the inflation tax in a real business cycle model money is incorporated into a real business cycle model using a cash in advance constraint the model economy is used to analyze whether the business cycle is different in high inflation and low inflation economies and to analyze the impact of variability in the growth rate of money in addition the welfare cost of the inflation tax is measured and the steady state properties of high and low inflation economies are compared

what accounts for the changes in u s fiscal policy transmission using vector autoregressions on u s time series for 1957 79 and 1983 2004 we find government spending shocks to have stronger effects on output consumption and wages in the earlier period we try to account for this observation within a dsge model featuring price rigidities and limited asset market participation specifically we estimate the structural parameters of the model for both periods by matching impulse responses model based counterfactual experiments suggest that most of the changes in fiscal policy transmission are accounted for by increased asset market participation and the more active monetary policy of the volcker greenspan period

explaining business cycles in small open economies abstract this paper analyzes the role of world price shocks fluctuations in the prices of capital intermediate and primary goods and in the world real interest rate in the generation and propagation of business cycles in small open developing countries i construct a stochastic dynamic multi sector small open economy model the model is a variant of the specific factors model and reflects the major structural characteristics of developing economies i utilize variance decomposition methods to quantitatively evaluate the impact of world price shocks the results indicate that world price shocks account for a significant fraction of business cycle variability in developing countries

what do interest rates reveal about the functioning of real business cycle models abstract this paper begins by documenting the extent to which the predictions of standard real business cycle rbc models are incompatible with observed movements in real interest rates the main finding of the paper is that extending the baseline model to include habit persistence in consumption and adjustment costs to capital significantly improves the model s empirical performance in our evaluation of the model s performance we take special care of estimating and testing predictions of the model using both moments drawn directly from the data and moments calculated after identifying shocks to the stochastic trend

optimal interest rate rules asset prices and credit frictions we study optimal taylor type interest rate rules in an economy with credit market imperfections our analysis builds on the agency cost framework of carlstrom and fuerst 1997 agency costs net worth and business fluctuations a computable general equilibrium analysis american economic review 87 893 910 which we extend in two directions first we embed monopolistic competition and sticky prices second we modify the stochastic structure of the model in order to generate a countercyclical premium on external finance this is achieved by linking the mean distribution of investment opportunities faced by entrepreneurs to aggregate total factor productivity we model monetary policy in terms of simple welfare maximizing interest rate rules we find that monetary policy should respond to increases in asset prices by lowering interest rates however when monetary policy responds strongly to inflation the marginal welfare gain of responding to asset prices vanishes within the class of linear interest rate rules that we analyze a strong anti inflationary stance always attains the highest level of welfare

adaptive learning with a unit root an application to the current account abstract this paper develops a simple two country two good model of international trade and borrowing that suppresses all previous sources of current account dynamics under rational expectations international debt follows a random walk under adaptive learning however the model s unit root is eliminated and international debt is either a stationary or an explosive process depending on agents specific learning algorithm some stationary learning algorithms result in debt following an ar 1 process with an autoregressive coefficient less than 0 8 because unit roots are a common and problematic feature of many international business cycle models our results offer a new approach for generating stationarity

using generalized method of moments to test mean variance efficiency this paper develops tests of unconditional mean variance efflciency under weak distributional assumptions using a generalized method of moments framework these tests are potentially more robust than commonly employed tests which rely on the assumption that asset returns are normally distributed and temporarily i i d using returns for size based portfolios from 1926 to 1988 we show that the conclusion concerning the mean variance effilciency of market indexes can be sensitive to the test considered the application of multivariate statistical techniques in financial economics has become common practice in recent years much of the development has been in the area of testing asset pricing models the assumption that asset returns follow a time invariant multivariate normal distribution permits tests of restrictions on model parameters in a pooled time series cross section framework these tests can be interpreted as tests of the mean variance efficiency of a portfolio or combination of portfolios gibbons 1982 jobson and korkie 1982 stambaugh 1982 shanken 1985 1987 kandel and stambaugh 1987 mackinlay 1987 and gibbons ross and shanken 1989 are examples of work presenting multivariate tests of the capital asset pricing model connor and korajczyk 1988 and lehmann and modest 1988 present multivariate tests of the arbitrage pricing model breeden gibbons and litzenberger 1989 present multivariate tests of the consumption based capm although these papers assume the normality of asset returns little analysis has been conducted to understand the sensitivity of the inferences to violations of this assumption 2 3

