Following a contractionary monetary policy shock, the aggregate output decreases over time for six to eight quarters, while the real interest rate increases immediately and remains high for three quarters, which can hardly be replicated by models characterized by a standard consumption Euler equation. This paper adopts a segmented markets framework where some households are permanently excluded from financial markets. The aggregate output and the nominal interest rate are modeled as exogenous autoregressive processes, while the real interest rate is determined endogenously. For intermediate levels of market segmentation, the model is able to account for both the persistent decreasing path of the aggregate output and the persistent increase in the real interest rate which follow an unanticipated increase in the nominal interest rate. The sign, the size and the persistence of the responses of the real interest rate and the money growth rate are close to those in the data.

This special issue features inequality. This is a subject that rightly draws immediate attention from both the profession and the popular press. The numbers themselves are intrinsically interesting, if not disturbing. There is, on the one hand, great variety in the distribution of earnings and an enormously right-skewed distribution of wealth. On the other hand, there is absolute and relative poverty. In developing countries there are extremes coexisting on both ends of the distribution. But developing economies also feature growth with time-varying levels of inequality. Macroeconomic growth, stability, and social policies seem correlated with poverty reduction in some instances.

We propose the relaxation algorithm as a simple and powerful method for determining the transition process in growth models numerically. This method has a number of important advantages: (1) It can easily deal with a wide range of dynamic systems including stiff differential equations and systems giving rise to a continuum of stationary equilibria. (2) The application of the procedure is fairly user-friendly. The only input required consists of the dynamic system. (3) The variant of the relaxation algorithm we propose exploits in a natural manner the infinite time horizon, which usually underlies optimal control problems in economics. As an illustrative application, we compute the transition process of the models of Jones [Jones, C.I. (1995) R&D-based models of economic growth. Journal of Political Economy 103 (3), 759–784] and Lucas [Lucas, R.E., Jr. (1988) On the mechanics of economic development. Journal of Monetary Economics 22, 3–42].

This paper constructs an endogenous growth model with productive government spending. In this model, the government can finance its costs through income tax and government debt and has a target level of government debt relative to the size of the economy. We show that there are two steady states. One is associated with high growth and the other with low growth. It is also shown that whether the government uses income taxes or government bonds makes the results differ significantly. In particular, an increase in government bonds reduces the growth rate in the high-growth steady state and raises the growth rate in the low-growth steady state. Conversely, an increase in the income tax rate reduces the growth rate in the low-growth steady state and there exists some tax rate that maximizes the growth rate in the high-growth steady state. Finally, the level of welfare in the low-growth steady state is lower than that in the high-growth steady state.

This issue collects 11 articles at the frontier of the field of Dynamic Macroeconomic Theory.

A majority of the articles discuss theoretical issues related to monetary policy. Many rich economies have now enjoyed a long period of stable monetary conditions, but many researchers remain puzzled as to what are the main mechanisms driving monetary stability. The field is of great importance to policymakers, and this issue's dynamic approaches will advance the debate. The other articles touch on other, equally inherently dynamic issues of macroeconomics, relating to growth, business cycles, and the role of credit. In light of the hard constraints we imposed on the length of the contributed articles, we will let the articles speak for themselves, and hope that the reader will enjoy this research sample as much as we do.

Many macroeconometric models depict situations where the shares of the major demand aggregates in output are stable over time. The joint dynamic behavior of the considered demand aggregate and output may thus be approximated by a cointegrated vector autoregression. However, the shares of many demand subaggregates in output are rather mobile and changing over time. In order to simultaneously capture the flexibility of the shares of the subaggregates and the long-run constancy of the share of the total aggregate, we consider trivariate systems of two macroeconomic subaggregates and output with error-correction terms that are nonlinear functions of the original variables. The merits of the models are evaluated by means of several forecasting experiments.

This paper explains how real wages are procyclical for those who stay with the same employer. On the basis of the Panel Study of Income Dynamics data for the period from 1974–1975 to 1990–1991, we find that the substantial wage procyclicality among job stayers is mostly accounted for by large wage adjustments during the period when the unemployment rate reaches a historical minimum level from the start of the employee's current job. This finding explains how the real wages of job stayers behave asymmetrically over the cycle and more importantly how the evidence of stayers' great wage procyclicality accords with the theoretical prediction of implicit contracts that stresses costless mobility.

This paper provides theoretical foundations to the contemporaneous increase in computer usage, human capital, and multitasking observed in many OECD countries during the 1990s. The links among work organization, technology, and human capital is modelled by establishing the conditions under which firms allocate the workers' time among several productive tasks. Organizational change is then analyzed in a dynamic perspective as the transition from specialization toward multitasking emphasizing its technological and educational determinants. We show that large enough “organizational shocks” can trigger a transition from specialization to multitasking, and this transition obviously should be accompanied by gradual increases in human capital.

This paper studies the effects of social insurance policies on efficiency and distribution of resources in a general equilibrium model of a closed economy with heterogeneous agents and repeated moral hazard. I compare optimal allocations in stationary recursive equilibria for economies with different guaranteed minimum consumption levels (social insurance). I show that the efficiency–equality trade-off associated with social insurance does not hold: Efficiency and inequality decrease as the minimum guaranteed consumption increases to around one third of the average consumption. However, if social insurance expands even further, the efficiency loss becomes very high and inequality increases.

