This paper presents a model that generates a nonmonotonic evolution of the return to education. The model highlights the role played by socioeconomic stratification in the joint determination of the supply of educated labor and the supply of physical capital. The recent theoretical literature attributes the increased education premium of the last decades to skill-biased technological progress. In contrast, our explanation is based on capital–skill complementarity and endogenous accumulation of physical and human capital in an environment characterized by credit constraints.

Franco Modigliani was a great clarifier of fundamental economic concepts. Often the mathematical rigor of our economic models is misleading, since underlying our actual use of these precisely defined models are some less-rigorous, sometimes even fallacious, concepts. Modigliani's energetic mind drove him to reflect on how our models actually function to yield policy prescriptions, and from that thinking to refine and redefine the concepts that underlie the models.

This paper devises a fiscal policy by means of which the first-best optimal equilibrium can be attained as a market equilibrium in an endogenous growth model with public capital. The optimal equilibrium requires that public (private) investment be zero along the transition to the balanced growth path if the initial ratio of public to private capital is higher (lower) than its long-term value. We also show that the transitional dynamics can be determined by noting that the continuity of the shadow prices involves the continuity of the consumption path.

The Editor, Advisory Board, and Associate Editors of Macroeconomic Dynamics extend their heartiest congratulations to Finn Kydland and Ed Prescott as the co-recipients of the 2004 Nobel Prize in Economics.

Finn has served on the MD advisory board since the journal's founding, and his advice during the journal's formative years has helped make MD the success it is today.

Much of the work which the Nobel Committee cited as the basis for awarding the prize to Finn and Ed was done while Ed was a junior faculty member at the Graduate School of Industrial Administration (now the Tepper School of Business) at Carnegie Mellon University, and while Finn was earning his doctorate at GSIA. As a result, the Board thought it would be appropriate to include a brief explication of the significance of Finn and Ed's work written by one of Finn's current Ph.D. students at Carnegie Mellon, Espen Henriksen. Espen is currently working to complete his thesis under Finn's supervision.

We incorporate a production technology that exhibits increasing returns to scale for small values of the capital stock and diminishing returns for the higher stocks at the firm level in a discrete-time version of Romer's endogenous growth model. We study the social planner's problem where the social production technology exhibits globally increasing returns to scale. The properties of the optimal paths are characterized. It is proved that for a given quality of knowledge technology, the countries can take off if their initial stock of capital is above a critical value. We analyze the effect of three factors on the critical value: initial knowledge, quality of knowledge technology, and level of fixed costs associated with production.

How do taxes affect human capital accumulation? This question has been studied extensively in the context of two model classes: overlapping generations (OLG) and infinite horizon (IH). These embody very different assumptions about the intergenerational transmission of physical and human capital. This paper investigates how such differences in intercohort persistence affect the responsiveness of human capital to taxation. A model is developed that nests OLG and IH models as special cases. The steady-state and transitional effects of tax changes are computed for varying degrees of persistence. The main finding is that stronger intercohort persistence magnifies the impact of taxation on human capital and leads to slower transitional dynamics. As a result, IH models generate systematically larger tax effects than OLG models. For the tax experiments studied here, models with complete persistence generate steady-state tax elasticities at least two times larger and transitional half-lives at least three times longer than do models without persistence.

We discuss the role of the elasticity of substitution in the local determinacy properties of a steady state or a stationary balanced growth path in a general multisector economy with CES technologies. Our main results are the following: We give some sufficient conditions for the occurrence of local indeterminacy in exogenous and endogenous growth models. We show that local indeterminacy takes place even without a capital intensity reversal from the private to the social level if the productive factors are weakly substitutable. Moreover, we show that the conditions for local indeterminacy in exogenous growth models and in endogenous growth models may be qualitatively different.

