We examine whether input–output interactions among industries impact the transmission of monetary policy shocks through the economy. Using vector autoregressive (VAR) methods we find evidence of heterogeneity in the output response to a monetary policy shock in both finished goods industries and intermediate goods industries. While output responses in finished goods industries can be related to heterogeneity in industry characteristics, this relationship is not so obvious for intermediate goods industries. For the intermediate goods industries in our sample, we find new evidence of demand-spillover effects that impact the transmission of monetary policy via input–output linkages.

A variety of international macroeconomic models predict a relationship between the real exchange rate and consumption. The empirical evidence in favor of such a relationship is limited, the so-called Backus and Smith puzzle. In this paper, we extend the analysis to allow for nonlinear dynamics and volatility changes across exchange rate regimes. Our findings suggest that long-run relationships in line with standard international business cycle models do exist for many Organization for Economic Co-operation and Development (OECD) countries. Further, Monte Carlo experiments illustrate that the nonlinear models can generate the Backus and Smith and the exchange rate disconnect puzzles. In this paper, we also contribute to the nonlinear real exchange rate literature by establishing a theoretical relationship between volatility and persistence. In accordance with the theoretical results, our empirical findings suggest that the increase in volatility in the post-Bretton Woods era is associated with relatively fast mean reversion of the real rate toward its equilibrium value.

By developing a class of dynamic stochastic general equilibrium models with nominal rigidities and assuming a two-country currency union with sovereign risk, we show that there is not necessarily a trade-off between the prevention of default risk and stabilizing inflation. Under optimal monetary and fiscal policy, comprising a de facto inflation stabilization policy, the tax rate as an optimal fiscal policy tool plays an important role in stabilizing inflation, although not completely because of the distorted steady state. Changes in the tax rate to minimize welfare costs via stabilizing inflation then improve the fiscal surplus, and because of this and the incompletely stabilized inflation, the default rate does not increase as much.

We highlight a state variable misspecification with one accepted method to implement stochastic volatility (SV) in DSGE models when transforming the nonlinear state-innovation dynamics to its linear representation. Although the technique is more efficient numerically, we show that it is not exact but only serves as an approximation when the magnitude of SV is small. Not accounting for this approximation error may induce substantial spurious volatility in macroeconomic series, which could lead to incorrect inference about the performance of the model. We also show that, by simply lagging and expanding the state vector, one can obtain the correct state-space specification. Finally, we validate our augmented implementation approach against an established alternative through numerical simulation.

In this paper, we study the relationship between changes in the world interest rate and within-country inequality during the 1985–2005 period in which the world interest rate sharply declined. In line with the predictions of the seminal model of Galor and Zeira [Income distribution and macroeconomics. Review of Economic Studies 60, 35–52], the analysis suggests that the decrease in the world interest rate is associated with a decrease in inequality in poor countries and an increase in inequality in rich ones.

This paper shows that money is a relevant macroeconomic indicator for the description of US monetary policy with simple rules. Empirical analysis based on novel real-time data reveals the economically and statistically significant effect of money on the federal funds rate during the Volcker–Greenspan era, highlighting an interest rate rule that better explains historical policy. The findings suggest that the bias against including money in mainstream macroeconomic models may be due to relying on an incorrect measure of money. A gradual deviation from this rule explains loose monetary policy prior to the Great Recession. Including money aggregates in rule-based policy presents a suitable framework to evaluate and guide Federal Reserve policy.

The Divisia monetary index weights each monetary asset by its expenditure share, evaluated at its user cost.See Barnett et al. [1997, equations (5) and (6)]. In a world of perfect certainty, the user costs can be computed directly from asset return data, and so, the index is model-free. In the presence of uncertainty, however, the true user cost of a monetary asset depends on the covariance of the asset's return with the marginal utility of wealth. Intuitively, an asset's value depends both on its expected payoff and on the asset's ability to hedge wealth fluctuations. As a result, the true user cost cannot be computed without an explicit model of preferences. It follows that the exact Divisia monetary index in a stochastic economy is not model-free, but depends on the underlying preference assumptions.

We study whether monetary authorities in the G7 countries were changing their responses to inflation in a similar manner during and following the Great Inflation era. We find that the common to the G7 countries inflation pattern during the Great Inflation period could be associated with a common pattern in the monetary policy response to inflation: we find that until the early 1980s monetary authorities in the G7 countries responded mildly to inflation, systematically fought it throughout the 1980s and lessened again their response during the 2000s. The estimated Taylor rule coefficients on inflation are co-integrated, implying the existence of a long-run relationship in the responses to inflation during and after the Great Inflation period. At the same time, principal component analysis of the residuals of the estimated Taylor rules indicates that the shocks' structure cannot account enough for the monetary policies' co-movements. We interpret these findings as suggestive of common monetary policy patterns.

