A Q-theory model with lumpy investment

We present an analytically tractable dynamic stochastic general equilibrium model that incorporates micro-level fixed and convex adjustment costs. We provide an explicit characterization of equilibrium dynamics by a system of nonlinear stochastic difference equations. We provide general conditions under which our model features investment lumpiness at the microeconomic level, but aggregate dynamics are isomorphic to those in a Q-theory model without fixed costs. This theoretical result is independent of the specification of the fixed cost distribution and also holds true when firms face persistent idiosyncratic productivity shocks.     

Capital reallocation: A tale of two frictions*

This paper explores the role of search and financial frictions in the used capital market. A tractable dynamic general equilibrium model with both frictions is developed to account for procyclicality of reallocation and the price of used capital. Both the aggregate productivity shock and the financial shock can generate procyclical reallocation of used capital. Quantitatively, the financial shock accounts for almost all the variation of used capital reallocation. The aggregate productivity shock is more responsible for the variation of the price of used capital as well as variables outside the used capital market.     

House price to income ratio and fundamentals: Evidence on long‐horizon forecastability

This paper studies the relationship between the house price‐to‐income ratio (PIR) and economic fundamentals, and investigates the long‐horizon forecastability of the PIR. We first construct a small DSGE model to derive a dynamic expression of PIR, linking PIR to macroeconomic fundamentals and the stance of monetary policy. Based on the theoretically derived PIR, variance decomposition suggests that interest rate and real income growth appear to be the main sources for the deviations of PIR. Using the difference between actual PIR and the estimated fundamental PIR as the predictor, we find that both in‐sample and out‐of‐sample forecastability of the PIR over the future dynamics of PIR are significant.     

Uninsured idiosyncratic investment risk and aggregate saving

This paper augments the neoclassical growth model to study the macroeconomic effects of uninsured idiosyncratic investment, or capital-income, risk. Under standard assumptions for preferences and technologies, individual policy rules are linear in individual wealth, ensuring that the equilibrium dynamics for aggregate quantities and prices are independent of the wealth distribution. The analysis thus remains highly tractable despite the incompleteness of markets. As compared to complete markets, the steady state is characterized by both a lower interest rate and a lower capital stock when the elasticity of intertemporal substitution is higher than the fraction of private equity in total wealth. For empirically plausible parameterizations, this condition is easily satisfied, and the reduction in aggregate saving and income is quantitatively significant. These findings contrast with Bewley models, where idiosyncratic labor-income risk leads to higher aggregate saving and income.     

Increased price flexibility and output stability

Simulation results of previous authors show an ambiguous effect of increased price flexibility on output stability in models incorporating a Mundell inflation effect on aggregate demand. This paper interprets their results in an analytically tractable model with imperfect, goods-market competition. To be destabilizing, increased flexibility must increase the “hump” of the price level's response to demand shocks. Output variability is always reduced by increasing the size of the flex-price sector and sometimes reduced by shortening contract lengths in the fix-price sector.     

Money,liquidity and welfare

This paper develops an analytically tractable Bewley model of money demand to shed light on some important questions in monetary theory, such as the welfare cost of inflation. It is shown that when money is a vital form of liquidity to meet uncertain consumption needs, the welfare costs of inflation can be extremely large. With log utility and parameter values that best match both the aggregate money demand curve suggested by Lucas (2000) and the variance of household consumption, agents in our model are willing to reduce consumption by 3–4% to avoid 10% annual inflation. The astonishingly large welfare costs of inflation arise because inflation increases consumption risk by eroding the buffer-stock-insurance value of money, thus hindering consumption smoothing at the household level. Such an inflation-induced increase in consumption risk at the micro level cannot be captured by representative-agent models or the Bailey triangle. Although the development of financial intermediation can mitigate the problem, with realistic credit limits the welfare loss of moderate inflation still remains several times larger than estimations based on the Bailey triangle. Our findings provide a strong justification for adopting a low inflation target by central banks, especially in developing countries where money is the major form of household financial wealth.     

