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.

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.

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.

This paper explores single-equation nonlinear error correction (NEC) models with linear and nonlinear cointegrated variables. Within the class of semiparametric NEC models, we use smoothing splines. Within the class of parametric models, we discuss the interesting properties of cubic polynomial NEC models and we show how they can be used to identify unknown threshold points in asymmetric models and to check the stability properties of the long-run equilibrium. A new class of rational polynomial NEC models is also introduced. We found multiple long-run money demand equilibria. The stability observed in the money-demand parameter estimates during more than a century, 1878 to 2000, is remarkable.

Axel Leijonhufvud made an enormous impact on macroeconomics in the late 1960s with the publication of his book On Keynesian Economics and the Economics of Keynes: A Study of Monetary Economics (1968). In this famous book, Leijonhufvud argued that the standard neoclassical synthesis (Hicks–Hansen IS-LM) interpretation of the General Theory totally misunderstood and misinterpreted Keynes. However, during the 1970's, interest in Keynes and Keynesian models waned as new classical equilibrium models became all the rage. Nevertheless, Leijonhufvud, from a position outside the mainstream, continued his research into problems of unemployment, business cycles, and inflation—issues that from his perspective are problems of coordination failure in complex dynamical systems. Axel Leijonhufvud is currently Professor Emeritus at the University of California, Los Angeles, and, since 1995, Professor of Monetary Economics at the University of Trento, Italy. In this interview the author discusses with Leijonhufvud a wide range of issues relating to his own work as well as his views on the development of macroeconomics after Keynes.