The paper analyzes an endogenous mechanism leading perfectly symmetric economies to diverge in the long run after unifying their financial asset markets. The standard growth model with overlapping generations of consumers (OLG) is extended to include uncertainty and a financial asset. In the absence of an international asset market, the two autarkic economies converge to the same globally attracting steady state under rational expectations dynamics. When the two asset markets are unified internationally, additional asymmetric steady states appear, implying that the steady state with equal levels of capital becomes unstable, causing symmetry breaking. The paper derives general sufficient conditions for a saddle node bifurcation of the symmetric steady state. A numerical example shows that these effects occur, in particular when the production function and the function of absolute risk aversion are isoelastic.

We study the dynamic macroeconomic effects of fiscal shocks under lump-sum tax financing. To this end, we develop an intertemporal macroeconomic model for a small open economy, featuring monopolistic competition in the intermediate goods market, endogenous (intertemporal) labor supply, and finitely lived households. Fiscal shocks are shown to yield endogenously determined (dampened) cycles for a realistic calibration of the model. Impulse response functions of fiscal policy shocks in the finite-horizon model differ substantially from those resulting from an infinitely lived representative agent model. This can be explained by the presence of Ethier-productivity effects, which increase the size of long-run output multipliers to a greater extent in the infinite-horizon model.

This paper characterizes the elasticity of factor substitution in one-sector convex growth models with a general production function. It shows that an elasticity of substitution that is asymptotically greater than unity is a sufficient (but not a necessary) condition for the existence of a lower bound on the marginal product of capital, which in turn can lead to unbounded endogenous growth. Hence, an elasticity of substitution that eventually becomes greater than unity can counteract the role of diminishing returns to capital. This renders factor substitution a powerful engine of growth.

Stock–flow job matching implies that there are two types of job seekers—those on the short side of their occupations who can easily find work, and those on the long side who expect extended unemployment spells. Using matching data and information on completed and uncompleted unemployment spells for England and Wales, this paper uses the stock–flow matching hypothesis to identify the fraction (incidence) of laid off workers who find themselves on the long side of the market and, conditional on being on the long side, their expected unemployment duration. The average incidence is around one-half and increases significantly in recessions. The expected duration is also strongly countercyclical—peaking at 15 months in the 1990–1992 recession and falling to a more modest 9 months by January 1999. Cross-section estimates also identify a North–South divide and a large city effect—the unemployed in large cities and in the North experience longer spells.

Externalities are a fundamental aspect of any modern interdependent economy. The fact that agents interact with one another makes it inevitable that their decisions will influence one another directly, in addition to any indirect impact that may occur through the market place. Ever since the earliest stages of the discipline, externalities have been of prime concern to economists, who have long argued that they provide an important motive for (economic) decision making. To cite one prominent example, in The Theory of Moral Sentiments, Adam Smith notes that “Though it is in order to supply the necessities and conveniences of the body that the advantages of external fortune are originally recommended to us, yet we cannot live long in the world without perceiving that the respect of our equals, our credit and rank in the society we live in, depend very much upon the degree in which we possess, or are supposed to possess those advantages. The desire of becoming the proper objects of this respect . . . is perhaps the strongest of all our desires” [Smith (1759, pp. 348–349)]. In modern terminology, Adam Smith is referring to a consumption externality.

In this paper, we prove in terms of the prototype model of social common capital that the optimum conditions for sustainable processes of capital accumulation involving both private capital and social common capital coincide precisely with those for market equilibrium with the social common capital taxes at certain specific rates under the stationary expectations hypothesis concerning the future schedule of marginal productivity of capital of all kinds.

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.

We study the money-in-the-utility-function model in which agents are heterogeneous in their initial wealth. We show that the Friedman rule is not optimal even if the government uses nonlinear income taxation for redistribution. A positive nominal interest rate raises social welfare because it relaxes the incentive compatibility constraint for highly endowed agents. Although the setup is close to that of da Costa and Werning [Journal of Political Economy (2008) 116, 82–112], who investigate skill heterogeneity, the role of the nominal interest rate in this paper here differs from the one in their model.

We study labor-income and consumption taxation in an overlapping-generations model featuring endogenous growth due to interfirm investment externalities. Consumption, saving, and labor supply display life-cycle features because mortality and labor productivity are age-dependent and because annuity markets may be imperfect. The government's method of revenue recycling critically affects the growth consequences of taxation. Purely consumptive government spending has a negative impact on growth. Redistribution of tax revenue from dissavers to savers may lead to an increase in growth due to beneficial intergenerational transfer effects.

This paper employs the rolling bicorrelation test to measure the degree of nonlinear departures from a random walk for aggregate stock price indices of fifty countries over the sample period 1995–2005. We find that stock markets in economies with low per capita GDP in general experience more frequent price deviations than those in the high-income group. This clustering effect is not due to market liquidity or other structural characteristics, but instead can be explained by cross-country variation in the degree of private property rights protection. Our conjecture is that weak protection deters the participation of informed arbitrageurs, leaving those markets dominated by sentiment-prone noise traders whose correlated trading causes stock prices in emerging markets to deviate from the random walk benchmarks for persistent periods of time.

