Research Database

We study optimal fiscal policy in a small open economy (SOE) with sovereign and private default risk and limited commitment to tax plans. The SOE's government uses linear taxation to fund exogenous expenditures and uses public debt to inter-temporally allocate tax distortions. We characterize a class of environments in which the tax on labor goes to zero in the long run, while the tax on capital income may be non-zero, reversing the standard prediction of the Ramsey tax literature. The zero labor tax is an optimal long run outcome if the economy is subject to sovereign debt constraints and the domestic households are impatient relative to the international interest rate. The front loading of tax distortions allows the economy to build a large (aggregate) debt position in the presence of limited commitment. We show that a similar result holds in a closed economy with imperfect inter-generational altruism, providing a link with the closed-economy literature that has explored disagreement between the government and its citizens regarding inter-temporal tradeoffs.

Technology change is modeled as the result of decisions of individuals and groups of individuals to adopt more advanced technologies. The structure is calibrated to the U.S. and postwar Japan growth experiences. Using this calibrated structure we explore how large the disparity in the effective tax rates on the returns to adopting technologies must be to account for the huge observed disparity in per capita income across countries. We find that this disparity is not implausibly large.

We extend the analysis of Kiyotaki and Wright, who study an economy in which the different commodities that serve as media of exchange are determined endogenously. Kiyotaki and Wright consider only symmetric, steady-state, pure-strategy equilibria, and find that for some parameter values no such equilibria exist. We consider mixed-strategy equilibria and dynamic equilibria. We prove that a steady-state equilibrium exists for all parameter values and that the number of steady-state equilibria is generically finite. We also show, however, that there may be a continuum of dynamic equilibria. Further, some dynamic equilibria display cycles.

We develop an asset pricing model with flexible heterogeneity in asset demand across investors, designed to match institutional and household holdings. A portfolio choice model implies characteristics-based demand when returns have a factor structure and expected returns and factor loadings depend on the assets' own characteristics. We propose an instrumental variables estimator for the characteristics-based demand system to address the endogeneity of demand and asset prices. Using U.S. stock market data, we illustrate how the model could be used to understand the role of institutions in asset market movements, volatility, and predictability.

Chile and Mexico experienced severe economic crises in the early 1980s. This paper analyzes four possible explanations for why Chile recovered much faster than did Mexico. Comparing data from the two countries allows us to rule out a monetarist explanation, an explanation based on falls in real wages and real exchange rates, and a debt overhang explanation. Using growth accounting, a calibrated growth model, and economic theory, we conclude that the crucial difference between the two countries was the earlier policy reforms in Chile that generated faster productivity growth. The most crucial of these reforms were in banking and bankruptcy procedures.

This note is intended to introduce economists to a simple SIR model of the progression of COVID-19 in the United States over the next 12-18 months. An SIR model is a Markov model of the spread of an epidemic in a population in which the total population is divided into categories of being susceptible to the disease (S), actively infected with the disease (I), and recovered (or dead) and no longer contagious (R). How an epidemic plays out over time is determined by the transition rates between these three states. This model allows for quantitative statements regarding the tradeoff between the severity and timing of suppression of the disease through social distancing and the progression of the disease in the population. Example applications of the model are provided. Special attention is given to the question of if and when the fraction of active infections in the population exceeds 1% (at which point the health system is forecast to be severely challenged) and 10% (which may result in severe staffing shortages for key financial and economic infrastructure) as well as the cumulative burden of the disease over an 18 month horizon.

Theoretical advances in macroeconomics made in the last three decades have had a major influence on macroeconomic policy analysis. Moreover, over the last several decades, the United States and other countries have undertaken a variety of policy changes that are precisely what macroeconomic theory of the last 30 years suggests. The three key developments that have shaped macroeconomic policy analysis are the Lucas critique of policy evaluation due to Robert Lucas, the time inconsistency critique of discretionary policy due to Finn Kydland and Edward Prescott, and the development of quantitative dynamic stochastic general equilibrium models following Finn Kydland and Edward Prescott.

