The credibility criterion commonly used in the strategic macroeconomic policy literature, subgame perfection or its variants, ignores a critical problem concerning intertemporal consistency of policy announcements. To capture this additional credibility constraint, this note applies two distinct notions of Renegotiation-Proof, originally proposed in the context of two-person repeated games. Macroeconomic policy games, where the benevolent government interacts with atomistic private agents, offers a new testing ground for these criteria to be evaluated. This note discusses the relative strengths and weaknesses of these criteria.

This paper investigates the quantitative importance of different savings motives on the distributions of wealth and consumption and aggregate capital accumulation by solving an overlapping generations model with intragenerational heterogeneity. Agents differ in age, ability, earnings shocks, and inherited bequests. In the baseline economy, there are uninsurable idiosyncratic risks associated with uncertain lifetime and earnings shocks. The model is calibrated to the U.S. economy and solved numerically. Then the allocations of the baseline economy are compared with those of an economy with complete annuity markets, one without earnings uncertainty, and one without altruism.

Benhabib and Farmer show that in a laissez-faire one-sector real business cycle model under aggregate increasing returns, under sufficiently high degrees of productive externality, the demand-side effect in the labor market triggered by agents' expectations about the economy's future outweighs the supply-side effect, making agents' expectations become self-fulfilling. This paper analytically demonstrates that the conduct of monetary policy under nominal gross domestic product (GDP) targeting reinforces the supply-side effect in the labor market, thereby making belief-driven aggregate fluctuations more difficult to occur. This reinforcement effect on labor supply is absent under nominal consumption targeting and inflation targeting. Hence, under these two monetary regimes, the necessary and sufficient conditions for the economy to display equilibrium indeterminacy and sunspot fluctuations are identical to those in Benhabib and Farmer's laissez-faire economy. The results are robust to an endogenous growth extension of the model, implying that targeting the nominal GDP growth rate is more desirable than targeting the nominal consumption growth rate or the inflation rate in terms of macroeconomic stability.

This paper uses a Bayesian approach to estimate a standard international real business cycle model augmented with preferences with zero wealth effect, variable capacity utilization, and investment adjustment costs. First, I find that the bulk of fluctuations in country-specific outputs, consumption, investments, and international relative prices can be attributed to country-specific neutral technology, investment-specific technology, and preference shocks. Second, my estimated model with economically meaningful shocks simultaneously accounts for the negative correlation between the real exchange rate and relative consumption and the negative correlation between the terms of trade and relative output. Last, through a marginal likelihood comparison exercise, I find that the success of the model depends on preferences with zero wealth effects; other frictions and alternative asset market structures play a less important role.

This paper analyzes exchange-rate dynamics following a money-based disinflation under different degrees of exchange-rate pass-through. Using a microfounded dynamic general equilibrium model with imperfect competition and nominal rigidities, it is shown that a monetary slowdown causes an appreciation of the exchange rate and a short-run fall in employment. Varying the degree of pass-through, however, significantly alters the magnitudes of these effects. As the degree of pass-through is reduced, the extent of the short-run appreciation of the exchange rate increases and the short-run impact of the disinflation on employment falls.

This paper reconsiders optimal inflation targeting in a model where persistence is generated by rational choices of the price makers because of a time-dependent pricing mechanism. In this framework, which generalizes the traditional Calvo model, inflation persistence is intrinsic, as it is micro-founded assuming that firms' pricing decisions depend on the time elapsed from the last price reset. We use a linear–quadratic approach to study the welfare effects and optimal policies. We disentangled two distortion sources showing how welfare falls in both the average of the probability of changing prices and its distribution among different firms. Described the underlying distortions of our setup, we analyze its normative implications for optimal inflation. The issues of uncertainty and robustness are also considered: By using robust control techniques, we, in fact, consider the consequences of implementing a “wrong” monetary rule due to a misinterpretation of sources of inflation inertia.

