This paper reconsiders optimal inflation targeting in a model where persistence is generated by rational choices of the price makers because of a time-dependent pricing mechanism. In this framework, which generalizes the traditional Calvo model, inflation persistence is intrinsic, as it is micro-founded assuming that firms' pricing decisions depend on the time elapsed from the last price reset. We use a linear–quadratic approach to study the welfare effects and optimal policies. We disentangled two distortion sources showing how welfare falls in both the average of the probability of changing prices and its distribution among different firms. Described the underlying distortions of our setup, we analyze its normative implications for optimal inflation. The issues of uncertainty and robustness are also considered: By using robust control techniques, we, in fact, consider the consequences of implementing a “wrong” monetary rule due to a misinterpretation of sources of inflation inertia.

This paper analyzes exchange-rate dynamics following a money-based disinflation under different degrees of exchange-rate pass-through. Using a microfounded dynamic general equilibrium model with imperfect competition and nominal rigidities, it is shown that a monetary slowdown causes an appreciation of the exchange rate and a short-run fall in employment. Varying the degree of pass-through, however, significantly alters the magnitudes of these effects. As the degree of pass-through is reduced, the extent of the short-run appreciation of the exchange rate increases and the short-run impact of the disinflation on employment falls.

Recently, Penn World Tables include new data that enable calculation of total factor productivity in addition to output for a large set of countries. We use these new data to examine convergence and divergence across countries by applying a new approach, which differentiates between the dynamics of output and of productivity. Our empirical results lead to two main new contributions to the literature. The first is on the interpretation of “β-convergence” in “growth regressions.” It means that output per worker in each country converges to productivity but does not imply convergence across countries, since productivity tends to diverge from the global frontier. The second contribution is to the literature, which finds that income gaps across countries are due mainly to differential technology adoption. This paper shows that the gaps in technology are not only large but keep growing over time.

This paper uses a Bayesian approach to estimate a standard international real business cycle model augmented with preferences with zero wealth effect, variable capacity utilization, and investment adjustment costs. First, I find that the bulk of fluctuations in country-specific outputs, consumption, investments, and international relative prices can be attributed to country-specific neutral technology, investment-specific technology, and preference shocks. Second, my estimated model with economically meaningful shocks simultaneously accounts for the negative correlation between the real exchange rate and relative consumption and the negative correlation between the terms of trade and relative output. Last, through a marginal likelihood comparison exercise, I find that the success of the model depends on preferences with zero wealth effects; other frictions and alternative asset market structures play a less important role.

Based on a multisector general equilibrium framework, we show that the sectoral elasticity of substitution plays the key role in the evolution of asymmetric tails of macroeconomic fluctuations and the establishment of robustness against productivity shocks. A non-unitary elasticity of substitution renders a nonlinear Domar aggregation, where normal sectoral productivity shocks translate into non-normal aggregated shocks with variable expected output growth. We empirically estimate 100 sectoral elasticities of substitution, using the time-series linked input-output tables for Japan and find that the production economy is elastic overall, relative to a Cobb-Douglas economy with unitary elasticity. In addition to the previous assessment of an inelastic production economy for the USA, the contrasting tail asymmetry of the distribution of aggregated shocks between the USA and Japan is explained. Moreover, the robustness of an economy is assessed by expected output growth, the level of which is led by the sectoral elasticities of substitution under zero-mean productivity shocks.

Benhabib and Farmer show that in a laissez-faire one-sector real business cycle model under aggregate increasing returns, under sufficiently high degrees of productive externality, the demand-side effect in the labor market triggered by agents' expectations about the economy's future outweighs the supply-side effect, making agents' expectations become self-fulfilling. This paper analytically demonstrates that the conduct of monetary policy under nominal gross domestic product (GDP) targeting reinforces the supply-side effect in the labor market, thereby making belief-driven aggregate fluctuations more difficult to occur. This reinforcement effect on labor supply is absent under nominal consumption targeting and inflation targeting. Hence, under these two monetary regimes, the necessary and sufficient conditions for the economy to display equilibrium indeterminacy and sunspot fluctuations are identical to those in Benhabib and Farmer's laissez-faire economy. The results are robust to an endogenous growth extension of the model, implying that targeting the nominal GDP growth rate is more desirable than targeting the nominal consumption growth rate or the inflation rate in terms of macroeconomic stability.