This paper studies the maturity composition and the term structure of interest rate spreads of government debt in emerging markets. In the data, when interest rate spreads rise, debt maturity shortens and the spread on short-term bonds rises more than the spread on long-term bonds. To account for this pattern, we build a dynamic model of international borrowing with endogenous default and multiple maturities of debt. Long-term debt provides a hedge against future fluctuations in interest rate spreads, while short-term debt is more effective at providing incentives to repay. The trade-off between these hedging and incentive benefits is quantitatively important for understanding the maturity structure in emerging markets. When calibrated to data from Brazil, the model accounts for the dynamics in the maturity of debt issuances and its comovement with the level of spreads across maturities.

In this paper, we show that there is substantial comovement between prices of primary commodities such as oil, aluminum, maize, or copper and real exchange rates between developed economies such as Germany, Japan, and the United Kingdom against the US dollar. We therefore explicitly consider the production of commodities in a two-country model of trade with productivity shocks and shocks to the supplies of commodities. We calibrate the model so as to reproduce the volatility and persistence of primary commodity prices and show that it delivers equilibrium real exchange rates that are as volatile and persistent as in the data. The model rationalizes an empirical strategy to identify the fraction of the variance of real exchange rates that can be accounted for by the underlying shocks, even if those are not observable. We use this strategy to argue that shocks that move primary commodity prices account for a large fraction of the volatility of real exchange rates in the data. Our analysis implies that existing models used to analyze real exchange rates between large economies that mostly focus on trade between differentiated final goods could benefit, in terms of matching the behavior of real exchange rates, by also considering trade in primary commodities.

Doan, Litterman, and Sims (DLS) have suggested using conditional forecasts to do policy analysis with Bayesian vector autoregression (BVAR) models. Their method seems to violate the Lucas critique, which implies that coefficients of a BVAR model will change when there is a change in policy rules. In this paper we construct a BVAR macro model and attempt to determine whether the Lucas critique is important quantitatively. We find evidence following two candidate policy rule changes of significant coefficient instability and of a deterioration in the performance of the DLS method.

We provide theory for calculating bounds on both the value of an individual’s human capital and the return on an individual’s human capital, given knowledge of the process governing earnings and financial asset returns. We calculate bounds using U.S. data on male earnings and financial asset returns. The large idiosyncratic component of earnings risk implies that bounds on values and returns are quite loose. However, when aggregate shocks are the only source of earnings risk, both bounds are tight.

Many economists have worried about changes in the demand for money, since money demand shocks can affect output variability and have implications for monetary policy. This paper studies the theoretical implications of changes in money demand for the nonneutrality of money in the limited participation (liquidity) model and the predetermined (sticky) price model. In the liquidity model, we find that an important connection exists between the nonneutrality of money and the relative money demands of households and firms. This model predicts that the real effect of a money shock rose by 100 percent between 1952 and 1980, and subsequently declined 65 percent. In contrast, we find that the nonneutrality of money in the sticky price model is invariant to changes in money demands or other monetary factors. Several researchers have concluded from VAR analyses that the effects of money shock over time are roughly stable. This view is consistent with the predictions of the sticky price model, but is harder to reconcile with the specific pattern of time variation predicted by the liquidity model.

We argue that the rationalization gains often predicted by static applied general equilibrium models with imperfect competition and scale economies are artificially boosted by an unrealistic treatment of fixed costs. We introduce sunk costs into one such model calibrated with real-world data. We show how this changes the oligopoly game in a way significant enough to affect, both qualitatively and quantitatively, the outcome of a trade liberalization exercise.

How does a country’s choice of exchange rate regime impact its ability to borrow from abroad? We build a small open economy model in which the government can potentially respond to shocks via domestic monetary policy and by international borrowing. We assume that debt repayment must be incentive compatible when the default punishment is equivalent to permanent exclusion from debt markets. We compare a floating regime to full dollarization.

