In dynamic general equilibrium models, private output is increased by government spending for goods and services, but decreased by government spending for employment. This paper presents the first evidence for the latter effect by studying the pre-WWII British wartime economy. Britain participated in numerous wars, increasing military employment greatly. British tax-smoothing policy and rare wartime governmental interventions reduce the difficulty of studying the effects of wartime government spending. This paper finds wartime decreases in industrial production, which can be explained by wartime government spending for military employment.

In the aftermath of the global financial crisis, questions have been raised regarding the value and applicability of modern macroeconomics. Motivated by these developments and recent advances in dynamical systems theory, the papers in this special issue of Macroeconomic Dynamics deal with specific aspects of the economy as a complex evolving dynamic system.

Recent empirical work on globalization and inflation analyzes multicountry data sets in panel and/or cross-section frameworks and reaches inconclusive results. This paper highlights their shortcomings and reexamines the issue utilizing heterogeneous panel cointegration techniques that allow for cross-section heterogeneity and dependence. It finds that in a sample of developing countries globalization of both trade and finance, on the average, exerts a significant and positive effect on inflation, whereas in a sample of developed countries there is, on the average, no significant impact of openness. Neither type of openness disciplines inflationary policy. Despite this, there are large variations in the effect across countries, due possibly to differences in the quality of political institutions, central bank independence, the exchange-rate regimes, financial development, and/or legal traditions.

We present a set of theoretical and empirical papers and briefly describe the specific contributions to the Macroeconomic Dynamics special issue on technology aspects in the process of development.

This paper proposes a framework of endogenous energy production with convex costs to investigate the general equilibrium effects of energy price shocks on the business cycle. This framework explicitly models the consumption of durables and nondurables and implements a high complementarity between energy and the usage of durables and capital. The model predicts energy price elasticities of various consumption variables that fall within reasonable agreement with empirical estimates. Convex costs in energy production produce energy price and energy supply dynamics that tallies well with empirical behavior. Our analysis confirms in a theoretical setting recent observations that not all energy price shocks are the same. They can be distinct in terms of energy price dynamics and impact on the business cycle, as well as energy price elasticities of various macro variables that can be useful indicators for their underlying causes.

This study develops a monetary Schumpeterian model with endogenous market structure (EMS) to explore the effects of monetary policy on the number of firms, firm size, economic growth, and social welfare. EMS leads to different results from previous studies in which market structure is exogenous. In the short run, a higher nominal interest rate reduces the growth rates of innovation, output, and consumption and decreases firm size through reduction in labor supply. In the long run, a higher nominal interest rate reduces the equilibrium number of firms but has no steady-state effect on economic growth and firm size because of EMS. Although monetary policy has no long-run growth effect, increasing the nominal interest rate permanently reduces the levels of output, consumption, and employment. Taking transition dynamics into account, we find that welfare is decreasing in the nominal interest rate and the Friedman rule is optimal in this economy.

Revisions of U.S. macroeconomic data are persistent, correlated with real-time data, and with high variability (around 80% of U.S. real-time data volatility). This paper adapts a DSGE-style model to accommodate both real-time and revised data from the U.S. economy. The results show a lesser role of both habit formation and price indexation than in the standard model. In the simulations, revision shocks to both output and inflation are expansionary because the Fed reacts by cutting interest rates. Consumption revisions, in contrast, are countercyclical, consumption mirrors the observed reduction in real-time consumption. In the variance decomposition, data revisions explain 9.3% of output changes.

This paper studies the evolution of wealth inequality in an economy with endogenous borrowing constraints. In the model economy, young agents need to borrow to finance human capital investments but cannot commit to repaying their loans. Creditors can punish defaulters by banishing them permanently from the credit market. At equilibrium, loan default is prevented by imposing a borrowing limit tied to the borrower's inheritance. The heterogeneity in inheritances translates into heterogeneity in borrowing limits: endogenously, some borrowers face a zero borrowing limit, and some are partly constrained, whereas others are unconstrained. Depending on the initial distribution of inheritances, it is possible that all lineages are attracted either to the zero-borrowing-limit steady state or to the unconstrained-borrowing steady state—long-run equality. It is also possible that some lineages end up in one steady state and the rest in the other—complete polarization.

