We develop an overlapping-generations model of growth and the environment in relation to public policy on education. Beyond the traditional mechanisms through which knowledge, growth, and the environment interplay, we stress the role played by education in environmental awareness. Assuming first that environmental awareness is constant, we show the existence of a balanced-growth path (BGP) along which environmental quality increases continually. Then, if education enhances environmental awareness, the equilibrium properties are modified: the economy can reach a steady state or converge to an asymptotic BGP. Therefore, education does not necessarily promote sustained and sustainable growth.

This paper characterizes optimal monetary policy in an economy with endogenous firm entry, a cash-in-advance constraint, and preset wages. Firms must make profits to cover entry costs; thus the markup on goods prices is efficient. However, because leisure is not priced at a markup, the consumption–leisure trade-off is distorted. Consequently, the real wage, hours, and production are suboptimally low. Because of the labor requirement for entry, insufficient labor supply also implies that entry is too low. This paper shows that in the absence of fiscal instruments such as labor income subsidies, the optimal monetary policy achieves higher welfare under sticky wages than under flexible wages. The policy maker uses the money supply instrument to raise the real wage—the cost of leisure—above its flexible-wage level, in response to expansionary shocks to productivity and entry costs. This increases labor supply, expanding production and firm entry.

We analyze the effects of children’s health on human capital accumulation and on long-run economic growth. For this purpose, we design an R&D-based growth model in which the stock of human capital of the next generation is determined by parental education and health investments. We show that (i) there is a complementarity between education and health: if parents want to have better educated children, they also raise health investments and vice versa; (ii) parental health investments exert an unambiguously positive effect on long-run economic growth, (iii) faster population growth reduces long-run economic growth. These results are consistent with the empirical evidence for modern economies in the twentieth century.

Human capital is embodied in people of different generations whose lifetimes are finite. We show that the finiteness of people's lives precludes human capital accumulation from driving long-run aggregate economic growth unless sufficiently strong externalities from aggregate human capital are introduced. Two possible channels for carrying forward such externalities are (i) knowledge spillovers and (ii) public education spending. Our findings shed new light on the foundations of the Uzawa–Lucas growth model. We also show that the cross-sectional Mincer equation, generated by a linear human capital accumulation equation at the individual level, does not carry forward to aggregate data.

This paper analyzes a two-phase endogenous growth model in which the adoption of a backstop technology (e.g., solar) yields a sustained supply of essential energy inputs previously obtained from exhaustible resources (e.g., oil). Growth is knowledge-driven and the optimal timing of technology switching is determined by welfare maximization. The optimal path exhibits discrete jumps in endogenous variables: technology switching implies sudden reductions in consumption and output, an increase in the growth rate, and instantaneous adjustments in saving rates. Due to the positive growth effect, it is optimal to implement the new technology when its current consumption benefits are substantially lower than those generated by old technologies.

We recast Diamond's search equilibrium model into that with a finite number of agents. The state of the model is described by a jump-Markov process, the transition rates of which are functions of the reservation cost, which are endogenously determined by value maximization by rational agents. The existence of stochastic fluctuations causes the fraction of the employed to move from one basin of attraction to the other with positive probabilities when the dynamics have multiple equilibria. Stochastic asymmetric cycles that arise are quite different from the cycles of the set of Diamond–Fudenberg nonlinear deterministic differential equations. By taking the number of agents to infinity, we get a limiting probability distribution over the stationary state equilibria. This provides a natural basis for equilibrium selection in models with multiple equilibria, which is new in the economic literature.

This paper studies the growth and welfare effects of macroprudential regulation in an overlapping generations model of endogenous growth with banking and agency costs. Indivisible investment projects combine with informational imperfections to create a double moral hazard problem à la Holmström–Tirole and a role for bank monitoring. When the optimal monitoring intensity is endogenously determined, an increase in the required reserve ratio (motivated by systemic risk considerations) has conflicting effects on investment and growth. On one hand, requiring banks to put away a fraction of the deposits that they receive reduces the supply of loanable funds. On the other, a higher required ratio raises incentives to save and mitigates banks' incentives to monitor, thereby lowering monitoring costs and freeing up resources to increase lending. In addition, it may mitigate the systemic risk externality associated with excessive leverage. This trade-off can be internalized by choosing the required reserve ratio that maximizes growth and welfare. However, the risk of disintermediation means that in practice financial supervision may also need to be strengthened, and the perimeter of regulation broadened, if the optimal ratio is relatively high.