We explore real-time adaptive nonlinear learning dynamics in stochastic macroeconomic systems. Rather than linearizing nonlinear Euler equations where expectations play a role around a steady state, we instead approximate the nonlinear expected values using the method of parameterized expectations. Further, we assume that these approximated expectations are updated in real time as new data become available. We argue that this method of real-time parameterized expectations learning provides a plausible alternative to real-time adaptive learning dynamics under linearized versions of the same nonlinear system, and we provide a comparison of the two approaches.

We derive a seminonparametric utility function containing the constant relative risk aversion (CRRA) function as a special case, and we estimate the associated Euler equations with U.S. consumption data. There is strong evidence that the CRRA function is misspecified. The correctly specified function includes lagged effects of durable goods and perhaps nondurable goods, is bounded as required by Arrow's Utility Boundedness Theorem, and has a positive rate of time preference. Constraining sample periods and separability structure to be consistent with the generalized axiom of revealed preference affects estimation results substantially. Using Divisia aggregates instead of the NIPA aggregates also affects results.

We characterize the necessary and sufficient conditions for optimality in discrete-time, infinite-horizon optimization problems with a state space of finite or infinite dimension. It is well known that the challenging task in this problem is to prove the necessity of the transversality condition. To do this, we follow a duality approach in an abstract linear space. Our proof resembles that of Kamihigashi (2003), but does not explicitly use results from real analysis. As an application, we formalize Sims's argument that the no-Ponzi constraint on the government budget follows from the necessity of the tranversality condition for optimal consumption.

In this paper, we investigate real-time behavior of constant-gain stochastic gradient (SG) learning, using the Phelps model of monetary policy as a testing ground. We find that whereas the self-confirming equilibrium is stable under the mean dynamics in a very large region, real-time learning diverges for all but the very smallest gain values. We employ a stochastic Lyapunov function approach to demonstrate that the SG mean dynamics is easily destabilized by the noise associated with real-time learning, because its Jacobian contains stable but very small eigenvalues. We also express caution on usage of perpetual learning algorithms with such small eigenvalues, as the real-time dynamics might diverge from the equilibrium that is stable under the mean dynamics.

Recently, Penn World Tables include new data that enable calculation of total factor productivity in addition to output for a large set of countries. We use these new data to examine convergence and divergence across countries by applying a new approach, which differentiates between the dynamics of output and of productivity. Our empirical results lead to two main new contributions to the literature. The first is on the interpretation of “β-convergence” in “growth regressions.” It means that output per worker in each country converges to productivity but does not imply convergence across countries, since productivity tends to diverge from the global frontier. The second contribution is to the literature, which finds that income gaps across countries are due mainly to differential technology adoption. This paper shows that the gaps in technology are not only large but keep growing over time.

A recent theoretical literature highlights the role of endogenous firm entry as an internal amplification mechanism of business cycle fluctuations. The amplification mechanism works through the competition effect (CE) and the variety effect (VE). This paper tests the significance of this amplification mechanism, quantifies its importance, and disentangles the CE and VE. To this end, we estimate a medium-scale real business cycle model with firm entry for the U.S. economy. The CE and VE are estimated to be statistically significant. Together, they amplify the volatility of output by 8.5% relative to a model in which both effects are switched off. The CE accounts for most amplification, whereas the VE only plays a minor role.

We pursue a semiparametric approach to examining core implications of the Fisher hypothesis, namely cointegration linking nominal interest rates and inflation, and homogeneity of the potential equilibrium relation. The sample is an unbalanced panel and comprises monthly time series from more than 100 economies. The time period of at most 45 years is subdivided into three regimes according to dominating monetary policies. To exploit the cross-sectional dimension for inference on parameter homogeneity, we apply mean group estimation of functional coefficients that allow the conditioning of key model parameters on economic states. The evidence in favor of cointegration is weakened over states of negative real interest rates that are likely to coincide with scenarios of high inflation. The ex post real interest rate is mostly diagnosed as unstable. The Fisher hypothesis is particularly confirmed for states characterized by large positive interest rate adjustments during the inflation-targeting regime.