We find that dollarization is potentially beneficial, even though it means the loss of the monetary instrument, precisely because this loss can strengthen incentives to maintain access to debt markets. Given stronger repayment incentives, more borrowing can be supported, and thus dollarization can increase international financial integration. This prediction of theory is consistent with the experiences of El Salvador and Ecuador, which recently dollarized, as well as with that of highly-indebted countries like Italy which adopted the Euro as part of Economic and Monetary Union: in each case, around the time of regime change, spreads on foreign currency government debt declined substantially.

In this paper we propose a general equilibrium model where heterogeneous agents specialize either in legitimate market activities or in criminal activities and majority rule determines the share of income redistributed and the expenditures devoted to the apprehension of criminals. We calibrate our model to the U.S. economy in 1990, and we conduct simulation exercises to evaluate the effectiveness of expenditures on police protection and income redistribution at reducing crime. We find that while expenditures on police protection reduce crime, it is possible for the crime rate to increase with redistribution. We also show that economies that adopt relatively more generous redistribution policies may have either higher or lower crime rates than economies with relatively less generous redistribution policies, depending on the characteristics of their wage distribution and on the efficiency of their apprehension technology.

Many kinds of economic behavior involve discrete and occasional individual choices. Despite this, econometric partial adjustment models perform relatively well at the aggregate level. Analyzing the classic employment adjustment problem, we show how such microeconomic adjustment is well described by a new form of partial adjustment model that aggregates the actions of heterogeneous producers.

We develop a model where individual establishments infrequently alter the sizes of their workforces because such adjustments involve fixed costs. In the market equilibrium, employment responses to aggregate disturbances include changes both in target employments selected by individual establishments and in the measure of establishments actively undertaking adjustment. Yet the model retains a partial adjustment flavor in its aggregate responses. Moreover, in contrast to existing discrete adjustment models, our generalized partial adjustment model is sufficiently tractable to allow general equilibrium analysis, and it naturally extends to accommodate persistent differences in productivity across establishments in general equilibrium.

This paper studies household beliefs during the recent US housing boom. To characterize the heterogeneity in households’ views about housing and the economy, we perform a cluster analysis on survey responses at different stages of the boom. The estimation always finds a small cluster of households who believe it is a good time to buy a house because house prices will rise further. The size of this “momentum” cluster doubled towards the end of the boom. We also provide a simple search model of the housing market to show how a small number of optimistic investors can have a large effect on prices without buying a large share of the housing stock.

This paper is an extension of Monika Piazzesi's and Martin Schneider's work while they were in the Research Department of the Federal Reserve Bank of Minneapolis.

No abstract available.

We consider a production economy with a finite number of heterogeneous, infinitely lived consumers. We show that, if the economy is smooth enough, equilibria are locally unique for almost all endowments. We do so by converting the infinite-dimensional fixed point problem stated in terms of prices and commodities into a finite-dimensional Negishi problem involving individual weights in a social value function. By adding artificial fixed factors to utility and production functions, we can write the equilibrium conditions equating spending and income for each consumer entirely in terms of time-zero factor endowments and derivatives of the social value function.

We show how to decentralize constrained efficient allocations that arise from enforcement constraints between sovereign nations. In a pure exchange economy, these allocations can be decentralized with private agents acting competitively and taking as given government default decisions on foreign debt. In an economy with capital, these allocations can be decentralized if the government can tax capital income as well as default on foreign debt. The tax on capital income is needed to make private agents internalize a subtle externality. The decisions of the government can arise as an equilibrium of a dynamic game between governments.

In what order should a developing country adopt policy reforms? Do some policies complement each other? Do others substitute for each other? To address these questions, we develop a two-country dynamic general equilibrium model with entry and exit of firms that are monopolistic competitors. Distortions in the model include barriers to entry of firms, barriers to international trade, and barriers to contract enforcement. We find that a reform that reduces one of these distortions has different effects depending on the other distortions present. In particular, reforms to trade barriers and barriers to the entry of new firms are substitutable, as are reforms to contract enforcement and trade barriers. In contrast, reforms to contract enforcement and the barriers to entry are complementary. Finally, the optimal sequencing of reforms requires reforming trade barriers before contract enforcement.

