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.

This paper explores investment fluctuations due to discrete changes in a plant's capital stock. The resulting aggregate investment dynamics are surprisingly rich, reflecting the interaction between a replacement cycle, the cross-sectional distribution of the age of the capital stock, and an aggregate shock. Using plant-level data, lumpy investment is procyclical and more likely for older capital. Further, the predicted path of aggregate investment that neglects vintage effects tracks actual aggregate investment reasonably well. However, ignoring fluctuations in the cross-sectional distribution of investment vintages can yield predictable nontrivial errors in forecasting changes in aggregate investment.

This paper provides experimental evidence on forward induction as a refinement criterion. In the basic extensive form, one of the two players chooses to play a battle-of-the-sexes game or to receive a certain payoff. According to forward induction, choosing to play the game is a signal about intended action. Though the presence of the outside option changes play, we find only limited support for the forward-induction hypothesis. The effects of the outside option also reflect the creation of a focal point through the asymmetry created by offering the outside option to one of the two players.

This paper provides experimental evidence on forward induction as a refinement criterion. In the basic extensive form, one of the two players chooses to play a battle-of-the-sexes game or to receive a certain payoff. According to forward induction, choosing to play the game is a signal about intended action. Though the presence of the outside option changes play, the authors find only limited support for the forward-induction hypothesis. The effects of the outside option also reflect the creation of a focal point through the asymmetry created by offering the outside option to one of the two players.