In this paper we study the role of bank capital adequacy requirements in the transmission of aggregate productivity shocks. We identify a gap between the empirical and the theoretical work that studies the “credit crunch” effects of these requirements, and how they can work as a financial accelerator that amplifies business cycles. This gap arises because the empirical work faces some difficulties in identifying the effects of capital requirements, whereas the theory still lacks a structural framework that can address these difficulties. We bridge that gap by providing a general equilibrium theoretical framework that allows us to study this financial accelerator. The main insight we obtain is that the “credit crunch” and financial accelerator effects are rather weak, which confirms the findings of existing empirical work. Additionally, by developing a structural framework, we are able to provide an explanation for this result.

We propose a sectoral–shift theory of aggregate factor productivity for a class of multisector economies with AK technologies and a constant production possibilities frontier. Loans are partly secured by collateral and partly based on reputation. We find that both the growth rate and total factor productivity (TFP) respond to random and persistent endogenous fluctuations in the sectoral distribution of physical capital, which, in turn, responds to reversible exogenous shifts in relative sector productivities. Endogenous debt limits on secured and unsecured loans slow down capital reallocation, preventing the equalization of risk-adjusted equity yields across sectors. Economywide factor productivity and the aggregate growth rate are both negatively correlated with the dispersion of sectoral rates of return, sectoral TFP, and sectoral growth rates. We also find highly volatile limit cycles in economies with small amounts of collateral.

This paper uses recent advances in financial econometrics to test the Friedman hypothesis that money supply volatility Granger-causes velocity. Comparisons are made among simple-sum and Divisia velocity series at the M1 and M2 levels of monetary aggregation, using quarterly data from 1959:1 to 2004:3. The conclusion is that the Friedman hypothesis cannot be rejected if money supply volatility is modeled explicitly, using models that capture important volatility effects that previous work has ignored.

I propose a new binary bivariate autoregressive probit model of the state of the business cycle. This model nests various special cases, such as two separate univariate probit models used extensively in the previous literature. The parameters are estimated by the method of maximum likelihood and forecasts can be computed by explicit formulae. The model is applied to predict the U.S. and German business cycle recession and expansion periods. Evidence of in-sample and out-of-sample predictability of recession periods by financial variables is obtained. The proposed bivariate autoregressive probit model allowing links between the recession probabilities in the United States and Germany turns out to outperform two univariate models.

We construct a unified overlapping-generations framework of equilibrium growth that includes the Blanchard “perpetual youth” model, the Samuelson model, and the infinitely lived–agent model as limit specifications for a “realistic” two-parameter survivorship function. We assess how the limit specifications compare with the general survival function, and analyze how exogenous changes in demographic conditions affect equilibrium growth and savings rates. Predicted effects are consistent with some cross-country correlations between demographic conditions and growth rates.

This paper considers a correlated unobserved-components model for output, employment, and hours in order to disentangle the causes for the last three jobless recoveries. The composition of the structural shocks during recessions and the periods immediately following recessions has changed, as have the responses of employment and hours to those shocks. Recessions before 1984 were followed by recoveries driven by positive permanent shocks to output, whereas post-1984 recessions were followed by weak recoveries in demand. Employment is more sensitive to demand shocks post-1984, leading to weak recoveries in employment. In addition, hours and employment were complements before 1984, but are treated as substitutes after 1984. Much of the initial decrease in demand is now absorbed on the intensive margin.

A (jump) Markov process (generalized birth-and-death process) is used to model interactions of a large number of agents subject to field-type externalities. Transition rates are (nonlinear) functions of the composition of the population of agents classified by the choices they make. The model state randomly moves from one equilibrium to another, and exhibits asymmetrical oscillations (business cycles). It is shown that the processes can have several locally stable equilibria, depending on the degree of uncertainty associated with consequences of alternative choices. There is a positive probability of transition between any pair of such basins of attraction, and mean first-passage times between equilibria can be different when different pairs of basins are calculated.