This paper presents a computable general equilibrium model of endogenous (stochastic) growth and cycles that can account for two key features of the aggregate data: balanced growth in the long run and business cycles in the short run. The model is built on Schumpeter's idea that economic development is the consequence of the periodic arrival of innovations. There is growth because each subsequent innovation leads to a permanent improvement in the production technology. Cycles arise because innovations trigger a reallocation of resources between production and R&D. The quantitative implications of the calibrated version of our model are very similar to those of Kydland and Prescott's (1982) model. Moreover, under some parameterizations, our model can correct two shortcomings of RBC models: It can account for the persistence in output growth and the asymmetry of growth within the business cycle.

This paper discusses the asymptotic behavior of distributions of state variables of Markov processes generated by first-order stochastic difference equations. It studies the problem in a context that is general in the sense that (i) the evolution of the system takes place in a general state space (i.e., a space that is not necessarily finite or even countable); and (ii) the orbits of the unperturbed, deterministic component of the system converge to subsets of the state space which can be more complicated than a stationary state or a periodic orbit, that is, they can be aperiodic or chaotic. The main result of the paper consists of the proof that, under certain conditions on the deterministic attractor and the stochastic perturbations, the Markov process describing the dynamics of a perturbed deterministic system possesses a unique, invariant, and stochastically stable probability measure. Some simple economic applications are also discussed.

The present paper studies the influence of variable labor utilization on local indeterminacy and expectations-driven fluctuations, in one-sector models with (nearly) constant returns to scale. It is shown that, in comparison to the configuration of constant input utilization, considering variable utilization reduces the actual possibilities of factor substitution and, consequently, the range of input substitution elasticities that are compatible with endogenous fluctuations. In particular, local indeterminacy and expectations-driven fluctuations occur only if utilization rates are sufficiently inelastic, whereas local determinacy prevails when utilization is highly elastic. However, accounting for the fact that variable utilization reduces the effective elasticity of capital/labor substitution leads us to argue that expectations-driven fluctuations are more plausible because they require larger elasticities of apparent input substitution. In contrast with the recent literature, the analysis does not rely on significantly increasing returns to scale in production. Accordingly, the results are not at variance with recent empirical studies emphasizing the importance of variable utilization and denying the evidence of large increasing returns.

This paper analyzes the global dynamics of a convex overlapping generations model with land. It derives a competitive equilibrium such that for every given initial level of capital per capita, the economy has a unique perfect-foresight equilibrium. It shows that the existence and uniqueness of this perfect-foresight equilibrium is robust to the presence of multiple steady-state levels of capital per capita. Furthermore, it shows that this model can provide an interesting insight into the economics of land taxation. Specifically, it shows that changes in the rate of land taxation may cause a bifurcation in the model's dynamical system and so may allow an economy with a low initial capital stock to break out of a “poverty trap” steady-state equilibrium.

This paper studies the transition dynamics predictions of an R&D-based growth model, and evaluates their performance in explaining income disparities across nations. We find that the fraction of the observed cross-country income variation explained by the transitional dynamics of the model is as large as the one accounted for by existing steady-state level regressions. Our results suggest that the traditional view of a world in which nations move along their distinct balanced-growth paths is as likely as the one in which countries move along adjustment paths toward a common (very long run) steady state.

This paper provides evidence that domestic opportunities to share risk have contributed to slower growth. We first provide a simple model economy that demonstrates how a country's ability to diversify risk is linked to its growth rate. In the context of the model economy, we then investigate empirically whether there is any systematic relationship between domestic opportunities to diversify risk and growth. We employ two econometric procedures: (1) traditional instrumental variables estimation and (2) dynamic panel methods. Interpreted in the context of the model economy, the empirical analysis reveals a robust negative relationship between domestic opportunities to diversify risk and both capital stock and output growth.

