Daily financial returns (and daily stock returns, in particular) are commonly modeled as GARCH(1, 1) processes. Here we test this specification using new model evaluation technology developed by Ashley and Patterson that examines the ability of the estimated model to reproduce features of particular interest: various aspects of nonlinear serial dependence, in the present instance. Using daily returns to the CRSP equally weighted stock index, we find that the GARCH(1, 1) specification cannot be rejected; thus, this model appears to be reasonably adequate in terms of reproducing the kinds of nonlinear serial dependence addressed by the battery of nonlinearity tests used here.

Yes, indeed; at least for macroeconomic policy interaction. We examine a Neo-Classical economy and provide the conditions for policy arrangements to successfully stabilize the economy when agents have either rational or adaptive expectations. For a contemporaneous-data monetary policy rule, the monetarist solution is unique and stationary under a passive fiscal/active monetary policy regime if monetary policy appropriately incorporates expectational heterogeneity. In contrast, the active fiscal/passive monetary policy regime's fiscalist solution is prone to explosiveness due to empirically plausible expectational heterogeneity. Nevertheless, this can be a well-defined, rather orthodox equilibrium. For operational monetary policy rules, only the results for the fiscalist solution prevail. Moreover, our results are plausible from an adaptive learning viewpoint.

We introduce increasing returns to scale into an otherwise standard New Keynesian model with capital, and study the determinacy and E-stability of equilibrium under Taylor-type interest rate rules. With very mild increasing returns supported by empirical research, the conventional wisdom regarding the design of interest rate rules can be overturned. In particular, the “Taylor principle” no longer guarantees either determinacy or E-stability of the rational expectations equilibrium.

We assess the effects of financial shocks on inflation, and to what extent financial shocks can account for the “missing disinflation” during the Great Recession. We apply a Bayesian vector autoregressive model to US data and identify financial shocks through a combination of narrative and short-run sign restrictions. Our main finding is that contractionary financial shocks temporarily increase inflation. This result withstands a large battery of robustness checks. Negative financial shocks help therefore to explain why inflation did not drop more sharply in the aftermath of the financial crisis. Our analysis suggests that higher borrowing costs after negative financial shocks can account for the modest decrease in inflation after the financial crisis. A policy implication is that financial shocks act as supply-type shocks, moving output and inflation in opposite directions, thereby worsening the trade-off for a central bank with a dual mandate.

The DICE (for Dynamic Integrated model of Climate and the Economy) introduced two important policy aspects to the economic discussion of global warming. First, it argues for a “climate-policy ramp” that deems back-loading of mitigation optimal. Second, it demonstrates that an intergenerational tradeoff is at the heart of the mitigation problem. In this paper we argue that both of these findings rest on contestable assumptions. To demonstrate this a recast DICE is presented. Its outcomes show that DICE's predictions are not robust with higher migitations earlier on and slower temperature increases along the optimal path. The adoption of a baseline scenario in which pollution is a negative externality makes mitigating climate change a Pareto improvement. The alleged sacrifice of present generations vanishes. This strengthens the case for immediate policy action.

The traditional economic approach to index number theory is based on a ratio of cost functions. Diewert defined superlative price and quantity indices as observable indices that were exact for a ratio of unit cost functions or for a ratio of linearly homogeneous utility functions. The present paper looks for counterparts to his results in the difference context, for both flexible homothetic and flexible nonhomothetic preferences. The Bennet indicators of price and quantity change turn out to be superlative for the nonhomothetic case. The underlying preferences are of the translation-homothetic form discussed by Balk, Chambers, Dickenson, Färe, and Grosskopf.

By endowing his agents with simple forecasting models, or representations, M. Woodford (“Learning to Believe in Sunspots,” Econometrica 58, 277–307, 1990) found that finite state Markov sunspot equilibria may be stable under learning. We show that common factor representations generalize to all sunspot equilibria the representations used by Woodford. We find that if finite state Markov sunspots are stable under learning then all sunspots are stable under learning, provided common factor representations are used.

