Carbon pricing aims to shift the risk-adjusted returns on investment in favor of green technologies vis-‘a-vis fossil investment, relying on efficient capital markets to redirect investment accordingly. Capital markets with financial frictions can distort this transmission of climate policy. This study analyses the impact of emission taxes on mitigation and low-carbon investment in the presence of financial frictions. We develop a two-sector environmental dynamic stochastic general equilibrium model calibrated to the Euro Area, to simulate an economic transition in line with the EU climate targets. Financial frictions dampen the response of the economy to the carbon tax such that the emissions target will be missed by 11 percentage points. Moreover, the adverse effects of financial frictions increase when climate policy is delayed. We further identify a volume and a risk effect that drive the impact of a financial wealth shock and an uncertainty shock on emission intensity.

The transition paths from plan to market have varied markedly across countries. Central and Eastern European and Baltic countries, which opted for fast and deep reforms including transformation of their business environments, rapidly narrowed the productivity gap with advanced economies. In contrast, in countries of the Commonwealth of Independent States, which embarked on reforms later and with less depth, the productivity gap remains large. Whereas the literature has focused mainly on empirical studies, this paper develops a dynamic search model of firm start-ups that reflects these trends. The model shows that an enabling business climate contributes to start-ups of highly productive firms at an earlier stage of transition, underscoring the importance of early reforms. The role of the state sector as an employer during transition rises in countries where reforming the business environment is particularly costly.

This paper studies stylized business-cycle properties of household production in four industrialized countries (Canada, the United States, Germany, and Japan). We employ a dynamic small open-economy business-cycle model that incorporates a household production sector. We use the model to generate data on home output, hours worked in the home sector, and hours spent on leisure. We find that in each country, home output is more volatile than market output, whereas home sector hours are about as volatile as those in the market sector. In each country, leisure is the least volatile series. Leisure hours and home hours are countercyclical in all countries, and home output is not highly correlated with market output. Home sector variables are generally less persistent than market variables and cross-country correlations related to home production tend to be lower than those related to market production. These findings demonstrate that despite some well-known structural differences in labor markets, the cyclical features of home sector variables are similar across the countries we consider.

This paper presents a model of development that is driven by matching between talents and technologies. Differences in productivity across countries are amplified by three dimensions of talent utilization: the range of talents utilized, the density of a specific talent utilized, and the average match quality in the economy. In our model, higher productivity increases the number of technologies available, enhancing the opportunities for individuals to match their talents to specific technologies and increasing the returns to search. More intensive search further contributes to talent utilization.

Exchange rates display excessive volatility and are disconnected from macroeconomic fundamentals. This paper presents a two-country general equilibrium model in which nonfundamental uncertainty (“sunspots”) in part drives stochastic fluctuations in the exchange rate in a class of rational expectation equilibria. In the model, a combination of financial frictions—incomplete asset markets and a proportional transaction cost associated with trading foreign-currency-denominated bonds—breaks the tight link between exchange rates and fundamentals. Moreover, the model generates a negative Backus–Smith correlation between relative consumption and the real exchange rate, because relative prices, acting as a source of shocks as opposed to shock absorbers, directly affect relative output and generate a large wealth effect on relative consumption. Using a random walk as an example of sunspot shocks, the volatility of exchange rates relative to that of output and consumption is found to be large in the presence of nontradable goods and distribution services.

This paper sets up a two-sector growth model with sectoral hysteresis because of intersectoral factor reallocation costs. The main results are: (i) The economy under study exhibits nonergodic growth implying path-dependency (history matters) and permanent consequences of temporary shocks. (ii) Flexible economies are more likely to take advantage of technological improvements. The analysis points to a new mechanism in the flexibility-growth nexus, which complements the findings of Bertola (1994). (iii) Periods of negative growth can be explained as optimal responses of an economy to favorable technology shocks. This result sheds light on the fact that economic development is associated with recurring downturns.

We identify international output and inflation uncertainty and analyze their impact on individual countries' macroeconomic performance. Output and inflation uncertainty on an international level is measured through the conditional variances of common factors in inflation and output growth, estimated from a bivariate dynamic factor model with GARCH errors. The impact of international and country-specific uncertainty is analyzed by including the conditional variances as regressors. We find increases in uncertainty during the first and second oil crisis, the 1980s and 1990s recessions as well as the recent Great Recession to be confined to the international level. The effect of international uncertainty results to be highly significant and unambiguously negative on countries' output growth and inflation rates whereas the impact of country-specific uncertainty is very mixed.

