We propose a Walrasian explanation for the existence of fixed prices, i.e., of trades in which either the price or the quantity exchanged does not reflect all publicly available information. Such trades result in a rigid price system that facilitates the sharing of social risks; they may also cause allocative distortions that increase the equilibrium price of insurance above its actuarially fair level. We demonstrate that the market for noncontingent claims is active only when this insurance "gain" outweighs the "cost" of allocative distortions. Fixed price equilibria are constrained optima, i.e., they cannot be dominated by an appropriately constrained central planner.

Most recent studies of macroeconomic behavior fall into one of two categories. The first, often called the equilibrium business cycle approach, stems from the fundamental contribution of Robert E. Lucas (1972), and related work by Thomas Sargent and Neil Wallace (1975) and many others. These studies espouse the view that a positive correlation between output and the stock of paper assets can arise if households are unable to identify the source and, therefore, the permanence of price movements. Employment and output responses in this view are driven by the intertemporal substitution effect, especially the substitution of current leisure for future consumption. Since cyclical fluctuations in employment are large relative to the corresponding real wage movements, substantial wage elasticity of labor supply is required to validate these models. The equilibrium approach to business cycles implies certain restrictions on the conduct of monetary policy. In particular, rational expectations undermine the ability of the monetary authority to influence economic activity in a systematic manner; see Sargent-Wallace for an example. Sticky wages and prices are the cornerstone of an alternative description of macroeconomic behavior. Rooted vaguely in Keynes, and more firmly in the dual decision hypothesis of Robert Clower (1984), this approach studies equilibria with quantity rationing; see Edmond Malinvaud (1977). The rationing story lacks a precise specification of the source of price stickiness, offering very little guidance about the eventual causes of price change. Considerable efforts were made in the 1970's to fill this lacuna in Keynesian macroeconomics. Beginning with work by Martin N. Baily (1974) and others, the implicit contracts literature focused on the incomplete insurability of human capital. Unable to find insurance against fluctuations in labor income elsewhere, workers demand insurance from those best placed to observe labor income-their own employers. Both wage inflexibility and layoffs, then, can be viewed as an outcome of a joint insurance-employment relationship between workers and firms; see Azariadis (1975). Critics like George Akerlof and Hajime Miyazaki (1980) soon discovered that the original contracting models could not produce layoffs without prohibiting severance pay or otherwise limiting the terms of the contract. Others pointed out that these models were determinedly microeconomic, offering few insights into the stickiness of nominal wages or the effectiveness of stabilization policy. Two quite distinct lines of research developed out of the original implicit contract ideas. One focuses on asymmetric information and implementability (see the QJE 1983 Symposium for original work and the review article by Oliver Hart, 1983) as a means of driving a wedge between the ex post marginal rates of substitution of the contractants. Under some technical assumptions, the outcome is involuntary underemployment or unemployment. We are most concerned here with the other line of research, which sought to fit labor or tDiscussants: Guillermo Calvo, Columbia University: Jo Anna Gray, Washington State University.

We characterize competitive equilibria with perfect foresight in a deterministic, three-period pure-exchange overlapping generations economy with perfect information and no commitment to loan contracts. Commitment is replaced by an enforcement mechanism that excludes defaulters from asset markets for one period. For hump-shaped endowment profiles, young individuals face endogenous debt constraints that ration current consumption. Changes in current and future yields affect these constraints, inducing an additional income effect on rationed household demand that makes current and future consumption complements. This mechanism can lead to multiple steady states, persistent indeterminacy and regime switching. We show that sensitivity to shocks and complex dynamic behaviour are consistent with endogenous debt limits but not with exogenous liquidity constraints.

Because sunspot equilibria seem to be of central importance for an understanding of rational expectations, we seek here to characterize completely a limited class of sunspot equilibria (stationary ones with two possible natural events) in the simplest overlapping generations model of production. We present a sufficient condition for the existence of stationary sunspot equilibria, examine how these are related to strictly periodic equilibria of the same order, and investigate how deterministic stationary equilibria bifurcate to stationary sunspot equilibria. A concluding section examines how our results survive in more general settings.

This introductory essay offers a brief guided tour of the main developments in the theory of implicit contracts, from its inception to the present. It is not intended as a survey but, rather, as an appraisal of the progress that has been made, the difficulties that remain, and as an outline of the microeconomic and macroeconomic issues that seem to invite additional work.

In U.S. data 1981–2012, unsecured firm credit moves procyclically and tends to lead GDP, while secured firm credit is acyclical; similarly, shocks to unsecured firm credit explain a far larger fraction of output fluctuations than shocks to secured credit. In this article, we develop a tractable dynamic general equilibrium model in which unsecured firm credit arises from self-enforcing borrowing constraints, preventing an efficient capital allocation among heterogeneous firms. Unsecured credit rests on the value that borrowers attach to a good credit reputation which is a forward-looking variable. We argue that self-fulfilling beliefs over future credit conditions naturally generate endogenously persistent business-cycle dynamics. A dynamic complementarity between current and future borrowing limits permits uncorrelated sunspot shocks to unsecured debt to trigger persistent aggregate fluctuations in both secured and unsecured debt, factor productivity, and output. We show that these sunspot shocks are quantitatively important, accounting for around half of output volatility.

This paper investigates the effect of limited enforcement of contracts on asset returns in a three-period pure- exchange overlapping generations economy. We consider a life-cycle setting with a safe and a risky asset and find that lack of commitment can significantly affect the rate of returns of these assets and possibly generate large equity premia.

We study a variant of the one-sector neoclassical growth model of Diamond in which capital investment must be credit financed, and an adverse selection problem appears in loan markets. The result is that the unfettered operation of credit markets leads to a one-dimensional indeterminacy of equilibrium. Many equilibria display economic fluctuations which do not vanish asymptotically; such equilibria are characterized by transitions between a Walrasian regime in which the adverse selection problem does not matter, and a regime of credit rationing in which it does. Moreover, for some configurations of parameters, all equilibria display such transitions for two reasons. One, the banking system imposes ceilings on credit when the economy expands and floors when it contracts because the quality of public information about the applicant pool of potential borrowers is negatively correlated with the demand for credit. Two, depositors believe that returns on bank deposits will be low (or high): these beliefs lead them to transfer savings out of (into) the banking system and into less (more) productive uses. The associated disintermediation (or its opposite) causes banks to contract (expand) credit. The result is a set of equilibrium