This paper revisits an important issue concerning the persistent real effect of a shock to monetary policy. Although recent sentiment has shifted away from price stickiness toward wage stickiness in explaining persistence, the present paper shows that introducing an input–output structure tends to make the former an equally important monetary transmission mechanism. Under staggered wage setting, the well-known relative-wage effect is the only source of endogenous sluggishness in wage, and thus price, adjustments, regardless of whether there is an intermediate input. Under staggered price setting, relative wages are constant, but the presence of an intermediate input creates a real-wage effect that prevents nominal wages from deviating too much from a sticky intermediate-input price. Meanwhile, stickiness in the intermediate-input price translates directly into sluggishness in marginal-cost movement. This reinforces the endogenous rigidity in the nominal wages and makes firms' pricing decisions even more rigid. Thus, although it makes no difference in output dynamics under staggered wage setting, the input–output structure improves the ability of staggered price setting in generating persistence. As a consequence, the conventional wisdom on the equivalence of price and wage staggering may continue to hold for some reasonable parameter values.

A standard result in the literature on monetary policy rules is that of certainty-equivalence: Given the expected values of the state variables of the economy, policy should be independent of all higher moments of those variables. Some exceptions to this rule have been pointed out in the literature, including restricting the policy response to a limited subset of state variables, or to estimates of the state variables that are biased. In contrast, this paper studies fully optimal policy rules with optimal estimation of state variables. The rules in this framework exhibit certainty-equivalence with respect to estimates of an unobserved state variable (“excess demand”) X, but are not certainty-equivalent when (i) X must be estimated by signal extraction and (ii) the optimal rule is expressed as a reduced form that combines policymakers' estimation and policy-setting stages. I find that it is optimal for policymakers to attenuate their reaction to a variable about which uncertainty has increased, while responding more aggressively to variables about which uncertainty has not changed.

This paper studies the effects of employment protection legislation when job separation requires a mandatory advance notice or a firm's costly closure. In a tight labor market, firms use mandatory notice since job-to-job transitions reduce the expected firing costs. In a world without the lengthy procedure imposed by advance notice, job turnover is mainly accommodated by unemployment inflows. As notice length increases, the fraction of job turnover accounted for by job-to-job movements increases. These results are consistent with the fact that the North American and European markets, despite their difference in employment protection legislation, have different unemployment flows but similar job flows.

Seasonality has been a major research area in economics for several decades. The paper assesses the recent development in the literature on the treatment of seasonality in economics, and divides it into three interrelated groups. The first group, pure noise models, consists of methods based on the view that seasonality is noise contaminating the data or, more correctly, contaminating the information of interest for the economists. The second group, time-series models, treats seasonality as a more integrated part of the modeling strategy, with the choice of model being data driven. The third group, economic models of seasonality, introduces economic theory, that is, optimizing behavior, into the modeling of seasonality.

This paper explores multiasset market dynamics. We consider a limited number of markets on which two types of agents are active. Fundamentalists specialize in a certain market to gather expertise. Chartists may switch between markets since they use simple extrapolative methods. Specifically, chartists prefer markets that display price trends but that are not too misaligned. The interaction between the traders causes complex dynamics. Even in the absence of random shocks, our artificial markets mimic the behavior of actual asset markets closely. Our model also offers reasons for the high degree of comovements in stock prices observed empirically.

We generalize a money-in-the-utility function model to include interest-bearing deposits and use the model to estimate the welfare cost of inflation. In the model, the user cost of deposits is invariant to inflation in steady state. Currency and deposits are assumed to be weakly separable and the model is calibrated using index number methods. We find that the welfare cost of inflation is substantially lower in the model with interest-bearing deposits than in models where all monetary assets are assumed to be non-interest bearing. We also show that higher inflation can raise or lower the rate of convergence to steady state depending on the coefficient of relative risk aversion, but the effect is weak. We provide evidence for OECD countries suggesting that there could be a positive effect of inflation on user costs, which would lead to higher welfare cost estimates.

Recent literature on independent and conservative Central Banks has highlighted the possibility of achieving lower inflation for no increase in the volatility of output—especially when political influences are taken into account. We extend this idea to allow for political uncertainty, where political parties get elected with a probability that may vary over time. We find that it is no longer possible to guarantee lower inflation at no cost at all times. But it is possible to guarantee one or other property if the bank is very conservative or if the governments are always liberal. That implies a conventional inflation–output stability trade-off. However, it is also possible to have conditions in which neither property applies.