Macroeconomic performance in the Economic and Monetary union (EMU) will be impaired if national fiscal policy flexibility and monetary flexibility of the ECB is limited, goods markets adjust sluggishly, labor mobility is low, and automatic stabilization from federal taxes and government spending is low. This paper analyzes the stabilization of output fluctuations induced by symmetric and asymmetric macroeconomic shocks in the EMU. It is shown how national fiscal flexibility and flexibility of the monetary policy of the ECB can stabilize fluctuations of the average EU business cycle that are generated by symmetric shocks. Furthermore, it is demonstrated how, under EMU, national fiscal flexibility and a system of fiscal transfers are able to stabilize differences in national business cycles that are generated by asymmetric shocks.

Equilibrium indeterminacy due to economies of scale (ES) in financial intermediation is quantitatively examined in a monetary business-cycle environment. Financial intermediation provides deposits that serve as a substitute for currency to purchase consumption, and depositing decisions are susceptible to nonfundamental shocks to confidence. The analysis considers various assumptions on nominal rigidities and the timing of deposit decisions. The results suggest that indeterminacy arises for small ES, and the resulting confidence shocks qualitatively mimic monetary shocks. A calibration exercise concludes that U.S. economic volatility from this nonfundamental source has increased over time while volatility from fundamental sources has decreased.

A static economy in which nominal taxes and transfers are balanced, as proposed by Balasko and Shell (1993), typically has a continuum of equilibrium money prices. This paper presents a constructive example in which the set of equilibrium money prices is not connected. By allowing negative consumption as a mathematical construct, closed form solutions for equilibrium tax-adjusted income are derived. The main result of the example implies that bankrupt taxpayers with negative tax-adjusted income can be free from bankruptcy as the price of money increases. This paradoxical outcome is similar to that of the transfer paradox, as suggested by Gale (1974), where tax-transfer plans make taxpayers better off.

This study documents the cyclical properties of business credit in the United States and in the Euro area and constructs a theoretical model that can successfully replicate the observed characteristics. I find that real business loans lag output; i.e., business credit is more strongly correlated with past output than with current output. Furthermore, real business loans correlate negatively with future output and investment and positively with past output and investment. I show that a fairly standard model of business and credit fluctuations with agency costs can neither generate the lagging behavior of business credit nor induce the observed cross-correlation patterns of output, investment, and business loans. I introduce a costly financial intermediation mechanism into an otherwise standard macroeconomic framework and show that the evolution of intermediary balance sheets and the interaction of intermediation and agency costs can induce the observed regularities.

This paper is about the effectiveness of qualitative easing, a form of unconventional monetary policy that changes the risk composition of the central bank balance sheet. We construct a general equilibrium model where agents have rational expectations, and there is a complete set of financial securities, but where some agents are unable to participate in financial markets. We show that a change in the risk composition of the central bank’s balance sheet affects equilibrium asset prices and economic activity. We prove that, in our model, a policy in which the central bank stabilizes non-fundamental fluctuations in the stock market is self-financing and leads to a Pareto efficient outcome.

This paper examines correlation and dependence structures between money and the level of economic activity in the USA in the context of a Markov-switching copula vector error correction model. We use the error correction model to focus on the short-run dynamics between money and output while accounting for their long-run equilibrium relationship. We use the Markov regime-switching model to account for instabilities in the relationship between money and output, and also consider different copula models with different dependence structures to investigate (upper and lower) tail dependence.

This interview was completed in May 2004, well before Stan Fischer had any idea he would become Governor of the Bank of Israel, a position he took up in May 2005. The interview took place in April 2004 in my office at the Russell Sage Foundation in New York City, where I was spending a sabbatical year. We completed it while running together in Central Park during the following weeks.

Our meeting at Russell Sage was just like the many meetings we have had over the years. I was not sitting with a Master of the Universe, a world VIP, but with the same Stan Fischer I had first met in 1973 when he was a young associate professor, freshly imported from Chicago. There was the same ability to listen carefully, the same ability to talk and to explain simply and straightforwardly. In addition, there was the accumulated wisdom of a professional life spent developing and applying macroeconomics to the very real world.

When I arrived as a PhD student at MIT in 1973, it was clear that Stan would quickly play a central role in the department. Within a few years, he was one of the most popular teachers, and one of the most popular thesis advisers. We flocked to his office, and I suspect that the only time for research he had was during the night. What we admired most were his technical skills (he knew how to use stochastic calculus)—, and his ability to take on big questions and to simplify them to the point where the answer, ex post, looked obvious. When Rudi Dornbusch joined him in 1975, macro and international quickly became the most exciting fields at MIT. Imitation is the sincerest form of admiration, and this is very much what we all did.