Building on the theoretical prediction that income tax progressivity increases the speed of convergence in neoclassical, open-economy growth models, this paper asks whether tax progressivity is a potential source of differences across regions in convergence rates. In a sample of U.S. data, over the period 1920–1990, regional convergence and tax progressivity are found to be positively correlated, which supports the theoretical results. Moreover, some data on six OECD countries also accord with such a positive relationship. Overall, the model is successful in predicting the large range of available convergence estimates when the tax rate is elastic enough with respect to the tax base.

When the financial positions of pension funds worsen, regulations prescribe that pension funds reduce the gap between their assets (invested contributions) and their liabilities (accumulated pension promises). This paper quantifies the business cycle effects and distributional implications of various types of restoration policies. We extend a canonical New-Keynesian model with a tractable demographic structure and, as a novelty, a flexible pension fund framework. Fund participants accumulate inflation-indexed or non-indexed benefits and funding adequacy is restored by revaluing previously accumulated pension wealth (Defined Contribution (DC)) or changing the pension fund contribution rate on labor income (Defined Benefit (DB)). Economies with DC pension funds respond similarly to adverse capital quality shocks as economies without pension funds. DB pension funds, however, distort labor supply decisions and exacerbate economic fluctuations. While DB pension funds achieve intergenerational risk-sharing, welfare analyses indicate that the negative effects of the induced distortions are sizeable.

The present paper studies the interaction between short-run business cycle fluctuations and economic growth at the empirical level. We identify a measure of potential output with that rate of growth consistent with a constant unemployment rate, and we estimate the effects of GDP growth rates on the latter in 13 Latin American and 18 OECD countries during the period 1981–2011. The results of both parametric (OLS/IV and a panel estimator that allows for parameter heterogeneity and cross-section dependence) and nonparametric (a penalized regression spline estimator) econometric techniques show that the measure of potential output experiences positive (negative) changes in periods of high (low) growth in the majority of countries. However, in contrast to the sample of OECD countries, we find that less than half of the sample of Latin American countries experience statistically significant changes in this measure of potential output in periods of low growth.

The literature on international business cycles has employed dynamic factor models (DFMs) to disentangle global from group-specific and national factors in countries’ macroeconomic aggregates. Therefore, the countries have simply been classified ex ante as belonging to the same region or the same level of development. This paper estimates a DFM for a sample of 106 countries and three variables (output, consumption, investment) over the period 1960–2014, in which the countries are classified according to the outcome of a cluster analysis. By comparing the results with those obtained by the previous grouping approaches, we show substantial deviations in the importance of global and group-specific factors. Remarkably, when the groups are defined properly, the “global business cycle” accounts for only a very small fraction of macroeconomic fluctuations, most evidently in the industrialized world. The group-specific factors, on the other hand, play a much greater role for national business cycles than previously thought—also in the pre-globalization period.

Recent empirical work on globalization and inflation analyzes multicountry data sets in panel and/or cross-section frameworks and reaches inconclusive results. This paper highlights their shortcomings and reexamines the issue utilizing heterogeneous panel cointegration techniques that allow for cross-section heterogeneity and dependence. It finds that in a sample of developing countries globalization of both trade and finance, on the average, exerts a significant and positive effect on inflation, whereas in a sample of developed countries there is, on the average, no significant impact of openness. Neither type of openness disciplines inflationary policy. Despite this, there are large variations in the effect across countries, due possibly to differences in the quality of political institutions, central bank independence, the exchange-rate regimes, financial development, and/or legal traditions.

This paper examines the effect of the elasticity of technological substitution on the existence of equilibrium indeterminacy in two-sector economies. Following recent empirical evidence, the elasticity of substitution between capital and labor is below unity and we find that this requires a higher degree of productive externalities in order to still be able to produce indeterminate equilibria. However, empirically realistic rates of substitution do not rule out indeterminacy.

We incorporate keeping-up-with-the-Joneses (KUJ) preferences into the Blanchard–Yaari framework and develop a model of balanced growth. In this context we investigate status preference, demographic shocks, and pension policy. We find that a higher degree of KUJ lowers economic growth, whereas, in contrast, a decrease in the fertility and mortality rates increase it. In the second part of the paper we extend the model by incorporating a pay-as-you-go (PAYG) pension system with a statutory retirement date. The latter implies that the growth rate is higher under PAYG. We also consider the implications of pension reform under both defined benefit and defined contribution schemes.