Consumption choice and asset pricing with a non-price-taking agent

Summary. This paper develops a pure-exchange model to study the consumption-portfolio problem of an agent who acts as a non-price-taker, and to analyze the implications of his behavior on equilibrium security prices. The non-price-taker is modeled as a price leader in all markets; his price impact is then recast as a dependence of the Arrow-Debreu prices on his consumption, allowing a tractable formulation. Besides the aggregate consumption, the endowment of the non-price-taker appears as an additional factor in driving equilibrium allocations and prices. Comparisons of equilibria between a price-taking and a non-price-taking economy are carried out. Received: March 29, 1996; revised version October 29, 1996     

Unequal opportunities and human capital formation

This paper develops a tractable, heterogeneous agents general equilibrium model where individuals have different endowments of the factors that complement the schooling process. The paper explores the relationship between inequality of opportunities, inequality of outcomes, and aggregate efficiency in human capital formation. Using numerical solutions we study how the endogenous variables of the model respond to two different interventions in the distribution of opportunities: a mean-preserving spread and a change in the support. The results suggest that a higher degree of inequality of opportunities is associated with lower average level of human capital, a lower fraction of individuals investing in human capital, higher inequality in the distribution of human capital, and higher wage inequality. In particular, the model does not predict a trade-off between aggregate efficiency in human capital formation (as measured by the average level of human capital in the economy) and equality of opportunity.     

Stochastic Growth and Factor Income Risk

Abstract. This paper examines the effects of aggregate factor income risk in a tractable version of the stochastic Romer endogenous growth model. Labor supply is endogenous. The presence of labor income risk unambiguously increases savings and growth due to precautionary motives. Households not only underaccumulate but also work less along the balanced growth path of the competitive economy when compared with the Pareto-efficient allocation. The paper also discusses distributive disturbances for the case of inelastic labor supply. Here, growth effects are negative for empirically plausible correlations of the underlying shocks.     

The Environmental Kuznets Curve and Flow versus Stock Pollution: The Neglect of Future Damages

In this paper we offer a possible explanation for the empirical finding that the pollution-income relationship (PIR) for flow pollutants is an environmental Kuznets curve (EKC), i.e. inverted-U shaped, but that the PIR for stock pollutants is monotonically rising. We analyse an overlapping generations model with two pollutants: The flow pollutant causes immediate damages, but the stock pollutant harms the environment only in the future. Hence, a succession of myopic governments lets stock pollution grow with income. In contrast, the flow pollutant follows an EKC whose downturn might be caused by the neglect of future damages and by ever rising stock pollution: Without the stock pollutant the PIR for the flow pollutant can increase monotonically. We also show that the turning point of the EKC for the flow pollutant lies at lower levels of income and of flow pollution if stock pollution is high and harmful. This casts doubts on most empirical EKC studies because they assume that the turning point occurs at the same income level in all countries. However, it is consistent with recent empirical findings that the income level at the turning point of the EKC varies across countries.     

Aggregate comparative statics

In aggregative games, each playerʼs payoff depends on her own actions and an aggregate of the actions of all the players. Many common games in industrial organization, political economy, public economics, and macroeconomics can be cast as aggregative games. This paper provides a general and tractable framework for comparative static results in aggregative games. We focus on two classes of games: (1) aggregative games with strategic substitutes and (2) nice aggregative games, where payoff functions are continuous and concave in own strategies. We provide simple sufficient conditions under which positive shocks to individual players increase their own actions and have monotone effects on the aggregate. The results are illustrated with applications to public good provision, contests, Cournot competition and technology choices in oligopoly.     

Structural transformation and productivity growth in India during 1960–2010

In this paper, we examine the role of structural change and sectoral productivity growth in explaining the aggregate productivity of India relative to the United Sates during 1960–2010. We set up a simple two sector general equilibrium model and calibrate it to fit the structural transformation of United States. Our calibrated model for India highlights the relative importance of agricultural productivity growth in explaining its slow process of catching up in terms of aggregate productivity. We show that India could have progressed at a much faster rate and closed a substantial part of its aggregate productivity gap if its agricultural sector had grown at a rate at par with the United States. It is India's relative productivity growth in the non-agricultural sector that explains all the recent success in its closing the aggregate productivity gap with the United States. We also found that an elimination of relative distortion in agriculture in India could result into a modest improvement in the aggregate labour productivity.     

Tractable dynamic global games and applications

We present a family of tractable dynamic global games and its applications. Agents privately learn about a fixed fundamental, and repeatedly adjust their investments while facing frictions. The game exhibits many externalities: payoffs may depend on the volume of investment, on its volatility, and on its concentration. The solution is driven by an invariance result: aggregate investment is (in a pivotal contingency) invariant to a large family of frictions. We use the invariance result to examine how frictions, including those similar to the Tobin tax, affect equilibrium. We identify conditions under which frictions discourage harmful behavior without compromising investment volume.     

A theory of (relative) discounting

We derive a representation theorem for time preferences (on the prize-time space) which identifies a novel notion of relative discounting as the key ingredient. This representation covers a variety of time preference models, including the standard exponential and hyperbolic discounting models and certain non-transitive time preferences, such as the similarity-based and subadditive discounting models. Our axiomatic work thus unifies a number of seemingly disparate time preference structures, thereby providing a tractable mathematical format that allows for investigating certain economic environments without subscribing to a particular time preference model. This point is illustrated by means of an application to sequential bargaining theory.     

