaker than in previous studies. This evidence against unit roots is stronger for real and nominal asset prices. Our results show that rejection of the null of a unit root in the macro dataset is substantially higher for non-linear than linear models. Finally, the results from a Monte Carlo experiment show that rejection frequencies are very close to the nominal size of the test when the DGP is a linear unit root process. This leads us to reject the hypothesis that overfitting deterministic components explains the higher rejection frequencies of nonlinear tests.

This paper examines the growth-effects of inflation at alternative stages of financial development. We propose an endogenous growth model where intermediated savings generate capital. Informational problems cause banks to ration credit and hold liquid assets offering (real) returns that vary inversely with inflation. Inflation therefore acts like a tax on capital accumulation. However financial development lessens credit-rationing, which reduces the demand for these liquid assets and softens the incidence of the inflation tax. Sizeable and statistically significant interactions between inflation and measures of financial development in cross-country and panel regressions provide empirical support for our model.

We investigate the relevance of Carroll's sticky information model of inflation expectations for four major European economies (France, Germany, Italy and the United Kingdom). In contrast to the most rational expectation models, households in the sticky information environment update their expectations occasionally rather than instantaneously due to the costs of acquiring and processing information. Using survey data on household and expert inflation expectations we argue that the model adequately captures the dynamics of household inflation expectations. We estimate two alternative parametrizations of the sticky information model which differ in the stationarity assumptions about the underlying series. Our baseline stationary estimation suggests that the average frequency of information updating for European households is roughly once in 18 months. The vector error-correction model implies households update information about once a year.

We examine a model in which the utility function has been engineered so that it is optimal for consumers to aim for a fixed target level of retirement resources. In this case, consumption displays excess sensitivity to current income as well as perfect old age insurance. In an overlapping generations model, this leads naturally to multiple and unstable equilibria. Under static expectations, it also leads to a well-defined dynamics, including possible historical traps, implosions involving ever-diminishing capital stock and ever-increasing interest rates, and the feasibility of optimal one-time interventions.

In the 1980s there was an increase in cross-sectional wage inequality while simultaneously there was a decrease in the time series volatility of aggregate output. This paper argues that increased efficiency of the labor market may help explain both features of the data. Increases in labor market efficiency or equivalently reduced search frictions increase wage inequality by increasing the degree of positive assortive matching. Simultaneously, aggregate volatility of output decreases as labor market efficiency increases since reduced frictions insulate the economy from shocks that affect employment. In a calibrated model the improvement in labor market efficiency explains around 20 percent of the decline in output volatility and roughly 40 percent of the increase in wage inequality after 1985.

This paper investigates the role of equity markets in the determination of money demand. Expected equity returns are found to be significant determinants of money demand in the long run. We also uncover a strong positive drift in the elasticity of money demand with respect to expected equity returns. Moreover, this elasticity has recently become positive. We explain the puzzle of positive interest elasticity by modifying a conventional model of money demand. We show that if equities are also allowed to provide some liquidity, then the model can support both positive and negative elasticities with respect to expected returns.

This paper studies whether the out-of-sample forecasting performance of a dynamic stochastic general equilibrium (DSGE) model improves by taking its nonlinear rather than its linear approximation to the data. We address this question within a New Keynesian monetary economy, considering both environments of simulated and real data. Precisely, we estimate our model based on its linear respectively quadratic approximate solution, generate out-of-sample forecasts for three observables (output, inflation, and the nominal interest rate), and compare the quality of forecasts by several statistical measures of accuracy. We find that the value of nonlinearities in terms of predictive power depends crucially on whether the model is well specified. For simulated data, the nonlinear model indeed forecasts noticeably better as compared to its linearized counterpart, whereas for real data, we find no substantial differences in predictive abilities.

This paper focuses on the reallocation of labour resources in a New Keynesian environment with labour market search and endogenous separations. We show that the introduction of variation in hours per worker alters the incentives for intertemporal substitution in a way that generates a more steeply downward sloping Beveridge curve and reduces the tendency to synchronize gross job flows. We find that the impact of labour supply elasticity on the slope of the Beveridge curve and the correlation of gross job flows is determined primarily by variation in the response to monetary shocks. When hours variation is suppressed, the correlation of job creation with job destruction and that of unemployment with vacancies are strongly positive in response to monetary shocks. With variation in hours both measures of reallocation take on the correct negative sign.