money interest rates and exchange rates with endogenously segmented markets we analyze the effects of money injections on interest rates and exchange rates when agents must pay a baumol tobin style fixed cost to exchange bonds and money asset markets are endogenously segmented because this fixed cost leads agents to trade bonds and money infrequently when the government injects money through an open market operation only those agents that are currently trading absorb these injections through their impact on these agents consumption these money injections affect real interest rates and real exchange rates the model generates the observed negative relation between expected inflation and real interest rates as well as persistent liquidity effects in interest rates and volatile and persistent exchange rates

interest rates and currency prices in a two country world abstract this paper is a theoretical study of the determination of prices interest rates and currency exchange rates set in an infinitely lived two country world which is subject both to stochastic endowment shocks and to monetary instability formulas are obtained for pricing all equity claims nominally denominated bonds and currencies and these formulas are related to earlier closely related results in the theories of money finance international trade

redistributive shocks and productivity shocks abstract a productivity innovation reduces labor share at impact making it countercyclical it subsequently produces a long lasting increase that peaks five years later at a level larger in absolute terms than the initial drop before slowly returning to average i e labor share overshoots we estimate a bivariate shock process to the production function that under competition in factor markets accounts for this overshooting we pose this process in an otherwise standard real business cycle economy and we find that the contribution of productivity innovations to the variance of hours is 1 of that in the standard rbc model

how well do linear approximation methods work abstract in this paper we investigate the accuracy of approximating policy functions for three different approximation methods in the context of a neoclassical model with a production tax we find that a variant of the king plosser and rebelo procedure yields the best approximations overall but that in certain instances researchers may be better off using a discrete state space solution to the euler equations of the model

on some computational aspects of equilibrium business cycle theory abstract this paper evaluates the accuracy of quadratic approximate methods in the context of a simple real business cycle model the level of accuracy is found to be very high on the face of the results reported here we are confident that the different computation methods proposed to date in this literature can be employed interchangeably

a toolbox for the numerical study of linear dynamic rational expectations models espanolse presenta una guia para resolver y estudiar modelos de expectativas racionales dinamicas lineales ldre luego de codificar el modelo se aplica una function simple para log linealizarlo simular los efectos de series exogenas de shocks calcular condiciones de momentos muestrales y poblacionales y obtener funciones de impulso respuesta se resuelven y estudian detalladamente tres modelos clasicos en la literatura de real business cycles brock and mirman ldre toolbox of matlab functionsoptimal growth and uncertainty the discounted case journal of economic theory 4 3 479 513 1972 king plosser and rebelo production growth and business cycles i the basic neoclassical model journal of monetary economics 21 195 232 1988 y mendoza real business cycles in a small open economy american economic review 81 4 797 818 1991 englishby simplifying the computational tasks and by providing step by step explanations of the procedures required to study a linear dynamic rational expectations ldre model this paper and the accompanying ldre toolbox of matlab functions guide a researcher with almost no experience in computational work to resolve and study his own model after coding the model following specific guidelines a single function call is all that is needed to log linearize the model simulate it under exogenous sequences of shocks compute sample and population moment conditional models in the real business cycles literature are solved and studied throughout to give detailed examples of the steps involved in solving and studying ldre models using the ldre toolbox namely the economies in brock and mirman optimal growth and uncertainty the discounted case journal of economic theory 4 3 479 513 1972 king plosser and rebelo production growth and business cycles i the basic neoclassical model journal of monetary economics 21 195 232 1988 and mendoza real business cycles in a small open economy american economic review 81 4 797 818 1991

