Progressive taxation and macroeconomic stability in two-sector models with social constant returns

It has been shown that, in the two-sector Benhabib–Farmer–Guo model with technologies of social increasing returns that exhibits indeterminacy, progressive income taxes de-stabilize the economy. This paper revisits the robustness of the tax implication in the two-sector Benhabib–Nishimura model with technologies of social constant returns that exhibits indeterminacy. We show that a progressive income tax stabilizes the economy against sunspot fluctuations, and thus the tax implication based on the two-sector Benhabib–Farmer–Guo model is not robust.     

On the minimum degree of returns to scale in sunspot models of the business cycle

Bennett and Farmer (J. Econ. Theory 93 (2000) 118) claim that the degree of increasing returns to scale required for indeterminacy in a single sector growth model can be lowered by allowing for preferences that are non-separable in consumption and leisure. In this paper I show that the example they give violates concavity. In a more general setup, which does not impose specific functional forms on utility, I prove that there are no concave utility functions compatible with indeterminacy if the elasticity of scale is lower than the inverse of the labor share in production.     

Indeterminacy in a small open economy with endogenous labor supply

Summary. We establish conditions under which indeterminacy can occur in a small open economy business cycle model with endogenous labor supply. Indeterminacy requires small externalities in technologies with social constant returns to scale, independently of the intertemporal elasticities in both consumption and labor. Received: December 12, 2001; revised version: May 17, 2002 RID="*" ID="*"The paper has benefited from discussions with Jess Benhabib and Mark Weder, as well as from the comments of an anonymous referee. Correspondence to: Q. Meng     

Understanding the effects of technology shocks

The research led by Gali (AER 1999) and Basu et al. (AER 2006) raises two important questions regarding the validity of the RBC theory: (i) How important are technology shocks in explaining the business cycle? (ii) Do impulse responses to technology shocks found in the data reject the assumption of flexible prices? Using an RBC model, this paper argues that the conditional impulse responses of the U.S. economy to technology shocks are not grounds to reject the notion that technology shocks are the main driving force of the business cycle and the assumption of flexible prices, in contrast with the conclusions reached by the literature.     

ENDOGENOUS TIME PREFERENCE,INTEREST‐RATE RULES,AND INDETERMINACY*

This paper extends the Benhabib et al. flexible‐price, money‐in‐the‐utility‐function model by considering endogenous time preference and re‐examines equilibrium indeterminacy in response to alternative interest‐rate rules. We show that either an active or a passive interest‐rate feedback rule can generate local indeterminacy even if consumption and real money balances are Edgeworth independent. This result is in sharp contrast to that in the related literature. We also find that in the presence of endogenous time preference, local indeterminacy may occur regardless of whether the monetary policy is based on the interest‐rate feedback rule or money growth‐rate targeting.     

Multi-product firms and business cycle dynamics

Recent empirical evidence provided by Bernard et al. (2010) and Broda and Weinstein (2010) shows that a significant share of product creation and destruction in U.S. industries occurs within existing firms and accounts for an important share of aggregate output. In the present paper, and consistent with this evidence, we relax the standard assumption of mono-product firms in a dynamic stochastic general equilibrium model. Our analysis is based on a model of firm dynamics with two deviations from the conventional real business cycle framework—imperfect competition with endogenous entry and multi-product firms. The combination of these two features enables our model to successfully generate a mechanism that accounts for the strong procyclicality of product creation. Due to the proliferation effect induced by firm-level adjustments in product scope, we show that our model embodies a quantitatively important magnification mechanism of aggregate shocks.     

Public debt and optimal taxes without commitment

Benhabib and Rustichini [Optimal taxes without commitment, J. Econ. Theory 77 (1997) 231-259] study the properties of optimal capital taxes in economies without commitment and no government debt. They find that capital taxes may be different from zero at steady state. This note shows that, once governments have the possibility of issuing debt and smoothing taxes over time, optimal steady state capital taxes turn out to be zero.     

