A small macroeconomic model is constructed to study the transmission of the monetary policy conducted by the Deutsche Bundesbank (DBB) since the middle of the 1970s. For this purpose, quarterly, seasonally unadjusted data for the period from 1975 to 1998 are used; that is, the period until the introduction of the Euro is considered. A vector error correction model is constructed for the German monetary sector based on M3, GNP, an inflation rate, a long-term interest rate, and a short-term rate that represents the policy variable of the DBB. Moreover, import price inflation is included as an exogenous variable to capture foreign effects. An impulse response analysis highlights the effects of changes in the short-term interest rate and shows the interaction of the main variables of the monetary sector.We thank Alexander Benkwitz for helping with the computations and Massimiliano Marcellino, Paulo Rodrigues, Phillipe Andrade, Harald Uhlig, Adrian Pagan, and two anonymous referees for comments. Financial support was provided by the Deutsche Forschungsgemeinschaft, Sonderforschungsbereich 373, and the European Commission under the Training and Mobility of Researchers Programme (contract No. ERBFMRXCT980213). The paper was presented at the EEA meeting and the ESEM in Venice in 2002.

The paper studies the effects of an expansionary fiscal policy in a general equilibrium model of a small open economy. Households are assumed to possess habit-forming, endogenous rates of time preference. In response to fiscal shocks, the model generates cyclical endogenous persistence and procyclical time paths for consumption, employment, and investment, as well as a countercyclical path for the current account. Furthermore, fiscal shocks are shown to have positive long-run effects on output and negative long-run effects on consumption.

Linear models with infinite horizon generally admit infinitely many rational expectations solutions. Consequently, some additional selection devices are needed to narrow the set of relevant solutions. The viewpoint of this paper is that a solution will be more likely to arise if it is locally determinate (i.e., locally isolated), locally immune to sunspots, and locally stable under learning. These three criteria are applied to solutions of linear univariate models along which the level of the state variable evolves through time. In such models the equilibrium behavior of the level of the state variable is described by a linear recursive equation characterized by the set of its coefficients. The main innovation of this paper is to define new perfect-foresight dynamics whose fixed points are these sets of coefficients, thus allowing us to study the property of determinacy of these sets, or, equivalently, of the associated solutions. It is shown that only one solution is locally determinate in the new dynamics. It is also locally immune to sunspots and locally stable under myopic learning. This solution corresponds to the saddle path in the saddle-point case.

We develop a simple open-economy growth model in which productivity growth and education influence each other, and use it to empirically address issues of causality between them. Technology adoption fostered by human capital and economic openness determines productivity growth; the framework allows us to evaluate whether the effects of these two variables on growth documented in previous cross-country regression studies carry over to a simultaneous system closely allied to a model. This model implies that an increase in openness will stimulate technical change but, for empirically plausible values of the intertemporal elasticity of substitution, it will cause a decrease in the level of education. The empirical analysis specifies productivity growth and human capital as endogenous variables and finds evidence broadly consistent with the theory—openness and education stimulate productivity growth, and there is a negative effect of this growth on human capital accumulation.

This paper examines the dynamic implications of different preference formulations in open-economy business-cycle models with incomplete asset markets. In particular, we study two preference formulations: a time-separable preference formulation with a fixed discount factor, and a time-nonseparable preference structure with an endogenous discount factor. We analyze the moment implications of two versions of an otherwise identical open-economy model—one with a fixed discount factor and the other with an endogenous discount factor—and study impulse responses to productivity and world real-interest-rate shocks. Our results suggest that business-cycle implications of the two models are quite similar under conventional parameter values. We also find that the approximation errors associated with the solutions of these two models are of the same magnitude.

This paper shows that high-frequency, irregularly spaced, foreign exchange (FX) data can generate nonnormality, conditional heteroskedasticity, and leptokurtosis when aggregated into fixed-interval calendar time, even when these features are absent in the original DGP. Furthermore, we introduce a new approach to modeling these high-frequency irregularly spaced data based on the Poisson regression model. The new model is called the autoregressive conditional intensity model and it has the advantage of being simple and of maintaining the calendar timescale. To illustrate the virtues of this approach, we examine a classical issue in FX microstructure: the variation in information content as a function of fluctuations in the intensity of activity levels.

