Hours worked and the return to working are weakly correlated. Traditionally, the ability to account for this fact has been a litmus test for macroeconomic models. Existing real-business-cycle models fail this test dramatically. We modify prototypical real-business-cycle models by allowing government consumption shocks to influence labor-market dynamics. This modification can, in principle, bring the models into closer conformity with the data. Our empirical results indicate that it does.

This paper investigates whether there are simple versions of the permanent income hypothesis which are consistent with the aggregate U.S. consumption and output data. Our analysis is conducted within the confines of a simple dynamic general equilibrium model of aggregate real output, investment, hours of work and consumption. We study the quantitative importance of two perturbations to the version of our model which predicts that observed consumption follows a random walk: (i) changing the production technology specification which rationalizes the random walk result, and (ii) replacing the assumption that agents' decision intervals coincide with the data sampling interval with the assumption that agents make decisions on a continuous time basis. We find substantially less evidence against the continuous time models than against their discrete time counterparts. In fact neither of the two continuous time models can be rejected at conventional significance levels. The continuous time models outperform their discrete time counterparts primarily because they explicitly account for the fact that the data used to test the models are tine averaged measures of the underlying unobserved point-in-time variables. The net result is that they are better able to accommodate the degree of serial correlation present in the first difference of observed per capita U.S. consumption.

We develop and estimate a general equilibrium search and matching model that accounts for key business cycle properties of macroeconomic aggregates, including labor market variables. In sharp contrast to leading New Keynesian models, we do not impose wage inertia. Instead we derive wage inertia from our specification of how firms and workers negotiate wages. Our model outperforms a variant of the standard New Keynesian Calvo sticky wage model. According to our estimated model, there is a critical interaction between the degree of price stickiness, monetary policy, and the duration of an increase in unemployment benefits.

We describe a general equilibrium model in which an agency problem arises because bankers must exert an unobserved and costly effort to perform their task. Suppose aggregate banker net worth is too low to insulate creditors from bad outcomes on their balance sheet. Then, banks borrow too much in equilibrium because there is a pecuniary externality associated with bank borrowing. Social welfare is increased by imposing a binding leverage restriction on banks. We formalize this argument and provide a numerical example.

Two modifications are introduced into the standard real-business-cycle model: habit preferences and a two-sector technology with limited intersectoral factor mobility. The model is consistent with the observed mean risk-free rate, equity premium, and Sharpe ratio on equity. In addition, its business-cycle implications represent a substantial improvement over the standard model. It accounts for persistence in output, comovement of employment across different sectors over the business cycle, the evidence of “excess sensitivity” of consumption growth to output growth, and the “inverted leading-indicator property of interest rates,” that interest rates are negatively correlated with future output. (JEL D10, E10, E20, G12)

This paper develops the quantitative implications of optimal fiscal policy in a business cycle model. In a stationary equilibrium, the ex ante tax rate on capital income is approximately zero. There is an equivalence class of ex post capital income tax rates and bond policies that support a given allocation. Within this class, the optimal ex post capital tax rates can range from close to independently and identically distributed to close to a random walk. The tax rate on labor income fluctuates very little and inherits the persistence properties of the exogenous shocks; thus there is no presumption that optimal labor tax rates follow a random walk. Most of the welfare gains realized by switching from a tax system like that of the United States to the Ramsey system come from an initial period of high taxation on capital income.

Flow of funds; Monetary policy

We argue that the government-spending multiplier can be much larger than one when the zero lower bound on the nominal interest rate binds. The larger is the fraction of government spending that occurs while the nominal interest rate is zero, the larger is the value of the multiplier. After providing intuition for these results, we investigate the size of the multiplier in a dynamic, stochastic, general equilibrium model. In this model the multiplier e�ect is substantially larger than one when the zero bound binds. Our model is consistent with the behavior of key macro aggregates during the recent financial crisis. We thank the editor, Monika Piazzesi, Rob Shimer, and two anonymous referees for their