risk return and equilibrium a revisit this paper reports the results of tests of the major implications of the two parameter capital asset pricing model the findings indicate that the relationship between stock returns and systematic risk contains important nonlinearities during 1935 82 these nonlinearities cannot be ascribed to previously documented anomalies related to firm size or january seasonality moreover the test results appear to be sensitive to the choice of the proxy for the market portfolio

interest rates and inflation a consensus has emerged among practitioners that the instrument of monetary policy ought to be the short term interest rate that policy should be focused on the control of inflation and that inflation can be reduced by increasing short term interest rates at the center of this consensus is a rejection of the quantity theory such a rejection is a difficult step to take given the mass of evidence linking money growth inflation and interest rates increases in average rates of money growth are associated with equal increases in average inflation rates and interest rates these observations need not rule out a constructive role for the use of short term interest rates as a monetary instrument one possibility is that increasing short term rates in the face of increases in inflation is just an indirect way of reducing money growth sell bonds and take money out of the system another possibility is that while control of monetary aggregates is the key to low long run average inflation rates an interest rate policy can improve the short run behavior of interest rates and prices the shortrun connections among money growth inflation and interest rates are very unreliable so there is much room for improvement these possibilities are surely worth exploring but doing so requires new theory the analysis needed to reconcile interest rate policies with the evidence on which the quantity theory of money is grounded cannot be found in old textbook diagrams

solving the real business cycles model of small open economies by a sample independent approach abstract one hallmark of small open economy models with a time separable preference assumption is the non uniqueness of their steady states following king et al j monetary econ 21 1988 195 232 most studies compute a log linear approximation solution to their small open economies around the sample means of the corresponding variables the resulting reliance of the outcome on a particular sample may lead to different implications about the business cycles properties of a small open economy this paper proposes a sample independent approach to solving this kind of model and shows its superiority over a sample dependent method through some simulation results

the economic effects of production taxes in a stochastic growth model this paper analyzes the effects of stochastic taxes on production in simple stochastic growth model in so doing the paper explicitly examines the importance of uncertainty on the decisions of individual agents this importance is emphasized by comparing economic outcome to various realizations of tax rates under uncertainty and perfect foresight copyright 1990 by american economic association

aggregate and welfare effects of redistribution of wealth under inflation and price level targeting abstract an unanticipated rise in the price level redistributes wealth from lenders to borrowers its size depends on the monetary policy regime as inflation targeting it and price level targeting pt have different implications for the price level path following price level movements the effects of an unexpected 1 price level increase are measured and assessed under both regimes overall the redistribution of wealth and the implied aggregate and welfare effects are larger under it than they are under pt the youngest the poorest and the government gain at the expense of the rest of the population and when the government gain is given to households as lump sum transfers the effects on gdp are negative and long lasting

reassessing discretionary fiscal policy in 1992 president bush proposed legislation intended to speed up the recovery from the 1990 91 recession congress rejected this proposal for countercyclical fiscal policy stimulus in early 1993 president clinton proposed his own stimulus package but congress rejected this proposal too many reasons were given for deciding against these two discretionary fiscal policy proposals but perhaps the most common one was the large federal budget deficit in the early 1990s with the rapid disappearance of budget deficits in recent years this reason to vote against a discretionary fiscal stimulus is unlikely to be mentioned in the next economic cycle discretionary countercyclical fiscal policy again appears to be a politically feasible option but should america use it after so many years of disuse much has happened in macroeconomics since the 1960s and 1970s when discretionary countercyclical fiscal policy was last considered a serious option in the united states first monetary policy making has changed substantially over the last two decades the federal reserve s interest rate decisions have become more explicit more systematic and more reactive to changes in both inflation and output the fed has placed a greater emphasis on keeping inflation low the experience with this new policy has been very favorable inflation has been low since the early 1980s and the real economy has been more stable the 1980s and 1990s saw two lengthy expansions separated by a relatively short and mild recession in terms of the tradeoff between output variability and inflation

