We propose a model that generates an economic expansion following good news about future total factor productivity (TFP) or investment-specific technical change. The model has three key elements: variable capital utilization, adjustment costs to investment, and preferences that exhibit a weak short-run wealth effect on the labor supply. These preferences nest,as special cases, the two classes of utility functions most widely used in the business cycle literature. Our model generates recessions that resemble those of the post-war U.S. economy without relying on negative productivity shocks. Recessions are caused not by contemporaneous negative shocks but by lackluster news about future TFP or investment-specific technical change.

The influential Krugman-Flood-Garber (KFG) model of balance of payment crises assumes that a fixed exchange rate is abandoned if and only if international reserves reach a critical threshold value. From a positive standpoint, the KFG rule is at odds with many episodes in which the central bank has plenty of international reserves at the time of abandonment. We study the optimal exit policy and show that, from a normative standpoint, the KFG rule is suboptimal. We consider a model in which the fixed exchange rate regime has become unsustainable due to an unexpected increase in government spending. We show that, when there are no exit costs, it is optimal to abandon immediately. When there are exit costs, the optimal abandonment time is a decreasing function of the size of the fiscal shock. For large fiscal shocks immediate abandonment is optimal. Our model is consistent with the evidence that many countries exit fixed exchange rate regimes with plenty of international reserves in the central bank's vault.

We explore the business cycle implications of expectation shocks and of two well-known psychological biases, optimism and verconfidence. The expectations of optimistic agents are biased toward good outcomes, while overconfident agents overestimate the precision of the signals that they receive. Both expectation shocks and overconfidence can increase business cycle volatility, while preserving the model’s properties in terms of comovement, and relative volatilities. In contrast, optimism is not a useful source of volatility in our model.

Large devaluations are generally associated with large declines in real exchange rates. Burstein, Eichenbaum, and Rebelo (2005) argue that the primary force causing these declines is often the slow adjustment in the price of nontradable goods and services. We develop a model which embodies two complementary forces that account for the large declines in the real exchange rate that occur in the aftermath of large devaluations. The first force is sticky nontradable goods prices. Instead of simply assuming that nontradable goods prices are sticky, we develop conditions under which this phenomenon can emerge as an equilibrium outcome. The second force is the impact of real shocks that often accompany large devaluations. These real shocks lead to a decline in the price of nontradable goods relative to traded goods. We argue that sticky nontradable goods prices generally play an important role in explaining post-devaluation movements in real exchange rates. However, there are cases in which sticky nontradable goods prices are not sustainable as an equilibrium phenomenon. In these cases real shocks are the primary driver of real exchange rate movements.

The carry trade strategy involves selling forward currencies that are at a forward premium and buying forward currencies that are at a forward discount. We compare the payoffs to the carry trade applied to two different portfolios. The first portfolio consists exclusively of developed country currencies. The second portfolio includes the currencies of both developed countries and emerging markets. Our main empirical findings are as follows. First, including emerging market currencies in our portfolio substantially increases the Sharpe ratio associated with the carry trade. Second, bid-ask spreads are two to four times larger in emerging markets than in developed countries. Third and most dramatically, the payoffs to the carry trade for both portfolios are uncorrelated with returns to the U.S. stock market.

We address three questions: (i) Can classical models be reconciled with the fact that many crises are marked by high rates of depreciation and small increases in seignorage revenue? (ii) What are the implications of different financing methods for post-crisis rates of inflation and depreciation? (iii) How do governments pay for the fiscal costs associated with currency crises? To study these questions we use a general equilibrium model in which prospective government deficits trigger a currency crisis. We then use our model in conjunction with fiscal data to interpret government financing in the wake of three recent currency crises: Korea (1997), Mexico (1994) and Turkey (2001).

Changes in the price of nontradable goods relative to tradable goods account for roughly 50 percent of the cyclical movements in real exchange rates.

This paper describes the empirical regularities of growth and business cycles that characterize market economies. Relatively little is know at this point about economic fluctuations in planned economies, partly because the system of national income accounting used by these countries produces information that is not easily comparable with data for market economies. Still, the lessons from market economies are likely to become increasingly relevant as planning economies rely more on market forces.

In this paper we argue that the primary force behind the large drop in real exchange rates that occurs after large devaluations is the slow adjustment in the price of nontradable goods and services. Our empirical analysis uses data from five large devaluation episodes: Argentina (2001), Brazil (1999), Korea (1997), Mexico (1994), and Thailand (1997). We conduct a detailed analysis of the Argentina case using disaggregated CPI data, data from our own survey of prices in Buenos Aires, and scanner data from supermarkets. We assess the robustness of our findings by studying large real-exchange-rate appreciations, medium devaluations, and small exchange-rate movements.