Introducing susceptible-infected-recovered epidemiology dynamics with vaccines into an endogenous growth model, we investigate the impact of government infectious disease policy on macroeconomic performance. We find that any expenditure that improves health, whether to reduce the contact rate or increase the recovery rate or the vaccination rate, and regardless of whether it comes directly from the households or the government, has a positive impact on economic growth, but does not necessarily improve the welfare. The reason people’s health has improved but their welfare has fallen is because government expenditures must be covered by taxes, which will reduce their disposable income and consumption.

In a canonical monetary policy model in which the central bank learns about underlying fundamentals by estimating the parameters of a Phillips curve, we show that the bank’s loss function is asymmetric such that parameter overestimates may be more or less costly than underestimates, creating a precautionary motive in estimation. This motive suggests the use of a more efficient variance-adjusted least-squares estimator for learning about fundamentals. Informed by this “precautionary learning” the central bank sets low inflation targets, and the economy can settle near a Ramsey equilibrium.

Occurrences of an old phenomenon, the expropriation of foreign-owned property, peaked in the 1970s when virtually every significant oil-producing developing country nationalized its oil. Nationalization was again on the rise in the 2000s. Using novel data, this paper quantitatively evaluates the effects of nationalization. First, the paper finds significant productivity losses associated with nationalization in a sample of oil-producing countries. Venezuela in particular experienced a striking decline in productivity. Second, the paper presents a new channel through which nationalization affects productivity: a long-term pre-announcement can shift the composition of the workforce with a huge decline in highly skilled foreign workers and result in higher extraction and lower exploration. Guided by a quantitative dynamic partial equilibrium framework disciplined by features of the Venezuelan data, this paper then evaluates the effects of nationalization. A comparison of the simulated and time series data shows that the model can explain about 80% of the productivity pattern over 1961–1980 in the Venezuelan oil industry. Counterfactual experiments suggest that the shift in the composition of the workforce is important in accounting for the productivity pattern. Furthermore, if nationalization had been sudden, long-run losses would have been lower.

Can monetary policy stimulate consumption through inflation expectations? We study how US consumers revise inflation expectations and readiness to spend in response to monetary policy shocks using a structural vector-autoregressive model, where we identify exogenous policy shocks with interest rate surprises around FOMC announcements. Based on survey data, we construct measures of changes in consumers’ readiness to spend conditional on how consumers update their inflation expectations. Expansionary policy shocks tend to increase readiness to spend conditional on higher expected inflation outside the zero lower bound (ZLB), but the effect is small. At the ZLB, consumers increasingly reduce their readiness to spend if they expect higher inflation. Overall, we find only limited evidence suggesting that policy-induced variations in inflation expectations are associated with adjustments that are in line with the predictions of standard macroeconomic models.

This paper provides conditions under which an algorithm for the computation and simulation of Bewley–Huggett–Aiyagari models, based on state-space discretization, will converge to all true solutions. These conditions are shown to be satisfied in two standard examples: the Aiyagari model and its extension to endogenous labor. Bewley–Huggett– Aiyagari models are general equilibrium models with incomplete markets and idiosyncratic, but no aggregate, shocks. The algorithm itself is based on discretization, while the theory importantly allows for making simulations using the approximate computational solution of the value function problem rather than the true model solution. The numerical results of applying the algorithm to both models are provided and investigated in terms of replication, revealing that the Aiyagari model overestimates the degree of precautionary savings in the high-risk-and-high-risk-aversion case. The results also show that both models almost certainly have a unique general equilibrium. Theoretically, the existence of equilibria was known, but uniqueness remained an open question.