When I came back to MIT in 1982, this time as a faculty member, Stan had acquired near-guru status. Teaching the advanced macro courses with him, and writing “Lectures on Macroeconomics,” which we finished in 1988, was one of the most exciting intellectual adventures of my life. We both felt that there was a new macroeconomics, more micro-founded and full of promises and that we understood its architecture and its usefulness. Although we had not thought of it as a textbook, it quickly became one, and it is nice to know that it still sells surprisingly well today.

As the years had passed, Stan had taken more and more interest in applying theory to the real world, working with Rudi on hyperinflation, being involved in the economics of peace with George Shultz in the Middle East. In 1988, he decided to jump from academia to the real world, and became Chief Economist of the World Bank. After a brief return to MIT, he then returned to Washington in 1994 to become First Deputy Managing Director of the IMF, where he remained until 2001. That part of his life has been well documented in newspapers and magazines: While at the IMF, he was on the front lines during the Mexican crisis, the Russian crisis, the Asian crises, and many others. From the peeks I got of him during those times, what strikes me most is how he remained the same as he had been at MIT: calm, careful about the facts, analytical, using macroeconomic theory even in the middle of the most intense fires. Many thought and hoped that he would become the managing director of the IMF. Antiquated rules and country politics prevented it from happening. The IMF's loss turned out to be the private sector's gain. In 2002, Stan joined Citigroup, where he is the President of Citigroup International. He is still active in macro policy debates and remains one of the wise men of our profession.

The October 1929 crash led to a complete freeze of New York open markets. Studying the Fed monetary policy conduct in a nonlinear framework, using credit spreads between open market rates and the Fed's instrument rates as a proxy for liquidity risk, we present econometric evidence that the Fed was well aware of such risks as early as 1930, reacted to the financial stress and altered its monetary policy in consequence. Our outcomes revisit conventional wisdom about the presumed passivity of the Fed throughout the 30s.

I model an international payments system with a financial center and periphery to reproduce various aspects of the International Gold Standard. This period was characterized by frequent crises associated with scarce stocks of reserves, high short-term interest rates with subsequent gold inflows, and transmission of output contractions across countries. I find that a common international currency and no legal restrictions on exchange help the periphery share reserves with the financial center, improving the world's welfare and mitigating output losses due to reserve crises. Also, the center has incentives for restrictive rediscounting while the periphery has motives for developing central banking.

We employ a novel approach for analyzing the effects of relative consumption and relative wealth preferences on economic growth. In the pertinent literature, these effects are usually assessed by examining the dependence of the growth rate on the two parameters of the utility function that seem to measure the strength of the relative consumption and the relative wealth motives. Applying our fundamental factor approach, we identify specifications in which the traditional approach yields incorrect qualitative conclusions. The problematic specifications have the common unpleasant property that the parameter that seems to determine the strength of the relative consumption motive actually also affects the elasticity of intertemporal substitution of absolute consumption (and the strength of the relative wealth motive). Since the standard approach is unaware of the additional effect(s), it attributes the total change in the growth rate incorrectly to the change in the strength of the relative consumption motive.

This paper analyzes the dynamical properties of monetary models with regime switching. We start with the analysis of the evolution of inflation when policy is guided by a simple monetary rule where coefficients switch with the policy regime. We rule out the possibility of a Hopf bifurcation and demonstrate the possibility of a period-doubling bifurcation. As a result, a small change in the parameters (e.g., a more active policy response) can lead to a drastic change in the path of inflation. We show that the New Keynesian model with a current-looking Taylor rule is not prone to bifurcations. A New Keynesian model with a hybrid rule, however, exhibits the same pattern of period-doubling bifurcations as the analysis with a simple monetary rule.

We estimate the elasticity of substitution between high-skill and low-skill workers using panel data from 32 countries during 1970–2015. Most existing estimates, which are based only on US microdata, find a value close to 1.6. We bring international data together with a theory-informed macro-approach to provide new evidence on this important macroeconomic parameter. Using the macro-approach, we find that the elasticity of substitution between tertiary-educated workers and those with lower education levels falls between 1.7 and 2.6, which is higher than previous estimates but within a plausible range. In some specifications, estimated elasticity is above the value required for strong skill-bias of technology, suggesting strong skill-bias is possible.