This paper tests for output convergence across n = 51 economies, employing the definition of Pesaran [Journal of Econometrics 138, 312–355 (2007)]. The definition requires output gaps to be stationary around a constant mean. But when all n(n − 1)/2 pairs of log per capita output gaps are considered, this results in more than 1,000 unit root tests to be conducted. Hence, because of the ensuing multiplicity of the testing problem, a nontrivial number of output gaps will be falsely declared to be stationary when each of the n(n − 1)/2 hypotheses is tested at some conventional level like 5%. To solve the problem, we employ recent multiple testing techniques that allow us to bound the expected fraction of false rejections at a desired level. Monte Carlo results illustrate the usefulness of the techniques. The empirical results show that the data do not support the notion of output convergence after controlling for multiplicity.

The presumption that R&D is a key driver of economic growth is difficult to reconcile with empirical evidence. For example, in most studies, which identify technical change with total factor productivity (TFP), the link between TFP and measures of knowledge is found to be weak.

This paper shows that a reconciliation may be possible in a model where R&D contributes to growth through investment-specific technical change. Such a model predicts that the empirical link between knowledge and productivty would be weak even if the generation of knowledge is the predominant factor of economic growth. The paper also shows that estimates of the production function for knowledge using patent data may be biased.

We construct a multiple-shock, discrete-time version of the Mortensen–Pissarides labor market search model to investigate the basic model's well-known tendency to underpredict the volatility of key labor market variables. In addition to the standard labor productivity shock, we introduce shocks to matching efficiency and job separation. We estimate the multiple-shock model and then simulate its properties. Although it generates significantly more volatility while preserving the Beveridge curve relationship, the multiple-shock model generates counterfactual implications for the cyclicality of job separations. Using a business cycle accounting approach, next we show that the model requires significantly procyclical and volatile matching efficiency and counterfactually procyclical job separations to render the observed data without error. We conjecture that the basic Mortensen–Pissarides model lacks mechanisms to generate sufficiently strong labor market reallocation over the business cycle, and suggest nontrivial labor force participation and job-to-job transitions as promising avenues of research.

First generation immigrants to the United States have higher fertility rates than natives. This paper analyzes to what extent this factor provides political support for immigration, using an overlapping generation model with production and capital accumulation. In this setting, immigration represents a dynamic trade-off for native workers as more immigrants decrease current wages but increase the future return on their savings. We find that immigrant fertility has surprisingly strong effects on voter incentives, especially when there is persistence in the political process. If fertility rates are sufficiently high, native workers support immigration. Persistence, either due to inertia induced by frictions in the legal system or through expectational linkages, significantly magnifies the effects. Entry of immigrants with high fertility has redistributive impacts across generations similar to pay-as-you-go social security: initial generations are net winners, whereas later generations are net losers.

Since the 1970s, the characteristics of international business cycles have changed, and deeper economic integration has modified the features of cross-country comovement. We formally test for correlation shifts in measures of real economic activity and economic/financial integration. In Europe we find some statistically significant evidence of higher correlations for several subgroups of countries following the creation of the EMU in 1999. We detect significantly more pronounced correlations between Mexico and the United States and between Mexico and Canada in North America after the enforcement of the NAFTA in 1994. Results are derived from an econometric framework based on nonparametric iterated stationary bootstrap methods, whose statistical reliability and performance we assess through Monte Carlo simulations.

The aim of this research is to build on a theory for explaining economic development in a (neoclassical) growth model with endogenous fertility. The economy is inhabited by overlapping generations of rational and identical individuals and identical competitive firms producing with a constant-returns-to-scale technology and no externalities. From a theoretical perspective, the distinguishing feature of this work is that endogenous fertility per se explains the existence of low- and high-development regimes. It provides different reasons (history driven or expectations driven) why some countries enter development trajectories with high GDP and low fertility and others experience underperformances with low GDP and high fertility. The model is also capable to reproduce fertility fluctuations and explain the baby busts and baby booms observed in the last century in some developed countries.

In this note, we study the basic Ramsey models with labor–leisure choice. We first study the deterministic model and find that a closed-form solution exists and is represented by the Gauss hypergeometric functions. We next incorporate stochastic productivity shocks into the model. We prove that the analytical solution path still exists if the coefficient of relative risk aversion is equal to the capital share.