The global financial crisis was characterized by heightened financial risk in the USA, which spread to the rest of the world, including emerging economies. This paper constructs a core–periphery model with a global banking network and financial frictions. Due to a common-lender effect, when global banks lend to an emerging economy, heightened financial risk in the center depresses cross-border lending to the emerging economy, reducing real activities and exacerbating monetary policy trade-offs. As financial markets become more integrated, exchange rate flexibility becomes less welfare enhancing and active capital account policy becomes more welfare enhancing.

We examine optimal policy in an open-economy model with uncertainty and learning, where monetary policy actions affect the economy through the real exchange rate channel. Our results show that the degree of caution or activism in optimal policy depends on whether central banks are in coordinated or uncoordinated equilibrium. If central banks coordinate their policy actions then activism is optimal. In contrast, if there is no coordination, caution prevails. In the latter case caution is optimal because it helps central banks to avoid exposing themselves to manipulative actions by other central banks.

Costas Azariadis was born in Athens, Greece, in 1943. He attended the National Technical University in Athens and received a degree in chemical engineering in 1969. He then attended Carnegie Mellon University, receiving an MBA in 1971 and his Ph.D. in 1975. His doctoral dissertation was advised by Edward Prescott and Robert Lucas. Azariadis's first academic appointment was as an assistant professor at Brown University between 1973 and 1977, after which he moved to the University of Pennsylvania. In 1992, he moved to UCLA. In addition, Azariadis spent two semesters at Hebrew University and Princeton and has held briefer visiting positions all over the world.

Elhanan Helpman is on a quest for knowledge. He is a researcher in transition, constantly redefining his fields of interest by altering the questions asked and the techniques used. Like many of the great economists, Elhanan has worked in many areas: open economy macro, trade under uncertainty, the new international economics, growth theory, and political economy, to list the most famous. However, this interview is not intended as a review of his contributions. Rather, it is about what drives Elhanan's creative process: his wide-ranging reading, his characteristic stubbornness in tackling problems, the conceptualization of his larger research agenda, and his recollections of how he initiated transitions between fields. It is a very personal interview for those in search of creative inspiration.

A recent article in The Economist magazine divided economists into “poets” and “plumbers,” the former articulating radical new visions of the field and the latter patiently installing the infrastructure needed to implement those visions. Bob Shiller is the rare economist who is both poet and plumber. Not only that, he is also entrepreneur and pundit. His work has fundamentally changed the theory, econometrics, practice, and popular understanding of finance.

Starting in the late 1970's, Bob boldly challenged the prevailing orthodoxy of financial economics. He showed that financial asset prices often deviate substantially from the levels predicted by simple efficient-markets models, and he developed new empirical methods to measure these price deviations. In the early 1980's, Bob went on to argue that economists need a much more detailed understanding of investor psychology if they are to understand asset price movements. He pioneered the emerging field of behavioral economics and its most successful branch, behavioral finance. At the end of the century, Bob articulated his vision of finance in a wildly successful popular book, Irrational Exuberance. He became so well known that TIAA-CREF asked him to appear in a series of full-page advertisements in the popular press.

Although Bob does not believe that investors use financial markets in a perfectly rational manner, he does believe that these markets offer great possibilities to improve the human condition. His recent work asks how existing financial markets can be used, and new financial markets can be designed, to improve the sharing of risks across groups of people in different regions, countries, and occupations. He has explored risk-sharing possibilities not only in journal articles, but also in business ventures and a 2003 book, The New Financial Order: Risk in the 21st Century.

It was a great privilege for me to interview Bob Shiller. Bob's arrival at Yale when I was a Ph.D. student there set the course of my career as an economist. Bob reinvigorated the Yale tradition of macroeconomics, with its emphasis on the central role of financial markets in the macroeconomy and its idealism about the possibility of improving macroeconomic outcomes. First as a thesis adviser, then as a coauthor, mentor, and friend, Bob showed me how to contribute to this tradition.

The interview took place at the 2003 annual meetings of the Allied Social Science Associations in Washington, D.C. We met in a hotel suite, ate a room service meal, and had the enjoyable conversation that is reproduced below.

