Creator: Prescott, Edward C. and Ríos-Rull, José-Víctor Series: Advances in dynamic economics Abstract:
A necessary feature for equilibrium is that beliefs about the behavior of other agents are rational. We argue that in stationary OLG environments this implies that any future generation in the same situation as the initial generation must do as well as the initial generation did in that situation. We conclude that the existing equilibrium concepts in the literature do not satisfy this condition. We then propose an alternative equilibrium concept, organizational equilibrium, that satisfies this condition. We show that equilibrium exists, it is unique, and it improves over autarky without achieving optimality. Moreover, the equilibrium can be readily found by solving a maximization program.
Keyword: Rational behavior, Equilibrium, and Overlapping generations Subject (JEL): D51 - Exchange and Production Economies and E13 - General Aggregative Models: Neoclassical
Creator: Cooley, Thomas F., Hansen, Gary D. (Gary Duane), and Prescott, Edward C. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 535 Keyword: Equilibrium and Business cycle Subject (JEL): E13 - General Aggregative Models: Neoclassical and E32 - Business Fluctuations; Cycles
Creator: McGrattan, Ellen R. and Prescott, Edward C. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 694 Abstract:
Prior to the mid-1980s, labor productivity growth was a useful barometer of the U.S. economy’s performance: it was low when the economy was depressed and high when it was booming. Since then, labor productivity has become significantly less procyclical. In the recent downturn of 2008–2009, labor productivity actually rose as GDP plummeted. These facts have motivated the development of new business cycle theories because the conventional view is that they are inconsistent with existing business cycle theory. In this paper, we analyze recent events with existing theory and find that the labor productivity puzzle is much less of a puzzle than previously thought. In light of these findings, we argue that policy agendas arising from new untested theories should be disregarded.
Keyword: Intangible capital, Nonneutral technology change, Labor productivity, Labor wedge, and RBC models Subject (JEL): E01 - Measurement and Data on National Income and Product Accounts and Wealth; Environmental Accounts, E13 - General Aggregative Models: Neoclassical, and E32 - Business Fluctuations; Cycles
Creator: McGrattan, Ellen R. and Prescott, Edward C. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 610 Abstract:
U.S. stock prices have increased much faster than gross domestic product GDP) in the postwar period. Between 1962 and 2000, corporate equity value relative to GDP nearly doubled. In this paper, we determine what standard growth theory says the equity value should be in 1962 and 2000, the two years for which our steady-state assumption is a reasonable one. We find that the actual valuations were close to the theoretical predictions in both years. The reason for the large run-up in equity value relative to GDP is that the average tax rate on dividends fell dramatically between 1962 and 2000. We also find that, given legal constraints that effectively prohibited the holding of stocks as reserves for pension plans, there is no equity premium puzzle in the postwar period. The average returns on debt and equity are as theory predicts.
Subject (JEL): E13 - General Aggregative Models: Neoclassical, G12 - Asset Pricing; Trading Volume; Bond Interest Rates, and H30 - Fiscal Policies and Behavior of Economic Agents: General
Creator: McGrattan, Ellen R. and Prescott, Edward C. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 494 Abstract:
During the downturn of 2008–2009, output and hours fell significantly while labor productivity rose. These facts have led many to conclude that there is a significant deviation between observations and current macrotheories that assume business cycles are driven, at least in part, by fluctuations in total factor productivities of firms. We show that once investment in intangible capital is included in the analysis, there is no inconsistency. Measured labor productivity rises if the fall in output is underestimated; this occurs when there are large unmeasured intangible investments. Microevidence suggests that these investments are large and cyclically important.
Keyword: Intangible capital, Business cycles, and Productivity Subject (JEL): E13 - General Aggregative Models: Neoclassical and E32 - Business Fluctuations; Cycles
Creator: Prescott, Edward C. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 527 Abstract:
This essay reviews the development of neoclassical growth theory, a unified theory of aggregate economic phenomena that was first used to study business cycles and aggregate labor supply. Subsequently, the theory has been used to understand asset pricing, growth miracles and disasters, monetary economics, capital accounts, aggregate public finance, economic development, and foreign direct investment.
