We develop an N-regime Markov-switching model in which the latent state variable driving the regime switching is endogenously determined with the model disturbance term. The models structure captures a wide variety of patterns of endogeneity and yields a simple test of the null hypothesis of exogenous switching. We derive an iterative filter that generates objects of interest, including the model likelihood function and estimated regime probabilities. Using simulation experiments, we demonstrate that the maximum likelihood estimator performs well in finite samples and that a likelihood ratio test of exogenous switching has good size and power properties. We provide results from two applications of the endogenous switching model: a three-state model of US business cycle dynamics and a three-state volatility model of US equity returns. In both cases, we find statistically significant evidence in favor of endogenous switching.

This paper integrates seemingly disjoint studies on consumer behavior in micro and macroanalyses via an intertemporal two-stage budgeting procedure with durable goods and liquidity constraints. The model specifies an indirect utility function as a function of nondurable consumption, commodity (nondurables) prices, and durables stock, and derives the demand functions for nondurable goods. A demand function for durable goods is derived in an adjustment cost framework. The consumption growth equation accounts for relative price effects with precautionary saving, durables stock, and liquidity constraints. The stochastic discount factor is approximated by a time-varying linear function of nondurable consumption growth, commodity price growth, durables stock growth, and disposable income growth. The demand functions for six nondurable goods and services are jointly estimated with the Euler equations for bonds, stocks, and durable goods with allowance for liquidity constraints, using US data. Estimation provides new findings for intertemporal consumption and a multifactor consumption-based capital asset pricing model.

This paper derives the optimal unemployment insurance (UI) transfer scheme, UI benefits, and UI contribution fees: When a worker has to earn his or her UI eligibility through work, the UI benefits do not last forever, and the UI agency has imperfect monitoring power on the strategic behavior of the worker. We show that the consideration of the UI eligibility rule generates the effective entitlement effect, which serves as an additional incentive device and alters the nature of the optimal UI transfer scheme established in literature. In contrast with previous studies, we find that when the effective entitlement effect is large, it completely removes the moral hazards in job searches, job acceptances, and job quits. As a result, the optimal UI benefits and contribution fees become constant. Calibrated to the data in the United States, the model reproduces some key features of the existing UI system.

We first explore empirical evidence of parameter and shock uncertainties in a state-space model with Markov switching. The evidence indicates that uncertainties in the U.S. economy have been too great to accurately define monetary policy rules. We then explore monetary policy rules under uncertainty with two approaches: the RLS learning algorithm and robust control. The former allows the parameters to be learned for a given model. Yet, as our results of the RLS learning in a framework of optimal control indicate, the state variables do not necessarily converge even in a nonstochastic model. The latter, by permitting uncertainty with respect to model misspecification, allows for a broader framework. Our study on robust control shows that robust optimal monetary policy rules reveal a stronger response to fluctuations in inflation and output than when no uncertainty exists, implying that uncertainty does not necessarily require caution.

This paper proves the existence of competitive equilibrium in a single-sector dynamic economy with heterogeneous agents, elastic labor supply, and complete asset markets. The method of proof relies on some recent results concerning the existence of Lagrange multipliers in infinite-dimensional spaces and their representation as a summable sequence and a direct application of the inward-boundary fixed point theorem.

This article presents a solution algorithm for linear rational expectation models under imperfect information, in which some decisions are made based on smaller information sets than others. In our solution representation, imperfect information does not affect the coefficients on crawling variables, which implies that, if a perfect-information model exhibits saddle-path stability, for example, the corresponding imperfect-information models also exhibit saddle-path stability. However, imperfect information can significantly alter the quantitative properties of a model. Indeed, this article demonstrates that, with a predetermined wage contract, the standard RBC model remarkably improves the correlation between labor productivity and output.

Country risk premia can substantially affect macroeconomic dynamics. We concentrate on one of their most important determinants—a country’s net foreign asset (NFA) position and—in contrast to the existing research—investigate its nonlinear link to risk premia. The importance of this particular nonlinearity is two-fold. First, it allows to identify the NFA level above which the elasticity becomes much (possibly dangerously) higher. Second, such a nonlinear relationship is a standard ingredient of dynamic stochastic general equilibrium (DSGE) models, but its proper calibration/estimation is missing. Our estimation shows that indeed the link is highly nonlinear and helps to identify the NFA position where the nonlinearity kicks in at approximately −70% to −75% of GDP. We also provide a proper calibration of the risk premium—NFA relationship which can be used in DSGE models and demonstrate that its slope matters significantly for economic dynamics in such a model.