Martin Feldstein is one of the most influential empirical economists of the late twentieth century. In the 1960's, as a research fellow at Oxford University, where he earned a D.Phil. in Economics, he pioneered the empirical analysis of production functions for hospitals and for other health care providers. In the process, he helped to launch the modern field of health economics. In the 1970's, shortly after moving from Oxford to Harvard, his research expanded from health economics to a broader range of social insurance programs, particularly Social Security and unemployment insurance. He developed theoretical models for analyzing how these programs affected the incentives facing households and firms, and then marshaled empirical evidence to document the substantive importance of these program-induced distortions. Feldstein's work sparked an active public policy debate on the economic effects of these programs, and this debate continues to the present day.

Feldstein was one of the first to use household-level data from surveys and administrative records to analyze how taxes and government transfer programs affect household behavior. His research contributions, and his pedagogical role in training dozens of graduate students, accelerated the diffusion of new empirical strategies in the field of applied economics. Researchers in public finance still make widespread use of the TAXSIM computer model, a household-level program for computing tax liabilities, which Feldstein began to build during the 1970's.

In the early 1980's, Feldstein spent two years as the Chairman of the Council of Economic Advisers. During that time, he warned frequently of the long-term economic costs of large budget deficits, even though this was a very unpopular view on political grounds. Feldstein's time in Washington expanded his interests still further, to encompass international economic policy issues as well as domestic questions. When he returned to Harvard and the NBER in the mid-1980's, Feldstein directed several projects on the sources of, and policy responses to, international economic crises.

Throughout the late 1980's and early 1990's, Feldstein continued to make central contributions to his primary field of public finance. In a series of papers on how taxable income responds to changes in marginal tax rates, Feldstein developed a new framework for evaluating the efficiency cost of income taxation. These papers also contributed in a very significant way to the debate on how congressional tax analysts should compute the revenue effects of tax reforms. He also continued his long-standing interest in social insurance policy. His 1995 Ely Lecture to the American Economic Association was a clarion call drawing economic researchers to the analysis of Social Security reform proposals, and it anticipated the very active policy debate of the last half decade.

Feldstein has been actively involved in both undergraduate and graduate teaching during his 35 years on the Harvard faculty. He has served on the dissertation committees of more than 60 graduate students, and he has trained many of the current leaders in the field of public economics. He currently directs and lectures in Harvard's Principles of Economics course, which is the largest undergraduate course at Harvard.

Martin Feldstein has made landmark contributions in many subfields of applied economics. He has also played a critical role in shaping the direction of economic research more generally in his position as President of the National Bureau of Economic Research, a post he has held since 1977. Feldstein has made the NBER a clearinghouse for a wide range of current policy-relevant economic research, and he has directed numerous research projects that have generated important new economic insights. During Feldstein's tenure as NBER president, yellow-covered NBER working papers and, increasingly, the NBER internet site, www.nber.org, have become standard starting points for researchers investigating many topics in applied economics.

In 1977, Martin Feldstein received the John Bates Clark Medal from the American Economic Association, recognizing him as the outstanding economist under the age of 40. Twenty-five years later, in 2002, he was elected president of that association.

This interview was conducted at Martin Feldstein's office at the NBER. One wall of the small conference room in which we worked is decorated with original drawings of some of the political cartoons that lampooned Feldstein's deficit worries during his time at the Council of Economic Advisers. Outside the conference room, a glass case contains literally hundreds of books that are the results of NBER research studies dating back to 1920. The interview follows a loose chronological pattern.

This paper is helpful for understanding interactive-agent economies. It presents a user-friendly framework for exploring the implications of economic interaction, and demonstrates its wide applicability. Agents repeatedly face binary choices and receive i.i.d. shocks; payoffs depend upon one's own action and shocks, as well as upon the actions of a subset of other agents. Simulations explore how properties change as the number of agents, the number of neighbors, and the degree of interaction change. Key results in this framework include the following: The law of large numbers can readily be postponed or defeated, stationarity and ergodicity are trivial to deduce, any equilibrium distribution may be attained in “globally interactive” economies, continuous- and discrete-time analogues generally behave very similarly, dynamics can be sensitive to details of the interaction structure (implying that popular mean-field approximations are not always appropriate), and substantial persistence is typical.