This paper addresses the problem of multiple equilibria in a model of time-consistent monetary policy. It suggests that this problem originates in the assumption that agents have rational expectations and proposes several alternative restrictions on expectations that allow the monetary authority to build credibility for a disinflationary policy by demonstrating that it will stick to that policy even if it imposes short-run costs on the economy. Starting with these restrictions, the paper derives conditions that guarantee the uniqueness of the model's steady state; monetary policy in this unique steady state involves the constant deflation advocated by Milton Friedman.

This paper explores how different credit market and banking regulations affect business fluctuations. Capital adequacy- and reserve requirements are analyzed for their effect on the risk of severe downturns. We develop an agent-based macroeconomic model in which financial contagion is transmitted through balance sheets in an endogenous firm-bank network, which incorporates firm bankruptcy and heterogeneity among banks to capture the fact that contagion effects are bank specific. Using concepts from the empirical literature to identify amplitude and duration of recessions and expansions, we show that more stringent liquidity regulations are best to dampen output fluctuations and prevent severe downturns. Under such regulations, both leverage along expansions and amplitude of recessions become smaller. More stringent capital requirements induce larger output fluctuations and lead to deeper, more fragile recessions. This indicates that the capital adequacy requirement is procyclical and therefore not advisable as a measure to prevent financial contagion.

In this paper we present and discuss a simple financial accelerator agent-based model, whose conceptual core is the interaction of heterogeneous firms and the banking system. Its simplicity notwithstanding, the model is able to replicate through simulations a large number of stylized facts concerning the shape and evolution over time of the distribution of firms' sizes, growth rates, profits, and “bad debt.”

This paper introduces a general procedure that tests the significance of the departures from utility maximization, departures defined as violations of the general axiom of revealed preference (GARP). This general procedure is based on (i) an adjustment procedure that computes the minimal perturbation in order to satisfy GARP by using the information content in the transitive closure matrix and (ii) a test procedure that checks the significance of the necessary adjustment. This procedure can be easily implemented and programmed, and we run Monte Carlo simulations to show that it is quite powerful.

We examine the determinants of income mobility and inequality in a Ramsey model with elastic labor supply and heterogeneous wealth and ability. Both agents with lower wealth and those with greater ability tend to supply more labor, implying that labor supply decisions may have an equalizing or unequalizing effect depending on the relative importance of the two sources of heterogeneity. Moreover, these decisions are central to the extent of mobility observed in an economy. The relationship between mobility and inequality is complex. For example, a reduction in the interest rate and an increase in the wage rate reduce capital income inequality and allow upward mobility of the ability-rich. However, the increase in the labor supply of high-ability agents in response to higher wages raises earnings dispersion and thus has an offsetting effect. As a result, high mobility can be associated with an increase or a decrease in overall income inequality.

Standard economic theories of asset markets assume that assets are valued entirely for the consumption streams they can finance. This paper examines the introduction of the demand for status (as a function of wealth) into a model of uninsurable idiosyncratic risk—the “spirit of capitalism” (“soc”) assumption. We find that soc preferences lead to less inequality in wealth; placing wealth into the utility function leads to a shrinking wealth distribution. The drop in wealth concentration is smaller if the utility function implies status is a luxury good, but no parametrization leads to higher wealth Gini coefficients than the benchmark case. We then consider the consequences of revenue-neutral tax reforms with and without soc preferences, finding that they make little difference for this policy experiment.

We analyze the impact of increasing longevity on technological progress within an overlapping generations research and development (R&D)-based growth framework and test the model's implication on Organization for Economic Co-operation and Development (OECD) data from 1960 to 2011. The central hypothesis is that—by raising the incentives of households to invest in physical capital and in R&D—decreasing mortality positively affects technological progress and productivity growth. The empirical results confirm the theoretical prediction. This implies that the demographic changes we observed in industrialized economies over the last decades were not detrimental to economic prosperity, at least as far as technological progress and productivity growth are concerned.