We introduce increasing returns to scale into an otherwise standard New Keynesian model with capital, and study the determinacy and E-stability of equilibrium under Taylor-type interest rate rules. With very mild increasing returns supported by empirical research, the conventional wisdom regarding the design of interest rate rules can be overturned. In particular, the “Taylor principle” no longer guarantees either determinacy or E-stability of the rational expectations equilibrium.

In this paper, we compare the empirical properties of closed- and open-economy DSGE models estimated on Euro area data. The comparison is made along several dimensions; we examine the models in terms of their marginal likelihoods, forecasting performance, variance decompositions, and their transmission mechanisms of monetary policy.

In this paper, we investigate the impact of globalization on wages earned by low- and high-skill workers when openness leads to the outsourcing of high-tech jobs abroad. We have shown that low-skill workers may become considerably better off after globalization because high-skill workers start accepting low-tech jobs. The switch in the behavior of high-skill workers brings about general equilibrium responses from the firm side of the labor market with the outside options for low-skill workers improving significantly. This feedback works as a magnification mechanism that leads to a discontinuous wage increase that one would not be able to get without careful modeling of the frictions in the labor market.

One part of the literature on endogenous growth concerns models where public infrastructure affects the private production process. An unsolved puzzle in this literature concerns observed public investment-to-output ratios for developed economies, which tend to fall short of theoretical model-based optimal ratios. We reexamine the optimal choice of public investment in a more general framework. This setting allows for long-lasting capital stocks, a lower depreciation rate for public capital than for private capital, an elasticity of intertemporal substitution that differs from unity, and the need to finance a nontrivial share of public services in output. Given other fundamentals in the economy, we show that the optimal public investment-to-output ratio is smaller for low-growth economies, for economies populated by consumers with low preferences for substituting consumption intertemporally, and when public capital is durable. For a calibrated economy, we show that a combination of these factors solves the public investment puzzle.

This paper shows that growth and income distribution dynamics are closely linked through occupation, financial intermediation, and education. We use micro data from Thailand for 1976–1996. The compositional changes across these characteristics account for half of the Thai inequality increase and 40% of the Thai growth and poverty reduction. Financial deepening and educational expansion contributed to increasing inequality, whereas occupational transformation contributed to poverty alleviation. The changes in income gaps across the income–status groups, that is, divergence and then convergence, give rise to inverted-U inequality dynamics. These two growth-related components of inequality dynamics, composition and income-gap dynamics, explain virtually all the change in overall inequality, except its initial rise. Thus, inequality dynamics can be viewed as an integral part of the wider process of growth, as Kuznets speculated.

We consider a linear growth model with idiosyncratic productivity shocks in which producers cannot commit to repay their loans. Borrowing constraints are determined endogenously by the borrowers' incentives to repay, assuming that defaulters lose a share of output and are excluded from future trade in the credit market. We characterize necessary and sufficient conditions for the enforceability of a first-best equilibrium growth path. Weak property rights, impatient producers, and small productivity differentials can make the efficient growth path nonenforceable and lead to an inefficient equilibrium with binding borrowing constraints. For some economies, multiple balanced growth paths coexist.

This paper characterizes the global dynamics of the saving rate in the neoclassical growth model with CES production. The study is based on qualitative phase-diagram analysis. The analytical conditions characterizing the cases that may arise theoretically depending on the parameters' configuration are obtained. It is well known that the saving rate behaves monotonically if technology is Cobb-Douglas. However, when the elasticity of substitution is nonunitary, the saving rate path may exhibit nonmonotonic behavior.

This paper explores the equilibrium properties of boundedly rational heterogeneous agents under adaptive learning. In a modified cobweb model with a Stackelberg framework, there is an asymmetric information diffusion process from leading to following firms. It turns out that the conditions for at least one learnable equilibrium are similar to those under homogeneous expectations. However, the introduction of information diffusion leads to the possibility of multiple equilibria and can expand the parameter space of potential learnable equilibria. In addition, the inability to correctly interpret expectations will cause a “boomerang effect” on the forecasts and forecast efficiency of the leading firms. The leading firms' mean square forecast error can be larger than that of following firms if the proportion of following firms is sufficiently large.

The paper utilizes a common approach to derive sufficient conditions for strictly monotonic behavior of three ratios along the transition to the steady state in the Ramsey–Cass–Koopmans model: the consumption–capital ratio, the consumption–output ratio (and the saving rate), and the consumption–wage ratio. These conditions are then applied to derive additional results on the transitional dynamics of the distribution of wealth in the model (when individual consumers are differentiated by their initial wealth endowments).

We explore asset pricing in the context of the one-sector Benhabib-Farmer-Guo (BFG) model with increasing returns to scale in production and compare our results with financial implications of the standard dynamic stochastic general equilibrium (DSGE) model. Our main goal is to determine the effects of local indeterminacy and the presence of sunspot shocks on asset pricing. We find that the BFG model does not adequately represent key stylized facts of U.S. capital markets and does not improve on the asset-pricing results obtained in the standard DSGE model.

We compare the numerical methods that are most widely applied in the computation of the standard business cycle model with flexible labor. The numerical techniques imply economically insignificant differences with regard to business cycle summary statistics. Furthermore, these results are robust with regard to the choice of the functional form of the utility function and the model's parameterization. In addition, the extended path approach, albeit time-consuming, and the Galerkin projection are found to be the most accurate methods, given that we have not used function approximations beyond the second degree.