The new classical view that macroeconomic fluctuations can be modeled as an equilibrium system perturbed by transitory monetary disturbances has been challenged in recent years by another equilibrium view of fluctuations, the so-called real business cycle theory. In this latter framework, shocks to the production function induce both intertemporal substitution of labor supply and permanent shifts in the stochastic trend of output. Monetary shocks, on the other hand, play only a minor role in this view of the cycle. Much of the empirical support for the real business cycle view of fluctuations is based on a re-examination of traditional methods for detrending economic time series. The issues raised by the real business cycle theorists are not new; indeed, they go back at least to the NBER's first business cycle studies. However, the real business cycle theorists attach a radical economic interpretation to what, on the surface, appears to be a purely technical note on the proper method for detrending economic data. This paper reviews the debate over stochastic trends, discusses the economic implications of the real business cycle interpretation of stochastic trend models, and weighs the time series evidence for some of the stronger claims made by real business cycle theorists. We conclude that, while this literature raises real and useful questions about the interpretation of observed fluctuations, the new classical view of the cycle is not ruled out by the data.

This paper reports some empirical evidence on the relation between the expected real interest rate and monetary aggregates in postwar U.S. data. We find some evidence against the hypothesis, implied by the Real Business Cycle model of Litterman and Weiss (1985), that the expected real interest rate follows a univariate autoregressive process, not Granger-caused by monetary aggregates. Our findings, however, are consistent with a more general bivariate model--suggested by what Barro (1987, Chapter 5) refers to as "the basic market-clearing model"--in which the real rate depends on its own lagged values and on lagged output. Taking this bivariate model as our null hypothesis, we find no evidence that money-stock changes have a significant liquidity effect on the expected real interest rate.

We study a variant of the one-sector neoclassical growth model of Diamond in which capital investment must be credit financed, and an adverse selection problem appears in loan markets. The result is that the unfettered operation of credit markets leads to a one-dimensional indeterminacy of equilibrium. Many equilibria display economic fluctuations which do not vanish asymptotically; such equilibria are characterized by transitions between a Walrasian regime in which the adverse selection problem does not matter, and a regime of credit rationing in which it does. Moreover, for some configurations of parameters, all equilibria display such transitions for two reasons. One, the banking system imposes ceilings on credit when the economy expands and floors when it contracts because the quality of public information about the applicant pool of potential borrowers is negatively correlated with the demand for credit. Two, depositors believe that returns on bank deposits will be low (or high): these beliefs lead them to transfer savings out of (into) the banking system and into less (more) productive uses. The associated disintermediation (or its opposite) causes banks to contract (expand) credit. The result is a set of equilibrium interest rates on loans that validate depositors' original beliefs. We investigate the existence of perfect foresight equilibria displaying periodic (possibly asymmetric) cycles that consist of m periods of expansion followed by n periods of contraction, and propose an algorithm that detects all such cycles.

There were three important changes in the United States economy during the 1980s. First, from 1982-90, the decade featured the longest consecutive stretch of positive quarterly output growth in United States history. Second, wage inequality expanded greatly as the wages of highly skilled workers grew markedly faster than the wages of less skilled workers (Katz and Murphy (1992)). Finally, consumption inequality also expanded as the consumption of highly skilled workers grew faster than that of less skilled workers (Attanasio and Davis (1994)). This paper argues that these three aspects of the United States economic experience can be interpreted as being part of an efficient response to a macroeconomic shock given the existence of a particular technological impediment to full insurance. I examine the properties of efficient allocations of risk in an economic environment in which the outside enforcement of risksharing arrangements is infinitely costly. In these allocations, relative productivity movements have effects on both the current and future distribution of consumption across individuals. If preferences over consumption and leisure are nonhomothetic, these changes in the allocation of consumption will generate persistent cycles in aggregate output that do not occur in efficient allocations when enforcement is costless.

We introduce, into a version of the Real Business Cycle model, mild increasing returns-to-scale. These increasing returns-to-scale occur as a consequence of sector specific externalities, that is externalities where the output of the consumption and investment sectors have external effects on the output of firms within their own sector. Keeping the production technologies for both sectors identical for expositional simplicity, we show that indeterminacy can easily occur for parameter values typically used in the real business cycle literature, and in contrast to some earlier literature on indeterminacies, for externalities mild enough so that labor demand curves are downward sloping.

In this paper we make the following three claims. (1), in contradiction with the conventional view according to which the French depression was very different to that observed in the US, we argue that there are more similarities than differences between the French and U.S. experiences and therefore a common explanation should be sought. (2), poor growth in technological opportunities appear neither necessary nor sufficient to account for the French depression. (3), changes in institutional and market regulation appear necessary to account for the overall changes observed over the period. Moreover, we show that the size of these institutional changes may by themselves be enough to quantatively explain the French depression. However, at this time, we have no theory to explain the size or the timing of these changes.

This paper proposes a simple method for guiding researchers in developing quantitative models of economic fluctuations. We show that a large class of models, including models with various frictions, are equivalent to a prototype growth model with time varying wedges that, at least on face value, look like time-varying productivity, labor taxes, and capital income taxes. We label the time varying wedges as efficiency wedges, labor wedges, and investment wedges. We use data to measure these wedges and then feed them back into the prototype growth model. We then assess the fraction of fluctuations accounted for by these wedges during the great depressions of the 1930s in the United States, Germany, and Canada. We find that the efficiency and labor wedges in combination account for essentially all of the declines and subsequent recoveries. Investment wedge plays at best a minor role.

The durable goods sector is much more interest sensitive than the non-durables sector, and these sectoral differences have important implications for monetary policy. In this paper, we perform VAR analysis of quarterly US data and find that a monetary policy innovation has a peak impact on durable expenditures that is roughly five times as large as its impact on non-durable expenditures. We then proceed to formulate and calibrate a two-sector dynamic general equilibrium model that roughly matches the impulse response functions of the data. We derive the social welfare function and show that the optimal monetary policy rule responds to sector-specific inflation rates and output gaps. We show that some commonlyprescribed policy rules perform poorly in terms of social welfare, especially rules that put a higher weight on inflation stabilization than on output gap stabilization. By contrast, it is interesting that certain rules that react only to aggregate variables, including aggregate output gap targeting and rules that respond to a weighted average of price and wage inflation, may yield a welfare level close to the optimum given a typical distribution of shocks.

We report estimates of the dynamic effects of a technology shock, and then use these to estimate the parameters of a dynamic general equilibrium model with money. We find: (i) a positive technology shock drives up hours worked, consumption, investment and output; (ii) the positive response of hours worked reflects that the Fed has in practice accommodated technology shocks; (iii) model parameter values and functional forms that match the response of macroeconomic variables to monetary policy shocks also work well for technology shocks; (iv) while technology shocks account for a large fraction of the lower frequency component of economic fluctuations, they account for only a small part of the business cycle component of fluctuations.

Preliminary and incomplete

We add a nominal tax system to a sticky-price monetary business cycle model. When nominal interest income is taxed, the coefficient on inflation in a Taylor-type monetary policy rule must be significantly larger than one in order for the model economy to have a determinate rational expectations equilibrium. When depreciation is treated as a charge against taxable income, an even larger weight on inflation is required in the Taylor rule in order to obtain a determinate and stable equilibrium. These results have obvious implications for assessing the historical conduct of monetary policy.