In this paper I review the contribution of real business cycles models to our understanding of economic fluctuations, and discuss open issues in business cycle research.

This paper documents four basic facts about investment goods and investment prices. First, investment has a very significant nontradable component in the form of construction services. Second, distributions services (wholesaling, retailing, and transportation) are much less important for investment than for consumption. Third, the import content of investment is much larger than that of consumption. Finally, in the aftermath of three large devaluations, the rate of exchange rate pass-through is, perhaps not surprisingly, highest for imported equipment and lowest for construction services.

Balanced growth models are commonly used in macroeconomics because they are consistent with the well-known Kaldor facts regarding economic growth. These models, however, are inconsistent with one of the most striking regularities of the growth process-the massive reallocation of labour from agriculture into manufacturing and services. This paper presents a simple model consistent with both the Kaldor facts and the dynamics of sectoral labour reallocation.

This paper studies some continuous-time cash-in-advance models in which interest rate smoothing is optimal. We consider both deterministic and stochastic models. In the stochastic case we obtain two results of independent interest: (i) we study what is, to our knowledge, the only version of the neoclassical model under uncertainty that can be solved in closed form in continuous time; and (ii) we show how to characterize the competitive equilibrium of a stochastic continuous time model that cannot be computed by solving a planning problem. We also discuss the scope for monetary policy to improve welfare in an economy with a suboptimal real competitive equilibrium, focusing on the particular example of an economy with externalities.

This paper presents capital utilization corrected measures of technology shocks for aggregate and disaggregated (two-digit Standard Industrial Classification code) industries. We correct for variations in capital utilization by employing industrial electrical use as a measure of capital services. In contrast, the standard measures of technology shocks used in the Real Business Cycle literature are based on economy wide data and assume that capital services are proportional to the stock of measured capital. To assess the impact of these differences, we contrast selected properties of the competing technology shock measures. We argue that the properties of technology shocks for the manufacturing sector are quite different than those used in the RBC literature. We also find that correcting for capital utilization has important implications for the properties of the Solow residual.

This paper discusses a dynamic model that is consistent with the main empirical regularities of economic fluctuations in open economies. While other models in this class have relied on non-separable preferences or finite horizons to generate a realistic consumption volatility, we show that there is a simple class of time separable preferences that is consistent with the cyclical volatilities of the components of the national income accounts identity as well as with the countercyclical character of the balance of trade.

Recent estimates of the potential growth effects of tax reform vary wildly, ranging from zero to eight percentage points. Using an endogenous growth model, we assess which model features and parameter values are important for determining the quantitative impact of tax reform. We find that the critical parameters are factor shares, depreciation rates, the elasticity of intertemporal substitution, and the elasticity of labor supply. The elasticities of substitution in production, on the other hand, are relatively unimportant. The quantitative estimates in several recent papers are compared with each other and with some of the evidence from U.S. experience. We find that Robert Lucas's conclusion, that tax reform would have little or no effect on the U.S. growth rate, is theoretically robust and consistent with the evidence.

This paper discusses in detail the Hodrick-Prescott (1980) filter from time and frequency domain perspectives, motivating it as a generalization of the exponential smoothing filter. We show that the HP filter — when applied to large samples — contains a centered fourth difference and hence renders stationary time series that are ‘difference-stationary’ and, indeed, integrated of higher order. However, our application of the HP filter to U.S. time series and to the simulated outcomes of real business cycle models leads us to question its widespread use as a unique method of trend elimination. We provide examples of how HP filtering dramatically alters measures of persistence, variability, and comovement.

One of the central predictions of growth theory, old and new, is that income taxes have a negative effect on the pace of economic expansion. This paper examines a method of obtaining average marginal income tax rates that combines information on statutory rates with the amount of tax revenue collected and with data on income distribution. This method is applied to the countries included in Sicat and Virmani's summary of statutory income tax rates for 1984. There is a positive correlation between the income-weighted average marginal tax rates and the level of real per capita income. This simply reflects the fact that developed countries tend to rely more on income taxes than less developed countries.

Neoclassical transitional dynamics are a central element of standard macroeconomic theory. Quantitative experiments with the fixed-savings-rate models of the 1960's showed lengthy transitions, thus potentially rationalizing sustained differences in growth rates across countries. We investigate quantitative transitional dynamics in various neoclassical models with intertemporally optimizing households. Lengthy transitions occur only with very low intertemporal substitution. Generally, when one tries to explain sustained economic growth with transitional dynamics, there are extremely counterfactual implications. These result from the fact that implied marginal products are extraordinarily high in the early stages of development.

