Although industrialized countries continue to have business cycles, such cycles have changed significantly in character. In what follows I shall describe some of these changes and point to their possible implications for research and policy. Perhaps the most obvious change is that business recessions-periods of actual decline in economic activity -have become less frequent, shorter and milder. Interruptions to a steady rate of growth are more often simply slowdowns rather than actual declines in aggregate economic activity. This kind of shift can be observed in the business recessions identified by the National Bureau of Economic Research. On the whole, the five recessions of 194870 were shorter than the five recessions of 1920-38, produced smaller declines in output, income and employment, and were less widespread in impact. But recent recessions have been accompanied by higher rates of unemployment than might have been expected in view of other evidence attesting to their mildness. One of the factors underlying this shift toward recessions of lesser severity, and one reason why it may be expected to persist, is the trend in the industrial composition of employment. Industries that normally experience larger percentage reductions in employment when recession hits are less important in the overall economic picture nowadays, while industries that often continue to expand right through recession have become more important. Of the eleven major industrial sectors that account for total employment, seven experienced reductions averaging three percent or more during the five recessions of 1948-70 (Table 1). These seven sectors include manufacturing of durable goods like autos and appliances, with an average drop of 12 percent; mining, with an average drop of 10 percent; transportation and utilities, with an average drop of 5 percent; and farming, manufacturing of nondurable goods like textiles, construction, and federal employment, with drops of 3 to 4 percent. Employment in these seven sectors constituted more than half of total employment in 1955, but by 1972 their share had declined to about two-fifths. The other four major sectors--wholesale and retail trade; services; finance, insurance, and real estate; and state and local government -experienced much smaller declines or actual increases in employment during the five most recent recessions. They accounted for slightly less than half of total employment in 1955; by 1972 they accounted for three-fifths of the total. In short, the industries that have coiitributed most to reduced employment during recession have shown little or no growth during the past fifteen years or so, while those that have contributed least to recession have grown much faster. The added stability has reduced the impact of recession upon total employment by something like one-third. If the 1955 distribution of employment among the eleven sectors had prevailed in all five recessions of * Vice-President/Research, National Bureau of Economic Research, Inc., and Senior Research Fellow, Hoover Institution, Stanford University.

A. The Effective Price of Heroin Traditional representations of demand curves assume that the dollar price of a good is the only significant element of the cost to the consuming individual. For most goods, other aspects of consumption such as transaction costs and uncertainty about quality are assumed to play a minor role. Not so with heroin. Heroin is different because, first, users face significant transaction costs. Often they must search intently for an opportunity to score. In addition, in any attempt to score they risk being arrested or victimized by other addicts. The consequences of these transaction costs include withdrawal symptoms, beatings, and jail. Second, users face quality uncertainties which may be even more significant. The amount of pure heroin and the toxicity of adulterants vary widely among street bags. The possible consequences include fraud and death. Against these possible consequences of purchasing and using heroin, the dollar price may be relatively unimportant.Consequently, in describing the cost of consuming heroin, it is best to speak in terms of an effective price of heroin. The eff ective price is defined as an index including the following elements: dollar price, amount of pure heroin, toxicity of adulterants, access time, and threats of victimization and arrest. Many of these elements are uncertain quantities from the point of view of the consumer.

Japan has been in a slump for the past decade. After GDP had been growing by on average 4 percent during the 1980’s, the growth rate dropped to 1 percent in the 1990’s. Asset prices also fluctuated significantly: capital gains on stocks and real estate in the 1980’s, followed by capital losses in the 1990’s, were both on the order of a few years’ worth of GDP, even after taking inflation into account. Together with production and asset prices, the fraction of nonperforming loans fluctuated substantially. These are by no means all bank loans. For the nonfinancial corporate sector in Japan, the ratio of financial assets to total assets is about 40 percent, much higher than in the United States. Such financial assets include loans to and securities of other private agents. That is, nonfinancial institutions simultaneously borrow from and lend to each other on a significant scale. Many nonperforming loans are interlocked, paralyzing the financial system. It is important to recognize that these swings have been experienced by almost all sectors of the Japanese economy. Yet in other countries, comparable movements in asset prices have had less widespread consequences. For example, the recent fluctuations in the NASDAQ index in the United States have been no smaller than those of asset prices in Japan, but the damage appears to be contained to closely related sectors. Although U.S. equity-holders, particularly pension funds, have lost value, the level of nonperforming loans is relatively limited up to now. The question is: Why does there appear to be more contagion in some countries than in others? Has contagion anything to do with the nature of financing or the extent to which there are inter-locking loans? In this theoretical paper, we examine two different mechanisms by which contagion may occur. In both cases, propagation is through balancesheet effects. First, through the indirect effects that fluctuations in asset prices have on collateral values. Second, through the direct effects that default on or postponement of debt repayments have when there are chains of credit.

Plenary talk delivered at the annual meeting of the Society for Economic Dynamics.(This abstract was borrowed from another version of this item.)

We argue that long-term debt has a role in controlling management's ability to finance future investments. Companies with high (widely held) debt will find it hard to raise capital, since new security-holders will have low priority relative to existing creditors; conversely for companies with low debt. We show that there is an optimal debt--equity ratio and mix of senior and junior debt if management undertakes unprofitable as well as profitable investments. We derive conditions under which equity and a single class of senior long-term debt work as well as more complex contracts for controlling investment behavior.

The authors present a structural model of the U.S. economy that combines their price-contracting specification with a term-structure relationship, an aggregate demand curve, and a monetary-policy reaction function. The model matches important features of postwar data well and provides a structural explanation of the correlation between real output and the short-term nominal rate of interest. The authors perform a battery of monetary-policy experiments that show that, as viewed through the lens of this model, monetary policy has struck a good balance recently among competing monetary-policy objectives. Copyright 1995 by American Economic Association.

We present a structural model of the U.S. economy that combines our price-contracting specification with a term-structure relationship, an aggregate demand curve, and a monetary-policy reaction function. The model matches important features of postwar data well and provides a structural explanation of the correlation between real output and the short-term nominal rate of interest. We perform a battery of monetary-policy experiments which show that, as viewed through the lens of this model, monetary policy has struck a good balance recently among competing monetary-policy objectives.

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