Search theory routinely assumes that decisions about the acceptance/rejection of job offers (and, hence, about labor market movements between jobs or across employment states) are made by individuals acting in isolation. In reality, the vast majority of workers are somewhat tied to their partners—in couples and families—and decisions are made jointly. This paper studies, from a theoretical viewpoint, the joint job-search and location problem of a household formed by a couple (e.g., husband and wife) who perfectly pools income. The objective of the exercise, very much in the spirit of standard search theory, is to characterize the reservation wage behavior of the couple and compare it to the single-agent search model in order to understand the ramifications of partnerships for individual labor market outcomes and wage dynamics. We focus on two main cases. First, when couples are risk averse and pool income, joint search yields new opportunities—similar to on-the-job search—relative to the single-agent search. Second, when the two spouses in a couple face job offers from multiple locations and a cost of living apart, joint search features new frictions and can lead to significantly worse outcomes than single-agent search.

We solve equilibrium models of lumpy investment wherein establishments face persistent shocks to common and plant-specific productivity. Nonconvex adjustment costs lead plants to pursue generalized (S, s) rules with respect to capital; thus, their investments are lumpy. In partial equilibrium, this yields substantial skewness and kurtosis in aggregate investment, though, with differences in plant-level productivity, these nonlinearities are far less pronounced. Moreover, nonconvex costs, like quadratic adjustment costs, increase the persistence of aggregate investment, yielding a better match with the data. In general equilibrium, aggregate nonlinearities disappear, and investment rates are very persistent, regardless of adjustment costs. While the aggregate implications of lumpy investment change substantially in equilibrium, the inclusion of fixed costs or idiosyncratic shocks makes the average distribution of plant investment rates largely invariant to market-clearing movements in real wages and interest rates. Nonetheless, we find that understanding the dynamics of plant-level investment requires general equilibrium analysis.

This study attempts to determine whether entry regulation is more restrictive in unit or branch banking states.

A model is developed in which entry, defined as the formation of a new bank or branch, is explained as being a response to the general economic climate plus regulation. Using time series data and dating the onset of effective entry regulation with the passage of the banking Act of 1935, it is ascertained that effective entry regulation has caused the aggregate rate of entry into commercial banking to fall by about sixty percent. This analysis included adjustments for changes in economic conditions. The effect of entry regulation, however, has not been uniform. Entry rates in unit banking states is estimated to be seventy percent lower than it would have been in the absence of regulation, while limited branching and statewide branching states have experienced fifty and forty percent declines, respectively.

This analysis suggests that entry in unit banking states has been more restricted than in branch banking states. Two reasons are cited that may account for this differential impact of regulation. First, regulators may tend to be more pessimistic than potential entrants regarding the profitability of a new banking office. This pessimism may not have a significant effect upon entry when other factors indicate a high probability of success, but may be important in marginal cases. Thus, because branch banking states tend to be more prevalent in the west, and because this has been the area of greatest economic growth in the past forty years, the pessimism of regulators would tend to be less apparent in branch banking areas. Second, regulators apparently prefer to issue charters for new branches rather than for new banks because they have more information on which to base their decisions. In addition, if the market demand is misjudged, a branch bank has retained earnings and other branches from which to carry short-term losses.

The central finding of the recent structural vector autoregression (SVAR) literature with a differenced specification of hours is that technology shocks lead to a fall in hours. Researchers have used this finding to argue that real business cycle models are unpromising. We subject this SVAR specification to a natural economic test and show that when applied to data from a multiple-shock business cycle model, the procedure incorrectly concludes that the model could not have generated the data as long as demand shocks play a nontrivial role. We also test another popular specification, which uses the level of hours, and show that with nontrivial demand shocks, it cannot distinguish between real business cycle models and sticky price models. The crux of the problem for both SVAR specifications is that available data require a VAR with a small number of lags and such a VAR is a poor approximation to the model’s VAR.