Agents can learn from financial markets to predict macroeconomic outcomes, and learning dynamics can feed back into both the macroeconomy and financial markets. This paper builds on the adaptive learning (AL) model of [Slobodyan, S. and R. Wouters (2012a) American Economic Journal: Macroeconomics 4, 65–101.] by introducing the term structure of interest rates. This extension enables term structure information to fully characterize agents’ expectations in real time. This feature addresses an imperfect information issue neglected in the related AL literature. The term structure of interest rates results in a strong channel of persistence driven by multi-period forecasting. Including the term structure in the AL model results in a model fit similar to that obtained in the rational expectation (RE) version of the model, but it greatly reduces the importance of other endogenous sources of aggregate persistence such as price and wage stickiness and the elasticity of the cost of adjusting capital. The model estimated also shows that term premium innovations are a major source of persistent fluctuations in nominal variables under AL. This stands in sharp contrast to the lack of transmission of term premium shocks to the macroeconomy under REs.

We introduce skill decay during unemployment into a New Keynesian model with hiring frictions and real-wage rigidity. Plausible values of quarterly skill decay and real-wage rigidity turn the long-run marginal cost–unemployment relationship positive in a “European” labor market with little hiring but not in a fluid “American” one. If the marginal cost–unemployment relationship is positive, determinacy requires a passive response to inflation in the central bank's interest feedback rule if the rule features only inflation. Targeting steady-state output or unemployment helps to restore determinacy.

We incorporate a production technology that exhibits increasing returns to scale for small values of the capital stock and diminishing returns for the higher stocks at the firm level in a discrete-time version of Romer's endogenous growth model. We study the social planner's problem where the social production technology exhibits globally increasing returns to scale. The properties of the optimal paths are characterized. It is proved that for a given quality of knowledge technology, the countries can take off if their initial stock of capital is above a critical value. We analyze the effect of three factors on the critical value: initial knowledge, quality of knowledge technology, and level of fixed costs associated with production.

Macroeconomics is at a crossroads. The call of real science is drawing it forward to a degree that is without precedent in the history of the field. But the field's origins are related to the exceptional policy relevance of macroeconomics, and the field continues to be pressed for answers to difficult policy problems that sometimes are beyond the current capabilities of the field. Continuing tensions exist between policy demands and the constraints of systematic, rigorous scientific development. A commonly mentioned example is the increasing size of structural macroeconometric models. While highly regarded in many governments, those massive models are greeted with skepticism by the best economics journals.

Through their influence on the cross-sectional distribution of productivity across firms and workers, job creation and destruction likely have an impact on the rate at which aggregate productivity changes over time. However, the nature of this effect is not, a priori, clear. Although a broad consensus has emerged suggesting that job destruction enhances productivity by eliminating inefficient production units, theories disagree with regard to the effect of job creation. If job flows represent the reallocation of labor from low- to high-productivity positions, job creation would boost productivity growth. If, instead, they represent changes in employment along a primarily low-skill dimension, the effect would be negative. This paper estimates the influence of job creation and destruction on total factor productivity (TFP) growth using annual data on four-digit U.S. manufacturing. As expected, the results reveal a positive association between job destruction and changes in TFP. Yet, they also indicate that job creation tends to have a negative effect on productivity growth.

We estimate asymmetries in innovations to Solow residuals for 11 Organization for Economic Co-operation and Development (OECD) countries using stochastic frontier analysis. Likelihood ratio statistics and variance ratios imply that all countries with net energy imports have significant negative asymmetries, whereas other countries do not. We construct a simple theoretical model in which the measured Solow residual combines effects from technology, factor utilization, and the terms of trade. For oil importers, the model implies an asymmetric response of measured total factor productivity to oil price increases and decreases. When we condition Solow residuals separately on positive and negative oil price changes to allow asymmetric responses, evidence for remaining negative asymmetric innovations to the Solow residuals vanishes for all countries except Switzerland. Switzerland's relatively dominant financial sector suggests that their asymmetries could be due to a financial crisis, a hypothesis that we test and fail to reject.