Deals with a study which examined data on business cycles available from 1850 to 1950 in the United States and Great Britain. Review of related literature; Methods used; Findings and its implications.

The wide cross-country disparity in rates of economic growth is the most puzzling feature of the development process. This paper describes a class of models in which this heterogeneity in growth experiences can be the result of cross-country differences in government policy. These differences can also create incentives for labor migration from slow-growing to fast-growing countries. In the models considered, growth is endogeneous despite the absence of increasing returns because there is a "core" of capital goods that can be produced without the direct or indirect contribution of factors that cannot be accumulated, such as land.

Why do the countries of the world display considerable disparity in long-term growth rates? This paper examines the hypothesis that the answer lies in differences in national public policies that affect the incentives that individuals have to accumulate capital in both its physical and human forms. Our analysis shows that these incentive effects can induce large differences in long-run growth rates. Since many of the key tax rates are difficult to measure, our procedure is an indirect one. We work within a calibrated, two-sector endogenous growth model, which has its origins in the microeconomic literature on human capital formation. We show that national taxation can substantially affect long-run growth rates. In particular, for small open economies with substantial capital mobility, national taxation can readily lead to "development traps" (in which countries stagnate or regress) or to "growth miracles" (in which countries shift from little growth to rapid expansion). This influence of taxation on the rate of economic growth has important welfare implications: in basic endogenous growth models, the welfare cost of a 10 percent increase in the rate of income tax can be 40 times larger than in the basic neoclassical model.

This paper presents the neoclassical model of capital accumulation augmented by choice of labor supply as the basic framework of modern real business cycle analysis. Preferences and production possibilities are restricted so that the economy displays steady state growth. Then we explore the implications of the basic model for perfect foresight capital accumulation and for economic fluctuations initiated by impulses to technology. We argue that the neoclassical approach holds considerable promise for enhancing our understanding of fluctuations. Nevertheless, the basic model does have some important shortcomings. In particular, substantial persistence in technology shocks is required if the model economy is to exhibit periods of economic activity that persistently deviate from a deterministic trend.

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.

This paper studies the implications of procyclical capital utilization rates for inference regarding cyclical movements in labor productivity and the degree of returns to scale. We organize our investigation around five questions that we study using a measure of capital services based on electricity consumption: (1) Is the phenomenon of near or actual short-run increasing returns to labor an artifact of the failure to accurately measure capital utilization rates? (2) Can we find a significant role for capital services in aggregate and industry-level production technologies? (3) Is there evidence against the hypothesis of constant returns to scale? (4) Can we reject the notion that the residuals in our estimated production functions represent technology shocks? (5) How does correcting for cyclical variations in capital services affect the statistical properties of estimated aggregate technology shocks? The answer to the first two questions is yes. The answer to the third and fourth questions is no. The answer to the fifth question is "a lot."

This paper describes the empirical regularities relating fiscal policy variables, the level of development, and the rate of growth. We employ historical data, recent cross-section data, and newly constructed public investment series. Our main findings are: (i) there is a strong association between the development level and the fiscal structure: poor countries rely heavily on international trade taxes, while income taxes are only important in developed economies; (ü) fiscal policy is influenced by the scale of the economy, measured by its population (1W investment in transport and communication is consistently correlated with growth (iv) the effects of taxation are difficult to isolate empirically.

This paper investigates the sensitivity of Solow residual based measures of technology shocks to labor hoarding behavior. Using a structural model of labor hoarding and the identifying restriction that innovations to technology shocks are orthogonal to innovations in government consumption, we estimate the fraction of the variability of the Solow residual that is due to technology shocks. Our results support the view that a significant proportion of movements in the Solow residual are artifacts of labor hoarding behavior. Specifically, we estimate that the variance of innovations to technology is roughly 50 percent less than that implied by standard real business cycle models. In addition, our results suggest that existing real business cycle studies substantially overstate the extent to which technology shocks account for the variability of postwar aggregate U.S. output.

Changes in the price of nontradable goods relative to tradable goods account for roughly 50 percent of the cyclical movements in real exchange rates.

Which investment model fits firm-level data? To answer this question we estimate alternative models using Compustat data. Surprisingly, the two best-performing specifications are based on Hayashi's (1982) model. This model's implication that Q is a sufficient statistic for determining a firm's investment decision has been often rejected because cash-flow and lagged-investment effects are present in investment regressions. But, we find that these regressions are quite fragile and ineffectual for evaluating model performance. So, forget what investment regressions told you. Models based on Hayashi (1982) provide a very good description of investment behavior at the firm level.

