This paper systematically examines the interrelations between equilibrium indeterminacy, endogenous entry and exit of intermediate input firms, and increasing returns to specialization within two versions of a parsimonious one-sector monopolistically competitive RBC model. The technology for producing an intermediate good is postulated to display internal increasing returns to scale in our benchmark framework, whereas positive productive externalities are considered in the alternative setting. We analytically show that either formulation will exhibit belief-driven cyclical fluctuations provided the equilibrium wage-hours locus is positively sloped and steeper than the household’s labor supply curve. We also find that ceteris paribus our alternative macroeconomy is more susceptible to indeterminacy and sunspots than the baseline counterpart.

This study presents an overlapping-generations model featuring capital accumulation, collective wage-bargaining, and probabilistic voting over fiscal policy. The study characterizes a Markov-perfect political equilibrium of the voting game within and across generations, and it derives the following results. First, the greater bargaining power of unions lowers the capital growth rate and creates a positive correlation between unemployment and public debt. Second, an increase in the political power of elderly persons lowers the growth rate and shifts government expenditure from unemployed persons to elderly ones. Third, prohibiting debt finance increases the growth rate and benefits future generations; however, it worsens the state of present-day employed and unemployed persons.

Arbitrage between consumption and saving occurs in a context of an aging society where family solidarity is deteriorating. Maximizing inter-temporal utility makes it possible to calculate the preference for saving. The arbitrage involves subjective satisfaction with the quality of life, anticipated survival, and consumption profiles. Simultaneous equations based on the Korean Longitudinal Study on Aging, 2006–2014 (10,205 adults aged 45 and over) show that the preference for saving is determined only by and through these endogenous variables, with no other direct socioeconomic effects. People spending more money in education are those with the highest preference for saving. Socioeconomic variables influence the preference for saving in agreement to the economic theory of the life cycle, but through the structured filter of endogenous subjective variables and consumption profiles.

In this paper I develop a dynamic stochastic general equilibrium model of credit frictions in which the production technology provides a U-shaped average cost curve, enabling endogenous solutions for firm size and quantity. Firms weigh the present value of future net revenues against the opportunity cost of staying in business in their entry or exit decisions. I find that credit frictions increase variable investment costs and result in a larger firm size and a smaller number of firms in the steady state. As the economy deviates from the steady state, however, the presence of credit frictions increases fluctuation in the number of firms, raising market entry during an economic upturn and market exit during a downturn. Also, I find that allowing free entry mitigates some of the effects of credit frictions due to macroeconomic fluctuations. In addition to the homogeneous-firm model, I examine the model when firms have heterogeneous access to credit and find that different credit access gives rise to different firm sizes in the steady state. Firms with easier access to credit become larger than those with less access to credit. Heterogeneous credit access also means that these two types of firms will respond differently to a common technology shock.

We assess the impact of fiscal and monetary policy shocks on US survey-based consumer expectations within states of low and high public debt. Following an unexpected increase in government spending, consumption intentions rise in the low-debt state and fall in the high-debt state. Overall, such a shock has adverse effects on expectations in high-debt states. Similarly, contractionary monetary policy shocks induce pessimistic expectations in the high-debt state but not in the low-debt state. The estimated responses suggest that higher public debt fuels considerations regarding its repayment, giving rise to state dependencies in the updating of expectations in response to both fiscal and monetary policy shocks.

We assess the responses of output and inflation to monetary policy shocks in the context of a Bayesian, monetary structural vector autoregressive model. We allow money supply and leverage measures to enter into the interest rate policy rule and use an identification approach that is by construction devoid of any price puzzles. We provide a comprehensive comparison between monetary policy shocks under a policy regime that follows a standard Taylor rule and those that augment the standard reaction function of the central bank with measures of leverage and the money supply. We find that contractionary monetary policy is more pronounced and persistent when the reaction function of the central bank is augmented with measures of money and leverage than when the reaction function follows a typical Taylor rule. Our results support the use and inclusion of monetary aggregates in monetary policy and business cycle analysis.