This note studies fiscal–monetary policy interactions in an endogenous growth model with multiple assets. The “growth-rate Laffer curve” clarifies an important tension between economic growth and government revenue and reveals that higher economic growth does not always finance a larger budget deficit. There are two Pareto-ranked balanced-growth equilibria, which can both be E-stable. Although fiscal policy can eliminate the expectational indeterminacy, it rules out the equilibrium with a higher growth rate and higher welfare. Near the lower bound of the nominal interest rate, an arbitrarily small budget deficit will select the low-growth equilibrium to be the unique E-stable equilibrium.

This paper analyzes the process of decision-making on consumption in a two-period consumption setting, assuming the return on savings is uncertain in the sense of Knight [Risk, Uncertainty, and Profit. Boston: Houghton Mifflin (1921)]. The results imply that a naïve strategy to save zero is optimal for a continuum of income values. Under the Permanent Income Hypothesis, consumption equals current income only when current income is equal to permanent income. Indeed Campbell and Mankiw [in Olivier Blanchard and Stanley Fischer (eds.), NBER Macroeconomics Annual, pp. 185–214. Cambridge, MA: MIT Press (1989)] assumed that consumers who spend their total income are only following a simple rule of thumb. However, the naïve strategy obtained casts doubt on their interpretation.

The financial woes that initiated the financial crisis of 2007/08 have, at least in part, been traced to excessive bank risk-taking. What induced this behavior? One explanation is the persistently low short-term interest rates during the mid-2000s. We exploit an extensive panel of matched Austrian banks and firms during 2000–2008 to investigate the effects of the European Central Bank's (ECB) policy of persistently low interest rates during 2003q3–2005q3. Our analysis suggests that this policy likely caused Austrian banks to hold risker loan portfolios than they would have in its absence.

The Encyclopedia Americana, 2002 edition, concludes its entry on Milton Friedman as follows: “His major work, A Monetary History of the United States, 1867–1960, was published in 1963.” That might be seen as an indirect compliment to Anna J. Schwartz, who coauthored the Monetary History with Friedman but is not mentioned in the encyclopedia entry. Similarly, the Nobel Committee neglected to mention Schwartz when, in awarding Friedman his Prize in 1976, it described A Monetary History as “[h]is major work [and] … one of Friedman's most profound and also most distinguished achievements.” Fortunately, the economics profession as a whole has not been so negligent, and the phrase “Friedman and Schwartz” has become second nature to economists when discussing the importance of monetary policy.

Beside her collaborations with Friedman, Anna Schwartz is perhaps best known for her longevity, which is on an epoch-shattering scale. Her career as an economic researcher began a quarter-century before the publication of A Monetary History, and has continued in the 40 years since. Schwartz's first journal article was published in May 1940, the month Winston Churchill became Prime Minister of the United Kingdom and over 18 months before the United States entered World War II. She has worked at the National Bureau of Economic Research in New York City continuously since 1941. Monetary economics has been a constant interest for her, and she is the only person to have had items published in the inaugural issues of both the Journal of Money, Credit, and Banking (February 1969) and the Journal of Monetary Economics (January 1975).The JME piece was a book review, and so does not appear in the bibliography below. Schwartz's numerous book reviews make rewarding reading and include a prediction in Kyklos in 1968 of an era when economists would use Internet connections to download macroeconomic databases. The JME moved into its fiftieth volume in 2003, and Schwartz became one of only two authors (the other being Thomas Sargent) to have published in both volumes 1 and 50 of the journal. With the NBER branching out in the 1970's into a national network of researchers, Schwartz has been for a quarter century an unmistakable fixture at the NBER monetary economics program's regular meetings at Cambridge, Massachusetts. At the time of the interview, her contributions to the NBER's various working paper series spanned from NBER Technical Paper No. 4, 1947, to NBER Working Paper No. 9321, November 2002. The latter paper covered the issue of equity price behavior, the same subject of her 1940 publication, implying that Schwartz had entered a remarkable seventh decade of research in that area. Much of Schwartz's early research was on UK economic growth and fluctuations in the nineteenth century, and was reflected in a two-volume study essentially completed in the early 1940's but not published until 1953 [Gayer et al. (1953)]. Robert Lucas, who read the volume as a graduate student in history, describes it as “an amazingly ambitious and exciting mix of history and theory.”