I study repayment behavior for college graduates who borrow under the U.S. Federal Student Loan Program to finance higher education. I develop a dynamic model with uninsurable shocks to earnings and student loan rates that explains the repayment pattern in U.S. data: college graduates with lower debt will lock-in interest rates, while those with higher debt will switch to an income-contingent plan. Default does not occur among the most financially constrained group of college graduates. I use the model to quantify the effects of a reform introduced in 2006 that eliminates the possibility to lock-in interest rates for student loans. The reform induces a significant increase in default rates, which is largely accounted for by low-income borrowers.

This paper develops a human-capital-based endogenous growth scenario in which an economy initially produces the agricultural good, characterized by diminishing returns to scale, then produces `traditional manufacturing' under constant-returns and finally produces `modern manufacturing' under increasing-returns. Transition dates are endogenous and depend on the non-essentiality of the industrial goods in preferences and fixed costs in the technology of the modern manufacturing. Each transition is followed by a jump in the long-run growth rate of real income. The theoretical model is calibrated to U.S. historical data. It `predicts' the first transition to occur around 1820s and the second transition to happen around 1900.

This paper studies the Japanese depression in the interwar period using the business cycle accounting methodology and a general equilibrium model with time-varying markups. I find that the initial slowdown of the economy can be explained by a decline in productivity. However, I also find that when only productivity change is taken into account, a prototype neoclassical growth model predicts that in the 1930s, output recovers more rapidly than is actually supported by the data. Using restrictions from theory, I quantify the contribution of an increase in markups in the manufacturing and mining sectors and find that a substantial fraction of the weak recovery can be explained by this factor. I argue that this increase in markups is caused by government-promoted cartelization.

This paper explores the determinants of workers’ remittances using a novel dataset of bilateral remittance flows. The paper finds that some of the variables commonly used in gravity equations are very powerful in explaining remittance flows. The evidence on the motives to remit is mixed, but altruism may be less of factor than commonly believed. Most strikingly, remittances do not seem to increase in the wake of a natural disaster and appear aligned with the business cycle in the home country, suggesting that remittances may not play a major role in limiting vulnerability to shocks. To encourage remittances and maximize their economic impact, policies should be directed at reducing transaction costs, promoting financial sector development, and improving the business climate.

As long as workers do not value their leisure much, the Mortensen-Pissarides search and matching model implies that unemployment and job vacancies would be much less responsive to changes in labor productivity than what we observe in the business cycles of the Canadian labor market. These findings parallel the work of Shimer (2005) for the United States. The combined data from both countries present an additional difficulty for the model. Even if the unobserved value of leisure is allowed to be as high as required to fit the business cycle in the United States or in Canada, as proposed by Hagedorn and Manovskii (2007), another failure arises. The model lacks ability to reconcile the similar labor cycles with the large policy differences in the UI benefits and income taxes in the two countries when the value of leisure is assumed to be the same in both countries.

In this paper we estimate a model where inflation, a measure of de facto central bank independence and an index of de facto exchange rate regime are simultaneously determined by a set of economic, political and institutional variables. De facto central bank independence is hampered by socio-political turbulence and benefits from the balance of powers between the executive and the parliament. Inflation is explained by de facto central bank independence, by the level and volatility of public expenditure and by the de facto exchange rate regime. Openness (real and financial) affects inflation through the exchange rate regime channel. Success in controlling inflation, in turn is crucial to sustain central bank independence and exchange rate stability.

This paper shows that an analytical analysis of the determinacy properties of the New Keynesian model with both staggered wages and prices is possible, despite the high dimensional nature (4D) of this model, if it is appropriately reformulated in continuous time. Our analysis supports Galí's (2008) numerical findings on the determinacy frontier and its reformulated Taylor principle, where a generalized Taylor rule that employs a weighted combination of wage and price inflation as a measure of the inflation gap is used.

Fast-growing countries tend to experience rapid export growth with little secular change in their terms of trade. This contradicts most international macroeconomic models, which predict that productivity and labor-supply shocks can affect exports only through changes in the terms of trade. This paper generalizes the monopolistic competition trade model of Helpman and Krugman (1985), providing a basis for growth-led exports without declining terms of trade. The key mechanism behind this result is that fast-growing countries are able to develop new varieties of products that can be exported without pushing down the prices of existing products. There is strong support for the new model in the long-run export growth of many countries in the post-war era. These results have major implications for the analysis of supply shocks in international macroeconomic models.

This paper presents a Dynamic New Keynesian model with wealth effects to study the performance of monetary policy under Ricardian and non-Ricardian fiscal regimes. The model is calibrated to euro area quarterly data. The interactions between fiscal policy and interest rate rules have critical implications for equilibrium uniqueness. Within the class of Ricardian fiscal rules, active monetary policies are not necessary for equilibrium determinacy. However, monetary authorities overreacting to inflation not only improve macroeconomic performance, but also generate similar outcomes under different fiscal rules. Conversely, under non-Ricardian fiscal regimes, interest rate pegs are predicted to reduce inflation variability.

