We study a New Keynesian model with bounded rationality, where agents choose their expectations heterogeneously from a discrete choice set. The range of their set of possible expectation values can be interpreted as the anchoring of expectations. In the model, multiple locally stable steady states can arise that reflect coordination on particular expectation values. Moreover, bad shocks to the economy can trigger a self-reinforcing wave of pessimism, where the zero lower bound on the nominal interest rate becomes binding, and agents coordinate on a locally stable liquidity trap steady state. When we let the anchoring of expectations evolve endogenously, it turns out that the anchoring of expectations at the time the bad shocks hit the economy is crucial in determining whether the economy can recover from the liquidity trap. Finally, we find that a higher inflation target makes it less likely that self-reinforcing liquidity traps arise.

This paper considers a model of linear capital taxation for an economy where capital and labor income are subject to idiosyncratic uninsurable risk. To keep the model tractable, we assume that investment decisions are made before uncertainty is realized, so that the realization of the capital and labor income shocks only affects current consumption. In this setting, we are able to jointly analyze capital and labor income risk and derive analytical results regarding the optimal taxation of capital. We find that the optimal capital tax is positive in the long run if there is only capital income risk. The reason for this is that the capital tax provides insurance against capital income risk. Furthermore, for high levels of risk, increasing the capital tax may actually induce capital accumulation. On the other hand, if there is only labor income risk, the optimal capital tax is zero. The sign of the optimal tax can only be negative if the two types of risk are negatively correlated and labor income risk is large enough.

We investigate the aggregate and distributional effects of banking spreads in an economy with informality. We build a heterogeneous agents model with incomplete markets, credit frictions, and a rich occupational choice setting, in which informality is an option for both employers and workers. The main finding is that reductions in spreads for formal firms increase wages, output, and welfare but have a deleterious impact on unemployment and inequality. Dropping spreads for informal firms lead to reduction in inequality indicators at the expense of consumption and welfare. By calibrating the model for Brazil, we also find that a hypothetical extinction of the informal sector can be harmful for poor agents, but combined with a spread reduction, it can generate strong positive effects on output and welfare.

We develop an N-regime Markov-switching model in which the latent state variable driving the regime switching is endogenously determined with the model disturbance term. The models structure captures a wide variety of patterns of endogeneity and yields a simple test of the null hypothesis of exogenous switching. We derive an iterative filter that generates objects of interest, including the model likelihood function and estimated regime probabilities. Using simulation experiments, we demonstrate that the maximum likelihood estimator performs well in finite samples and that a likelihood ratio test of exogenous switching has good size and power properties. We provide results from two applications of the endogenous switching model: a three-state model of US business cycle dynamics and a three-state volatility model of US equity returns. In both cases, we find statistically significant evidence in favor of endogenous switching.

We provide an overview to the special issue entitled New Tools for Global Analysis of Economic Dynamics by detailing the main aim of each contribution being part of it.

Agents can learn from financial markets to predict macroeconomic outcomes, and learning dynamics can feed back into both the macroeconomy and financial markets. This paper builds on the adaptive learning (AL) model of [Slobodyan, S. and R. Wouters (2012a) American Economic Journal: Macroeconomics 4, 65–101.] by introducing the term structure of interest rates. This extension enables term structure information to fully characterize agents’ expectations in real time. This feature addresses an imperfect information issue neglected in the related AL literature. The term structure of interest rates results in a strong channel of persistence driven by multi-period forecasting. Including the term structure in the AL model results in a model fit similar to that obtained in the rational expectation (RE) version of the model, but it greatly reduces the importance of other endogenous sources of aggregate persistence such as price and wage stickiness and the elasticity of the cost of adjusting capital. The model estimated also shows that term premium innovations are a major source of persistent fluctuations in nominal variables under AL. This stands in sharp contrast to the lack of transmission of term premium shocks to the macroeconomy under REs.