labor productivity and the business cycle can r b c models be saved abstract standard r b c models do not enable one to reproduce the main labor market stylized facts employment is more variable than productivity and average productivity leads the cycle in order to mimic these features we consider a model with indivisible labor labor hoarding and adjustment costs the model is then simulated and compared to u s stylized facts we show that government expenditure shock and some specific labor adjustment costs are necessary to explain the lead of the average productivity over the business cycle

on inflation as a regressive consumption tax abstract evidence on the portfolio holdings and transaction patterns of households suggests that the burden of inflation is not evenly distributed we build a monetary growth model consistent with key features of cross sectional household data and use this framework to study the distributional impact of inflation at the aggregate level our model economy behaves similar to standard monetary growth models within the representative agent abstraction inflation has however important distributional effects since it is effectively a regressive consumption tax thus neglecting the distributional consequences of inflation may prove misleading in assessing the effects of inflation in our economy

liquidity loanable funds and real activity abstract this paper develops a general equilibrium model of two traditional explanations of the monetary black box linking money and real activity the liquidity effect and the loanable funds effect these effects are modeled with a monetary production economy in which central bank injections of cash are funnelled into the economy through the credit market since only borrowers have direct access to the newly injected cash monetary injections cause nominal interest rates to fall if firms are borrowers then monetary injections also increase current and future real activity

market models and heteroscedasticity of residual security returns bickel s tests provide attractive robust alternatives to traditional tests of heteroscedasticity nyse securities have homoscedastic residuals once nonnormality of security returns is allowed some portfolio designs may generate some heteroscedastic residuals but this heteroscedasticity is reduced by the kraus litzenberger quadratic market model this result suggests a misspecification in the traditional market model

should central banks respond to movements in asset prices in recent decades asset booms and busts have been important factors in macroeconomic fluctuations in both industrial and developing countries in light of this experience how if at all should central bankers respond to asset price volatility we have addressed this issue in previous work bernanke and gertler 1999 the context of our earlier study was the relatively new but increasingly popular monetary policy framework known as inflation targeting see e g bernanke and frederic mishkin 1997 in an inflation targeting framework publicly announced medium term inflation targets provide a nominal anchor for monetary policy while allowing the central bank some flexibility to help stabilize the real economy in the short run the inflation targeting approach gives a specific answer to the question of how central bankers should respond to asset prices changes in asset prices should affect monetary policy only to the extent that they affect the central bank s forecast of inflation to a first approximation once the predictive content of asset prices for inflation has been accounted for there should be no additional response of monetary policy to assetprice fluctuations in use now for about a decade inflationtargeting has generally performed well in practice however so far this approach has not often been stress tested by large swings in asset prices our earlier research employed simulations of a small calibrated macroeconomic model to examine how an inflation targeting policy defined as one in which the central bank s instrument interest rate responds primarily to changes in expected inflation might fare in the face of a boom and bust cycle in asset prices we found that an aggressive inflationtargeting policy rule in our simulations one in which the coefficient relating the instrument interest rate to expected inflation is 2 0 substantially stabilizes both output and inflation in scenarios in which a bubble in stock prices develops and then collapses as well as in scenarios in which technology shocks drive stock prices intuitively inflation targeting central banks automatically accommodate productivity gains that lift stock prices while offsetting purely speculative increases or decreases in stock values whose primary effects are through aggregate demand conditional on a strong policy response to expected inflation we found little if any additional gains from allowing an independent response of central bank policy to the level of asset prices in our view there are good reasons outside of our formal model to worry about attempts by central banks to influence asset prices including the fact that as history has shown the effects of such attempts on market psychology are dangerously unpredictable hence we concluded that inflationtargeting central banks need not respond to asset prices except insofar as they affect the inflation forecast in the spirit of recent work on robust control the exercises in our earlier paper analyzed the performance of policy rules in worst case discussants robert shiller yale university glenn rudebusch federal reserve bank of san francisco kenneth rogoff harvard university