We extend Diamond's (1965) OLG model to allow agents to choose whether to participate in the second period of life. The valuation of early exit (x) is a key parameter. We characterize competitive equilibria, efficient allocations, and predictions for income and life expectancy over time. We find that, with logarithmic utility, for any value of x, there is a range of initial values of the capital stock for which some agents would prefer to exit in equilibrium. The shape of the transition function and the number of steady state equilibria depend crucially on the value of capital's share of income.

This paper explores theoretically and empirically the view that Taylor rules are often nonlinear due to asymmetric central bank preferences, and that the nature of these asymmetries changes across different policy regimes. The theoretical model uses a standard new Keynesian framework to establish equivalence relations between the shape of nonlinearities in Taylor rules and asymmetries in monetary policy objectives. These relations are estimated and tested for the United Kingdom (UK) and the United States (US) over various subperiods by means of smooth transition regressions.There is often evidence in favor of nonlinear rules in both countries, and their character changes substantially over subperiods. The period preceding inflation targeting in the UK is characterized by a concave rule supporting dominant recession avoidance preferences, while the inflation targeting period is characterized by a convex rule supporting dominant inflation avoidance preferences on the part of policymakers. Dominant inflation avoidance appears during the Vietnam War in the US while, during the Burns/Miller and the Greenspan periods, recession avoidance dominates. Under Volcker the Taylor rule is linear. This is consistent with an offset by inflation avoidance of the more prevalent recession avoidance of the Fed.Findings from both countries support the view that reaction functions and the asymmetry properties of the underlying loss functions change in line with the regime and the main macroeconomic problem of the day.

William Baumol and his co-authors have analyzed the impact of differential productivity growth on the health of different sectors and on the overall economy. They argued that technologically stagnant sectors experience above average cost and price increases, take a rising share of national output, and slow aggregate productivity growth. Using industry data for the period 1948-2001, the present study investigates Baumol's diseases for the overall economy. It finds that technologically stagnant sectors clearly have rising relative prices and declining relative real outputs. Additionally, technologically progressive sectors tend to have slower hours and employment growth outside of manufacturing. Finally, sectoral shifts have tended to lower overall productivity growth as the share of stagnant sectors has risen over the second half of the twentieth century.

New information technologies and reductions in transportation costs have led pundits to pronounce the "death of distance." These claims would suggest that distance is no longer a barrier to growth for remote areas and small urban centers. Despite extensive research on the localized effects of agglomeration, very few studies have empirically investigated the broader spillover effects of proximity and location in the urban system. This study attempts to fill this void using U.S. county level employment data. A primary innovation is that urban centers, from which distance is measured, are differentiated by their position within six tiers (rural plus 5 urban) of the American urban hierarchy. Net agglomeration economies can thus originate from multiple sources throughout the entire 360° span. Our findings indicate that proximity to higher-tiered urban centers continues to be an important positive determinant of local job growth, all the way from the smallest to largest urban centers.

We investigate the optimality of monetary policy targeting rules in a macroeconomic model based on explicit micro-foundations for intrinsic persistence in inflation and real output. For the corresponding social welfare loss function to be minimized by the central bank, inertia arises endogenously in both the inflation and output gap stabilization objectives. In this framework, inflation targeting closely approximates the optimal precommitment policy for empirically relevant parameter values. Alternative policy rules, such as nominal income growth targeting, "speed-limit" targeting, or price level targeting, do not perform as well. Previous research has demonstrated lower social welfare losses with these alternative targeting rules; such findings are shown to be primarily a consequence of assuming the central bank minimizes a simple social loss function that is not consistent with the micro-foundations of a model with intrinsic persistence.

This paper examines the impact of unemployment insurance on the propagation of monetary disturbances in a staggered price model of the business cycle. To motivate a role for risk sharing behavior, I construct a quantitative equilibrium model that gives prominence to an efficiency-wage theory of unemployment based on an imperfectly observable labor effort. Dynamic simulations reveal that under a full insurance arrangement, staggered price-setting is incapable of generating persistent real effects of a monetary shock. Introducing partial insurance, however, bolsters the amount of endogenous wage rigidity present in the model, enriching the propagation mechanism. Positive real persistence appears in versions of the model that exclude capital accumulation as well as in versions that do not.