No abstract available.

Portfolio autarky obtains when residents of every country are prohibited from owning real assets located in other countries. Such a regime and a laissez-faire regime, both characterized by free trade in goods, are studied in a model whose resource and technology assumptions are those of the standard two-country, two- (nonreproducible) factor, two- (nonstorable) good model. But to ensure a market for assets (land), the model is peopled by overlapping generations; each two-period lived individual supplies one unit of labor only in the first period of his life. Unique equilibria are described and shown to exist, and, in terms of a “growth model” version of the Pareto criterion, laissez-faire is shown to be optimal and portfolio autarky to be nonoptimal.

Scapegoating is often said to be a source of inefficiency in organizations. In this paper, I analyze the consequences of scapegoating within a firm in a model where reputation concerns drive the actions of superiors. Consider delegation choices, for example. Hiring efficient workers may be a good idea if successful production is the only way to build reputation. But if successful scapegoating also increases reputation, superiors will tend to hire less efficient workers and will eventually blame them for failures. I characterize scapegoating as an activity “nested” after failures. Even though the results of scapegoating do not affect welfare directly, they do so indirectly through the decisions governing the probability of success in production. We examine how activities “nested” after good results may increase efficiency without relying on costly incentives and why superiors tend to hire better workers during good times.

I argue that Farmer and Guo's one-sector real business cycle model with indeterminacy and sunspots fails empirically and that its failure is inherent in the logic of the model taken together with some simple labor market facts.

Concentration of insured deposit funding among the top four commercial banks in the U.S. has risen from 15% in 1984 to 44% in 2018, a roughly three-fold increase. Regulation has often been attributed as a factor in that increase. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 removed many of the restrictions on opening bank branches across state lines. We interpret the Riegle-Neal act as lowering the cost of expanding a bank's funding base. In this paper, we build an industry equilibrium model in which banks endogenously climb a funding base ladder. Rising concentration occurs along a transition path between two steady states after branching costs decline.

Most firms begin very small, and large firms are the result of typically decades of persistent growth. This growth can be understood as the result of some form of organization capital accumulation. In the US, the distribution of firm size k has a right tail only slightly thinner than 1/k. This is shown to imply that incumbent firms account for most aggregate organization capital accumulation. And it implies potentially extremely slow aggregate convergence rates. A benchmark model is proposed in which managers can use incumbent organization capital to create new organization capital. Workers are a specific factor for producing consumption, and they require managerial supervision. Through the lens of the model, the aftermath of the Great Recession of 2008 is unsurprising if the events of late 2008 and early 2009 are interpreted as a destruction of organization capital, or as a belief shock that made consumers want to reduce consumption and accumulate more wealth instead.

The puzzling behavior of inflation in the Great Recession and its aftermath has increased the need to better understand the constraints that firms face when setting prices. Using new data and theory, I demonstrate that each firm's choice of how much information to acquire to set prices determines aggregate price dynamics through the patterns of pricing at the micro level, and through the large heterogeneity in pricing policies across firms. Viewed through this lens, the behavior of prices in recent years becomes less puzzling, as firms endogenously adjust their information acquisition strategies. In support of this mechanism, I present micro evidence that firms price goods using plans that are sticky, coarse, and volatile. A theory of information-constrained price setting generates such policies endogenously, and quantitatively matches the discreteness, duration, volatility, and heterogeneity of policies in the data. Policies track the state noisily, resulting in sluggish adjustment to shocks. A higher volatility of shocks does not reduce monetary non-neutrality and generates slight inflation, while progress in the technology to acquire information results in deflation.

