This paper analyzes the determination of public debt in a dynamic politico-economic model with overlapping generations. Sizeable levels of public debt can be rationalized in this model. The elasticity of substitution between public and private consumption determines the size of public debt and could explain differences of debt across countries. I compare the optimal policies under commitment and in a “political equilibrium” without commitment. Public debt can be higher or lower when commitment is absent, depending on the elasticity of substitution between public and private consumption. Consequently, under certain conditions, the no-commitment debt level can be closer to a normative benchmark with higher weight for future generations.

We formulate a central bank's problem of selecting an optimal long-run inflation rate as the choice of a distorting tax by a planner who wishes to maximize discounted stationary utility for a heterogeneous population of infinitely lived households in an economy with constant aggregate income and public information. Households are segmented into agents who store value in currency alone and agents who have access to both currency and loans. We show that the optimum inflation rate is positive, because inflation reduces the value of the outside option for credit agents and raises their debt limits.

We revisit the sources of the bias in Federal Reserve forecasts and assess whether a precautionary motive can explain the forecast bias. In contrast to the existing literature, we use forecasts submitted by individual Federal Open Market Committee (FOMC) members to uncover members' implicit loss function. Our key finding is that the loss function of FOMC members is asymmetric: FOMC members incur a higher loss when they underpredict (overpredict) inflation and unemployment (nominal and real growth) as compared to their making an overprediction (underprediction) of similar size. We also find that an asymmetric loss function, in some cases, weakens evidence against forecast rationality, though results depend on the variable being projected and the subgroup of FOMC members being studied. Furthermore, we add to the recent controversy on the relative quality of FOMC forecasts compared to staff forecasts. Our results suggest that differences in predictive ability could indeed stem from differences in preferences.

This paper develops a stochastic growth model that reproduces the main stylized facts of Imperial China's dynastic cycle—in particular, the time path of taxation, public spending, and corruption and their attendant impacts on production and income distribution. In this model, the emperor uses part of his tax income to finance the building of public capital and administrative institutions. This “institutional capital” enhances the productivity of the economy and limits extortion by the county magistrates. The dynastic cycle is driven by random shocks to the authority of the emperor and his central administration, which change the efficiency of institutional capital.

We analyze a general R&D-based endogenous growth model with a growth-essential natural resource. The economy comprises two separate sectors, final output and R&D, both directly or indirectly dependent on the natural resource. Because the resource is exhaustible and it is an essential productive input, increasing returns to scale to manmade inputs are compatible with nonexplosive sustained growth. The instability problem usually associated with increasing returns is overcome thanks to the existence of imperfect markets in a decentralized economy. We find an admissible range of values for the elasticity of capital in the R&D sector under which growth is fully endogenous and saddlepath stable, with no need of exogenous population growth.

We present a simple theoretical model that illustrates the benefits of regional connectivity and specialization for growth. Starting with one community, we show how welfare measured by utility per head increases as the number of connected communities increases. We assume a common connectivity infrastructure through which a central planner is able to add new communities to the pool of already connected communities, a costly but rewarding activity that is funded by levying a tax on those already connected. We find that increasing production costs lead to faster transitions toward the steady state, whereas increasing transportation and communication costs tend to lengthen the transition. The results point to reductions in transportation and communication costs, in particular, as a suitable vehicle for speeding up growth and underline the existence of a positive scale effect that induces integration and reinforces both transitional and steady state growth.

This paper applies smooth transition regressions to incorporate nonlinearity into the impact of trading volume on exchange rate volatility, the so-called mixture distribution hypothesis (MDH). Linking this analysis to the Tobin tax debate, we provide the first empirical corroboration that such a tax may be effective in limiting speculation and reducing exchange rate volatility, especially in turbulent times. Our study points to two main results. First, we show that nonlinearities should be taken into account to explain the MDH. When volatility, spreads, and volume are simultaneously high, the relationship between trading volume and volatility tends to grow stronger and thus the MDH holds in turbulent periods. Second, on the assumption of constant trading volume elasticity, a Tobin tax would have been stabilizing and effective in the 2008 crisis.

In a dynamic stochastic general equilibrium model with monopolistic competition and flexible prices, we assume that producers must estimate their demand elasticities, which leads to heterogeneous expectations because of idiosyncratic shocks. I argue that these expectations shape firms' perceptions of relative prices, market shares, and individual demand elasticities, thereby distorting their price-setting and production. This model concludes that discarding the conventional assumption of known and exogenous demand elasticity generates business cycle fluctuations indistinguishable from those produced by traditional productivity shocks.

By means of an endogenous growth model of directed technical change with vertical and horizontal R&D, we study a transitional-dynamics mechanism that is consistent with the changes in the shares of the high- versus the low-tech sectors found in recent European data. Under the hypothesis of a positive shock in the proportion of high-skilled labor, the technological-knowledge bias channel leads to unbalanced sectoral growth with a noticeable shift of resources across sectors. A calibration exercise suggests that the model is able to account for up to from 50 to about 100 percent of the increase in the share of the high-tech sector observed in the data from 1995 to 2007. However, the model predicts that the dynamics of the share of the high-tech sector has no significant impact on the dynamics of the economic growth rate.

This paper assesses the empirical relevance of financial frictions in the Euro Area (EA) and the United States (US). It provides a comprehensive set of comparisons between two models: (i) a Smets and Wouters (SW) [F. Smets and R. Wouters, Shocks and frictions in US business cycles: A Bayesian DSGE approach, American Economic Review 97(3), 586–606 (2007)] model with financial frictions originating in nonfinancial firms and (ii) a SW model with frictions originating in financial intermediaries. The introduction of financial frictions in either way improves the models' fit compared to a standard SW model, and the empirical comparisons reveal that the latter model outperforms the former both in the euro area and in the United States. Two main factors explain this result: first, the magnitude of the financial accelerator effect, and second, the role of the investment-specific technology shock in affecting financial variables.