Firm dynamics and markup variations: Implications for sunspot equilibria and endogenous economic fluctuations

This paper analyzes how the interaction between firms’ entry-and-exit decisions and variations in competition gives rise to self-fulfilling, expectation-driven fluctuations in aggregate economic activity and in measured total factor productivity (TFP). The analysis is based on a dynamic general equilibrium model in which net business formation is endogenously procyclical and leads to endogenous countercyclical variations in markups. This interaction leads to indeterminacy in which economic fluctuations occur as a result of self-fulfilling shifts in the beliefs of rational forward looking agents. When calibrated with empirically plausible parameter values and driven solely by self-fulfilling shocks to expectations, the model can quantitatively account for the main empirical regularities characterizing postwar U.S. business cycles and for 65% of the fluctuations in measured TFP.     

A business cycle model with variable capacity utilization and demand disturbances

We develop a dynamic general-equilibrium model with demand (preference) shocks, estimated using Hall's (J. Labour Economics 15 (1997) 223) residual, that replicates U.S. business cycles well, at least compared to the real business cycle models. The key factor is cyclical capital utilization, which is based on imperfect competition, slow adjustments in capital stock, and fixed requirement of labor input. We also demonstrate theoretically that a representative-agent economy with preference shocks could be viewed as the reduced form of a heterogeneous-agents economy with incomplete markets. Specifically, a heterogeneous-agents economy with incomplete markets is aggregated into a representative-agent economy with preference shocks. This result would provide a microeconomic foundation for preference shock models. It is also shown that a shock to marginal utility of consumption and a shock to marginal disutility of labor have different effects.     

Shocking the eurozone

In this paper, the monetary transmission mechanism within the European Monetary Union is investigated. The impulse response functions and forecast error variance decompositions of a structural vector error correction model (SVECM) are compared with those of a New Keynesian theoretical model. The identifying restrictions of the SVECM are directly derived from the theoretical model. Two permanent shocks are identified, one having only nominal, and one having only real effects. The three transitory shocks comprise a short-term interest-rate shock, an aggregate demand shock and a money demand shock. The main conclusions are that permanently reducing the inflation objective depresses output in the first year, but has no real effects in the long run. Regarding output variability, the results indicate that aggregate demand shocks are most important during the first year, after which aggregate supply shocks dominate.     

Collateral constraints and the amplification mechanism

Kiyotaki and Moore (J. Polit. Economy 105 (1997) 211) have offered a theory for how common shocks to credit-constrained firms are amplified through changes in collateral values and transmitted as fluctuations in output. I clarify and extend their model by showing that their collateral amplification mechanism is not robust to the introduction of markets that allow these firms to hedge against common shocks. A theory of incomplete hedging is proposed in which the supply of hedging available in the economy is constrained by the aggregate value of collateral. I illustrate how the constraint reinstates amplification effects and discuss empirical implications of this new mechanism.     

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.     

Multiple equilibria in a growth model with monopolistic competition

Summary The standard neoclassical growth model is modified by introducing a market structure characterized by monopolistic competition and variable demand elasticities. In equilibrium, the price elasticity of the demand schedule facing a typical firm is a function of the aggregate savings rate. The latter feature results from an assumed wedge between the elasticity of substitution across goods in productive activities and that in consumption. In contrast with most examples in the literature our model does not require increasing returns (internal or external) in order to generate multiple equilibria.Thanks are due to Jess Benhabib, Duncan Foley, Oded Galor and participants in seminars at the Econometric Society Summer Meetings (Boston, 1993), NBER 1993 Summer Institute, CORE, UAB, and European University Institute for helpful comments.     

Stabilization policy and indeterminacy in a small open economy

This paper studies the (de)stabilizing effects of income tax rules in a two-sector small open economy with production externalities. The paper shows that in the model with positive sector-specific externalities in the investment sector and negative sector-specific externalities in the consumption sector (or positive aggregate investment externalities), a regressive income tax rule can stabilize such an economy against indeterminacy, whereas a progressive income tax rule can increase the tendency for indeterminacy to occur. This paper also studies two variants that consider an imperfect world bond market and an endogenous labor supply, respectively, and shows that the qualitative results stated above remain valid. Moreover, increasing the level of sector-specific investment externalities can decrease (increase) the minimal level of tax progressivity required for indeterminacy if the investment externalities are below (above) a certain critical value and if the negative externalities in the consumption sector are taken as given.     