It is well known that the neoclassical model does not generate comovement among macroeconomic aggregates in response to news about future total factor productivity. We show that this problem is generally more severe in open economy versions of the neoclassical model. We present an open economy model that generates comovement both in response to sudden stops and to news about future productivity and investment-specific technical change. We find that comovement is easier to generate in the presence of weak short-run wealth effects on the labor supply, adjustment costs to labor, and/or investment, and whenever the real interest rate faced by the economy rises with the level of net foreign debt.

We assess the importance of nominal rigidities using a new weekly scan- ner data set from a major U.S. retailer, that contains information on prices, quantities, and costs for over 1,000 stores. We …nd that nominal rigidities are important but do not take the form of sticky prices. Instead, nominal rigidities take the form of inertia in reference prices and costs, de…ned as the most common prices and costs within a given quarter. Weekly prices and costs ‡uctuate around reference values which tend to remain constant over extended periods of time. Reference prices are particularly inertial and have an average duration of roughly one year. So, nominal rigidities are present in our data, even though weekly prices change very frequently, roughly once every two weeks. We argue that the retailer chooses the frequency with which it resets references prices so as to keep the realized markups within plus/minus twenty percent of the desired markup over reference cost.

High-interest-rate currencies tend to appreciate relative to low-interest-rate currencies. We argue that adverse-selection problems between participants in foreign exchange markets can account for this ‘forward premium puzzle.’ The key feature of our model is that the adverse selection problem facing market makers is worse when, based on public information, a currency is expected to appreciate.

Currencies that are at a forward premium tend to depreciate. This `forward-premium puzzle' represents an egregious deviation from uncovered interest parity. We document the properties of returns to currency speculation strategies that exploit this anomaly. The first strategy, known as the carry trade, is widely used by practitioners. This strategy involves selling currencies forward that are at a forward premium and buying currencies forward that are at a forward discount. The second strategy relies on a particular regression to forecast the payoff to selling currencies forward. We show that these strategies yield high Sharpe ratios which are not a compensation for risk. However, these Sharpe ratios do not represent unexploited profit opportunities. In the presence of microstructure frictions, spot and forward exchange rates move against traders as they increase their positions. The resulting `price pressure' drives a wedge between average and marginal Sharpe ratios. We argue that marginal Sharpe ratios are zero even though average Sharpe ratios are positive. We display a simple microstructure model that simultaneously rationalizes `price pressure' and the forward premium puzzle. The central feature of this model is that market makers face an adverse selection problem that is less severe when the currency is expected to appreciate.

The wide cross-country disparity in rates of economic growth is the most puzzling feature of the development process. This paper describes a class of models in which this heterogeneity in growth experiences can be the result of cross-country differences in government policy. These differences can also create incentives for labor migration from slow-growing to fast-growing countries. In the models considered, growth is endogeneous despite the absence of increasing returns because there is a "core" of capital goods that can be produced without the direct or indirect contribution of factors that cannot be accumulated, such as land.

This paper uses a unified analytical framework to assess, both qualitatively and quantitatively, the relevance of the different hypotheses that have been proposed to explain the real effects of exchange rate-based stabilizations. The four major hypotheses analyzed are: (i) the supply-side effects associated with an inflation decline; (ii) the perception that the exchange rate peg is temporary; (iii) the fiscal adjustments that tend to accompany the peg; and (iv) the existence of nominal rigidities in wages or prices.

This paper describes a simple model of technology adoption which combines the two engines of growth emphasized in the recent growth literature: human capital accumulation and technological progress. Our model economy does not create new technologies, it simply adopts those that have been created elsewhere. The accumulation of human capital is closely tied to this adoption process: accumulating human capital simply means learning how to incorporate a new intermediate good into the production process. Since the adoption costs are proportional to the labour force, the model does not display the counterfactual scale effects that are standard in models with endogenous technical progress. We show that our model is compatible with various standard results on the effects of economic policy on the rate of growth.

California telecommunications company Wireworld is considering an acquisition of Nusantara Communications, a subsidiary of Indonesian conglomerate Bakrie & Brothers. Nusantara had invested $50 million in developing the advanced rural telephone system, which had the potential to provide much-needed telecommunications services to the mostly rural Indonesian population. If if were exported, the worldwide market for this product in the next five years was projected to be in the billions. Should Wireworld acquire this small company halfway around the world? Was it prepared to enter the Indonesian marketplace and beyond?