Working Papers

Macroeconomics and Econometrics

1. New 06/05/08 The Great Depression. This is a working paper version of Chapter 6 of my book in progress, Expectations Employment and Prices. It uses a search model of the labor market to provide a micro-founded interpretation of Keynes' explanation of the Great Depression.

2. Generalizing the Taylor Principle: A Comment. Davig and Leeper (2007) have proposed a condition they call the generalized Taylor principle to rule out indeterminate equilibria in a version of the new-Keynesian model where the parameters of the policy rule follow a Markov switching process. We show that although their condition rules out a subset of indeterminate equilibria, it does not establish uniqueness of the fundamental equilibrium. We discuss the differences between indeterminate fundamental equilibria included by Davig and Leeper's condition and fundamental equilibria that their condition misses.

3. Understanding the New-Keynesian Model when Monetary Policy Switches regimes. More on the Generalized Taylor Principle. Our first paper on this topic (see #4 below) uses a solution concept that allows some paths to be unbounded. In this paper we restrict ourselves to bounded solutions. We study a New-Keynesian model in which monetary policy may switch between regimes. We derive sufficient conditions for indeterminacy that are easy to implement and we show that the necessary and sufficient condition for determinacy, provided by Davig and Leeper, is necessary but not sufficient. More importantly, we use a two-regime model to show that indeterminacy in a passive regime may spill over to an active regime, no matter how active the latter regime is. As a result, a passive monetary policy is more damaging than has been previously thought. Our results imply that the propagation of shocks in an active regime, such as that of the Federal Reserve in the post-1982 period, may be substantially affected by the possibility of a return to a passive regime of the kind that was followed in the 1960s and 1970s.

4. Revised 09/21/06 Old Keynesian Economics. This paper was prepared for a conference in honor of Axel Leijonhufvud, held at UCLA on August 30th and 31st 2006. The paper documents work in progress that I plan to turn into a full length book manuscript. It is closely related to Shooting the Auctioneer (see below). Like "Shooting the Auctioneer" the paper "Old Keynesian Economics" combines a theory of search in the labor market with a general equilibrium model. Unlike that paper, (and unlike the work of Bob Hall and Rob Shimer that inspired "Shooting the Auctioneer"), "Old Keynesian Economics" closes a DSGE model (augmented by search in the labor market) with the assumption that output is determined by aggregate demand.  In contrast, Hall and Shimer suggest closing a model of this kind with the assumption that the wage is sticky. "Old Keynesian Economics" is an attempt to provide Keynesian economics with an alternative microfoundation that does not rely on sticky wages or prices.

5. Minimal State Variable Solutions to Markov-Switching Rational Expectations Models. Joint with Tao Zha and Dan F. Waggoner. We develop a new method for computing minimal state variable solutions (MSV) to Markov switching rational expectations models. We provide an algorithm to compute an MSV solution and we show how to test a given solution for uniqueness and boundedness. We construct an example, calibrated to US data, and we show that the MSV solution in our example is unique. This solution can potentially explain the observed reduction in the variance of inflation and the interest rate after 1980, in three different ways. The policy rule might have changed, the variance of the fundamental shocks might have fallen or the private sector equations might have been different across regimes. We compare these three explanations for the change in variance and we show that any one of them can potentially account for the facts. Our paper provides the necessary tools for a future empirical study of this issue.

6. Updated 31/08/07 Indeterminacy in a Forward Looking Regime Switching Model. Joint with Tao Zha and Dan F. Waggoner. This note is about the properties of Markov switching rational expectations models (MSRE). We discuss possible solution concepts for linear and non-linear models and distinguish between bounded and stationary equilibria. We present a simple model that switches between two regimes. The first regime, treated in isolation, has a unique determinate rational expectations equilibrium and the second contains a set of indeterminate sunspot equilibria. We prove that an MSRE model that switches between the regimes with known transition probabilities, always contains a continuum of indeterminate equilibria. This result holds for all values of the transition probabilities. Our work shows that the established or assumed uniqueness result for MSRE models in the existing literature (see e.g. Davig and Leeper) is incorrect.

