We use a micro-founded macroeconometric modeling framework to investigate the design of monetary policy when the central bank faces uncertainty about the true structure of the economy. We apply Bayesian methods to estimate the parameters of the baseline specification using postwar U.S. data and then determine the policy under commitment that maximizes household welfare. We find that the performance of the optimal policy is closely matched by a simple operational rule that focuses solely on stabilizing nominal wage inflation. Furthermore, this simple wage stabilization rule is remarkably robust to uncertainty about the model parameters and to various assumptions regarding the nature and incidence of the innovations. However, the characteristics of optimal policy are very sensitive to the specification of the wage contracting mechanism, thereby highlighting the importance of additional research regarding the structure of labor markets and wage determination.

ABSTRACT __________________________________________________________________________ The current literature offers two views on the nature of the labor income process. According to the first view, which we call the “restricted income profiles ” (RIP) model, individuals are subject to large and very persistent shocks while facing similar life-cycle income profiles (MaCurdy, 1982). According to the alternative view, which we call the “heterogeneous income profiles ” (HIP) model, individuals are subject to income shocks with modest persistence while facing individual-specific income profiles (Lillard and Weiss, 1979). In this paper we study the restrictions imposed by the RIP and HIP models on consumption data—in the context of a life-cycle model—to distinguish between these two hypotheses. In the life-cycle model with a HIP process, which has not been studied in the previous literature, we assume that individuals enter the labor market with a prior belief about their individual-specific profile and learn over time in a Bayesian fashion. We find that learning is slow, and thus initial uncertainty affects decisions throughout the life cycle. The resulting HIP model is consistent with several features of consumption data including (i) the substantial rise in within-cohort consumption inequality, (ii) the non-concave shape of the ageinequality profile, and (iii) the fact that consumption profiles are steeper for higher educated individuals. The RIP model we consider is also consistent with (i), but not with (ii) and (iii). These results bring new

In this paper, I consider a dynamic economy in which a government needs to finance a stochastic process of purchases. The agents in the economy are privately informed about their skills, which evolve stochastically over time; I impose no restriction on the stochastic evolution of skills. I construct a tax system that implements a symmetric constrained Pareto optimal allocation. The tax system is constrained to be linear in an agent’s wealth, but can be arbitrarily nonlinear in his current and past labor incomes. I find that wealth taxes in a given period depend on the individual’s labor income in that period and previous ones. However, in any period, the expectation of an agent’s wealth tax rate in the following period is zero. As well, the government never collects any net revenue from wealth taxes.

Using a model with constant relative risk-aversion preferences, endogenous labor supply and partial insurance against idiosyncratic wage risk, the paper provides an analytical characterization of three welfare effects: (a) the welfare effect of a rise in wage dispersion, (b) the welfare gain from completing markets, and (c) the welfare effect from eliminating risk. Our analysis reveals an important trade-off for these welfare calculations. On the one hand, higher wage uncertainty increases the cost associated with missing insurance markets. On the other hand, greater wage dispersion presents opportunities to raise aggregate productivity by concentrating market work among more productive workers. Our welfare effects can be expressed in terms of the underlying parameters defining preferences and wage risk or, alternatively, in terms of changes in observable second moments of the joint distribution over individual wages, consumption and hours.

I extend the Epstein-Zin-lognormal consumption-based asset-pricing model to allow for general i.i.d. consumption growth processes. Information about the higher moments—equivalently, cumulants—of consumption growth is encoded in the cumulantgenerating function (CGF). I express four observable quantities (the equity premium, riskless rate, consumption-wealth ratio and mean consumption growth) and the Hansen-Jagannathan bound in terms of the CGF, and present applications. Models in which consumption is subject to occasional disasters can be handled easily and flexibly within the framework. The importance of higher cumulants is a double-edged sword: those model parameters which are most important for asset prices, such as disaster parameters, are also the hardest to calibrate. It is therefore desirable to make statements which do not depend on a particular calibrated consumption process. First, I use properties of the CGF to derive restrictions on the time-preference rate and elasticity of intertemporal substitution that must hold in any Epstein-Zin-i.i.d. model which is consistent with the observable quantities. Second, I show that “good deal ” bounds on the maximal Sharpe