Since at least the mid-2000s, many advanced economies have experienced low productivity growth. This development is often related to declining productivity gains at the technology frontier, which is largely determined by the US. We challenge this explanation by studying the effects of US technology shocks on productivity levels in advanced economies. We find positive but small spillovers of US technology shocks. For many countries, the elasticity of their productivity with respect to a 1% increase in the US technology level is significantly lower than 1. Thus, the recent US productivity slowdown must have had a limited effect on productivity developments in advanced economies. Nevertheless, after 5 years, the degree of productivity spillovers varies across countries. Therefore, we analyze the role of institutions in shaping these results. Our findings suggest that isolated institutional characteristics are not able to explain the observed various spillover degrees.

We model an economy where present biased preferences affect the bequest leaving decisions. Using Bequest in the Utility (BIU) setup, we show that the optimal inheritance tax rate under present bias can be derived in terms of estimable sufficient statistics. This optimal tax rate decreases with the level of temptation and a subsidy can be optimal at some level of bequests received. We then use the Barro-Becker Dynastic (BBD) setup to derive the expression for the optimal inheritance tax rates. We observe that if the agents internalize the taxes on the amount of bequest that they leave (sensitive generations), present bias and optimal tax rates are negatively related as in BIU, that is, providing an incentive by extending subsidies or lowering taxes is recommended to subside the effects of temptation. However, if agents ignore the taxes to be paid by their descendants on the inheritance left (ignorant generations), optimal tax rates increase with the level of present bias. This is because the present bias reduces the tax base and the rationale of providing incentives does not work anymore. Our calibration exercise supports all these theoretical findings.

Using monthly headline inflation data covering 184 countries for the period between January 1971 and December 2020, this paper investigates the role of standard gravity variables on inflation convergence across country pairs. The convergence analysis by unit root tests is based on ten-year rolling windows to control for potential structural changes over time, whereas the corresponding results are connected to the standard gravity variables in the preceding year to investigate the drivers of inflation convergence and its speed. Regarding the existence of inflation convergence, empirical results show that having a common currency, a free trade agreement, proximity, a common border, or a colonial relationship between countries increases the probability of inflation convergence. Regarding the speed of inflation convergence, the very same gravity variables are shown to reduce the half-life of convergence. In both cases, the effects of having a common currency are shown to dominate those of other gravity variables.

In the presence of frictions, the existing literature shows that currency substitution is detrimental for domestic aggregate stability. This paper singles out the role of currency substitution and shows that diversified currency holdings operate as an automatic stabilizer that mitigates belief-driven cyclical fluctuations in Farmer’s (1997) indeterminate monetary economy. When the foreign inflation rate is lower than the domestic inflation rate, the model’s steady state always displays saddle-path stability. Hence, equilibrium indeterminacy originally present in the domestic country is entirely removed in the presence of diversified currency holdings. When the foreign inflation rate is higher than the domestic inflation rate, then depending on the degrees of currency substitution and relative risk aversion, indeterminacy is either impossible or the requisite level of the foreign inflation rate for indeterminacy is too high to square with data. The stabilizing effect of diversified currency holdings on domestic aggregate stability is robust to whether domestic and foreign currencies display as Edgeworth substitutes or complements, or are additively separable in the household’s preferences.

This study develops a new dynamic general equilibrium model to explore the role of people’s love of novelty as a cultural preference in innovation and innovation-based growth. The model considers (a) an infinitely lived representative consumer who has standard love-of-variety preferences for differentiated products and additional love-of-novelty preferences for new products and (b) technological progress driven by two costly and time-consuming innovation activities, new product development and existing product development. We demonstrate that consumers’ love of novelty is a source of innovation-based growth, wherein economies with a moderate love of novelty can achieve innovation and long-run growth through endogenous cycles between periods in which new product development is active and those in which existing product development is active. However, if love of novelty preference is too weak or too strong, the economy is caught in an underdevelopment trap with less innovation and no long-run growth. We also provide some suggestive empirical evidence that supports our theoretical predictions.

Short-selling constraints are common in financial markets, while physical assets such as housing often lack markets for short-selling altogether. As a result, investment decisions are often restricted by such constraints. This paper studies asset prices in behavioral heterogeneous-belief models with short-selling constraints and arbitrarily many belief types. We provide conditions on beliefs such that short-selling constraints bind for different types, along with analytic expressions for price and demands that allow us to construct fast solution algorithms relevant for a wide range of models. An application studies how an alternative uptick rule, as in the United States, affects price dynamics and wealth distribution in a market with many belief types in evolutionary competition. In a numerical example, we highlight a scenario in which a modified version of the alternative uptick rule, triggered by smaller percentage falls in price, reduces both asset mispricing and wealth inequality relative to the current regulation. As extensions, we show how our method applies to multiple asset markets with short-selling constraints, additional heterogeneities, and price setting by a market maker.