We document that declining hours worked are the primary driver of widening inequality in the bottom half of the male labor earnings distribution in the United States over the past 52 years. This decline in hours is heavily concentrated in recessions: hours and earnings at the bottom fall sharply in recessions and do not fully recover in subsequent expansions. Motivated by this evidence, we build a structural model to explore the possibility that recessions cause persistent increases in inequality; that is, that the cycle drives the trend. The model features skill-biased technical change, which implies a trend decline in low-skill wages relative to the value of non-market activities. With this adverse trend in the background, recessions imply a potential double-whammy for low skilled men. This group is disproportionately likely to experience unemployment, which further reduces skills and potential earnings via a scarring effect. As unemployed low skilled men give up job search, recessions generate surges in non-participation. Because non-participation is highly persistent, earnings inequality remains elevated long after the recession ends.

No abstract available.

This paper describes how to specify and estimate rational expectations models in which there are exact linear relationships among variables and expectations of variables that the econometrician observes.

This paper essentially puts together procedures that are used in the computation of equilibria in models with a very large number of heterogeneous agents. It is not a complete description of all procedures used in the literature. It describes procedures that deal with infinitely lived agent versions of the growth model with and without aggregate uncertainty, overlapping generations models, and dynamic political economy models.

In this paper we analyze the efficacy of seignorage as a tax associated with various monetary arrangements in a computable general equilibrium model. For the economies examined, we find that seignorage tax is not a good one relative to a tax on labor income. If the after-tax real return is –5 percent, as it was in the 1974–1978 period, welfare is approximately 0.5 percent of consumption lower than it would be if the after-tax return were zero.

The relative efficiency of alternative income tax systems is analyzed in a dynamic, general equilibrium model having an endogenous labor supply and imperfect risk sharing. This theoretical model allows different tax systems to be compared with respect to their labor distortion effects, their automatic income stability properties, and the welfare they provide on average to a representative consumer-laborer. The comparisons are done for the optimal tax parameters under each given tax system. Despite a role for income stabilization, the optimal income tax schedule turns out to be regressive.

This paper provides a simple counterexample to the standard belief that in a world economy in which all countries are small, strategic interactions between policymakers are trivial and thus cooperative and noncooperative government policies coincide. It is well known that this holds for tariff policies. However, this paper demonstrates the result does not apply to government policies generally. Indeed, this paper presents a simple counterexample for the case of fiscal policy. In addition, the paper analyzes how optimally coordinated fiscal policies differ from noncooperative policies. It finds that, relative to optimally coordinated levels, noncooperative government spending can be too high or too low, depending on the sign of a transmission effect which captures the overall effect countries’ actions have on each other.

Many unions in the United States have for several years engaged in what is known as pattern bargaining—a union determines a sequence for negotiations with firms within an industry where the agreement with the first firm becomes the take-it-or-leave-it offer by the union for all subsequent negotiations. In this paper, we show that pattern bargaining is preferred by a union to both simultaneous industrywide negotiations and sequential negotiations without a pattern. In recent years, unions have increasingly moved away from patterns that equalized wage rates across firms when these patterns did not equalize interfirm labor costs. Allowing for interfirm productivity differentials within an industry, we show that for small interfirm productivity differentials, the union most prefers a pattern in wages, but for a sufficiently wide differential, the union prefers a pattern in labor costs.

We ask what fraction of the variation in incomes across countries can be accounted for by investment distortions. In our neoclassical growth model the relative price of investment to consumption is a good measure of the distortions. Using data on relative prices we estimate a stochastic process for distortions and compare the resulting variance of incomes in the model to that in the data. We find that the variation of incomes in the model is roughly 4/5 of the variability of incomes in the data. Our model does well in accounting for 6 key regularities on income and investment in the data.

The paper itself is followed by three appendices: Appendix 1 describing the log-likelihood function, Appendix 2 describing the construction of labor share of income associated with the production of consumption and investment goods, and the Data Appendix.

