Federal Reserve Bank of Minneapolis

ABSTRACT We find support for a negative relation between conditional expected monthly return and conditional variance of monthly return, using a GARCH‐M model modified by allowing (1) seasonal patterns in volatility, (2) positive and negative innovations to returns having different impacts on conditional volatility, and (3) nominal interest rates to predict conditional variance. Using the modified GARCH‐M model, we also show that monthly conditional volatility may not be as persistent as was thought. Positive unanticipated returns appear to result in a downward revision of the conditional volatility whereas negative unanticipated returns result in an upward revision of conditional volatility.

The authors construct a model of a dynamic economy in which lenders cannot force borrowers to repay their debts unless the debts are secured. In such an economy, durable assets play a dual role: not only are they factors of production but they also serve as collateral for loans. The dynamic interaction between credit limits and asset prices turns out to be a powerful transmission mechanism by which the effects of shocks persist, amplify, and spill over to other sectors. The authors show that small, temporary shocks to technology or income distribution can generate large, persistent fluctuations in output and asset prices. Copyright 1997 by the University of Chicago.

We reconcile trade theory with plant-level export behavior, extending the Ricardian model to accommodate many countries, geographic barriers, and imperfect competition. Our model captures qualitatively basic facts about U.S. plants: (i) productivity dispersion, (ii) higher productivity among exporters, (iii) the small fraction who export, (iv) the small fraction earned from exports among exporting plants, and (v) the size advantage of exporters. Fitting the model to bilateral trade among the United States and 46 major trade partners, we examine the impact of globalization and dollar appreciation on productivity, plant entry and exit, and labor turnover in U.S. manufacturing.

We present a qualitative and quantitative analysis of the standard growth model modified to include precautionary saving motives and liquidity constraints. We address the impact on the aggregate saving rate, the importance of asset trading to individuals, and the relative inequality of wealth and income distributions.

A paradigm is presented where both the extent of financial intermediation and the rate of economic growth are endogenously determined.

A paradigm is presented in which both the extent of financial intermediation and the rate of economic growth are endogenously determined. Financial intermediation promotes growth because it allows a higher rate of return to be earned on capital, and growth in turn provides the means to implement costly financial structures. This financial intermediation and economic growth are inextricably linked in accord with the Goldsmith-McKinnon-Shaw view on economic development. The model also generates a development cycle reminiscent of the Kuznets hypotheses. In particular, in the transition from a primitive slow-growing economy to a developed fast-growing one, a nation passes through a stage in which the distribution of wealth across the rich and poor widens. Copyright 1990 by University of Chicago Press.

We find support for a negative relation between conditional expected monthly return and conditional variance of monthly return, using a GARCH-M model modified by allowing (1) seasonal patterns in volatility, (2) positive and negative innovations to returns having different impacts on conditional volatility, and (3) nominal interest rates to predict conditional variance. Using the modified GARCH-M model, we also show that monthly conditional volatility may not be as persistent as was thought. Positive unanticipated returns appear to result in a downward revision of the conditional volatility whereas negative unanticipated returns result in an upward revision of conditional volatility.

The supply and price of skilled labor relative to unskilled labor have changed dramatically over the postwar period. The relative quantity of skilled labor has increased substantially, and the skill premium, which is the wage of skilled labor relative to that of unskilled labor, has grown significantly since 1980. Many studies have found that accounting for the increase in the skill premium on the basis of observable variables is difficult and have concluded implicitly that latent skill-biased technological change must be the main factor responsible. This paper examines that view systematically. We develop a framework that provides a simple, explicit economic mechanism for understanding skill-biased technological change in terms of observable variables, and we use the framework to evaluate the fraction of variation in the skill premium that can be accounted for by changes in observed factor quantities. We find that with capital-skill complementarity, changes in observed inputs alone can account for most of the variations in the skill premium over the last 30 years.

We propose and characterize a model of preferences over acts such that the decision maker prefers act f to act g if and only if E μ φ( E π u○f) ⩾ E μ φ( E π u○g), where E is the expectation operator, u is a von Neumann-Morgenstern utility function, φis an increasing transformation, and μis a subjective probability over the set Πof probability measures πthat the decision maker thinks are relevant given his subjective information. A key feature of our model is that it achieves a separation between ambiguity, identified as a characteristic of the decision maker's subjective beliefs, and ambiguity attitude, a characteristic of the decision maker's tastes. We show that attitudes toward pure risk are characterized by the shape of u, as usual, while attitudes toward ambiguity are characterized by the shape of φ. Ambiguity itself is defined behaviorally and is shown to be characterized by properties of the subjective set of measures Π. One advantage of this model is that the well-developed machinery for dealing with risk attitudes can be applied as well to ambiguity attitudes. The model is also distinct from many in the literature on ambiguity in that it allows smooth, rather than kinked, indifference curves. This leads to different behavior and improved tractability, while still sharing the main features (e.g., Ellsberg's paradox). The maxmin expected utility model (e.g., Gilboa and Schmeidler (1989)) with a given set of measures may be seen as a limiting case of our model with infinite ambiguity aversion. Two illustrative portfolio choice examples are offered. Copyright The Econometric Society 2005.