This paper develops a model positing a nonlinear relationship between public investment and growth. The model is then applied to a panel of African countries, using nonlinear estimating procedures. The growth-maximizing level of public investment is estimated at about 10% of GDP, based on System GMM estimation. The paper further runs simulations, obtaining the constant optimal public investment share that maximizes the sum of discounted consumption as between 8.1% and 9.6% of GDP. Compared with the observed end-of-panel mean value of no more than 7.26%, these estimates suggest that there has been significant public underinvestment in Africa.

This paper argues that trade specialization played an indispensable role in supporting the Industrial Revolution. We calibrate a two-good and two-sector overlapping generations model for England's historical development and investigate how much different England's development path would have been if it had not globalized in 1840. The open-economy model is able to match the data closely, but the closed-economy model cannot explain the fall in the value of land relative to wages observed in the nineteenth century. Without globalization, the transition period in the British economy would have been considerably longer than that observed in the data and key variables, such as the share of labor force in agriculture, would have converged to figures very distant from the actual ones.

This study provides an infinite-horizon model of rational bubbles in a production economy. A bubble can arise when the pursuit of status is modeled explicitly, capturing the notion of “the spirit of capitalism.” Using a parameterized model, I demonstrate the specific conditions for the existence of bubbles and their implications. Bubbles crowd out investment, stimulate consumption, and slow economic growth. I also discuss a stochastic bubble that bursts with an exogenous probability. I show that there could be multiple stochastic bubbly equilibria. Moreover, I suggest that taxing wealth properly can eliminate bubbles and achieve the social optimum.

This paper develops a model to assess the quantitative effects of entry costs and financial frictions on cross-country income and total factor productivity (TFP) differences, with a primary focus on the interaction between entry costs and financial frictions. The model is calibrated to match the establishment-level statistics for the U.S. economy, assuming a perfect financial market. The simulations based on the calibrated model show that entry costs and financial frictions together account for 55% and 46% of the cross-country variation in output and TFP in the data. Moreover, a substantial portion of the variation is accounted for by the interaction between entry costs and financial frictions. The main mechanism is that financial frictions amplify the effect of entry costs.

This paper aims at characterizing the debt-consolidation processes put forward by some European countries in order to assess welfare and, in particular, the inequality effects involved. For this purpose, we built a general equilibrium heterogeneous-agent model capable of exploring the relationship between fiscal policy variables and the endogenous cross-section distribution of income and wealth. Using a utilitarian welfare criterion, results show that different strategies yield different outcomes. Despite the positive welfare gains observed, transition costs affect all episodes and are determinant in sorting among the welfare-enhancing strategies. Our results confirm the superiority of adjustments partially based on the reduction of unproductive expenditures over those based on tax raises or on the reduction of social transfer. Welfare is further enhanced when consolidation strategies involve an equilibrated mix between expenditure and transfer cuts and tax increases, because debt consolidation processes mostly or exclusively based on social transfers cuts have a strong negative effect on welfare inequality. Moreover, shock volatility and persistency (also shaping inequality) help explain different results across countries: under high income inequality, consolidation processes are expected to yield smaller inequality effects on welfare, whereas a worse consumption–leisure trade-off may arise.

This paper develops a dynamic dual-economy model and examines how the long-run outcome of an economy depends on the initial distribution of wealth and sectoral productivity. It is shown that, for fast transformation into a developed economy, the initial distribution must be such that extreme poverty is not prevalent so that most people can take education to acquire basic skills and the size of the “middle class” is large enough so that an adequate number of people can access education to acquire advanced skills. Both conditions seem to have held in successful East Asian nations, where, as in the model economy undergoing such transformation, the fraction of workers with advanced skills rose greatly and inequalities between these workers and others fell over time. In contrast, if the former condition holds but the latter does not, which would be the case for many nations falling into the “middle income trap,” consistent with facts, the fraction of workers with basic skills and the share of the modern sector rise, but inequality between workers with advanced skills and with basic skills worsens and the traditional sector persists for long periods. If the former condition does not hold, which would be true for the poorest economies, the dual structure and high inequality between workers without basic skills and others persist for very long periods. Consistently, Hanushek and Woessmann (2012) [Hanushek, Eric A. and Ludger Woessmann (2012) Do better schools lead to more growth? Cognitive skills, economic outcomes, and causation. Journal of Economic Growth 17, 267–321] find that the share of students with basic skills and that of top performance have significant effects on economic growth that are complementary to each other.