In this paper we investigate the issue of whether a floating currency is the right exchange rate regime for Canada or whether Canada should consider a currency union with the United States. In the context of the framework recently proposed by James L. Swofford, we use a semi-nonparametric flexible functional form—the asymptotically ideal model (AIM), introduced by William A. Barnett and A. Jonas—and pay explicit attention to the theoretical regularity conditions of neoclassical microeconomic theory, following the suggestions of William A. Barnett and William A. Barnett and Meenakshi Pasupathy. Our results indicate that U.S. dollar deposits are complements to domestic (Canadian) monetary assets, suggesting that Canada should continue the current exchange rate regime, allowing the exchange rate to float freely with no intervention in the foreign exchange market by the Bank of Canada.

Cultural variables in economic analysis have recently experienced a strong renewal. This evolution sheds a new light on the old debate between the “Beckerian model” of fertility and the “synthesis model” of fertility. In this paper, I propose a fertility model making the evolution of culture endogenous. The whole population is divided into two cultures corresponding to specific preferences for fertility. Parents decide their fertility rate and try to transmit their culture to their children. Differential fertility between cultures gives rise to an evolutionary process while differential effort to transmit the parental culture gives rise to a cultural process. The long-run distribution of preferences and the average total fertility rate both result from interactions between these processes. As a result, a fertility transition cannot appear without productivity shocks in favor of the culture that is not biased toward quantity of children. However, asymmetric productivity shocks are not always sufficient to cause a fertility transition.

This paper analyzes the behavior of a central bank under strong (“Knightian”) uncertainty when the short-run trade-off between output and inflation is represented by the sticky information Phillips curve proposed by Mankiw and Reis [Quarterly Journal of Economics 117(4), 1295–1328 (2002)]. By solving the robust control problem analytically, we show why model uncertainty does not affect the optimal monetary policy response to demand and productivity shocks, whereas it causes a stronger reaction of the monetary policy instrument to a cost-push (i.e., markup) shock. Differently from what occurs in sticky price models, the antiattenuation effect can result in a degree of price level stabilization that is greater or less than that experienced in the rational expectation model, depending on the central bank's degree of conservatism. These results dramatically affect the rationale for delegating monetary policy to a central banker more conservative than the society.

We study how the use of judgment or “add-factors” in forecasting may disturb the set of equilibrium outcomes when agents learn by using recursive methods. We isolate conditions under which new phenomena, which we call exuberance equilibria, can exist in a standard self-referential environment. Local indeterminacy is not a requirement for existence. We construct a simple asset-pricing example and find that exuberance equilibria, when they exist, can be extremely volatile relative to fundamental equilibria.

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.

We use a new statistical test based on the signal coherence function to detect subtle periodicities in the Chilean exchange rate. We resort to a unique intraday data set that allows us to capture persistent cyclical movements during the day that challenge the random walk hypothesis. We provide a microstructural explanation for the observed behavior, and also look at the day-of-the-week effect for the Chilean peso and find that the different days of the week indeed have different behavior patterns. This is an important result for investment allocation and risk assessment.

This paper evaluates the welfare gains arising from deeper trade integration in the European Monetary Union. To do this, the European Monetary Union is represented in a realistic way by an intertemporal general equilibrium model with incomplete financial markets, sticky prices, and home bias in production. The model is estimated and not rejected by the data. Two main results emerge: (i) an increase in vertical trade (occuring at the early stage of the production process) implies welfare gains whereas (ii) an increase in horizontal trade (occuring at the late stage of the production process) implies welfare losses.

This paper investigates the impact of the desire to keep up with the Joneses (KUJ) on economic growth and optimal tax policy in a continuous-time, overlapping-generations model with AK technology and exogenous, gradual retirement. Due to the desire to KUJ, the propensity to consume out of total wealth rises (declines), and the balanced growth rate declines (increases), when the households' individual total (physical and human) wealth is increasing (decreasing) with age. The rate of retirement determines whether or not a household's total wealth is increasing with age. If total wealth is increasing (decreasing) with age, an optimal allocation is decentralized by an intergenerationally progressive (regressive) lump-sum tax system. The desire to KUJ strengthens the intergenerational regressivity (progressivity) of the optimal tax system. The optimal tax implications of the desire to KUJ are a key finding of this paper.

This paper characterizes the saving rate in the Ramsey–Cass–Koopmans model analytically with a general production function when there exist both exogenous and endogenous growth. It points out conditions involving the share of capital and the elasticities of factor and intertemporal substitution under which the saving rate path to its steady-state value exhibits overshooting or undershooting or is monotonic. Simulations illustrate these interesting dynamics. The paper also identifies the general class of production functions that render the saving rate constant along the entire transition path and hence make the Ramsey–Cass–Koopmans model isomorphic to that of Solow and Swan.

This paper studies the long- and short-run relationships between inflation and financial development. Applying the Pooled Mean Group estimator of Pesaran, Shin, and Smith (1999, Journal of the American Statistical Association 94, 621–634) to unbalanced panel data for 87 countries over the period 1960–2005, we find that a negative long-run relationship between inflation and financial development coexists with a positive short-run relationship. However, when the data are split into different income or inflation groups, these results can be observed only in low-income or low-inflation economies.