Schwartz's collaboration with Milton Friedman on the relationship between the quantity of money and other variables began in 1948. Their early findings on the importance of money were reported by Friedman in a 1952 American Economic Review paper, but, by and large, he had problems promoting their work in the 1950's. Friedman's solo work in the fifties on flexible exchange rates, the consumption function, and the limits of stabilization policy would cement his reputation and be cited in his eventual Nobel award, but the monetary policy studies initially made a much more limited impact. All of Friedman's remaining 1950's writings on money were in “in-house” University of Chicago publications or in congressional testimony.A short excerpt from a Journal of Political Economy paper by Friedman on money did appear in the 1959 proceedings issue of the American Economic Review. Two books by Friedman in the early 1960's previewed some findings from the monetary history project with Schwartz. The first of these, A Program for Monetary Stability, is now recognized as a classic, but its muted reception is evidenced by the fact that economists have never been able to agree on which year it was published. The second book, Capitalism and Freedom (1962), was intended for a wide audience, but was virtually driven underground when all major U.S. newspapers declined to review it. In 1969, a Federal Reserve Bank of New York official, Richard Davis, gave this perspective on reactions to early monetarist work of the 1950's and early 1960's: “[E]conomists regarded this group—when they regarded it at all—as a mildly amusing, not quite respectable collection of eccentrics…. The fact is that the view held by Friedman and others on the predominant importance of money was just not given serious attention by most economists.”

The turning point was in 1963, when Friedman and Schwartz's 15 years of research finally saw print in their Monetary History and the article “Money and Business Cycles.” The Monetary History is justly celebrated, and has remained in print for 40 years.Furthermore, of the 93 books listed by Princeton University Press in its Economics and Finance Catalogue 2003, the Monetary History is the only pre-1994 publication included. The “Cycles” paper, as Davis acknowledged, provided “[b]y far the largest mass of evidence” on the cyclical relation between money and output. In addition, the paper's “tentative sketch” of the monetary transmission mechanism became a cornerstone of the monetarist literature, and an inspiration to many monetary economists, including the late Rudiger Dornbusch, as they endeavored to escape the “single interest rate channel” view of the transmission mechanism.

Schwartz began the 1970's with another collaboration with Friedman, Monetary Statistics, and went on in 1973 to join a number of economists, including fellow monetarists Karl Brunner and Allan Meltzer, in forming the Shadow Open Market Committee (SOMC). The SOMC commented regularly on U.S. economic policy and, in particular, offered monetary policy recommendations to address the severe inflation problem of the 1970's. Schwartz remains on the SOMC 30 years later, the only founding member to serve since the SOMC's inception.

Friedman and Schwartz's final major collaboration, Monetary Trends in the United States and the United Kingdom, was published in 1982. Among monetary economists, the response to Monetary Trends was mild compared to the reception for the Monetary History. Work by Friedman and Schwartz and other monetarists had already changed macroeconomic thinking substantially, and most academic work was now concerned with rigorous modeling of short-run dynamics, rather than the empirical evidence on long-run relations that concerned Friedman and Schwartz in their Trends study.

Schwartz's own work over the past 20 years has been prolific, and has often been in collaboration with Michael Bordo, with whom she has written some 25 articles. While her areas of research have included banking regulation and the role of international financial institutions, Bordo's and her mutual interest in monetary economics and economic history has repeatedly been evident in their work. Among the issues that their studies, sometimes with further collaborators, have addressed are the role of monetary targets in Canada and the United Kingdom in the face of money demand instability, whether monetary policy rules could have avoided the Great Contraction, the historical record of alternative monetary policy regimes, and the history of economic thought, including the development of monetarism.