This paper introduces imperfect knowledge and learning behavior of economic agents into the Kiyotaki and Moore model and studies the interaction of agents' collateral price beliefs, collateral constraint, and aggregate economic activity over the business cycle. It establishes the E-stability condition and the convergence of the real time learning process. In addition, it shows that learning strengthens the role of collateral constraints in aggregate fluctuations.

This paper establishes new stylized facts about labor market dynamics in developing economies, which are distinct from those in advanced economies, and then proposes a simple model to explain them. We first show that the response of hours worked and employment to a technology shock—identified by a structural VAR model with either short-run or long-run restrictions—is substantially smaller in developing economies. We then present compelling empirical evidence that several structural factors related to the relevance of subsistence consumption across countries can jointly account for the relative volatility of employment to output and that of consumption to output. We argue that a standard real business cycle (RBC) model augmented with subsistence consumption can explain the several salient features of business cycle fluctuations in developing economies, especially their distinct labor market dynamics under technology shocks.

Taking Dutta and Kapur's study (Review of Economic Studies 65, 551–572, 1998) as a case of the Tobin effect, this note investigates the extent to which the Tobin effect persists with the addition of sophisticated financial instruments in incomplete markets. On one hand, after dynamic contracts are introduced to the fullest extent, money demand as a precautionary device is crowded out completely, and there is thus no room for the Tobin effect to persist. On the other hand, the Tobin effect may be strengthened under conditions of coexistence of fiat money and dynamic insurance contracts with limited transfers thanks to relaxed incentive compatibility conditions in a moderately inflationary environment.

This paper examines the consequences of international financial integration in a two-sector standard incomplete markets model with occupational choice under risk and financial constraints affecting entrepreneurial activity. We endogenize international productivity differences and discuss the implications of international integration for the macroeconomy, inequality, and welfare. Lending countries are characterized by tighter domestic constraints and experience an increase in gross national product, whereas the gross domestic product effect is ambiguous. We conclude that international integration is beneficial only for economies where there are substantial financial constraints on entrepreneurial activity. Otherwise, a majority of households suffer, due to the unequal distribution of welfare gains and losses across the heterogeneous population.

Should foreign aid be tied or untied? We study this question in the context of a dynamic growth model in which agents can accumulate human capital through education. We compare the growth and welfare implications of three polar scenarios in which foreign aid is either (i) completely untied, (ii) tied to public investment in infrastructure, or (iii) tied to public spending on education. Our results indicate that tying aid to education is more beneficial from a long-run welfare perspective than the two alternative scenarios. We also compute the optimal allocation of foreign aid and find that the largest fraction of aid flows ought to be tied to public spending on education. Finally, we study the transitional dynamics of the recipient economy following an aid inflow and find that aid programs that are tied (entirely or partially) to public spending on education generally entail some welfare losses in the short run.

A nation's economy is a complex nonlinear dynamical system with links to other national economies. Classical macroeconomic models typically incorporate linear approximations to the nonlinear world and add simple dynamics to capture adjustments over time. Most of these simplifications offer little insight into the nonlinear structure of economic relationships that exist. Nor do they provide useful predictions beyond the short-term predictions of the autoregressive linear models from which they are derived.

This paper presents a monetary stochastic general equilibrium model that allows the real cyclical movements of the economy to be explained as a consequence of exogenous monetary, public spending, and technology shocks. The model is calibrated and simulated, and its accuracy in replicating the cyclical movements in the real variables is compared with that of the standard real business cycle (RBC) model. We find that our model fits the observed data better than the existing RBC models, especially for the labor market.

This paper provides estimates of the probability of an economy hitting its effective lower bound (ELB) on the nominal interest rate and of the expected duration of such an event for eight advanced economies. To that end, a mean-adjusted panel vector autoregression with static interdependencies and the possibility of regime change is estimated. The simulation procedure produces ELB risk estimates for both the short term, where the current phase of the business cycle plays an important role, and the medium term, where the occurrence of an ELB situation is determined mainly by the equilibrium values of macroeconomic variables. The paper also discusses the ELB event probability estimates with respect to previous approaches used in the literature.