7. A method to generate structural impulse-responses for measuring the effects of shocks in structural macro models, Joint with Andreas Beyer, ECB working paper #586, February 2006. We develop a technique for analyzing the response dynamics of economic variables to structural shocks in linear rational expectations models. Our work differs from standard SVARs since we allow expectations of future variables to enter structural equations. We show how to estimate the variance-covariance matrix of fundamental and non-fundamental shocks and we construct point estimates and confidence bounds for impulse response functions. Our technique can handle both determinate and indeterminate equilibria. We provide an application to U.S. monetary policy under pre and post Volcker monetary policy rules.

8. Updated 09/05/06 Shooting the Auctioneer. Joint with Andrew Hollenhorst. This is a new project based on recent ideas by Rob Shimer and Bob Hall.  Most dynamic stochastic general equilibrium models (DSGE) of the macroeconomy assume that labor is traded in a spot market. Two exceptions (Andolfatto AER 1986, Merz JME 1995) combine the two-sided search model of Mortensen and Pissarides, (Re Studs 1995) with a one-sector real business cycle model. These hybrid models are successful, in some dimensions, but they cannot account for observed volatility in unemployment and vacancies. Following a suggestion by Hall, Re. Stats 2004, building on work by Shimer 2004, this paper shows that a relatively standard DSGE model with sticky wages can account for these facts. Using a second-order approximation to the policy function we simulate moments of an artificial economy with and without sticky wages. We compute the welfare costs of the sticky wage equilibrium and find them to be small.

9. On the Indeterminacy of New-Keynesian Economics. Joint with Andreas Beyer.  ECB working paper #323. This  is an extension of On the Indeterminacy of Determinacy and Indeterminacy (AER forthcoming) that generalizes the argument to a class of three equation linear models. There has been a large literature in New-Keynesian economics in which single equations are estimated using instrumental variables. Often- the assumptions that identify these equations are not spelled out. Our paper gives four examples which suggest that policy conclusions arising from this work should be treated extremely carefully. In the most disturbing of our examples an indeterminate model based on Benhabib-Farmer (The Monetary Transmission Mechanism RED 2000) is shown to have the same reduced form as a standard determinate New-Keynesian model. Computer code associated with the paper is available HERE. The readme file explains how to run the Matlab programs in this directory.

10. Identifying the Monetary Transmission Mechanism using Structural Breaks. Joint with Andreas Beyer. An earlier version of this paper appeared as ECB working paper #275.  This is a new version as of July 2005. The basic idea is to use structural breaks as a kind of natural experiment to help to identify a subset of equations of a complete structural model. We apply the idea to U.S. monetary policy by showing a) that a break occurred around 1979 and b) by using the assumption that this break was solely in the policy rule to identify the private sector of a rational expectations model. The most recent version has formal tests for a structural break using the work of Bai Lumsdaine and Stock (Re. Studs. 1998) and impulse responses from our loosely identified model.

10. The Preferences of the Representative American. Joint with Lee Ohanian. March 1998. This is an old paper that probably will not be revised. It estimates a real business cycle model using an instrumental variables estimator.  In light of my recent work on identification (see above) I am highly suspicious of our reported conclusions.
     

11. Business Cycles with Heterogeneous Agents. May 2002. This is part of a project that studies the implications of long-lived stochastic overlapping generations models. The main contribution of the paper is a method for solving these models in closed form. I haven't revised the paper for a while although its still on my agenda. Gauss code for the simulations is available here.
     

12. Fiscal Policy, Equity Premia and  Heterogeneous Agents,    May 2002. This paper follows on from (10).  It explores the equity premium puzzle in a long-lived agent model and it argues that market incompleteness can be captured by rapid change  in the traders who participate in the equity markets.  The paper is also on my "get to soon" list..