Futures-market exchanges guarantee the performance of all contracts to encourage active trading between anonymous partners. Traders buy from or sell to the clearinghouse. The exchanges rely primarily on a margin system — traders post a performance bond that they forfeit if they default — to manage their risk exposure. The market value of the performance guarantee is the amount a trader would have to pay to insure his performance if there were no exchange guarantee. An underpriced guarantee subsidizes high-risk traders and ultimately undermines the credibility of the exchange's commitment to perform. An adequate margin policy fairly prices the exchange performance guarantee within an (economically insignificant) varepsilon neighborhood. I show that the value of a call (put) option with a strike price equal to the futures price minus (plus) the margin is an upper bound to the market value of the exchange's performance guarantee. The probability that the futures price change exceeds the margin is the probability that the option expires “in the money.” I estimate the value of the option on the December S&P 500 futures contract during the market crash in October 1987 to illustrate the technique. For the first half of the month the value of the performance guarantee was fairly priced. On the day of the crash it was underpriced by as much as 10% of the value of the futures contract. Futures-market margin committees moved quickly; by the end of the month the value of the performance guarantee was fairly priced.

Nine out of the last ten recessions in the United States have been preceded by an increase in the price of oil as noted by Hamilton [Palgrave Dictionary of Economics]. Given the small share of energy in gross domestic product this phenomenon is difficult to explain using standard models. In this paper, I show that firm entry can be an important transmission and amplifying channel for energy price shocks. The results from the baseline dynamic stochastic general equilibrium (DSGE) model predict a drop in output that is two times the impact in a model without entry. The model also predicts an increase in energy prices would lead to a decline in real wages, investment, consumption, and return on investment. Additionally, using US firm level data, I demonstrate that a rise in energy prices has a negative impact on firm entry as predicted by the DSGE model. This lends further support toward endogenizing firm entry when analyzing the effects of energy price shocks.

Traditionally identified monetary shocks in a structural vector autoregression (SVAR) model typically result in long-lasting effects on output and total factor productivity (TFP). In this paper, I argue that the typical monetary shock has been confounded with the news shock about future technology. I propose and implement a novel SVAR approach that effectively “cleans” the technology component from the traditional Cholesky monetary shock. With the new identification, I find that a monetary shock exerts smaller and less persistent effects on output and the level of measured TFP than a traditionally identified monetary shock. Finally, I show that the SVAR impulse responses can be replicated by augmenting the standard New Keynesian model with a time-varying inflation target and a non-Ricardian fiscal policy regime.

This paper argues that output can respond to public education spending in a delayed and persistent manner through human capital accumulation. We refer to this as a “time-release” response, reflecting that the output response grows as students exposed to increased expenditures sequentially enter the labor market. We first develop and calibrate a stochastic overlapping generations model to formalize the propagation of spending shocks over a long time horizon. We then empirically explore this time-release aspect of shocks to government education expenditures on output using US state-level data for the period 1963–2016 and a panel structural vector autoregression methodology. Consistent with the model, our empirical results show that the dynamic response of output to shocks to government education expenditures is positive, significant, and long-lasting.

The events driven by the financial crisis have highlighted limits and drawbacks of current paradigms. Economists began to rethink the role and impacts of financial factors and standard policies. At the same time, a more general sentiment of revision has challenged several consolidated “dogmas.” Accordingly, this special issue of Macroeconomic Dynamics aims to refresh the debate on some important macroeconomic topics from new and fresh perspectives. A number of questions relating to the challenges faced by macroeconomic theory and policies are raised. The issue, first, discusses some topics that stemmed from the financial factors, such as overleveraging, forward guidance, bank regulation; it then explores other “waters” related to price-setting behavior, productivity, and growth.

We build a two-country model of endogenous growth to study the welfare effects of taxes on tradable primary inputs when countries engage in asymmetric trade. We obtain explicit links between persistent gaps in productivity growth and the incentives of resource-exporting (importing) countries to subsidize (tax) domestic resource use. The exporters' incentive to subsidize hinges on slower productivity growth and is disconnected from the importers' incentive to tax resource inflows—i.e., rent extraction. Moreover, faster productivity growth exacerbates the importers' incentive to tax, beyond the rent-extraction motive. In a strategic tax game, the only equilibrium is of Stackelberg type and features, for a wide range of parameter values, positive exporters' subsidies and positive importers' taxes at the same time.