I build a model with a microfoundation to understand how productivity changes in the manufacturing and the agricultural sectors impact the relative size of a city and the surrounding rural area, both in terms of physical area and population. I also examine rural-urban differentials in land rentals. I find that the "Green Revolution" is more important than the Industrial Revolution in terms of the impact on the urbanization process. Government policies on the optimal sizes of cities are discussed.

This paper investigates the empirical validity of different classes of 'development trap' models of economic growth. Quah (1993) finds that the cross country distribution of per capita income is moving toward a twin peaked distribution. This finding has supported and encouraged a large theoretical literature on development traps that produce twin peaks through physical and human capital accumulation. Contrary to these models, physical and human capital are found to be moving toward single peaked distributions. The productivity residual is moving toward a twin peaked distribution that mirrors that of per capita income. Quah's result appears to be driven by productivity differences rather than factor accumulation. The importance of productivity is consistent with cross sectional results by Klenow & Rodriguez-Clare (1997) and Hall & Jones (1999). Kremer, Onatski & Stock (2001) and Jones (1997) have questioned the robustness of the lower peak in output. This paper shows that the productivity residual has a more prominent and more robust lower peak than output. A further examination suggests that dynamic interaction between human capital accumulation and productivity may act in the long run to eliminate the low peak in productivity.

In this paper, we use information from U.S. states to determine the social return to schooling. We estimate a macro-Mincerian model where aggregate earnings (or income) depend upon physical capital, labor, average years of schooling and average labor force experience. We find that the social return to U.S. schooling is 9 to 16 percent, which matches estimates of the private return found in the labor literature. Our results therefore provide evidence that U.S. schooling is indeed productive, but generates no positive externalities.

The Great Moderation refers to the fall in US output growth volatility in the mid-1980s. At the same time, the US experienced a moderation in inflation and lower average inflation. Asset pricing theory predicts that moderations -- real or nominal -- influence interest rates. Using annual data since 1890, we find that an earlier 1946 moderation in output and consumption growth was comparable to that of 1984. To assess the impact of these moderations, we also isolate the 1969-1983 Great Inflation using quarterly data since 1947. We examine the quantitative predictions of a consumption-based asset pricing model for shifts in the unconditional average of US interest rates across these time periods. A central finding is that such shifts probably were related to changes in average inflation rather than to moderations in inflation and consumption growth.

Recent microeconomic studies have documented extensive downward nominal wage rigidity (DNWR) for job stayers in many OECD countries, but critics argue that the effect might be undone by compositional changes and flexibility in wages of new entrants. Using data for hourly nominal wages at industry level, we explore the existence of DNWR on industry wages in 19 OECD countries, over the period 1973-1999. We propose a novel method to detect DNWR. We reject the hypothesis of no DNWR in the overall sample. The fraction of wage cuts prevented due to DNWR has fallen over time, from 61 percent in the 1970s to 16 percent in the late 1990s, but the number of industries affected by DNWR has increased. DNWR is more prevalent when unemployment is low and union density is high. Strict employment protection legislation also leads to fewer wage cuts.

We develop a New Keynesian model with staggered price and wage setting where downward nominal wage rigidity (DNWR) arises endogenously through the wage bargaining institutions. It is shown that the optimal (discretionary) monetary policy response to changing economic conditions then becomes asymmetric. Interestingly, in our baseline model we find that the welfare loss is actually slightly smaller in an economy with DNWR. This is due to that DNWR is not an additional constraint on the monetary policy problem. Instead, it is a constraint that changes the choice set and opens up for potential welfare gains due to lower wage variability. Another finding is that the Taylor rule provides a fairly good approximation of optimal policy under DNWR. In contrast, this result does not hold in the unconstrained case. In fact, under the Taylor rule, agents would clearly prefer an economy with DNWR before an unconstrained economy ex ante.

We address the poverty trap rationale for aid to Africa. We calibrate models that embody typical explanations for stagnation: coordination failures, ineffective mix of occupational choices and imperfect capital markets, and insufficient human capital accumulation coupled with high fertility. Calibration is ideally suited for this evaluation given the paucity of high-quality data, the high degree of model nonlinearity, and the need for conducting counterfactual policy experiments. We find that calibrations that yield multiple equilibria -- one being prosperity and the other stagnation -- are not particularly robust in capturing the African situation. This tempers optimism about foreign aid typically prescribed based on models of multiplicity. Moreover, conditional on multiplicity, the calibrated models indicate that the cost of policy interventions needed to trigger development in stagnant economies is small. The lack of reforms in Africa, despite the low estimated costs, suggests political hurdles to reform. It is not clear that foreign aid would be able to circumvent these. Taken together, we conclude that the case for foreign aid to Africa is weak.