Imperfect competition and indeterminacy of aggregate output

This paper shows imperfect competition can lead to indeterminacy in aggregate output in a standard DSGE model with imperfect competition. Indeterminacy arises in the model from the composition of aggregate output. In sharp contrast to the indeterminacy literature pioneered by Benhabib and Farmer [J. Benhabib, R. Farmer, Indeterminacy and increasing returns, J. Econ. Theory 63 (1) (1994) 19-41] and Gali [J. Gali, Monopolistic competition, business cycles, and the composition of aggregate demand, J. Econ. Theory 63 (1) (1994) 73-96], indeterminacy in our model is global; hence it is more robust to structural parameters. In addition, sunspots in our model can be autocorrelated. The paper provides a justification for exogenous variations in desired markups, which play an important role as a source of cost-push shocks in the monetary policy literature. Our model outperforms a standard RBC model driven by technology shocks in several dimensions, including the volatility of labor market and the hump-shaped output dynamics.     

Rent Seeking for Pure Public Goods: Wealth and Group's Size Heterogeneity

We study how between‐group wealth and size asymmetries affect aggregate rent‐seeking efforts when two groups compete for the allocation of a pure public good. Unlike with previous analyses on between‐group asymmetries, we measure the utility cost of rent‐seeking in terms of the loss in private consumption an individual faces when contributing to this activity. Our main result is that fewer between‐group asymmetries do not necessarily imply greater aggregate rent‐seeking efforts. The result is at odds with the commonly held notion that the more homogeneous the contestants in a static rent‐seeking model, the greater the aggregate rent‐seeking efforts.     

Trade balance dynamics and exchange rates: In search of the J‐curve using a structural gravity approach

This paper uses a structural gravity approach, specifying currency movements as trade cost component to derive an empirical trade balance model, which incorporates multilateral resistance terms and accounts for the cross‐country variation in the exchange rate pass‐through into import and export prices. The model is estimated using quarterly bilateral trade flows between 47 countries over the period 2010Q1 to 2017Q2, disaggregated into 97 commodity groups. Our results support the existence of an “aggregate” J‐curve, pooled over commodity groups; at the same time they point to considerable heterogeneity in the trade balance dynamics across industries below the surface of aggregate data.     

Sectoral Employment Dynamics in Australia and the COVID-19 Pandemic

We develop a multivariate time series model of employment in 19 sectors for Australia. We use this model to determine the long-run effect of a 1% increase in economic activity in any chosen sector on aggregate employment. Our findings point to manufacturing and construction sectors as those that generate the largest positive spillovers for the aggregate economy. Moreover, we provide an interactive web-based app that produces our model's forecasts based on any user-specified scenario. As the restrictions associated with the COVID-19 pandemic evolve, the sectoral employment multipliers together with these interactive tools will provide useful information for policymakers.     

Credible redistributive policies and migration across U.S. states

We ask whether worker mobility has undermined the ability of U.S. states to redistribute income. We build a tractable model where both migration decisions and redistribution policies are jointly determined. Our model features a large number of heterogeneous regions and skilled and unskilled workers with idiosyncratic migration costs. The calibrated model is able to account for the main features of interstate migration, as well as some qualitative features of the cross-sectional distribution of redistributive policies. We conduct a counterfactual experiment in order to isolate the effect of worker mobility on state-level redistributive policies. We find that migration has induced substantial convergence in tax rates across U.S. states, but no race to the bottom. Interestingly, the degree of convergence has been much lower for transfers due to an offsetting tax-base effect.     

Investment-specific technological changes: The source of long-run TFP fluctuations

Technological innovations originating in the capital–producing sector may spillover to the rest of the economy and enhance aggregate TFP in the long-run. This paper assesses the quantitative importance of investment-specific technological changes in long-run movements in aggregate TFP. To this end, we construct a two-sector business cycle model where an IST diffusion process influences long-run movements in aggregate TFP via spillover. We then establish the linkage between the primitive shocks of the model and two shocks that can be identified from a VAR approach: one shock accounting for the long-run movement in aggregate TFP and the other accounting for the long-run movement in the inverse of the relative price of investment. We show analytically that the correlation of these two long-run shocks can be fruitful in distinguishing the quantitative importance of IST innovations in long-run movements in aggregate TFP. Using post-war U.S. data, we find that these two long-run shocks identified by the MFEV approach are almost perfectly collinear. Moreover, these two shocks can explain a significant, and surprisingly similar, fraction of the business-cycle fluctuations in other important macro variables. Our findings suggest that embodied technological changes are an important driver of long-run movements in aggregate TFP.