This paper compares the effects of pro- and countercyclical government spending on income inequality and welfare in a small open economy. We examine the consequences of alternative government spending rules following shocks to productivity, domestic interest rates, terms of trade, and export demand. The simulated results show that welfare and income inequality indices can move in opposite directions for government spending rules, with countercyclical spending improving welfare and procyclical spending improving income equality.

This paper examines the mechanisms that determine the “vanishing effect of finance” on economic growth found in recent studies. Based on both current (171 countries, 1960–2014) and historical (21 OECD countries, 1870–2009) data, the results show that financial development promotes growth in poorer countries by increasing education and investment, and by decreasing fertility. The relevance of these transmission channels declines when countries become richer. The growth effect of the financial sector in high-income countries primarily depends on new ideas and potentials for innovation projects. Consequently, the major decline in factor productivity growth since the early 2000s has contributed to the reduction in the financial sector’s average effect on growth.

This note analytically examines the interrelations between macroeconomic (in)stability and investment adjustment costs in a one-sector endogenously growing small–open economy representative-agent model. We show that under costly capital accumulation, the economy exhibits indeterminacy and sunspots if and only if the equilibrium wage–hours locus slopes upward and is steeper than the household's labor supply curve. By contrast, the economy without adjustment costs for capital investment always displays saddlepath stability and equilibrium uniqueness, regardless of the degree of increasing returns inaggregate production.

This paper studies the dynamic propagation of a liquidity shock through two real propagation channels: dynamic complementarities and time-varying capital utilization. The findings for an economy with intertemporal externalities are: (1) An otherwise transient liquidity shock will have real effects on output for several years; (2) time-varying capital utilization strongly augments this propagation; (3) the real effects of monetary shocks last longer when external productivity depreciates faster; and (4) nominal prices respond more sluggishly to a change in the money supply when there is a strong real propagation channel.

We study identification in a class of linear rational expectations models. For any given exactly identified model, we provide an algorithm that generates a class of equivalent models that have the same reduced form. We use our algorithm to show that a model proposed by Jess Benhabib and Roger Farmer is observationally equivalent to the standard new-Keynesian model when observed over a single policy regime. However, the two models have different implications for the design of an optimal policy rule.

We argue that a fixed exchange rate can be an optimal choice even if a policy maker could commit to the first-best monetary policy whenever the private sector's beliefs reflect incomplete information about the policy maker's dependability. This model implies that joining a currency area may be optimal for its impact not on the behavior of the policy maker, but on the beliefs of the private sector. Monetary policies are evaluated using a new Keynesian model of a small open economy solved under imperfect policy credibility. We quantify the minimum distance between announced policy and the private sector's beliefs that is necessary for a peg to perform better than an independent monetary policy when the policy maker can commit to the first-best policy.

One usually assumes that the joint probability distribution is known or that agents will use Bayesian updating to estimate the true probabilities after a number of trials when the states of nature are finite in classical decision theory under uncertainty. If there are important states that have very low probabilities of occurrence, then each agent must make a subjective assessment of the probability distribution until a sufficient number of outcomes are observed in order to generate a precise estimate of the probability distribution. If one assumes that all agents know the states and their payoffs, the probability distribution is stationary, and they observe all outcomes that unfold over time, then it will take at least 10 times the mean time between occurrences of the lowest probability event in order to generate enough outcomes that all agents share the same objective knowledge of the distribution. The mean time of recurrence depends on both the probability distribution and the time unit used between recordings of the observations. If at least one state has a low probability of occurrence, then the time to convergence will exceed the period of stationarity of the process.

Jacques Drèze was born in Verviers, Belgium, in 1929 and completed his Ph.D. in Economics in 1958 at Columbia. His contribution to economics is exceptional, opening up new paths of research in various areas including general equilibrium, decision theory, game theory, econometrics (in particular, Bayesian econometrics), followed by contributions to macroeconomics and economic policy. Drèze has been president of the Econometric Society as well as associate editor and co-editor of Econometrica; founding member and first president of the European Economic Association; president of the International Economic Association and honorary member of the American Economic Association and the National Academy of Sciences. He has received 15 honorary doctorates, including one from the University of Chicago. He has engaged in the promotion and development of research and higher education in Europe, being a founding member of the Centre for Operations Research and Econometrics (CORE) and of the European Doctoral Program in Quantitative Economics (EDP). He has also actively participated in the most pressing economic problems in Europe.