Challenges raised by aging (increasing longevity) have prompted policy debates featuring policy proposals justified by reference to some notion of intergenerational equity. However, very different policies ranging from presavings to indexation of retirement ages have been justified in this way. We develop an overlapping-generations model in continuous time that encompasses different generations with different mortality rates and thus longevity. Allowing for trend increases in both longevity and productivity, we address the normative issue of intergenerational equity under a utilitarian criterion when future generations are better off in terms of both material and nonmaterial well-being. Increases in productivity and longevity are shown to have very different implications for intergenerational distribution. Further, the socially optimal retirement age, dependency ratio, and intergenerational burden sharing in the case of a trend increase in longevity are shown to depend on how individuals' utility for time/leisure is affected by age and longevity.

We propose a simple incomplete-markets small-open-economy model that is amenable to analytical dissection of its policy-relevant mechanisms. In contrast to its complete-markets limit, the equilibrium real exchange rate is irreducible from the incomplete-markets equilibrium. Market incompleteness exacerbates the domestic-inflation and output-gap monetary-policy trade-off in two ways: its steepness and its resulting endogenous cost-push to the trade-off. The latter depends on an equilibrium combination of structural shocks and on agents' beliefs of future events. Thus, in comparison to its complete-markets and closed-economy limits, standard Taylor-type rules are less capable of inducing determinate rational expectations equilibrium in our environment. Despite the larger policy trade-off under incomplete markets, simple policies that also respond to exchange-rate growth are able to manage expectations that drive the endogenous cost-push term. However, policies that respond directly to expectations may turn out to exacerbate the cost-push trade-off further, and thus, to be more likely to fuel self-fulfilling multiple or unstable equilibria.

Skill-biased technical change occupied empirical economists for much of the 1990s. The empirical literature firmly established a positive correlation between technology indicators and demand shifts. In the minds of many, that has established a causal relationship. This leap of faith, however, is at odds with Hicks's conventional wisdom that endogenous technological change will be biased toward using cheap and abundant resources. In addition, if the rate of technical change is considered to be endogenous, the assumption of an exogenous bias toward skilled labor should at least be questioned. Two hypotheses explaining endogenous skill bias in technical change have been suggested in the theoretical literature: the acceleration effect and the market size effect. In this paper these are studied in a single endogenous-growth model to derive the sufficient and necessary conditions for both hypotheses. After confronting these conditions with the evidence, the paper concludes that it strongly favors the acceleration hypothesis.

In a seminal paper, Robert E. Lucas, Jr. provided the theoretical relationship between aggregate demand and real output based on relative price confusion at the individual market level. Subsequently, an alternative New Keynesian aggregate supply relationship was derived and it was demonstrated that the two theories can be distinguished on the basis of how both the rate of inflation and the volatility of relative prices affect its slope. By emphasizing the first implication of New Keynesian theory, strong evidence was obtained supporting this model using international data. We also concentrate on the second difference between the two theories. We derive the individual market-level equilibrium relationship for the Lucas model, i.e., the disaggregate supply curve. We estimate the crucial parameters of the relationship between aggregate nominal demand shocks and real output using U.S. intranational state and industry data. We find that the Lucas model omits important New Keynesian features of the data.

We test the long-run neutrality of money proposition for the United States paying attention to the integration and cointegration properties of the variables. We use quarterly data (over the period from 1967:1 to 2014:1) and the new Center for Financial Stability Divisia monetary aggregates. We make a comparison among the narrower monetary aggregates, M1, M2M, MZM, M2, and ALL, and the broad monetary aggregates, M4+, M4-, and M3, and show that there is no statistically significant evidence against long-run monetary neutrality, consistent with both monetarist and Keynesian macroeconomic theory.

We propose a stock market model with chartists, fundamentalists and market makers. Chartists chase stock price trends, fundamentalists bet on mean reversion, and market makers adjust stock prices to reflect current excess demand. Fundamentalists’ perception of the stock market’s fundamental value is subject to animal spirits. As long as the stock market is relatively stable, fundamentalists neutrally believe in a normal fundamental value. However, fundamentalists optimistically (pessimistically) believe in a high (low) fundamental value when the stock market rises (falls) sharply. Our framework may produce boom-bust stock market dynamics that coevolve with waves of optimism and pessimism for parameter settings that would ensure globally stable stock market dynamics in the absence of animal spirits. Responsible for such a surprising outcome is the destabilizing nature of temporarily attracting virtual fixed points, brought about by animal spirits.