A small macroeconomic model is constructed to study the transmission of the monetary policy conducted by the Deutsche Bundesbank (DBB) since the middle of the 1970s. For this purpose, quarterly, seasonally unadjusted data for the period from 1975 to 1998 are used; that is, the period until the introduction of the Euro is considered. A vector error correction model is constructed for the German monetary sector based on M3, GNP, an inflation rate, a long-term interest rate, and a short-term rate that represents the policy variable of the DBB. Moreover, import price inflation is included as an exogenous variable to capture foreign effects. An impulse response analysis highlights the effects of changes in the short-term interest rate and shows the interaction of the main variables of the monetary sector.We thank Alexander Benkwitz for helping with the computations and Massimiliano Marcellino, Paulo Rodrigues, Phillipe Andrade, Harald Uhlig, Adrian Pagan, and two anonymous referees for comments. Financial support was provided by the Deutsche Forschungsgemeinschaft, Sonderforschungsbereich 373, and the European Commission under the Training and Mobility of Researchers Programme (contract No. ERBFMRXCT980213). The paper was presented at the EEA meeting and the ESEM in Venice in 2002.

Dynamic models in which agents' behavior depends on expectations of future prices or other endogenous variables can have steady states that are stationary equilibria for a wide variety of expectations rules, including rational expectations. When there are multiple steady states, stability is a criterion for selecting among them as predictions of long-run outcomes. The purpose of this paper is to study how sensitive stability is to certain details of the expectations rules, in a simple OLG model with constant government debt that is financed through seigniorage. We compare simple recursive learning rules, learning rules with vanishing gain, and OLS learning, and also relate these to expectational stability. One finding is that two adaptive expectation rules that differ only in whether they use current information can have opposite stability properties.

One usually assumes that the joint probability distribution is known or that agents will use Bayesian updating to estimate the true probabilities after a number of trials when the states of nature are finite in classical decision theory under uncertainty. If there are important states that have very low probabilities of occurrence, then each agent must make a subjective assessment of the probability distribution until a sufficient number of outcomes are observed in order to generate a precise estimate of the probability distribution. If one assumes that all agents know the states and their payoffs, the probability distribution is stationary, and they observe all outcomes that unfold over time, then it will take at least 10 times the mean time between occurrences of the lowest probability event in order to generate enough outcomes that all agents share the same objective knowledge of the distribution. The mean time of recurrence depends on both the probability distribution and the time unit used between recordings of the observations. If at least one state has a low probability of occurrence, then the time to convergence will exceed the period of stationarity of the process.

The objective of this book is to provide “a systematic theory of endogenous business fluctuations and growth with a hierarchical structure of integrated macro-dynamical models” (p. 372). The starting point is Tobin's neoclassical model of monetary growth, and successive chapters show how Tobin's model can be extended in various “realistic” directions while preserving the relevant adding-up and balance-sheet constraints of a macro model. The work reported here is squarely in an ongoing European theoretical tradition that eschews the stochastic, representative-agent, approach to macroeconomic modeling. Absent stochastic disturbances, the authors provide a qualitative analysis of dynamic behavior for a variety of closed-economy models—a variety that, as the authors themselves point out, is closely related to three prototype models studied in Part I of Sargent's 1977 book, Macroeconomic Theory.

This book has an ambitious objective: “the discussion and the practical illustration of techniques used in applied macroeconometrics” (p. v). At less than 300 pages, the text is relatively small, which implies that it will have problems competing with many of the heavyweight general econometric texts in terms of scope. On the other hand, there is the potential for it to address issues that these sorts of texts typically do not. Several come to mind: At a “high” level, the importance of interdependence in systems and the ongoing issue of identification; and at a practical level, problems with short samples, data revisions, and unobserved variables.