The interview mainly aims at inviting Jacques Drèze to explain what have been his major contributions and what avenues he suggests for future research in macroeconomics. The interview has been conducted sequentially. It started in October 2002 at the European University Institute. The long material collected along these highly illuminating talks was polished and condensed in the following pages. They are organized in the following way. The first section refers to Jacques' initial experiences in Belgium followed by his study of economics in the United States. The second section is devoted to the unity underlying an apparent diversity in his research interests. The third section is devoted to his more recent contributions to macroeconomics, which may be stated as “incomplete markets drive multiplicity of equilibria, calling for active economic policies.” The interview concludes with his contribution to the promotion of research and, in particular, research institutions across Europe.

Both Pierre Dehez and Omar Licandro were students of Jacques Drèze. Dehez and Drèze co-authored several papers, some of which are mentioned in the interview.

This paper studies the effects of China’s one-child policy on human capital and income. I build and calibrate a quantitative OLG model with intergenerational transfers. The model generates a quantity–quality trade-off, so a restriction on fertility leads to an increase in human capital, and higher human capital then contributes to higher individual income and welfare. Calibrating the model to match survey data on urban households, I find that the one-child policy increases the human capital of affected agents by about 47% relative to a counterfactual with no fertility restrictions. However, the effect on aggregate income is negative as the size of the labor force falls.

In this paper we empirically examine the sources of the volatility of the foreign exchange risk premia. Using a nonlinear structural Vector Autoregression (VAR) model based on no-arbitrage condition to identify various macroeconomic shocks and the foreign exchange risk premia, we find that more than 80% of the volatilities of the currency risk premia can be accounted for by the standard macroeconomic shocks that drive output and inflation. By explicitly modelling the currency risk premia in the VAR system, we also offer a potential reconciliation for the seemingly contradicting observations from the previous VAR analysis of the exchange rate “overshooting” behavior under exogenous monetary innovations.

We develop a growth model where knowledge is embodied in individuals and diffused across sectors through labor mobility. The existence of labor mobility costs constrains mobility and thus generates labor misallocation. Different levels of labor misallocation imply different levels of exploitation of available knowledge and therefore different total factor productivity across countries. We derive a positive relationship between growth and labor mobility, which is consistent with the empirical evidence, by assuming aggregate constant returns to capital. We also analyze the short- and long-run effects of labor mobility costs in the case of decreasing returns to capital. It turns out that changes in mobility costs have larger economic effects when different types of workers have small rather than large complementarities. Finally, we show that different labor income taxes or labor market tightness imply different rates of labor mobility and therefore can explain differences in Gross Domestic Product across countries.

This note studies the implications of the price reset hazard function for the monetary transmission mechanism of sticky price models. I first document some general analytical results that highlight the central role of the price (accumulative) distribution in linking the hazard function and the impulse response function. I find that nominal rigidity underlying increasing hazard functions is more successful than real rigidity in replicating realistic macro persistence. In addition, numerical simulations show that the interaction between the increasing hazard function and the real rigidity provides a powerful propagation mechanism for monetary shocks.

This note uses a nonlinear structural vector autoregression model to empirically investigate the effectiveness of official foreign exchange (FX) interventions in an economy when interest rates are constrained to the zero level, based on Japanese data in the 1990s. The model allows us to estimate the effects of FX interventions operating through different channels. We find that FX interventions are still capable of influencing the foreign exchange rate in a zero-interest-rate environment, even though their effects are greatly reduced by the zero lower bound on interest rates. Our results suggest that although it might be feasible to use the exchange rate as an alternative monetary policy instrument at zero interest rates as proposed by McCallum (Inflation Targeting and the Liquidity Trap, NBER working paper 8225, 2000), the exchange rate–based Taylor rule may not be very effective in achieving the ultimate policy goals.

