Previous equilibrium "business cycle" models are extended by the incorporation of an economy-wide capital market.One aspect of this extension is that the relative price that appears in commodity supply and demand functions becomes an anticipated real rate of return on earning assets, rather than a ratio of actual to expected prices.From the standpoint of expectation formation, the key aspect of the extended model is that observation of the economy-wide nominal interest rate conveys current global information to individuals.With respect to the effect of money supply shocks on output, the model yields results that are similar to those generated in simpler models.A new result concerns the behavior of the anticipated real rate of return on earning assets.Because this variable is the pertinent relative price for commodity supply and demand decisions, it turns out to be unambiguous that positive money surprises raise the anticipated real rate of return.In fact, this response provides the essential channel in this equilibrium model by which a money shock can raise the supply of commodities and thereby increase output.However, it is possible through a sort of "liquidity" effect that positive money surprises can depress the economy-wide nominal interest rate.

A discretionary policymaker can create surprise inflation, which may reduce employment and raise government revenue. But when people understand the policymaker's objectives, these surprises cannot occur systematically. In equilibrium people form expectations rationally and the policymaker optimizes in each period, subject to the way that people form expectations. Then, we find that (1) the rates of monetary growth and inflation are excessive; (2) these rates depend on the slope of Phillips curve, the natural unemployment rate, and other variables that affect the benefits and costs from inflation; (3) the monetary authority behaves countercyclically; and (4) unemployment is independent of money policy. Outcomes improve if rules commit future policy choices in the appropriate manner. The value of these commitments--which amount to long-term contracts between the government and the private sector--underlies the argument for rules over discretion.

This paper contrasts consumer choice under uncertain lifetimes with the behavior that would arise if each individual's lifetime were announced at birth. In a model that includes life insurance and excludes investments in human capital, the expected utility under uncertain lifetimes exceeds that under known lifetimes when the latter expectation is based on preannouncement survival probabilities. This conclusion emerges, first, because the model without human capital contains no planning benefits from knowledge of the horizon and, second, because the prior announcement of lifetimes forces risk-averse consumers to undertake an extra gamble that they could otherwise avoid by using life insurance.

A representative-consumer model with Epstein-Zin-Weil preferences and i.i.d. shocks, including rare disasters, accords with observed equity premia and risk-free rates if the coefficient of relative risk aversion equals 3–4. If the intertemporal elasticity of substitution exceeds one, an increase in uncertainty lowers the price-dividend ratio for equity, and a rise in the expected growth rate raises this ratio. Calibrations indicate that society would willingly reduce GDP by around 20 percent each year to eliminate rare disasters. The welfare cost from usual economic fluctuations is much smaller, though still important, corresponding to lowering GDP by about 1.5 percent each year.

One of the cleverest features of the rational expectations revolution was the appropriation of the term rational. Thereby, the opponents of this approach were forced into the defensive position of either being irrational or of modeling others as irrational, neither of which are comfortable positions for most economists. In fact, much of the rational expectations view-that expectations are formed sensibly given the information that people have (and are motivated to acquire)-has been generally accepted. This viewpoint has permanently and usefully altered the way that most macroeconomists build models and carry out evaluations of shifts in governmental behavior. In this sense the rational expectations revolution has triumphed decisively.' The phrase, rational expectations macroeconomics, also suggests a particular theory of business fluctuations. This well-known theory shows how incomplete information about the quantity of money and the general price level can lead to nonneutrality of money. Specifically, changes in money lead to

My view in the early 1970's of Keynesian, non-market-clearing-type models was that the soundness of their theoretical structure hinged on an yet absent theory of the stickiness of wages or prices. The application of contracting theory to macro analysis seemed promising in this respect. The presence of employee risk aversion or of transaction costs associated with market arrangements which could include elements of capital that were specific to employment or other aspects of production and exchangeseemed to motivate some long-term, implicit or explicit agreements about wages or prices. In particular, a sluggish adjustment of wages to current economic conditions could be rationalized by this approach. Further consideration of the contracting model suggests that its rationale for wages and prices-as far it goes does not explain the key features of Keynesian analysis with regard to the determination of employment and output. For example, long-term labor agreements do not imply a failure of employment to increase when all parties to the agreements perceive that they could be made better off by such a change. The socalled involuntary unemployment of Keynesian models that is, a situation where everyone perceives accurately that the marginal product of labor exceeds the marginal value that potential workers place on their time-is not compatible with efficient labor agreements. Even in contracts that specify, ex ante, the value of nominal wages over some interval of time, it would be mutually advantageous for workers and firms to determine levels of employment in an efficient manner. The contracting approach may rationalize some departures of real wages from the marginal product of labor and/or the marginal value of worker time, but it does not imply that levels of employment would differ significantly from the (efficient) values that would have been attained under flexible wages. Rather than rationalizing the non-marketclearing model a useful as if approach, contracting analysis suggests that-despite the possible existence of sticky wages-the continuous market-clearing model may provide a satisfactory framework for the analysis of employment and output. Notably, the approach suggests that such market features wages or the apparent non-price, quantity rationing associated with layoffs would be of secondary interest in analyses of business cycles. Since the prevailing wage need not represent the marginal product of labor, the presence of excess labor supply at this wage need not signal involuntary unemployment in any economic sense. The conclusions derived from the contracting model can be generalized by observing that the key assumption of Keynesian analysis is the inefficiency of some aspects of private sector activity in comparison to corresponding activities carried out by the government. This central feature is, of course, the underlying basis for the policy activism that typifies Keynesian thinking. In some simple disequilibrium macro models, relative private sector inefficiency is represented by wages or prices, in contrast to the flexibility of such government policy instruments the money supply, taxes, or expenditures. Technical limitations of the private market in the coordination of production and exchange-as reflected in wage-price stickiness and the associated determination of employment and output through a non-price rationing process-are remedied through the superior coordinating *University of Rochester. I have benefited from comments by Herschel Grossman, Bob Hall, and Ben McCallum. The National Science Foundation has supported this research.

David Small raises a number of questions concerning my 1977 study of money growth and unemployment in the United States. My reexamination of the evidence indicates that his major criticisms are unfounded specifically, the estimated effects of monetary shocks on the unemployment rate are robust to his suggested changes in specification. On the other hand, there are some difficulties with the estimated unemployment effects of some real variables that is, with the determinants of the natural unemployment rate.

A new data set covers chief executive officers (CEOs) of large commercial banks over the period 1982-87. For newly hired CEOs, the elasticity of pay with respect to assets is about one-third. For continuing CEOs, the change in compensation depends on performance, as measured by stock and accounting returns. The sensitivity of pay to performance diminishes with experience, but the returns are not filtered for peer-group returns. Logit regressions relate the probability of CEO departure to age and performance, as measured by stock returns filtered for peer-group returns; CEO experience does not influence this relationship.