Many stock market analysts think that in 1929, at the time of the crash, stocks were overvalued. Irving Fisher argued just before the crash that fundamentals were strong and the stock market was undervalued. In this paper, we use growth theory to estimate the fundamental value of corporate equity and compare it to actual stock valuations. Our estimate is based on values of productive corporate capital, both tangible and intangible, and tax rates on corporate income and distributions. The evidence strongly suggests that Fisher was right. Even at the 1929 peak, stocks were undervalued relative to the prediction of theory.

No abstract available.

Intellectual property protection involves a trade-off between the undesirability of monopoly and the desirable encouragement of creation and innovation. As the scale of the market increases, due either to economic and population growth or to the expansion of trade through treaties such as the World Trade Organization, this trade-off changes. We show that, generally speaking, the socially optimal amount of protection decreases as the scale of the market increases. We also provide simple empirical estimates of how much it should decrease.

This paper provides a new rationalization for deposit insurance and systemic disintermediations. I consider an environment in which borrowers face no penalty for failing to repay obligations except the loss of their collateral. I assume that this collateral has aggregate risk. For a subset of the exogenous parameters, I demonstrate that an optimal arrangement features deposit insurance. For a strictly smaller set of parameters, it is optimal in some states of the world to have systemic disintermediation and concomitant falls in real output.

Between 1913 and 1929, real GDP per person in the UK fell 1 percent, while this same measure of economic activity rose about 25 percent in the rest of the world. Why was Britain so depressed in a decade of strong economic activity around the world? This paper argues that the standard explanations of contractionary monetary shocks and an overvalued nominal exchange rate are not the prime suspects for killing the British economy. Rather, we argue that large, negative sectoral shocks, coupled with generous unemployment benefits and housing subsidies, are the primary causes of this long and deep depression.

This paper develops new recursive methods for studying stationary sequential equilibria in games with private monitoring. We first consider games where play has occurred forever into the past and develop methods for analyzing a large class of stationary strategies, where the main restriction is that the strategy can be represented as a finite automaton. For a subset of this class, strategies which depend only on the players’ signals in the last k periods, these methods allow the construction of all pure strategy equilibria. We then show that each sequential equilibrium in a game with infinite histories defines a correlated equilibrium for a game with a start date and derive simple necessary and sufficient conditions for determining if an arbitrary correlation device yields a correlated equilibrium. This allows, for games with a start date, the construction of all pure strategy sequential equilibria in this subclass.

Recent studies say prices change about every four months. Economists have interpreted this high frequency as evidence against the importance of sticky prices for the real effects of monetary policy. Theory implies that this interpretation is correct if most price changes are regular, but not if most are temporary, as in the data. Temporary changes have a striking feature: after such a change, the nominal price tends to return exactly to its preexisting level. We study versions of Calvo and menu cost models that replicate this feature. Both models predict that the degree of aggregate price stickiness is determined mostly by the frequency of regular price changes, not by the combined frequency of temporary and regular price changes. Since regular prices are sticky in the data, the models predict a substantial degree of aggregate price stickiness even though micro prices change frequently. In particular, the aggregate price level in our models is as sticky as in standard models in which micro prices change about once a year. In this sense, prices are sticky after all.

In order to analyze careers both within and across firms, this paper proposes a matching model of the labor market that extends existing models of job assignment and learning about workers’ abilities. The model accounts for worker mobility across jobs and firms, for varying degrees of generality of ability, and for the possibility that firms affect the information they acquire about workers through job assignment. I characterize equilibrium assignment and wages, and show how, depending on how abilities and jobs are distributed across firms, equilibrium gives rise to widely varying patterns of job mobility within firms and turnover across firms, even if matching would be perfectly assortative in the absence of uncertainty. The implied job and wage dynamics display features that are consistent with a broad set of empirical findings on careers in firms and the labor market. In particular, workers can experience gradual promotions and wage increases following successful performance but few or no demotions when employed by the same firm. The model also produces turnover across firms and occupations after both successful and unsuccessful experiences, leading to wage increases or decreases following a firm or occupation change. Overall, the results in this paper provide a unified framework in which to interpret the dynamics of jobs and wages in firms and the labor market.