A central policy issue in the battle against HIV in sub-Saharan Africa (SSA) is whether and when high-prevalence countries might become autonomous in designing and implementing their own intervention policies against the disease. The aim of this research is twofold. First, it develops a framework for explaining economic development in a general equilibrium growth model with endogenous fertility and endogenous mortality forced by the threat of a persistent, deadly infectious disease, such as HIV/AIDS in SSA. Second, it aims to shed light on the interplay between foreign aid and endogenous domestic public policies in SSA countries severely afflicted by HIV. Consequently, it investigates the demographic and macroeconomic implications of an intervention against HIV/AIDS whose total amount is the sum of an exogenous component representing foreign aid and an endogenous public expenditure. On the assumption that these policies allow the same degree of HIV control, we show the emergence of quite different responses in terms of key demo-economic variables. These effects mainly pass through the fertility response to the evolving epidemic conditions.

This paper explores the introduction of collective risk-reallocation elements into defined-contribution pension contracts. We consider status-contingent, age-contingent, and asset-contingent arrangements to reallocate risk among participants. Eliminating asset market risk for the retired raises their welfare, whereas it lowers the welfare of the workers, despite the fact that they benefit later from the same arrangement. Overall welfare falls. The welfare effects are largest when personal and pension portfolios are optimally chosen. Allowing for intragenerational heterogeneity, the highest-skilled retirees benefit most, whereas the highest-skilled workers lose most. Our main results are qualitatively robust to a number of model variations and extensions.

In this paper, we investigate the ability of a modified real business cycle (RBC) model to reproduce asymmetries observed for macroeconomic variables over the business cycle. To replicate the empirical skewness of major U.S. macroeconomic variables, we introduce a capacity constraint into an otherwise prototypical RBC model. This constraint emerges because of the assumption of kinked marginal costs of utilization, where the kink is located at a utilization rate of 100%. We find that a model with a suitably calibrated cost function reproduces the empirical coefficients of skewness remarkably well.

We document the strong evidence of time variation in the volatility of Euro Area business cycles since 1970. Then we provide the quantitative sources of these changes using a medium-scale DSGE model allowing time variation in structural disturbance variances. We show that (1) the size of different types of shock oscillates, in a synchronized manner, between two regimes over time, with the high-volatility regime prevailing predominantly in the 1970s, sporadically in the 1980s and 1990s, and during the Great Recession; (2) their relative importance remains, however, unchanged across regimes, where neutral technology shocks and marginal efficiency of investment shocks are the dominant sources of business cycle fluctuations; and 3) these investment shocks, which affect the transformation of savings into productive capital, can be interpreted as an indicator of credit conditions.

This paper investigates the intergenerational sharing of shocks on the permanent income of new entry cohorts when prior-to-entry markets are missing. When Lucas trees are traded among generations, procyclical cohort-specific shocks are shared partially via the movement of asset prices; cohorts with lower endowments may benefit more from asset pricing dynamics than cohorts with higher endowments. Given a reasonable set of parameters concerning the Japanese labor market, the evaluated welfare loss ranges from 1% to 3% in terms of the certainty equivalence consumption level. The first-best outcome may be achieved by either a combination of subsidies and taxes or the introduction of prior-to-entry markets.

This paper documents three facts. First, the volatility of consumption growth relative to income growth rose from 1947 to 1960 and then fell dramatically by 50% from the 1960s to the 1990s. Second, the correlation between consumption growth and personal income growth fell by about 50% over the same time period. Finally, the absolute deviation of consumption growth from its mean exhibits one break in U.S. data, and the mean of the absolute deviations has fallen by about 30%. A standard dynamic stochastic general equilibrium model is unable to explain these facts. I examine ability of two hypotheses to account for these facts: a fall in credit constraints and changing beliefs about the permanence of income shocks. I find evidence for both explanations. The beliefs explanation is more consistent with the data.

This note builds on recent work by Serletis and Shahmoradi [Macroeconomic Dynamics 9 (2005), 542–559] and estimates the AIM model at different degrees of approximation, using the same optimization procedures as in Gallant and Golub [Journal of Econometrics. 26 (1984), 295–321]. We estimate the models subject to regularity and provide a comparison between the different versions. We argue that the AIM(3) model estimated subject to global curvature currently provides the best specification for research in semiparametric modeling of consumer demand systems.