We study the dynamics of the distribution of wealth in an economy with infinitely lived agents, intergenerational transmission of wealth, and redistributive fiscal policy. We show that wealth accumulation with idiosyncratic investment risk and uncertain lifetimes can generate a double Pareto wealth distribution.

This paper investigates the interactions between three key macroeconomic imbalances, namely current-account discrepancies (external imbalances), output gaps (internal imbalances), and exchange-rate misalignments. We estimate a panel VAR model for a sample of 22 industrialized countries over the period 1980–2011. Our findings show that macroeconomic imbalances strongly interact through a causal relationship. If current-account disequilibria threaten the stability of the global economy, their origin can be found in internal imbalances and exchange-rate misalignments: positive output-gap shocks as well as currency overvaluation deepen current-account deficits. In addition, although variations in external imbalances mainly result from exchange-rate misalignments in the euro area, they are mostly explained by output gaps for non-eurozone members.

This paper examines the mechanisms through which government spending affects the dynamics of the real exchange rate. Using a two-sector dependent open economy model with intersectoral mobility costs for private capital, we show that public investment generates (i) a nonmonotonic U-shaped adjustment path for the real exchange rate with sharp intertemporal trade-offs and (ii) a crowding-in of private consumption, consistent with stylized facts. The effects of public consumption, however, are in sharp contrast to those of public investment. The effect of government spending on the real exchange rate depends critically on (i) the sectoral composition of public spending, (ii) the underlying financing policy, (iii) the sectoral intensity of private capital in production, (iv) the relative sectoral productivity of public infrastructure, (v) the elasticity of substitution in production, and (vi) intersectoral mobility costs for capital. In deriving these results, we identify conditions under which the predictions of the neoclassical open economy model can be reconciled with empirical regularities. Our results underscore the importance of decoupling the effects of government investment from those of government consumption in understanding the relationship between fiscal policy and the real exchange rate.

We explore bifurcation phenomena in the open-economy New Keynesian model developed by Galí and Monacelli in 2005. We find that the open economy framework brings about more complex dynamics, along with a wider variety of qualitative behaviors and policy responses. Introducing parameters related to the open economy structure affects the values of bifurcation parameters and changes the location of bifurcation boundaries. As a result, the stratification of the confidence region, as previously seen in closed-economy New Keynesian models, remains an important research and policy risk to be considered in the context of the open-economy New Keynesian functional structures. In fact, econometrics and optimal policy design become more complex within an open economy. Dynamical inferences need to be qualified by the risk of bifurcation boundaries crossing the confidence regions. Policy design needs to take into consideration that a change in monetary policy can produce an unanticipated bifurcation, without adequate prior econometrics research.

We calculate that the extension of unemployment insurance benefits during downturns has significantly increased the variability of unemployment and vacancies in the United States. Taking this into account reduces the value of leisure necessary to match the wide labor market business cycles experienced in the United States using the Mortensen--Pissarides model. For this calculation, we analyze a version of the model where unemployment insurance benefits not only expire but must be earned with prior employment. With these features, we can calibrate the model to be consistent with unemployment responding strongly to productivity shocks and mildly to changes in unemployment insurance policies. Our preferred calibration predicts that the standard deviation of unemployment since 1945 would have fallen by around 37% if there had not been programs extending unemployment benefits during recessions. We also find that the enactment of the Emergency Unemployment Compensation program in 2008 increased the unemployment rate by 0.5 percentage points.

This paper proposes a Bayesian approach to estimating a factor-augmented GDP per capita equation. We exploit the panel dimension of our data and distinguish between individual-specific and time-specific factors. On the basis of 21 technology, infrastructure, and institutional indicators from 82 countries over a 19-year period (1990 to 2008), we construct summary indicators of each of these three components in the cross-sectional dimension and an overall indicator of all 21 indicators in the time-series dimension and estimate their effects on growth and international differences in GDP per capita. For most countries, more than 50% of GDP per capita is explained by the four common factors we have introduced. Infrastructure is the greatest contributor to total factor productivity, followed by technology and institutions.