Courts of Law and Unforeseen Contingencies

We study a contracting model with unforeseen contingencies inwhich the court is an active player. Ex ante, the contractingparties cannot include the risky unforeseen contingencies inthe contract they draw up. Ex post, the court observes whetheran unforeseen contingency occurred and decides whether to voidor uphold the contract. If the contract is voided by the court,the parties can renegotiate a new agreement ex post. There aretwo effects of a court that voids contracts. The parties' incentivesto undertake relationship-specific investment are reduced, andthe parties enjoy greater insurance against the unforeseen contingenciesthat the ex ante contract cannot account for. In this context,we fully characterize the optimal decision rule for the court.The behavior of the optimal court is determined by the trade-offbetween the need for incentives and the gains from insurancethat voiding in some circumstances offers to the agents.     

Testing the New Keynesian Phillips Curve Through Vector Autoregressive Models: Results from the Euro Area*

This paper addresses the issue of testing the ‘hybrid’ New Keynesian Phillips curve (NKPC) through vector autoregressive (VAR) systems and likelihood methods, giving special emphasis to the case where the variables are non‐stationary. The idea is to use a VAR for both the inflation rate and the explanatory variable(s) to approximate the dynamics of the system and derive testable restrictions. Attention is focused on the ‘inexact’ formulation of the NKPC. Empirical results over the period 1971–98 show that the NKPC is far from providing a ‘good first approximation’ of inflation dynamics in the Euro area.     

Do minimum quality standards bite in polluting industries?

We investigate the introduction of a minimum quality standard in a vertically differentiated duopoly where production is polluting. We examine the alternative frameworks with quality-dependent fixed or variable costs, under both price and quantity competition. Under Bertrand behaviour, the introduction of a binding MQS regulation reduces product differentiation, which causes an increase in the output and pollution. Hence its adoption must rely on the increase in consumer surplus generated by the increase in output and average quality. Conversely, in the Cournot setting, a binding MQS decreases output and pollution, and its adoption is driven by the fact that the balance between these effects and the associated increase in average quality yields a welfare improvement.     

Fiscal adjustments,labour market flexibility and unemployment

Using a panel of 17 countries for 1978–2009, we find that tax-driven consolidations increase unemployment by 0.25 percentage points. Labour market flexibility mitigates this: a one-point rise in the flexibility index reduces youth (long-term) unemployment by 0.6–0.7 (1.8–2.2) percentage points.     

Macroeconomic forecasting and structural change

The aim of this paper is to assess whether modeling structural change can help improving the accuracy of macroeconomic forecasts. We conduct a simulated real‐time out‐of‐sample exercise using a time‐varying coefficients vector autoregression (VAR) with stochastic volatility to predict the inflation rate, unemployment rate and interest rate in the USA. The model generates accurate predictions for the three variables. In particular, the forecasts of inflation are much more accurate than those obtained with any other competing model, including fixed coefficients VARs, time‐varying autoregressions and the naïve random walk model. The results hold true also after the mid 1980s, a period in which forecasting inflation was particularly hard. Copyright © 2011 John Wiley & Sons, Ltd.     

Discrimination,technology and unemployment

I study the interaction between discrimination and investment using a directed search model where firms decide the capital intensity of their production technologies before being matched. Discrimination makes some workers cheap to hire. As a consequence, some firms might save on capital costs adopting labour intensive technologies. This framework allows one to reconcile search models with three well-known facts regarding the labour market outcomes of minority workers: low wages, high unemployment and occupational segregation. Furthermore, the model questions the role of equal pay legislation in reducing inequality since removing this restriction, i.e., allowing firms to post type-contingent wages, eliminates the negative effects of discrimination on investment and wages.     

A Range-Based Finite Difference Approach to Valuing Options in Markov Switching Regimes*

Recognizing the inflexibility inherent in standard capital budgeting analysis, recent research has provided new insights using a real options framework. This paper uses the explicit finite difference approach to value real options. However, instead of assuming a constant return and volatility term, we assume that these variables are sensitive to changes in the economic environment. Accordingly, we adapt our approach to incorporate a Markov switching feature. Further, we recognize that some of the modeling assumptions can be violated in a practical application. Therefore, we recommend using range based estimates of the real option value, as opposed to a point estimate.     

On economic growth and minimum wages

We offer an analysis of the existence of a positive relationship between minimum wages and economic growth in a simple one-sector overlapping generations economy à la Romer (J Polit Econ 94:1002–1037, 1986), in the case of both homogeneous and heterogeneous labour and without considering any growth-sustaining externalities which the minimum wage can generate. Assuming also the existence of unemployment benefits financed with balanced-budget consumption taxes not conditional upon age, we show that the minimum wage can promote economic growth and welfare despite the occurrence of unemployment. There may also exist a growth- and welfare-maximising minimum wage.