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This paper uses a SVAR approach to discuss the cyclicality of fiscal and monetary policy in South Africa since 1994. There is a substantial South African literature on this topic, but much disagreement remains. Though not undisputed, there is a growing consensus that monetary policy has contributed to the remarkable stabilisation of the South African economy over this period. The evaluation of fiscal policy’s role in stabilisation has been less favourable and there is little evidence that a countercyclical fiscal stance was a fiscal priority over this period. This paper considers these issues in an empirical framework that addresses some of the shortcomings in the literature, specifically: it constructs a structural model in contrast with the reduced form models typically used in the South African literature, it incorporates the dynamic interaction between monetary and fiscal shocks on the demand side and supply shocks on the other and avoids controversy over “neutral ” base years and the size of fiscal elasticities. The model confirms the consensus on monetary policy, finding monetary policy to have been largely co untercyclical since 1994. On fiscal policy this paper finds evidence of pro-cyclicality especially in the more recent period, though the policy simulation suggests that the pro-cyclicality of fiscal policy has had little destabilising impact on real output.

This paper analyzes the welfare costs of business cycles when workers face uninsurable idiosyncratic labor income risk that has a cyclical component. In accordance with the previous literature, this paper decomposes individual labor income risk into an aggregate and an idiosyncratic component and assumes that these two components are stochastically independent. In contrast to the previous literature, this paper allows the idiosyncratic component to be multi-dimensional. The paper shows that the extension to the case of multidimensional risk increases the welfare costs of business cycles if the relative importance of the individual sources of idiosyncratic risk varies over the business cycle. For the case of worker displacement with logutility preferences, the introduction of multiple sources of idiosyncratic risk can increase the welfare cost of business cycles from.3 % (the one-dimensional case) to up to 1.4%. In other words, the introduction of multiple sources of idiosyncratic risk has the potential to increase the welfare costs of business cycles substantially.

ABSTRACT: The “business cycle ” is a fundamental, yet elusive concept in macroeconomics. In this paper, we consider the problem of measuring the business cycle. First, we argue for the ‘output-gap ’ view that the business cycle corresponds to transitory deviations in economic activity away from a permanent or “trend ” level. Then, we investigate the extent to which a general model-based approach to estimating trend and cycle for the U.S. economy leads to measures of the business cycle that reflect models versus the data. We find empirical support for a nonlinear time series model that produces a business cycle measure with an asymmetric shape across NBER expansion and recession phases. Specifically, this business cycle measure suggests that recessions are periods of relatively large and negative transitory fluctuations in output. However, several close competitors to the nonlinear model produce business cycle measures of widely differing shapes and magnitudes. Given this model-based uncertainty, we construct a model-averaged measure of the business cycle. The model-averaged measure also displays an asymmetric shape and is closely related to other measures of economic

at Gerzensee Switzerland on the integration of macroeconomic and microeconomic perspectives. Laibson acknowledges financial support from the NSF and the NIA. 1 Abstract: Lucas (1987) calculates the cost of economic fluctuations to be less than 0.1 % of consumption. In other words, we should be willing to pay no more than 0.1 % of our (permanent) consumption to eliminate all future business cycle fluctuations. The current paper shows that Lucas ’ calculationsmissthecostsoffluctuations arising from asset bubbles. We identify two novel types of costs: consumption booms/busts due to asset price volatility, and consumption volatility due to asset trading during bubble periods. We show that these effects rely on heterogeneity. If assets are spread proportionately over the population, the resulting welfare costs scale down to the magnitudes derived by Lucas. We calibrate our model using the Health and Retirement Survey. Our benchmark calibration, which assumes a coefficient of relative risk aversion of 3, implies that the asset bubbles of the last decade generated a social welfare cost equal to a permanent 4 % reduction in the level of national consumption. As expected, our calculations are sensitive to the details of the calibration, including the degree of balance sheet/trading heterogeneity, the coefficient of relative risk aversion, and the magnitude of the asset bubble. Our specifications with reasonable parameter values generate welfare costs ranging from 1 % to 10 % of (permanent) national consumption. 2 1