We explore asset pricing in the context of the one-sector Benhabib-Farmer-Guo (BFG) model with increasing returns to scale in production and compare our results with financial implications of the standard dynamic stochastic general equilibrium (DSGE) model. Our main goal is to determine the effects of local indeterminacy and the presence of sunspot shocks on asset pricing. We find that the BFG model does not adequately represent key stylized facts of U.S. capital markets and does not improve on the asset-pricing results obtained in the standard DSGE model.

This paper quantitatively examines the macroeconomic effects of size-dependent financial frictions on capital misallocation and aggregate total factor productivity. Based on panel data from China’s manufacturing sector, I find that among non-state-owned enterprises, (i) the dispersion of the marginal product of capital is large and persistent and (ii) large firms tend to have higher leverage, and lower mean and dispersion of the marginal product of capital than their small counterparts. This paper analyzes a dynamic stochastic general equilibrium model with heterogeneous agents and size-dependent financial frictions. By calibrating the model to a Chinese firm-level dataset, I show that in addition to matching the aforementioned stylized facts, the economy with a size-dependent borrowing constraint is able to reproduce the observed negative correlation between firm size and the marginal product of capital, as well as generate quantitatively modest TFP loss. Furthermore, ignoring firms’ size-dependent financing patterns may lead to an overstatement of TFP loss due to financial frictions.

Unemployment insurance benefits are often extended during recessions. Existing research shows that this policy increases the unemployment rate and the duration of unemployment. But less is known about why these changes occur. I construct a job search model with an endogenous participation decision to quantify the contributions of (i) search effort, (ii) job selectivity, and (iii) labor market participation, to changes in unemployment outcomes. In a model calibrated to the US economy, I show that the increased participation accounts for a large fraction of the increase in the unemployment rate following a permanent extension of benefits. This finding indicates the importance of changes in the participation decision of workers facing extended benefits for the unemployment rate—a mechanism that is understudied and frequently overlooked in the quantitative labor market research exploring the impact of UI policies.

This study investigates if the reaction function of the Federal Reserve switches between two distinct policy rules. Using a time-varying transition probability framework, we also determine if forward-looking macroeconomic or financial covariates signal an impending monetary regime switch. We find that US monetary policy is best described by a Markov-switching model with two regime processes, one of which controls for heteroskedasticity in the shocks to the policy rule. We find that the Fed switches between an aggressive regime with a relatively high weight on inflation and a dovish regime that is less responsive to inflationary pressures. We find that an increase in private forecasters’ expectations of an impending recession signals a switch from the more aggressive policy regime to the less aggressive regime. A recovery in equity returns signals a return back to the more aggressive regime.

This paper studies the macroeconomic effects of seven key TCJA provisions, including the tax cuts for individuals and businesses, the bonus depreciation of equipment, the amortization of R&D expenses, and the limits on interest deductibility. I use a dynamic general equilibrium model with interest deductibility and accelerated depreciation. I find that, initially, the tax reform had a small positive effect on output and investment. In the medium term, however, the effect on output will diminish, and the effect on investment will turn negative. The tax reform will depress investment in R&D. Government debt will surge.

This paper develops an efficient Stein-like shrinkage estimator for estimating slope parameters under structural breaks in seemingly unrelated regression models, which is then used for forecasting. The proposed method is a weighted average of two estimators: a restricted estimator that estimates the parameters under the restriction of no break in the coefficients, and an unrestricted estimator that considers break points and estimates the parameters using the observations within each regime. It is established that the asymptotic risk of the Stein-like shrinkage estimator is smaller than that of the unrestricted estimator, which is the method typically used to estimate the slope coefficients under structural breaks. Furthermore, this paper proposes an averaging minimal mean squared error estimator in which the averaging weight is derived by minimizing its asymptotic risk. Insights from the theoretical analysis are demonstrated in Monte Carlo simulations and through an empirical example of forecasting output growth of G7 countries.