This paper provides an explanation for the supervisory role of the central bank in a monetary general equilibrium model of bank liquidity provision. Under incomplete information on the individual banks' liquidity needs, individual banks find it optimal to invest solely in bank loans holding no cash reserves, and rely on the interbank market for their withdrawal demands. Using the costly state verification approach under uncertainty in aggregate liquidity demands, the supervisory role of the central bank as a large intermediary arises as an incentive-compatible arrangement by which banks hold the correct level of cash reserves. First, it takes up a delegated monitoring role for the banking system. Second, it engages in discount-window lending at a penalty rate, where the discount margin covers exactly the monitoring cost incurred. Finally, under the central banking mechanism, currency premium no longer exists in the sense that currency is worth the same as deposits having an equal face value.

This paper examines how wealth and income inequality dynamics are related to fluctuations in the functional income distribution over the business cycle. In a panel estimation for OECD countries between 1970 and 2016, although inequality is, on average countercyclical and significantly associated with the capital share, one-third of the countries display a pro- or noncyclical relationship. To analyze the observed pattern, we incorporate distributive shocks into an RBC model, where agents are ex ante heterogeneous with respect to wealth and ability. We find that whether wealth and income inequality behave countercyclically or not depends on the elasticity of intertemporal substitution and the persistence of shocks. We match the model to quarterly US data using Bayesian techniques. The parameter estimates point toward a non-monotonic relationship between productivity and inequality fluctuations. On impact, inequality increases in response to TFP shocks but subsequently declines. Furthermore, TFP shocks explain 17% of inequality fluctuations.

How much should society invest in medical care that extends the lives of the older generations? We derive a golden rule for the level of health care expenditures and find that the optimal level of life-extending health care expenditures should increase with rising productivity, increase with the retirement age, and also increase with the population growth rate if a higher growth rate lowers the ratio of retirees to working-age people sufficiently, while the effects of an improvement in medical technology are ambiguous. Moreover, we find that a market economy may be inefficient in terms of the provision of life-extending health care because an individual ignores the effect of his own longevity on the income of others.

The fiscal theory of the price level says that the price level can be made determinate if the government uses fiscal policies such that government liabilities explode unless the price in the first period is at the “right” level. The policy implications are disturbing, as they call for rather adventurous fiscal policies. We show that these disturbing policy implications are specific to the “Ricardian” models that have been used to develop the theory. By moving to non-Ricardian models, we see that price determinacy is consistent with reasonable fiscal policies.

One usually identifies bubble solutions to linear rational expectations models by extra components (irrelevant lags) arising in addition to market fundamentals. Although there are still many solutions relying on a minimal set of state variables, i.e., relating in equilibrium the current state of the economic system to as many lags as initial conditions, there is a conventional wisdom that the bubble-free (fundamentals) solution should be unique. This paper examines the existence of endogenous stochastic sunspot fluctuations close to solutions relying on a minimal set of state variables, which provides a natural test for identifying bubble and bubble-free solutions. It turns out that only one solution is locally immune to sunspots, independently of the stability properties of the perfect-foresight dynamics. In the standard saddle-point configuration for these dynamics, this solution corresponds to the so-called saddle stable path.

This paper analyzes whether the Fed had the ability through its conventional monetary policy to affect key economic and financial variables, and, in particular, the term structure of interest rates, during the recent financial crisis. This departs from the empirical literature that focuses mainly on the effectiveness of unconventional monetary policies during this episode, although these policies are appropriate only to the extent that the conventional policy was ineffective in the first place. Our identification strategy based on the conditional heteroskedasticity of the structural innovations allows us to specify a flexible structural vector auto-regressive process that relaxes the identifying assumptions commonly used in earlier studies. Comparing our results obtained from samples excluding and including the financial crisis, we find that the conventional monetary policy has lost its effectiveness shortly after the beginning of the financial turmoil. This result suggests that the Fed's use of unconventional policies was appropriate, at least, with the objective of changing the term structure of interest rates.

An estimated Markov-switching DSGE modeling framework that allows for parameter shifts across regimes is employed to test the hypothesis of regime-dependent credibility of Hong Kong's linked exchange rate system. The baseline model distinguishes two regimes with respect to the time-series properties of the risk premium. Regime-dependent impulse responses to macroeconomic shocks reveal substantial differences in spreads. To test the sensitivity of the results, a number of robustness checks are performed. The findings contribute to efforts at modeling exchange rate regime credibility as a nonlinear process with two distinct regimes.

We analyze the implications of trend growth for optimal monetary policy in the presence of search and matching unemployment. We show that trend growth interacts importantly with the inefficiencies stemming from the labor market. Higher trend growth exacerbates the inefficiencies of the labor market and therefore calls for larger deviations from price stability. Our analysis implies that lower trend growth reduces not only the level but also the optimal volatility of the nominal interest rate.