price smoothing policies a welfare analysis in post wwii experience u s monetary authorities have attempted to eliminate seasonal fluctuations in prices and nominal interest rates developments in financial markets and recently discovered empirical regularities regarding the seasonal cycle seem to make these activities questionable using a money in the utility function model this paper analyzes the welfare properties of price and interest rate smoothing policies and the sense in which the distinction between seasonal and cyclical fluctuations is relevant it is shown that smoothing policies are welfare improving but not optimal and that the origin of the shocks not the persistence of the fluctuations is relevant in formulating policies

testing asset pricing models with coskewness in this article we investigate portfolio coskewness using a quadratic market model as a return generating process we show that the portfolios of small large firms have negative positive coskewness with the market we test an asset pricing model including coskewness by checking the validity of the restrictions that it imposes on the return generating process we find evidence of an additional component in expected excess returns which is not explained by either covariance or coskewness with the market however this unexplained component is homogeneous across portfolios in our sample and modest in magnitude finally we investigate the implications of erroneously neglecting coskewness for testing asset pricing models with particular attention to the empirically detected explanatory power of firm size

production growth and business cycles ii new directions abstract this paper outlines new directions for investigations of real business cycle models consideration of stochastic growth of exogenous and endogenous forms analysis of suboptimal outcomes arising due to externalities of distorting taxes and implications of labor market heterogeneity

on estimating skewness in stock returns in recent years skewness has become a much discussed factor in financial research and many studies models involve the skewness of various financial variables this paper i points out the universal neglect in the finance literature of skewness sampling error and its significant consequences ii presents a simple approach for roughly constructing a confidence interval for skewness estimated from lognormal populations iii points out directions of further research for developing a comprehensive approach for estimating skewness reliably

financial market segmentation stock market volatility and the role of monetary policy we explore the role of monetary policy in a world of segmented nancial markets where the agents who trade stocks encounter nancial income risk although the rest do not in such an economy we ask the question of how the monetary authority operates when it aims to maximize total welfare we nd that optimal monetary policy has the novel role of sharing the nancial market risk traders face among all agents in the economy this nding holds for any concave utility function and is not sensitive to the degree of market segmentation when risk is shared perfectly in this way consumption is equalized between the two groups and agents if given the choice would be indierent between participating or not in the nancial markets we also explore the implications that this policy has for the volatility of stock prices and of ination when compared to the policies of constant money supply ination targeting and nominal interest rate pegging we nd that optimal monetary policy is not necessarily associated either with minimal stock price volatility or with minimal ination volatility

equilibrium in a production economy with an income tax this paper develops a method to study an infinite horizon production economy distorted by a state dependent income tax this setting permits taxes to depend on the capital stock an endogenous state variable and thus captures situations where the evolution for capital and taxes is jointly determined to solve this model the consumption function is represented as a fixed point of a nonlinear monotone operator that is defined such that its nth iteration computes the consumption function n steps away from the horizon for a corresponding finite horizon economy the oparator s monotonicity is exploited in proving the existence of and constructing an equilibrium copyright 1991 by the econometric society

tests of market models heteroskedasticity or misspecification abstract this paper investigates the nature and the incidence of heteroskedasticity and misspecification in the market models by utilizing tests that are generally applicable the results show that heteroskedasticity appears more frequently than misspecification even though both are serious problems the evidence also indicates that the use of a quadratic market model or equally weighted market returns may lead to a smaller percentage of heteroskedastic cases but that in general this advantage has to be offset against an increase in the occurrence of specification errors small firms and january returns are also observed to produce a higher incidence of both heteroskedasticity and misspecification

limited asset markets participation monetary policy and inverted aggregate demand logic abstract this paper incorporates limited asset markets participation in dynamic general equilibrium and develops a simple analytical framework for monetary policy analysis aggregate dynamics and stability properties of an otherwise standard business cycle model depend nonlinearly on the degree of asset market participation while moderate participation rates strengthen the role of monetary policy low enough participation causes an inversion of results dictated by conventional wisdom the slope of the is curve changes sign the taylor principle is inverted optimal welfare maximizing discretionary monetary policy requires a passive policy rule and the effects and propagation of shocks are changed however a targeting rule implementing optimal policy under commitment delivers equilibrium determinacy regardless of the degree of asset market participation our results may justify fed s behavior during the great inflation period