Sovereign defaults are associated with income and trade reductions and terms-of-trade deterioration. This paper develops a two-country model to study the interactions between income, trade, terms of trade, and foreign-debt default risk and default events. Such default risk and events are costly because they adversely affect the demand for a borrower country’s intermediate goods exports and its income. Consequently, trade flows change due to the income loss and consumption home bias. The defaulter’s terms of trade also deteriorate endogenously, which accelerates its income and trade losses. The model produces procyclical imports, exports, terms of trade, and other empirical features of emerging countries’ business cycles and default episodes.

We build an open-economy dynamic stochastic general equilibrium (DSGE) model that allows us to: (i) derive a time series for labor informality in Brazil spanning the period 2004–2018, whose evolution is consistent with the behavior of the main series provided by Pesquisa Nacional por Amostra de Domicílios (PNAD); (ii) run dynamic simulations showing that, in the presence of a large informal labor market (around 50% of the total labor force), expenditure-cutting measures lead, at worst, to mild short-run recessions in the formal sector and are likely to foster public debt sustainability. Likewise, adjustments through some kinds of distortionary taxation, mainly the corporate tax, and to a lesser extent, the consumption tax, also seem to improve both public debt dynamics and fiscal collection without a significant cost in terms of output. Thus, in countries with large informal economies experiencing fiscal woes, expenditure-based consolidations, as well as some sorts of tax-based adjustments, should be relied upon.

In this paper, we analyze the effects of demographic change on a pay-as-you-go (PAYG) pension system, financed with a defined contribution scheme. In particular, we examine the relationship between retirement, fertility, and pensions in a three-period overlapping generations model. We focus on both the case of mandatory retirement and the case where the retirement age is freely chosen. In the case of mandatory retirement, increasing longevity has an unambiguously negative impact on fertility and pension payouts and a positive effect on the level of physical capital in the steady state. On the other hand, when agents choose the time of retirement, an increase in life expectancy positively affects physical capital only when the tax rate is sufficiently low and can have a positive impact on pension benefits, because agents may find it optimal to retire later and to decrease fertility less. Finally, the effects of the social security tax on capital per worker are negative with mandatory retirement; however, they could be positive in the optimal retirement case.

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 analyzes the effects of corporate tax liability on firm-level total factor productivity (TFP) as the key driver of economic performance. This is a new dimension in the UK productivity puzzle that has not attracted attention so far. We use 6559 manufacturing firms over 2004–2011 to investigate whether higher levels of corporate tax affect the productivity catch-up process by reducing after-tax earnings that could alternatively be used for productivity-enhancing investment, particularly focusing on R&D- and export-intensive firms. Our key results are summarized as follows: first, higher levels of corporate taxation impact adversely on TFP and this finding is robust to different tax measures and insensitive to endogeneity bias; second, as R&D- and export-intensive firms tend to have relatively higher TFP growth, higher levels of tax liability as a share of earnings before interest and taxes decelerate TFP growth of these firms.

This study investigates the relationship between the sustainability of public debt and inequality in an endogenous growth model with heterogeneous agents. We show that the threshold for the sustainability of public debt is related to not only the relative size of public debt but also inequality. In addition, this study examines the effects of budget deficit and redistributive policies on the sustainability of public debt and inequality. We show that an increase in the deficit ratio or the redistributive tax makes public debt less sustainable. If the economy falls into the unsustainable region as a result of the policy change, both public debt and inequality continue to increase.