We investigate the economic importance of modeling nonlinearities in the dynamics of exogenous processes on the implied moments of endogenous variables in the context of the consumption-based asset pricing model. For this purpose, we model the endowment process alternatively as a linear autoregression and as a nonlinear threshold autoregression. The asset pricing model with nonlinear endowment is solved using quadrature techniques. A comparison of the moments of the model-implied rates of return in the two cases suggests that the economic impact of modeling nonlinearities is small.

Stock–flow job matching implies that there are two types of job seekers—those on the short side of their occupations who can easily find work, and those on the long side who expect extended unemployment spells. Using matching data and information on completed and uncompleted unemployment spells for England and Wales, this paper uses the stock–flow matching hypothesis to identify the fraction (incidence) of laid off workers who find themselves on the long side of the market and, conditional on being on the long side, their expected unemployment duration. The average incidence is around one-half and increases significantly in recessions. The expected duration is also strongly countercyclical—peaking at 15 months in the 1990–1992 recession and falling to a more modest 9 months by January 1999. Cross-section estimates also identify a North–South divide and a large city effect—the unemployed in large cities and in the North experience longer spells.

We examine optimal policy in an open-economy model with uncertainty and learning, where monetary policy actions affect the economy through the real exchange rate channel. Our results show that the degree of caution or activism in optimal policy depends on whether central banks are in coordinated or uncoordinated equilibrium. If central banks coordinate their policy actions then activism is optimal. In contrast, if there is no coordination, caution prevails. In the latter case caution is optimal because it helps central banks to avoid exposing themselves to manipulative actions by other central banks.

This paper examines the choice between government expenditure on public goods and transfer payments, in the form of a pension, in an overlapping-generations model. Government expenditure is tax-financed on a pay-as-you-go basis. A utilitarian judge chooses expenditures to maximize a social welfare function. The nonlinear solution is found to involve the ratio of a welfare-weighted average income, which depends on the inequality aversion of the judge, to arithmetic mean income. An approximation for this ratio is found that produces explicit solutions for the optimal composition. The result is used to obtain an indication of “implicit” inequality aversion for a range of countries.

This paper analyzes the process of decision-making on consumption in a two-period consumption setting, assuming the return on savings is uncertain in the sense of Knight [Risk, Uncertainty, and Profit. Boston: Houghton Mifflin (1921)]. The results imply that a naïve strategy to save zero is optimal for a continuum of income values. Under the Permanent Income Hypothesis, consumption equals current income only when current income is equal to permanent income. Indeed Campbell and Mankiw [in Olivier Blanchard and Stanley Fischer (eds.), NBER Macroeconomics Annual, pp. 185–214. Cambridge, MA: MIT Press (1989)] assumed that consumers who spend their total income are only following a simple rule of thumb. However, the naïve strategy obtained casts doubt on their interpretation.

We set up a dynamic stochastic model of a stylized economy comprising a final output sector (with traditional and modern firms) and an intermediate goods sector. It is shown that market integration reduces the volatility of the rate of return to capital invested in modern firms. The induced portfolio decisions of households lead to a reallocation of capital from traditional to modern firms. Despite the presence of a reverse precautionary saving channel, the growth rate unambiguously increases because of the reallocation of capital. Empirical estimates for OECD countries support the theoretical results.

In the discrete-time new-Keynesian model with public debt, Ramsey optimal policy eliminates the indeterminacy of simple-rules multiple equilibria between the fiscal theory of the price level versus new-Keynesian versus an unpleasant equilibrium. If public debt volatility is taken into account into the loss function, the interest rate responds to public debt besides inflation and output gap. Else, the Taylor rule is identical to Ramsey optimal policy when there is zero public debt. The optimal fiscal-rule parameter implies the local stability of public-debt dynamics (“passive” fiscal policy).