Macroeconomics has always rested on the fiction that the behavior of aggregates was stable and, therefore, individual market phenomena could be safely ignored. In an important recent contribution, David M. Lilien challenged this fiction and argued that a large component of fluctuations in unemployment could be explained by the dispersion of employment growth across industries. This paper develops models of consumption and investment paper in which the dispersion of economic activity can play a role. The econometric evidence suggests an important role for the dispersion of economic activity in explaining aggregate consumption and investment.

This paper examines consumption changes of workers following experiences of unemployment in different stochastic environments. The model developed in the paper predicts that consumption changes following unemployment spells should be small for workers the higher are their layoff and recall probabilities. These predictions are confirmed in estimates with panel data.

This paper examines the relationship between unemployment durations and cyclical movements in unemployment using an "employment calendar" constructed from recent questions in the Panel Study of Income Dynamics. We find that unemployment durations increase with the unemployment rate with the strongest effects for individuals with the longest elapsed durations. Copyright 1990 by MIT Press.

In this paper we explore the role of transitory income in the housing purchase decision. Because of moral hazard considerations banks typically require downpayments to be financed internally, hence transitory income is potentially important in overcoming the downpayment constraint. Using a novel approach to the measurement of permanent and transitory income, we estimate a two-stage model in which households decide whether to purchase housing in the first stage and the quantity to be purchased in the second. The results indicate a significant role for transitory income in both decision stages.

Sluggish wages and prices are generally the culprits in models of unemployment and business fluctuations. Price flexibility in standard fix-price models would restore the economy to full employment. This line of reasoning has often been at the heart of proposals to reform institutions in order to restore flexibility to wages and prices. There is, however, a strand of macroeconomic thought that questions the wisdom of too much price flexibility. John Maynard Keynes raised the issue in chapter 19 of the General Theory by noting that a deflation could raise real interest rates and thereby impede a return to full employment. In his 1975 paper Keynesian Models of Recession and James Tobin develops this point in a formal model. Low prices work to move the economy to full employment but falling prices, to the extent that they lead to expectations of deflation, raise the real interest rate (through the Mundell effect) and move the economy away from full employment. Instability is likely to occur if expectations of inflation adjust rapidly to actual inflation and the real interest rate effect is large. Our historical experience does include significant episodes where either reductions in inflation or actual deflation were accompanied by high real interest rates. Although other factors could be responsible, the experiences of the Great Depression, the Latin American countries in the late 1970's and the United States in the early 1980's all add surface plausibility to the real interest rate deflation link and thus to one aspect of the Keynes-Tobin story. Recently, Bradford De Long and Lawrence Summers (1984) have argued that the decrease in the variance of output following World War II can be largely attributable to the decrease in wage and price flexibility in the postwar era. The reason output fluctuations are smaller today is precisely because the Keynes-Tobin destabilizing mechanism is less operative today.' This paper examines whether increased price flexibility can be destabilizing in a version of John Taylor's contract model (1979, 1980) extended to include real interest rate effects. Taylor's model includes both backward and forward elements in wage-setting behavior and thus permits some rationality in the wage-setting process. We find that even with this limited degree of rationality, increased wage flexibility leads to a decrease in both the variance of output and the variance of prices. Nicholas Carlozzi and Taylor (1983) introduce the real rate of interest into a staggered contract framework and discuss in general terms and through simulations the effects that changing real rates may have on the system. They do not, however, study the effects of potential instability through increases in wage flexibility or provide any analytical results. They provide an extensive discussion of the implications of alternative policy rules on the stochastic behavior of the economy. We first add the real interest rate to the standard Taylor model and derive the solution and prove key analytical results. These results are further buttressed by simulations.

This paper examines the controversial link between interest rates and prices by introducing interest costs into John Taylor's model of overlapping wage contracts. We find that the presence of interest costs does affect the stabilization process and can make the tradeoffs between output and price variability less favorable.

A recent survey on models of agricultural supply equations listed over 500 studies in which variants of Nerlove's adaptive expectations model were employed.' One might naively assume that the scientific evidence overwhelmingly favored the adaptive expectations hypothesis, but this inference would not be warranted. In particular, there have been very few studies which have even attempted to estimate a expectations version of the traditional agricultural supply models and none that have explicitly tested the expectations hypothesis.2 In this paper we estimate a model of agricultural supply and demand for the chicken broiler industry under the maintained assumption of expectations in the sense of Muth (1961) and provide a series of tests of the model specification. We find that, in this case, the hypothesis of Muth rationality receives strong support. In recent years there has been increasing interest in models in which economic actors are assumed to form expectations of variables rationally. For the most part, empirical applications of the expectations hypothesis have employed single-equation econometric methods. These methods have permitted consistent estimation of equations under the assumption of the expectations hypothesis but do not allow for any explicit testing of the maintained hypothesis of rationality. This paper presents estimates of a simultaneous equation model of the chicken broiler industry using maximum likelihood methods and provides a joint test of the expectations hypothesis and the model specification. Our econometric procedure is related to the recent theoretical work of Wallis (1980) and combines time series analysis with traditional econometric estimation techniques. Under the assumption of expectations, the model can be solved for the expected price as a function of the expected values of the exogenous variables. This function can then be substituted into the model leading to a specification which contains the original endogenous and exogenous variables plus the expected values of the exogenous variables. In general, following this substitution, the model will contain overidentifying restrictions. Time series analysis is utilized to generate the necessary forecasts of the exogenous variables. The complete system of equations is estimated by full-information maximum likelihood, and the constraints are tested by a log-likelihood ratio test. The overidentifying constraints arise in the model because the suppliers are assumed to act as if they know both the underlying structure of the model and the stochastic processes governing the exogenous variables, the two requirements of expectations. While the expected price enters only the supply equation of our model, it is necessary, in the econometric formulation, to specify the demand equation. The instrumental variable procedures of McCallum (1976) and Nelson (1975b) are single-equation methods and do not permit a test of the expectations hypothesis. By specifying the complete model, the additional structure imposed on the problem allows us to estimate the coefficients and test the implied restrictions. There has not been universal agreement that the expectations hypothesis is the best theoretical device to model rational behavior. According to Muth's original formulation, economic actors forecast endogenous variables according to the true reduced form equations of the model. DeCanio (1979) and Friedman (1979) have argued that the economic actors actually Received for publication August 24, 1981. Revision accepted for publication March 2, 1982. ' University of New Mexico and University of California, Davis, respectively. We wish to thank G. King, R. L. Huntzinger, R. Pope, and L. Wegge for advice on this project. A. Nelson and E. Shaw contributed useful research assistance. I The paper by Askari and Cummings (1977) provides references for these studies. 2 Huntzinger's (1979) paper is one of the first attempts at estimatitng a expectations model of agricultural supply.

Causal relations between federal expenditure and taxation are analyzed using an approach based on the invariance of econometric relationships in the face of structural interventions. Institutional evidence for interventions or changes of regime combined with econometric tests for structural breaks are used to investigate the relative stability of conditional and marginal probability distributions for each variable. The patterns of stability are the products of underlying causal order. We find two distinct causal structures operating in the postwar era. Before the mid-1960's, taxes appear to cause spending. After the late 1960's, taxes and spending are causally independent.