We introduce a new index that explores the linkage between business-cycle fluctuations and deviations from long-run economic relationships. This index is virtually a measure of the distance between an attractor, a space spanned by the associated cointegrating vectors, and a point in the n-dimensional Euclidean space. The index is applied to U.S. quarterly data to demonstrate its association with an economy's vulnerability state. We find that the average of the index during expansions negatively correlates with the average contraction in output during recessions. A nonlinear error correction model based on a revised version of the index reveals a forecasting gain as compared to the linear error correction model.The authors gratefully acknowledge helpful comments from two anonymous referees, Ming-Li Chen, Ching-Fan Chung, Jin-Lung Lin, and participants of the 2001 winter meeting of the Econometric Society in New Orleans and the workshop at the Institute of Economics, Academia Sinica. Yau received financial support from the National Science Council of Taiwan under grant NSC 89-2415-H-030-011.

In their landmark paper, Bray and Savin note that the constant-parameters model used by their agents to form expectations is misspecified and that, using standard econometric techniques, agents may be able to determine the time-varying nature of the model's parameters. Here, we consider the same type of model as employed by Bray and Savin except that our agents form expectations using a perceived model with parameters that vary with time. We assume agents use the Kalman filter to form estimates of these time-varying parameters. We find that, under certain restrictions on the structure of the stochastic process and on the value of the stability parameter, the model will converge to its rational expectations equilibrium. Further, the restrictions on the stability parameter required for convergence are identical to those found by Bray and Savin.

Multiple-equilibria macroeconomic models suggest that consumers' and investors' perceptions about the state of the economy may be important independent factors for business cycles. In this paper, we verify empirically the interrelations between waves of optimism and pessimism and subsequent economic fluctuations. We focus on the behavior of nonfundamental movements in the consumer sentiment index, as a proxy for consumers' sunspots, and in the business formation index, representing investors' animal spirits, around economic turning points. We find that bearish consumers and entrepreneurs were present before the onset of some U.S. economic downturns, sometimes even when the fundamentals were all very strong. In particular, our analysis shows that self-fulfilling pessimism may have played a nontrivial role in the 1969–1970, the 1973–1975, and the 1981–1982 recessions. The results are robust to a range of alternative linear and nonlinear specifications. Our evidence provides some empirical support for the role of nonfundamental rational expectations in economic fluctuations.

This paper examines the effects of various structural shocks in the passive monetary-active fiscal regime in which the fiscal theory of the price level is valid, and compares these effects to those suggested by conventional theory (the active monetary-passive fiscal regime), within a framework of the New Keynesian sticky price model. The results suggest that the effects of structural shocks are substantially different in the passive monetary-active fiscal regime. First, a monetary contraction (an increase in the interest-rate) increases the inflation rate persistently, and increases output with lags. Second, a positive government spending shock leads to a consumption rise in the model that predicts a consumption fall based on conventional theory. Third, in response to aggregate-demand and aggregate-supply shocks, a period of inflation above (or below) the steady-state is followed by a period of inflation below (or above) the steady-state. This inflation reversal is also found in the impulse responses of the estimated VAR models during the 1940's and 1950's, which suggests that the passive monetary-active fiscal regime seems to be actually in place during that period.I thank the editor, an associate editor, and two anonymous referees for constructive suggestions, Christopher Sims for discussion on earlier drafts, Minjung Chae for research assistance, and Clayton Reck for editorial help. All remaining errors are mine.

This paper examines the effects of various structural shocks in the passive monetary-active fiscal regime in which the fiscal theory of the price level is valid, and compares these effects to those suggested by conventional theory (the active monetary-passive fiscal regime), within a framework of the New Keynesian sticky price model. The results suggest that the effects of structural shocks are substantially different in the passive monetary-active fiscal regime. First, a monetary contraction (an increase in the interest-rate) increases the inflation rate persistently, and increases output with lags. Second, a positive government spending shock leads to a consumption rise in the model that predicts a consumption fall based on conventional theory. Third, in response to aggregate-demand and aggregate-supply shocks, a period of inflation above (or below) the steady-state is followed by a period of inflation below (or above) the steady-state. This inflation reversal is also found in the impulse responses of the estimated VAR models during the 1940's and 1950's, which suggests that the passive monetary-active fiscal regime seems to be actually in place during that period.I thank the editor, an associate editor, and two anonymous referees for constructive suggestions, Christopher Sims for discussion on earlier drafts, Minjung Chae for research assistance, and Clayton Reck for editorial help. All remaining errors are mine.