The market economy is modeled as a decentralized joint production system. Markets in such an economy require the use of money or credit instruments to facilitate exchange. As a result, market economies are at risk for monetary instability induced by real-side production coordination failure. In particular, economies decentralized via centralized wholesaling markets are subject to precipitous collapses. The most stable monetary system is trade in specie. However, there very likely is a scarcity of specie, which generates inefficiency and discourages production. There is, then, a need for an elastic currency. Bank-issued bills of exchange are a perfectly elastic medium and eliminate the scarcity of specie and its attendant inefficiency, but are a less stable monetary system than is trade in specie. In the trade-off between elasticity and stability, fiduciary currency (or fiduciary deposits) lies between specie and bank-issued bills of exchange.

This study constructs a dynamic model of the coexistence of public and private schools to study the impact of voucher programs when there are nonlinear peer group effects. The government provides public schools as well as tuition vouchers for households attending private schools. School quality depends on expenditure per student and peer quality within the school. When peer quality is nonlinear, more agents will choose public schools if peer quality is more substitutable, whereas more agents will attend private schools if peer quality is more complementary. We find that vouchers will typically create a “cream skimming” effect and the impact of voucher programs on economic performance is sensitive to the way in which peer interactions affect school quality.

This paper analyzes periods of economic stagnation in a panel of countries. We test whether stagnation can be predicted by institutional characteristics and political shocks and compare the impacts of such variables with those of traditional macroeconomic variables. We examine the determinants of stagnation episodes using dynamic linear and nonlinear models. In addition, we analyze whether the effects of the included variables on the onset of stagnation differ from their effects on the continuation of stagnation. We find that inflation, negative regime changes, real exchange rate undervaluation, financial openness, and trade openness have significant effects on both the onset and the continuation of stagnation. Only for trade openness is there robust evidence of a differential impact. Open economies have a significantly lower probability of falling into stagnation, but once in stagnation they do not recover faster.

Habit formation is a fixture of contemporary new Keynesian models. The vast majority assume that agents form habits strictly over consumption of an aggregate good, leaving open the question of whether it might be preferable to have them form habits over differentiated products instead–an arrangement known as deep habits. I answer this question by estimating a model that nests both habit concepts as special cases. Estimates reveal that the data favor a specification in which consumption habits are stronger at the product level than at the aggregate level. A mix of significance tests and simulation results indicate that including deep habits greatly improves model fit, most notably with regard to inflation dynamics.

The New Keynesian Phillips curve (NKPC) driven by unit labor costs has been criticized for failing to match inflation dynamics and for failing to explain the duration of price contracts. This paper extends recent attempts in the literature to improve the fit of the NKPC, by introducing a fuller marginal cost proxy, unit total costs, that is derived from both labor and nonlabor unit costs; the latter include capital-related costs and production taxes. Borrowing costs are examined separately, as in the cost channel literature. Unit total costs are shown to improve the fit of the short-run variation in inflation and strengthen the empirical support for the role of expectations-based inflation persistence. They also imply a duration of fixed nominal contracts that is closer to those suggested by firm-level surveys. The cost channel becomes relatively less important when unit total costs, rather than unit labor costs, are used as a marginal cost proxy.

In overlapping-generations economies with life-cycle saving and exogenous growth, the laissez-faire equilibrium balanced growth path fails in general to achieve optimality, but is dynamically efficient if the marginal product of physical capital is greater than the growth rate of the economy. In this paper, we accommodate the concept of dynamic (in)efficiency in an overlapping-generations economy with endogenous growth due to human capital accumulation. We show that the condition that the marginal product of physical capital is larger than the growth rate of the economy is necessary but no longer sufficient for the dynamic efficiency of the laissez-faire equilibrium balanced growth path.

This paper examines an intertemporal optimizing consumer or a representative consumer-firm in a deterministic setting subject to a general (either linear or nonlinear) capital accumulation equation. Duality theory is used to recast the Hamilton–Jacobi equation for dynamic optimization in terms of an instantaneous and an intertemporal profit function. An envelope theorem allows derivation of an explicit solution for the value of the costate variable as a function of the state and other variables. The final model form only requires specification of atemporal functions that are linked into a closed-form solution for the optimal dynamic decision variables through a system of contemporaneous simultaneous equations.