The focus of this essay is on real business cycle (RBC) methodology. Those who employ the discipline behind the methodology to address various quantitative questions come up with essentially the same answer—evidence that the theory has a life of its own, directing researchers to essentially the same conclusions when they apply its discipline. Deviations from the theory sometimes arise and remain open for a considerable period before they are resolved by better measurement and extensions of the theory. Elements of the discipline include selecting a model economy or sometimes a set of model economies. The model used to address a specific question or issue must have a consistent set of national accounts with all the accounting identities holding. In addition, the model assumptions must be consistent across applications and be consistent with micro as well as aggregate observations. Reality is complex, and any model economy used is necessarily an abstraction and therefore false. This does not mean, however, that model economies are not useful in drawing scientific inference.
The vast number of contributions made by many researchers who have used this methodology precludes reviewing them all in this essay. Instead, the contributions reviewed here are ones that illustrate methodological points or extend the applicability of neoclassical growth theory. Of particular interest will be important developments subsequent to the Cooley (1995) volume, Frontiers of Business Cycle Research. The interaction between theory and measurement is emphasized because this is the way in which hard quantitative sciences progress.
Keyword: Depressions, Aggregate financial economics, Development, Aggregation, Neoclassical growth theory, Aggregate economic theory, Prosperities, RBC methodology, and Business cycle fluctuations Subject (JEL): B40 - Economic Methodology: General, E00 - Macroeconomics and Monetary Economics: General, E13 - General Aggregative Models: Neoclassical, E60 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook: General, E32 - Business Fluctuations; Cycles, and C10 - Econometric and Statistical Methods and Methodology: General
Creator: McGrattan, Ellen R. and Prescott, Edward C. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 472 Abstract:
A problem that faces many countries including the United States is how to finance retirement consumption as the population ages. Proposals for switching to a saving-for-retirement system that do not rely on high payroll taxes have been challenged on the grounds that welfare would fall for some groups such as retirees or the working poor. We show how to devise a transition path from the current U.S. system to a saving-for-retirement system that increases the welfare of all current and future generations, with estimates of future gains higher than those found in typically used macroeconomic models. The gains are large because there is more productive capital than commonly assumed. Our quantitative results depend importantly on accounting for differences between actual government tax revenues and what revenues would be if all income were taxed at the income-weighted average marginal tax rates used in our analysis.
Keyword: Medicare, Retirement, Social Security, and Taxation Subject (JEL): E13 - General Aggregative Models: Neoclassical, H55 - Social Security and Public Pensions, and I13 - Health Insurance, Public and Private
Creator: Prescott, Edward C. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 321 Abstract:
Americans now work 50 percent more than do the Germans, French, and Italians. This was not the case in the early 1970s when the Western Europeans worked more than Americans. In this paper, I examine the role of taxes in accounting for the differences in labor supply across time and across countries, in particular, the effective marginal tax rate on labor income. The population of countries considered is that of the G-7 countries, which are major advanced industrial countries. The surprising finding is that this marginal tax rate accounts for the predominance of the differences at points in time and the large change in relative labor supply over time with the exception of the Italian labor supply in the early 1970s.
Keyword: Social Security Reform, International Labor Supply, and International Tax Rates Subject (JEL): E62 - Fiscal Policy, E13 - General Aggregative Models: Neoclassical, E24 - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity, and H20 - Taxation, Subsidies, and Revenue: General
Creator: McGrattan, Ellen R. and Prescott, Edward C. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 534 Abstract:
Many countries are facing challenging fiscal financing issues as their populations age and the number of workers per retiree falls. Policymakers need transparent and robust analyses of alternative policies to deal with demographic changes. In this paper, we propose a simple framework that can easily be matched to aggregate data from the national accounts. We demonstrate the usefulness of our framework by comparing quantitative results for our aggregate model with those of a related model that includes within-age-cohort heterogeneity through productivity differences. When we assess proposals to switch from the current tax and transfer system in the United States to a mandatory saving-for-retirement system with no payroll taxation, we find that the aggregate predictions for the two models are close.
Keyword: Retirement, Medicare, Social Security, and Taxation Subject (JEL): H55 - Social Security and Public Pensions, E13 - General Aggregative Models: Neoclassical, and I13 - Health Insurance, Public and Private