the terms of trade the real exchange rate and economic fluctuations this paper examines the relationship between terms of trade and business cycles using a three sector intertemporal equilibrium model and a large multicountry database results show that terms of trade shocks account for nearly one half of actual gdp variability the model explains weak correlations between net exports and terms of trade the harberger laursen and metzler effect and produces large and weakly correlated deviations from purchasing power parity and real interest rate parity terms of trade shocks cause real appreciations and positive interest differentials although productivity shocks have opposite effects the puzzle that welfare gains of international asset trading are negligible is left unresolved copyright 1995 by economics department of the university of pennsylvania and the osaka university institute of social and economic research association

accumulation of human capital and the business cycle characteristics of business cycles are quite different across developed countries real wages and working hours are less sensitive to exogenous shocks in the united states than they are in britain and japan using a model with a microeconomic foundation this paper provides an economic explanation of these differences the cost of on the job training plays a crucial role workers seldom quit their jobs when the sunk training cost is high in such economies variances in employment and output become small and shocks tend to be absorbed by working hours and real wages thus these characteristics do not necessarily indicate that the economy is more efficient

measuring the reaction of monetary policy to the stock market movements in the stock market can have a significant impact on the macroeconomy and are therefore likely to be an important factor in the determination of monetary policy however little is known about the magnitude of the federal reserve s reaction to the stock market in part because the simultaneous response of equity prices to interest rates makes it difficult to estimate this paper uses an identification technique based on the heteroskedasticity of stock market returns to measure the reaction of monetary policy to the stock market we find a significant policy response with a 5 percent rise fall in the s p 500 index increasing the likelihood of a 25 basis point tightening easing by about a half

interest rate rules vs money growth rules a welfare comparison in a cash in advance economy abstract this paper considers the welfare consequences of two particularly simple rules for monetary policy an interest rate peg and a money growth peg the model economy consists of a real side that is the standard real business cycle model and a monetary side that amounts to imposing cash in advance constraints on certain market transactions the paper also considers the effect of assuming a rigidity in the typical household s cash savings choice the competitive equilibrium of the economy is not pareto efficient partly because of two distortions a distortion on the capital accumulation decision and a distortion on portfolio choice that arises from the assumed rigidity the principal result of the paper is that the interest rate rule but not the money growth rule entirely eliminates these two distortions and is thus the benevolent central banker s policy choice

does market incompleteness matter for asset prices in this paper we argue that market incompleteness resulting from limited stock market participation is important for understanding the behavior of asset prices jel e32 e44 g12

evidence of heteroscedasticity and mis specification issues in the market model results from the athens stock exchange the traditional tests and the relevant explanations given by researchers on the basis of their empirical results in cases where there is evidence of heteroscedasticity and surrounding mis specification issues in the market model is investigated and criticized to this purpose data from the athens stock exchange are used to get meaningful comparisons and results the authors first apply the classical heteroscedasticity and mis specification tests used in the literature by researchers and analyse the results also under a classical view they then apply more recent and efficient tests to find out contradictions and disproportions between the former and the latter tests as well as to draw comments and conclusions supplementary to the existing evidence and to propose other appropriate ways for estimation and specification of the market model it appears as a general conculsion of the authors work that singnificant distortions are observed in the traditional market model when it is used in small but con

estimating the federal reserve s implicit inflation target a state space approach abstract existing estimates of the federal reserve s implicit inflation target typically rely on the assumption that it is constant for the duration of the period of analysis this paper relaxes this assumption and estimates the implicit inflation target using a time varying parameter model and the kalman filter in applying this method to the volcker greenspan period it finds significant time variation in the implicit target that is consistent with hypotheses about opportunistic disinflation and the recent deflation scare