A number of economists find that growth and schooling are highly correlated across countries. A model is examined in which the ability to build on the human capital of one's elders plays an important role in linking growth to schooling. The model is calibrated to quantify the strength of the effect of schooling on growth by using evidence from the labor literature on Mincerian returns to education. The upshot is that the impact of schooling on growth explains less than one-third of the empirical cross-country relationship. The ability of reverse causality to explain this empirical relationship is also investigated. (JEL I2, J24, O4)

We construct a growth model consistent with China's economic transition: high output growth, sustained returns on capital, reallocation within the manufacturing sector, and a large trade surplus. Entrepreneurial firms use more productive technologies, but due to financial imperfections they must finance investments through internal savings. State-owned firms have low productivity but survive because of better access to credit markets. High-productivity firms outgrow low-productivity firms if entrepreneurs have sufficiently high savings. The downsizing of financially integrated firms forces domestic savings to be invested abroad, generating a foreign surplus. A calibrated version of the theory accounts quantitatively for China's economic transition. (JEL E21, E22, E23, F43, L60, O16, O53, P23, P24, P31).

, performed all the computations, and gave very helpful criticisms and suggestions. 'We will not exhaust the possible circumstances under which the monetary authority's control over inflation is very limited in monetarist economies. We will not even touch on the variety of nonmonetarist economies in which this is true. For examples of such nonmonetarist economies and a more general discussion of

Search‐theoretic models of monetary exchange are based on explicit descriptions of the frictions that make money essential. However, tractable versions of these models typically make strong assumptions that render them ill suited for monetary policy analysis. We propose a new framework, based on explicit micro foundations, within which macro policy can be studied. The framework is analytically tractable and easily quantifiable. We calibrate the model to standard observations and use it to measure the cost of inflation. We find that going from 10 percent to 0 percent inflation is worth between 3 and 5 percent of consumption—much higher than previous estimates.

Recent sovereign defaults in emerging countries are accompanied by interest rate spikes and deep recessions. This paper develops a small open economy model to study default risk and its interaction with output, consumption, and foreign debt. Default probabilities and interest rates depend on incentives for repayment. Default occurs in equilibrium because asset markets are incomplete. The model predicts that default incentives and interest rates are higher in recessions, as observed in the data. The reason is that in a recession, a risk averse borrower finds it more costly to repay non-contingent debt and is more likely to default. In a quantitative exercise the model matches various features of the business cycle in Argentina such as: high volatility of interest rates, higher volatility of consumption relative to output, a negative correlation of interest rates and output and a negative correlation of the trade balance and output. The model can also predict the recent default episode in Argentina.

This paper develops a forecasting procedure based on a Bayesian method for estimating vector autoregressions. The procedure is applied to ten macroeconomic variables and is shown to improve out-of-sample forecasts relative to univariate equations. Although cross-variables responses are damped by the prior, considerable interaction among the variables is shown to be captured by the estimates.

The authors propose a theory of economic development in which technology adoption and barriers to such adoptions are the focus. The size of these barriers differs across countries and time. The larger these barriers, the greater the investment a firm must make to adopt a more advanced technology. The model is calibrated to the U.S. balanced growth observations and the postwar Japanese development miracle. For this calibrated structure, the authors find that the disparity in technology adoption barriers needed to account for the huge observed income disparity across countries is not implausibly large. Copyright 1994 by University of Chicago Press.

This paper develops a forecasting procedure based on a Bayesian method for estimating vector autoregressions. The procedure is applied t o 10 macroeconomic variables and is shown to improve out-of-sample forecasts relative to univariate equations. Although cross-variable responses are damped by the prior, considerable interaction among the variables is shown to be captured by the estimates We provide unconditional forecasts as of 1982:12 and 1983:3. We also describe how a model such as this can be used to make conditional projections and to analyze policy alternatives. As an example, we analyze a Congressional Budget Office forecast made in 1982: 12 Although no automatic causal interpretations arise from models like ours, they provide a detailed characterization of the dynamic statistical interdependence of a set of economic variables, information that may help in evaluating causal hypotheses without containing any such hypotheses.

Abstract The results obtained in five years of forecasting with Bayesian vector autoregressions (BVAR's) demonstrate that this inexpensive, reproducible statistical technique is as accurate, on average, as those used by the best known commercial forecasting services. This article considers the problem of economic forecasting, the justification for the Bayesian approach, its implementation, and the performance of one small BVAR model over the past five years.

We develop a parsimonious model of innovation to confront firm‐level evidence. It captures the dynamics of individual heterogeneous firms, describes the behavior of an industry with firm entry and exit, and delivers a general equilibrium model of technological change. While unifying the theoretical analysis of firms, industries, and the aggregate economy, the model yields insights into empirical work on innovating firms. It accounts for the persistence of firms’ R&D investment, the concentration of R&D among incumbents, the link between R&D and patenting, and why R&D as a fraction of revenues is positively correlated with firm productivity but not with firm size or growth.

The central puzzle in international business cycles is that fluctuations in real exchange rates are volatile and persistent. We quantify the popular story for real exchange rate fluctuations: they are generated by monetary shocks interacting with sticky goods prices. If prices are held fixed for at least one year, risk aversion is high, and preferences are separable in leisure, then real exchange rates generated by the model are as volatile as in the data and quite persistent, but less so than in the data. The main discrepancy between the model and the data, the consumption—real exchange rate anomaly, is that the model generates a high correlation between real exchange rates and the ratio of consumption across countries, while the data show no clear pattern between these variables. Copyright 2002, Wiley-Blackwell.