The lack of a supranational legal authority that can enforce private contracts across borders makes debt repayment in an international setting contingent on borrowers' willingness to pay rather than ability to pay. This market failure (i.e., inadequate enforcement) causes investment to fall short of its unconstrained level. This paper examines how foreign aid affects a country's willingness to honor private investment agreements. We consider two types of aid: technical assistance and loan subsidies. We show that when enforcement is inadequate, aid has the following effects: (i) it reduces default risk, promotes capital flows, and can, in principle, restore investment to its unconstrained level; (ii) when default risk is high, aid can increase the welfare of both the recipient and the donor country. Thus, foreign aid serves as an enforcement mechanism in an international setting. This provides a nonaltruistic rationale for foreign aid. Finally, we discuss the implications of providing bilateral versus multilateral aid (e.g., by individual countries versus multilateral organizations).

Misallocation of resources across firms leads to lower aggregate productivity. In this paper, we provide new estimates of manufacturing productivity differences across countries and establish by how much they would be reduced if such misallocation were eliminated. Using World Bank survey data for formal manufacturing firms in 52 low- and middle-income countries, we show that manufacturing productivity would increase by an average of 62%, but productivity gaps relative to the United States would remain large. We also find that lower-income countries do not have more to gain from reducing misallocation, as efficiency of resource allocation is uncorrelated with income levels.

This paper explores the hypothesis that the sources of economic and financial crises differ from those of noncrisis business cycle fluctuations. We employ Markov-switching Bayesian vector autoregressions (MS-BVARs) to gather evidence about the hypothesis on a long annual U.S. sample running from 1890 to 2010. The sample covers several episodes useful for understanding U.S. economic and financial history, which generate variation in the data that aids in identifying credit supply and demand shocks. We identify these shocks within MS-BVARs by tying credit supply and demand movements to inside money and its intertemporal price. The model space is limited to stochastic volatility (SV) in the errors of the MS-BVARs. Of the 15 MS-BVARs estimated, the data favor a MS-BVAR in which economic and financial crises and noncrisis business cycle regimes recur throughout the long annual sample. The best-fitting MS-BVAR also isolates SV regimes in which shocks to inside money dominate aggregate fluctuations.

In structural VARs, unexpected monetary tightening often leads to the price puzzle, a counterintuitive increase in inflation in the impulse response function. The identification of impulse responses requires at least a minimal set of structural assumptions, and models exhibiting the price puzzle typically use standard assumptions focusing mainly on relationships among contemporaneous disturbances. This note uses a well-established stylized fact, the long lags of monetary policy, to motivate a simple additional identifying assumption. The assumption eliminates a single term in one equation of the reduced form, and with it the price puzzle.

We investigate the consequences of overleveraging and the potential for destabilizing effects arising from financial- and real-sector interactions. In a theoretical framework, we model overleveraging and demonstrate how a highly leveraged banking system can lead to unstable dynamics and downward spirals. Inspired by models developed by Brunnermeier, Sannikov and Stein, we empirically measure the deviation-from-optimal-leverage for a sample of large EU banks. This measure of overleveraging is used to condition the joint dynamics of credit flows and macroeconomic activity in a large-scale regime change model: a Threshold Mixed-Cross-Section Global Vector Autoregressive (T-MCS-GVAR). The regime-switching component of the model is meant to make the relationship between credit and real activity dependent on the extent to which the banking system is overleveraged. We find significant nonlinearities as a function of overleverage. The farther the observed leverage in the banking system from optimal leverage, the more detrimental is the effect of a deleveraging shock on credit supply and economic activity.

We estimate consumption Euler equations using U.K. household-level data, employing a switching regression technique. We find excess sensitivity to income for one group of households but not for a second group. The likelihood of excess sensitivity is greater for the young, those without liquid assets, the degree-educated, ethnic minorities and those with negative home equity, consistent with liquidity constraints and buffer-stock saving. Housing capital gains affect the consumption plans of the excess sensitivity group of households, but not the other group. These results are consistent with a “collateral channel” for housing. Around 20%–40% of U.K. households display excess sensitivity.