We consider a firm with assets-in-place and a growth option. There is a funding gap for the expansion investment, which is covered by entering into an equity-for-guarantee swap or fee-for-guarantee swap. We explicitly derive all contingent claim prices with the pricing and timing of the growth option taking business cycle and debt maturity into account. For short-term loan, we produce an explanation why Chinese government suggests that guarantee fee rate should be approximately the fraction 50% of the interest rate of bank loans with the same maturity, but for long-term debt, we show this fraction is too small.

This paper compares the different dynamics of the simple-sum monetary aggregates and the Divisia monetary aggregate indices over time, over the business cycle, and across high and low inflation and interest-rate phases. Although traditional comparisons of the series sometimes suggest that simple-sum and Divisia monetary aggregates share similar dynamics, there are important differences around turning points that cannot be evaluated by their average behavior. We use a factor model with a regime-switching model that separates the common movements underlying the monetary aggregate indices from idiosyncratic variations in each series. We find that the major differences between the simple-sum aggregates and Divisia indices occur around the beginnings and ends of recessions and during some high-interest-rate phases. We note the inferences' policy relevance, which is particularly dramatic at the broadest (M3) level of aggregation. Indeed, as Belongia [Journal of Political Economy, 104 (5) (1996), 1065–1083] has observed in this regard, “measurement matters.”

This paper studies optimal fiscal policy, in the form of taxation and the allocation of tax revenues between infrastructure and environmental investment, in a general-equilibrium growth model with endogenous subjective discounting. A green spending reform, defined as a reallocation of government expenditures toward the environment, can procure a double dividend by raising growth and improving environmental conditions, although the environment does not impact the production technology. Also, endogenous Ramsey fiscal policy eliminates the possibility of an “environmental and economic poverty trap.” In contrast to the case of exogenous discounting, green spending reforms are the optimal response of the Ramsey government to a rise in the agents' environmental concerns.

The aim of this paper is to study the optimal duration of unemployment benefit entitlement across the business cycle. We analyze whether the entitlement duration should be prolonged in bad and shortened in good times. Because of consumption smoothing, such a countercyclical policy can be welfare-enhancing as long as it does not affect labor market adjustment too severely and/or as long as it can even help to reduce inefficiencies there. If, however, the labor market is already quite inflexible, procyclical behavior may be preferable. In a calibrated dynamic business cycle framework, we find that countercyclical benefit entitlement duration may be preferable in the United States but not in Europe.

We investigate mean and volatility spillovers between the crude oil market and the debt, stock, and foreign exchange markets. In doing so, we estimate a four-variable VARMA–GARCH model with a BEKK representation and also examine the possible effects of monetary policy at the zero lower bound by including a dummy variable in both the conditional mean and variance equations. We find that the crude oil market and the financial markets are tightly interconnected and that monetary policy at the zero lower bound has strengthened their linkages.

This paper examines the question to what extent premia for macroeconomic risks in banking are sufficient to avoid banking crises. We investigate a competitive banking system embedded in an overlapping-generations model subject to repeated macroeconomic shocks. We show that even if banks fully incorporate macroeconomic risks into their pricing of loans, a banking system may enter bankruptcy with probability one. A major cause for this default is that risk premia of a competitive banking system may become too small if the capital base is low.

This paper presents a computable general equilibrium model of endogenous (stochastic) growth and cycles that can account for two key features of the aggregate data: balanced growth in the long run and business cycles in the short run. The model is built on Schumpeter's idea that economic development is the consequence of the periodic arrival of innovations. There is growth because each subsequent innovation leads to a permanent improvement in the production technology. Cycles arise because innovations trigger a reallocation of resources between production and R&D. The quantitative implications of the calibrated version of our model are very similar to those of Kydland and Prescott's (1982) model. Moreover, under some parameterizations, our model can correct two shortcomings of RBC models: It can account for the persistence in output growth and the asymmetry of growth within the business cycle.

Within the seminal asset-pricing model by Brock and Hommes (Journal of Economic Dynamics Control 22, 1235–1274, 1998), heterogeneous boundedly rational agents choose between a fixed number of expectation rules to forecast asset prices. However, agents’ heterogeneity is limited in the sense that they typically switch between a representative technical and a representative fundamental expectation rule. Here, we generalize their framework by considering that all agents follow their own time-varying technical and fundamental expectation rules. Estimating our model using the method of simulated moments reveals that it is able to explain the statistical properties of the daily and monthly behavior of the S&P500 quite well. Moreover, our analysis reveals that heterogeneity is not only a realistic model property but clearly helps to explain the intricate dynamics of financial markets.

