Research Database

We present a 2-country model with heterogeneous agents in which changes in a country’s monetary policy affect real interest rates, relative prices of traded and nontraded goods and real exchange rates. Nontransitory real effects of monetary policy stem solely from a friction (country-specific reserve requirements) that generates separate demands for a country’s money and bonds. Without violating the classical assumptions of individual rationality and flexible prices, the model’s implications seem qualitatively in accord with the U.S. experience of the 1980s: a monetary policy tightening leading to a rise in the real interest rate and to an initial rise in the real value of the dollar which is subsequently reversed. In the model a monetary policy change leads to different welfare effects for agents born at different times, living in different countries, or participating on different sides of a market. The welfare of some agents can be affected more by relative price changes than by real interest rate changes.

This paper presents a dynamic, stochastic general equilibrium study of the causes of the international Great Depression. We use a fully articulated model to assess the relative contributions of deflation/monetary shocks, which are the most commonly cited shocks for the Depression, and productivity shocks. We find that productivity is the dominant shock, accounting for about 2/3 of the Depression, with the monetary shock accounting for about 1/3. The main reason deflation doesn’t account for more of the Depression is because there is no systematic relationship between deflation and output during this period. Our finding that a persistent productivity shock is the key factor stands in contrast to the conventional view that a continuing sequence of unexpected deflation shocks was the major cause of the Depression. We also explore what factors might be causing the productivity shocks. We find some evidence that they are largely related to industrial activity, rather than agricultural activity, and that they are correlated with real exchange rates and non-deflationary shocks to the financial sector.

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Applied general equilibrium models with imperfect competition and economies of scale have been extensively used for analyzing international trade and development policy issues. They offer a natural framework for testing the empirical relevance of propositions from the industrial organization and new trade theoretical literature. This paper warns model builders and users that considerable caution is needed in interpreting the results and deriving strong policy conclusions from these models: in this generation of applied general equilibrium models, nonuniqueness of equilibria is not a theoretical curiosum, but a potentially serious problem. Disregarding this may lead to dramatically wrong policy appraisals.

This paper quantitatively tests the “new trade theory” based on product differentiation, increasing returns, and imperfect competition. We employ a standard model, which allows both changes in the distribution of income among industrialized countries, emphasized by Helpman and Krugman (1985), and nonhomothetic preferences, emphasized by Markusen (1986), to effect trade directions and volumes. In addition, we generalize the model to allow changes in relative prices to have large effects. We test the model by calibrating it to 1990 data and then “backcasting” to 1961 to see what changes in crucial variables between 1961 and 1990 are predicted by the theory. The results show that, although the model is capable of explaining much of the increased concentration of trade among industrialized countries, it is not capable of explaining the enormous increase in the ratio of trade to income. Our analysis suggests that it is policy changes, rather than the elements emphasized in the new trade theory, that have been the most significant determinants of the increase in trade volume.

The magnitude of and heterogeneity in systematic earnings risk has important implications for various theories in macro, labor, and financial economics. Using administrative data, we document how the aggregate risk exposure of individual earnings to GDP and stock returns varies across gender, age, the worker’s earnings level, and industry. Aggregate risk exposure is U-shaped with respect to the earnings level. In the middle of the earnings distribution, aggregate risk exposure is higher for males, younger workers, and those in construction and durable manufacturing. At the top of the earnings distribution, aggregate risk exposure is higher for older workers and those in finance. Workers in larger employers are less exposed to aggregate risk, but they are more exposed to a common factor in employer-level earnings, especially at the top of the earnings distribution. Within an employer, higher-paid workers have higher exposure to employer-level risk than lower-paid workers.

Inflation expectations have recently received increased interest because of the uncertainty created by the Federal Reserve’s unprecedented reaction to the Great Recession. The effect of this reaction on the real economy is also an important topic. In this paper I use various surveys to produce a term structure of inflation expectations – inflation expectations at any horizon from 3 to 120 months – and an associated term structure of real interest rates. Inflation expectations extracted from this model track actual (ex-post) realizations of inflation quite well, and in terms of forecast accuracy they are at par with or superior to some popular alternatives obtained from financial variables. Looking at the period 2008–2013, I conclude that the unconventional policies of the Federal Reserve kept long-run inflation expectations anchored and provided a large level of monetary stimulus to the economy.

This paper argues that the comovement between inflation and economic activity is an important determinant of real interest rates over time and across countries. First, we show that for advanced economies, periods with more procyclical inflation are associated with lower real rates, but only when there is no risk of default on government debt. Second, we present a model of nominal sovereign debt with domestic risk-averse lenders. With procyclical inflation, nominal bonds pay out more in bad times, making them a good hedge against aggregate risk. In the absence of default risk, procyclical inflation yields lower real rates. However, procyclicality implies that the government needs to make larger (real) payments when the economy deteriorates, which could increase default risk and trigger an increase in real rates. The patterns of real rates predicted by the model are quantitatively consistent with those documented in the data.

This paper studies optimal taxation of earnings when the degree of tax progressivity is allowed to vary with age. The setting is an overlapping-generations model that incorporates irreversible skill investment, flexible labor supply, ex-ante heterogeneity in the disutility of work and the cost of skill acquisition, partially insurable wage risk, and a life cycle productivity profile. An analytically tractable version of the model without intertemporal trade is used to characterize and quantify the salient trade-offs in tax design. The key results are that progressivity should be U-shaped in age and that the average marginal tax rate should be increasing and concave in age. These findings are confirmed in a version of the model with borrowing and saving that we solve numerically.

In standard approaches to monetary policy, interest rate rules often lead to indeterminacy. Sophisticated policies, which depend on the history of private actions and can differ on and off the equilibrium path, can eliminate indeterminacy and uniquely implement any desired competitive equilibrium. Two types of sophisticated policies illustrate our approach. Both use interest rates as the policy instrument along the equilibrium path. But when agents deviate from that path, the regime switches, in one example to money; in the other, to a hybrid rule. Both lead to unique implementation, while pure interest rate rules do not. We argue that adherence to the Taylor principle is neither necessary nor sufficient for unique implementation with pure interest rate rules but is sufficient with hybrid rules. Our results are robust to imperfect information and may provide a rationale for empirical work on monetary policy rules and determinacy.