This paper examines the heterogeneity of exchange rate pass-through into industry-specific import, producer, and consumer prices. Results show that depending on the imported input contents, price responsiveness to the aggregate and relative exchange rate changes displays significant differences. We found that direct exchange rate impacts are more significant than indirect effects. The importance of the indirect effects is largely influenced from energy, basic metal, and chemical industries that provide intermediate inputs to others. The time horizon plays a role in the transition process: exchange rate pass-through tends to get stronger and spread to different price indices over time. The short-run impacts of aggregate exchange rate changes are not significant, while relative exchange rate changes partially transmit to producer and consumer prices in low-import content industries. In the long run direct impacts of both aggregate and relative exchange rates are significant on import prices in all industries and producer prices in high-import content industries. Another interesting finding is that the relative and aggregate exchange rate changes have opposing impacts on domestic prices: asymmetric information about industry-specific exchange rates can create pricing opportunities.

In this paper, we identify the technology shock at business cycle frequencies to improve the performance of structural vector autoregression models in small samples. To this end, we propose a new identification method based on the spectral decomposition of the variance, which targets the contributions of the shock in theoretical models. Results from a Monte-Carlo assessment show that the proposed method can deliver a precise estimate of the response of hours in small samples. We illustrate the application of our methodology using US data and a standard Real Business Cycle model. We find a positive response of hours in the short run following a non-significant, near-zero impact. This result is robust to a large set of credible parameterizations of the theoretical model.

This paper investigates the quantitative implications of real wage rigidities and heterogeneity for two long-lasting puzzles in the business cycle literature: the low correlation between total hours worked and labor productivity and the large volatility of the labor wedge, defined as a gap between the marginal rate of substitution of aggregate leisure for aggregate consumption and the marginal product of aggregate labor. I shed light on these issues by extending a heterogeneous-agent model with an indivisible labor supply choice to real wage rigidities. I find that a small amount of real wage stickiness would be sufficient to resolve both anomalies when long-term wage contracts and heterogeneity are taken into account.

Soon after the start of transition to a market economy in the early 1990s, Poland has experienced both a dramatic decline in the fertility rate and an increase in the share of students among young high-school graduates. These two processes significantly changed the age structure of population and average income characteristics of households. Using a general equilibrium model with heterogeneous households and uninsured income shocks, I try to assess the impact of these changes on the Polish economy as a whole and inequalities within it. I find that, in the long term, the positive effects of the educational change on output per capita will more than offset the negative impact of lower fertility. I also show that the educational change increases income and consumption inequalities, while the fertility change decreases inequality in assets.

In a second-best optimal growth setup with only factor taxes, it is in general optimal to fully replace capital by labor income taxation in the long run. We revisit this important issue by developing a human-capital-based endogenous growth model with frictional labor search, allowing each firm to create multiple vacancies and each worker to determine market participation. We find that the conventional efficient bargaining condition is necessary but not sufficient for achieving constrained social optimality. We then conduct tax incidence exercises in balanced growth by calibrating to the U.S. economy with a preexisting 20% flat tax on capital and labor income. Our quantitative results suggest that, due to a dominant channel via the interactions between vacancy creation and market participation, it is optimal to switch only partially from capital to labor taxation in a benchmark economy where human-capital formation depends on both physical and human-capital stocks. This main finding is robust even along the transition with time-varying factor tax rates. Moreover, our quantitative analysis under alternative setups suggests that while endogenous human capital and labor-market frictions are essential for obtaining a positive optimal capital tax, endogenous leisure, nonlinear human-capital accumulation and endogenous growth are not crucial.

This article proposes a unified framework for solving and estimating linear rational expectations models with a variety of frequency-domain techniques, some established, some new. The solution methodology is applicable to a wide class of models and leads to straightforward construction of the spectral density for performing likelihood-based inference. We also generalize the well-known spectral decomposition of the Gaussian likelihood function to a composite version implied by several competing models. Taken together, these techniques yield fresh insights into the model’s theoretical and empirical implications beyond conventional time-domain approaches can offer. We illustrate the proposed framework using a prototypical new Keynesian model with fiscal details and two determinate monetary–fiscal policy regimes. The model is simple enough to deliver an analytical solution that makes the policy effects transparent under each regime, yet still able to shed light on the empirical interactions between US monetary and fiscal policies along different frequencies.