On the plausibility of sunspot equilibria

This paper presents a one-sector business cycle model with variable capacity utilization and externalities that stem from aggregate economic activity. It uses a new formulation of the endogenous capital utilization rate in which utilization costs appear in the form of variable maintenance expenses. Indeterminacy arises at approximate constant returns to scale. This result challenges the viewpoint that indeterminacy is empirically implausible. Sunspot driven model fluctuations duplicate a number of stylized facts of the business cycle. Plausible parameter space contains regions in which stationary sunspot equilibria are stable under learning.     

Income effects and indeterminacy in a calibrated one-sector growth model

This note analyzes how the indeterminacy of competitive equilibrium in one-sector growth models depends on the magnitude of the households' income effect on the demand for leisure. Since I am interested in quantitatively characterizing regions of indeterminacy, I use the Jaimovich and Rebelo [N. Jaimovich, S. Rebelo, Can news about the future drive the business cycle? Mimeo, Northwestern University, 2007] preferences that span a wide range of income effect values. I find that indeterminacy can occur for levels of aggregate-returns-to-scale that are well within recent empirical estimates. For these regions of indeterminacy, the model, when driven solely by sunspot shocks, generates second-moment properties that are consistent with the U.S. data at the business cycle frequency.     

Optimal random monetary policy with nominal rigidity

This paper studies a money-in-the-utility function model with imperfect competition and one-period ahead nominal price setting. Under standard assumptions on preferences, Friedman's rule—setting the money growth rate equal to the household time discount factor—generates an equilibrium that is optimal within the class of deterministic policies. We then provide conditions under which a random monetary policy increases ex ante expected welfare relative to Friedman's rule. The result obtains because random policy can reduce the distortion associated with imperfect competition. Our result exhibits original features relative to existing cases of welfare-improving random monetary policy, such as Polemarchakis and Weiss (J. Econom. Theory 15 (1977) 345).     

Nominal Wage Flexibility and Economic Performance: Evidence and Implications Across Industrial Countries

By considering the theoretical connection between labour and product markets, the paper evaluates the economic relationship of these markets within the contractual wage rigidity New Keynesian explanation of business cycles. The empirical analysis focuses on the short‐run cyclical behaviour of real output, prices and wages for 19 industrial countries. Time‐series and cross‐sectional regressions are estimated. Cross‐sectional cyclical correlations in the labour and goods markets are also evaluated across countries. Consistent with the theoretical predictions, aggregate uncertainty is an important factor in increasing the flexibility of the nominal wage in response to aggregate demand shocks. Wage flexibility accelerates price inflation and moderates the response of real output growth to aggregate demand shocks. Wage flexibility does not appear to be an important factor in differentiating the real and inflationary effects of energy price shocks across countries. Finally, aggregate uncertainty increases the responsiveness of output and price to productivity shocks.     

Exchange rate movements and monetary policy in Brazil: Econometric and simulation evidence

The literature on monetary economy has aroused growing interest in macroeconomics. Due to computational advancements, models have become increasingly more complex and accurate, allowing for an in-depth analysis of the relationships between real economic variables and nominal variables. Therefore, using a dynamic stochastic general equilibrium (DSGE) model, based on Gali and Monacelli (2005), we propose and estimate a model for the Brazilian economy by employing Bayesian methods so as to assess whether the Central Bank of Brazil takes exchange rate fluctuations into account in the conduct of monetary policy. The most striking result of the present study is that the Central Bank of Brazil does not directly change the interest rate path due to exchange rate movements. A simulation exercise is also used. Our conclusion is that the economy quickly accommodates shocks induced separately on the exchange rate, on the terms of trade, interest rate, and global inflation.     

Stochastic growth with correlated production shocks

This paper extends the stochastic growth model of Brock and Mirman [J. Econ. Theory4 (1972), 497–513] to allow the production shocks to be correlated over time. The resultant optimal savings and consumption policies depend not only upon the current level of output but also upon the most recent realization of the random shock. The properties of these policy functions are studied and it is shown that the Markov process on output, capital stock and consumption resulting from the application of these policies converges to a stationary distribution.