This study examines the cause of higher (5% or more) economic growth rates in countries around the world over the past 35 years. It explores the long- and short-term relationships between GDP and government expenditures in these countries. A panel data set of 60 countries over the period from 1976 to 2010 is deployed to implement pooled mean group estimation. Countries are divided into three economic growth rate groups: high, middle, and low. Panel-based/error correction models are used to estimate long-term equilibrium relationships and short-term dynamics between government expenditures and GDP growth rates. Results indicate that the hypothesis of a common long-term elasticity and a short-term dynamic relationship between GDP growth rates and government expenditures cannot be rejected for high group countries, whereas for middle group countries this is true only for the long term, not for the short term. No long-term or short-term relationship between these two variables exists for low-growth-rate countries.

This paper suggests that we need an alternative approach to economic modeling in general, and macroeconomic modeling in particular, if we are to capture salient characteristics of recent economic developments. Rather than focusing on models built on the basis of isolated, rational, optimizing agents, we should recognize that much simpler individuals following basic rules can collectively generate complex behavior. We have lessons to learn from studying the behavior of social insects for example. Noisy systems of interactive agents can generate aggregate phenomena such as sudden changes in the state of an economy or market, with no external shock. I give two examples of simple models of financial markets to illustrate this but would argue more generally that such models are indispensible if we are to understand aggregate economic phenomena.

Traditional regression models have reported conflicting results on the effectiveness of tax incentives in stimulating business investment. This study investigates the effects of the Bush tax cuts on U.S. investment using intervention analysis in conjunction with regression analysis that controls for relevant variables. Although intervention analysis has the advantage of allowing the behavior of investment to be influenced only by the time path of exogenous shocks such as tax reforms, control variables can test for the robustness of the results. We have found that the two tax reforms enacted in 2001 and 2003 had little impact on marginal investment incentives. The intervention analysis results are further reinforced by the evidence provided by alternative regression models that control for a host of variables. The failure of the tax reforms to stimulate investment spending may be attributable to several factors, such as a global savings glut, cheap global money, inappropriate designs for tax incentives, and budget deficits.

This paper considers an optimal endogenous growth model where the production function is assumed to exhibit increasing returns to scale and two types of resource (renewable and nonrenewable) are imperfect substitutes. Natural resources, labor, and physical capital are used in the final goods sector and in the accumulation of knowledge. Based on results in the calculus of variations, a direct proof of the existence of an optimal solution is provided. Analytical solutions for the planner case, balanced growth paths, and steady states are found for a specific CRRA utility and Cobb–Douglas production function. It is possible to have long-run growth where both energy resources are used simultaneously along the equilibrium path. As the law of motion of the technological change is not concave, reflecting the increasing returns to scale, so that the Arrow–Mangasarian sufficiency conditions do not apply, we provide a sufficient condition directly. Transitional dynamics to the steady state from the theoretical model are used to derive three convergence equations of output intensity growth rate, exhaustible resource growth rate, and renewable resource growth rate, which are tested based on OECD data on production and energy consumption.

Term premia are shown to provide crucial information for discriminating among alternative sources of change in the economy, namely shifts in the variance of structural shocks and in monetary policy. These sources have been identified as competing explanations for time-varying features of major industrial economies during the 1980s and 1990s. Although hardly distinguishable through the lens of standard dynamic stochastic general equilibrium (DSGE) models, lower nonpolicy shock variances and “tighter” monetary policy regimes imply higher and lower term premia, respectively. As a result, moving to tighter monetary policy alone cannot explain the improved U.S. macroeconomic stability in the 1980s and 1990s: term premia would have shifted downward, a fact inconsistent with the evidence of higher premia from early 80s onward. Conversely, favorable shifts in nonpolicy innovation variance imply movements in term premia that are at least qualitatively consistent with historical patterns.

Much empirical evidence finds that governments react to fiscal imbalances in a nonlinear way, through an increasing marginal response of primary surpluses to changes in debt. This paper shows that nonlinear fiscal regimes alter equilibria under active and passive monetary–fiscal policies. The Fisher equation combined with nonlinear fiscal policies leads to multiple steady states. Under passive interest rate rules, even if the steady state in which fiscal policy is active is locally saddlepath stable, there exist infinite equilibrium paths originating in the neighborhood of that steady state that converge into a high-debt trap. Under active interest rate rules, even if the steady state at which fiscal policy is active is locally unstable, there exists a saddle connection with the high-debt equilibrium along which inflation is uniquely determined.

This study considers adult mortality and analyzes the effect of public health investment on economic development, whereby investment increases savings but decreases fertility through a decrease in adult mortality. As the labor force increases, investment temporarily decreases capital per unit of labor. However, the decrease in fertility increases capital per unit of labor in subsequent periods. By considering these two opposing effects of decreasing fertility, we clarify the conditions required for investment to improve economic development via increasing savings and decreasing fertility. We examine panel estimation and present some weak evidence for our model.

We investigate whether recoveries following normal recessions differ from recoveries following recessions that are associated with either banking crises or housing crises. Using a parametric panel framework that allows for a bounce-back in the level of output during the recovery, we find that normal recessions are followed by strong recoveries in advanced economies. This bounce-back is absent following recessions associated with banking crises and housing crises. Consequently, the permanent output losses of recessions associated with banking crises and housing crises are considerably larger than those of normal recessions.