It is common to interpret rejections of the unit-root null hypothesis in favor of a trend stationary process with possible trend breaks as evidence that the data are better characterized as stationary about a broken trend. This interpretation is valid only if the model postulated under the alternative hypothesis is the only plausible alternative to the model postulated under the null. We argue that there are economically plausible models that are not well captured under either the null hypothesis or the alternative hypothesis of these tests. We show that applied researchers who ignore this possibility are likely to reject the unit-root null with high probability in favor of a trend stationary process with possible breaks. Our evidence shows that this potential pitfall is both economically relevant and quantitatively important. We explore the extent to which applied users may mitigate inferential errors by using finite-sample and bootstrap critical values.

Most of us are armchair economists. Whether our opinions are right or wrong, we can proffer them at little personal cost—the most we can lose is our reputation. Not so for János Kornai. For much of his life, speaking freely would have led him to land in jail, or worse. He faced a difficult choice. He could publish illegally, take the samizdat route, but reach a very small number of readers. He could instead respect a number of official taboos, publish legally, and reach a much wider readership. These difficulties have not prevented him from giving us the most informed and deepest critique of the socialist system to date. This interview is, I hope, successful in showing the degree to which Kornai's life and work have been intertwined, and how he came to believe what he believes today. Kornai is sharing his time between Harvard and Collegium Budapest. The interview took place in my office when I was visiting Harvard University in June 1998.

We focus on the interaction of frictions both at the firm level and in the banking sector in order to examine the transmission mechanism of the shocks and to reflect on the response of the monetary policy to increases in interest rate spreads, using DSGE models with financial frictions. However, VAR models are linear and the solutions of DSGEs are often linear approximations; hence they do not consider time variation in parameters that could account for inherent nonlinearities and capture the adaptive underlying structure of the economy, especially in crisis periods. A novel method for time-varying VAR models is introduced. As an extension to the standard homoskedastic TVP-VAR, we employ a Markov-switching heteroskedastic error structure. Overall, we conduct a comparative empirical analysis of the out-of-sample performance of simple and hybrid DSGE models against standard VARs, BVARs, FAVARs, and TVP-VARs, using data sets from the U.S. economy. We apply advanced Bayesian and quasi-optimal filtering techniques in estimating and forecasting the models.

Long-run income convergence is investigated in the U.S. context. We employ a novel pairwise econometric procedure based on a probabilistic definition of convergence. The time-series properties of all the possible regional income pairs are examined by means of unit root and non-cointegration tests, where inference is based on the fraction of rejections. We distinguish between the cases of strong convergence, where the implied cointegrating vector is [1, −1], and weak convergence, where long-run homogeneity is relaxed. To address cross-sectional dependence, we employ a bootstrap methodology to derive the empirical distribution of the fraction of rejections. We find supporting evidence of U.S. states sharing a common stochastic trend consistent with a definition of convergence based on long-run forecasts of state incomes being proportional rather than equal. We find that the strength of convergence between states decreases with distance and initial income disparity. Using Metropolitan Statistical Area data, evidence for convergence is stronger.

David Cass is undoubtedly one of the central contributors to modern dynamic economics. His fundamental contributions include work on optimal growth problems, overlapping-generations models, sunspot equilibria, and general equilibrium models with incomplete markets. His research has shaped in profound ways the manner in which we do both micro- and macroeconomics. From laying the foundations of real business-cycle theory via the Cass-Koopmans model, to providing us with general tools and techniques to analyze dynamic economic models, to furthering our understanding of monetary economics, to making fundamental contributions to the economics of extrinsic uncertainty, Cass's work has played a major part in the development of much of modern macroeconomic theory. In addition to being a first-class scholar, Cass is also truly his own man and a free spirit of the highest order.

In this interview, we tried to gain some insights into the story of David Cass and his approach to economic theory. Also, given the title as well as the intended readership of Macroeconomic Dynamics, we made a real effort to get him to discuss modern macroeconomics and the influence his work has had on its development. We edited out some parts of the discussion in the interests of space, but what remains is essentially unedited. As most readers will know, David Cass has collaborated extensively with Karl Shell over the years. We talked to Shell a few weeks after talking to Cass, and that interview is scheduled to appear in a future issue.

We met with Dave in his office at the University of Pennsylvania's Economics Department just before noon. Amid the boxes and piles of articles, books and CD's, he sat in his standard jeans and T-shirt, looking about as disheveled as he usually does. We chatted there for a while, went out and continued over lunch, and then returned to complete the interview several hours later. It was an unseasonably warm day in February, and Friday the 13th to be exact. That is traditionally an unlucky day, but one that turned out in this case to be a real treat, at least for us! We hope that you get as much out of this conversation with Dave as we did.