Empirical studies find that expenditures on both durable and nondurable goods fall following a contractionary monetary policy shock. However, in standard two-sector models with staggered nondurable goods prices and flexible durable goods prices, consumption of durables rises whereas that of nondurables falls in response to a contractionary policy shock. To resolve this co-movement problem, I extend the model to include a realistic financial friction that firms must pay for their productive inputs prior to production, i.e., working capital, along with habit formation in nondurable goods consumption. Following a positive interest rate shock, the working capital channel raises production costs, thereby discouraging production of both durable and nondurable goods. Furthermore, habit formation induces households to smooth the growth rate of nondurable goods consumption, and hence mitigates the fall in the nondurable goods sector. The model solves the co-movement problem and successfully generates a more sensitive response in the durable goods sector, as observed in the data.

The energy transition from fossil fuels to alternative energy sources has important consequences for technological change and resource extraction. We examine these consequences by incorporating a nonrenewable resource and an alternative energy source in a market economy model of endogenous growth through expanding varieties. During the energy transition, technological progress is nonmonotonic over time: It declines initially, starts increasing when the economy approaches the regime shift, and jumps down once the resource stock is exhausted. A moment of peak-oil does no longer necessarily occur, and simultaneous use of the resource and the alternative energy source will take place if the return to innovation becomes too low. Subsidies to research and development (R&D) and to renewables production speed up the energy transition, whereas a tax on fossil fuels postpones the switch to renewable energy.

In one-sector neoclassical growth models, consumption externalities lead to an inefficient allocation in a steady state and indeterminate equilibrium toward a steady state only if there is a labor–leisure trade-off. This paper shows that in a two-sector neoclassical growth model, even without a labor–leisure trade-off, consumption spillovers easily lead to an inefficient allocation in a steady state and indeterminate equilibrium toward a steady state. Negative consumption spillovers that yield ove-accumulation of capital in a one-sector model may lead to underaccumulation or overaccumulation of capital in two-sector models, depending on the relative capital intensity between sectors. Moreover, a two-sector model economy with consumption externalities is less stabilized than an otherwise identical one-sector model economy.

We analyze in some detail the full predeposit game in a simple, tractable, yet very rich, banking environment. How does run-risk affect the optimal deposit contract? If there is a run equilibrium in the postdeposit game, then the optimal contract in the predeposit game tolerates small-probability runs. However, this does not mean that small changes in run-risk are ignored. In some cases, the optimal contract becomes—as one would expect—strictly more conservative as the run-probability increases (until it switches to the best run-proof contract), and the equilibrium allocation is not a mere randomization over the equilibrium allocations from the postdeposit game. In other cases, the allocation is a mere randomization over the equilibria from the postdeposit game. In the first cases (the more intuitive cases), the incentive constraint does not bind. In the second cases, the incentive constraint does bind.

U.S. production has shifted from goods-producing to service-producing industries. We assess whether this shift contributed to the decline in U.S. output volatility over the period 1949–2005 and provide an estimate of its relative importance. Growth rates of GDP by industry are analyzed in a seemingly unrelated multivariate autoregression framework with time-varying innovation covariance matrices. These changing unobserved covariance matrices are modeled as a Wishart autoregressive process of order one, which results in a nonlinear state-space system. The particle filter is used to obtain estimates of the innovation covariance matrix at each point in time. Several counterfactual experiments make it possible to apportion the decline in output volatility between the shift in the sectoral composition and changes in innovations. Our main finding is that the shift into the service sector can explain about 30% of the decline in GDP's volatility, despite the fact that some sectors became even more volatile. This result is robust across a wide variety of alternative specifications.

We study the interaction between endogenous growth and Ricardian trade working solely through comparative advantage. The model is built on several facts about research and development and trade. Trade and growth affect each other in ways previously unexplored. The model can explain and reconcile in a single framework several phenomena usually analyzed separately. Because of a possible dynamic inefficiency, trade may raise or lower the growth rate of each trading partner. Trade leads to “effective technology transfer,” with the growth rate looking as if a country adopts its partner’s technology even though it does not. Economic growth can endogenously change the trading regime from incomplete to complete specialization (the Ricardian corner and interior, respectively), which can explain why trade helps some countries catch up but leaves others behind. Trade may raise or lower social welfare. The model specifies the conditions under which each possible outcome occurs. We examine a few of the model’s many testable implications and find them in agreement with the data.