A general model of optimal factor accumulation over an infinite horizon is presented in which the steady state depends on initial conditions and on the history of the system. In contrast to conventional results, any change in initial conditions or any temporary shock in the convergence process will in general change the optimal steady state. The result is shown to arise, when the discount rate is positive, from standard assumptions made about the technology of converting heterogeneous factors from one type to another. The dynamic optimizing models commonly used in economics are characterized by state or path independence. Steady state equilibria are determined by underlying exogenous parameters, independent of initial conditions and the history of the economy. Though certain phenomena may be well described by this type of analysis, one wonders whether there are other economic phenom-ena where initial conditions of history will indeed matter. In this paper we consider a model of dynamic optimization

[Recent papers which use the framework of temporary equilibrium with rationing to explain unemployment phenomena (sometimes termed "disequilibrium" theory, in which prices do not clear spot markets) are surveyed and evaluated critically. Models which posit fixed prices and then explore the effects of price rigidity are studied. I then consider attempts to explain why prices don't clear markets by considering models in which prices and quantity constraints are simultaneously determined. Many such models are based on perceived demand curves, leading one to consider the viability of unemployment equilibria under various restrictions about correctness or rationality of perceptions. I also consider in detail the role of a medium of exchange and assets in general and show that it is incorrect to link liquidity constraints and quantity rationing.]

Models of economic activity with frictions in coordinating trading have been shown to be capable of generating multiple steady states. (Peter Diamond, 1982, is the pioneering work; see my 1987a paper for a general discussion.) Less work has been done on out-of-steady-state dynamics in such models, which would enable us to examine what sort of fluctuations these models may generate. The absence of dynamics leaves open the question of which steady state the economy will reach, as well as whether the comovements of key variables resemble what is observed over the cycle. In my earlier paper (1987b), I presented a model combining search and aggregate demand approaches to unemployment to show how spillovers between product and labor markets could yield multiple equilibria. Here, a highly simplified dynamic model based on this work is presented, in which (self-fulfilling) sales expectations determine to which steady state the economy converges. These expectations are summarized by the asset values of firms which are producing output relative to those that are not. Two types of dynamic paths leading to stationary solutions can arise. The first is a saddle path. In addition, for certain parameter values, stable limit cycles emerge. Interestingly, over this cycle, asset values of firms (which one could interpret as stock market values) lead economic activity. I. Model Setup

In a Samuelson overlapping-generations model, conditions for an operative interegenerational transfer motive are derived without special assumptions about the form of the utility function. Crucial in determining if transfers will be positive is the rate at which individuals discount heirs' utility relative to the market interest rate. It is also shown that transfers of human capital (such as investment in education) are not equivalent to ordinary bequests for the bonds-as-net-wealth controversy. If intergenerational transfers take the form of human capital, issuance of government bonds or social security can affect the equilibrium solution, even if the transfer motive is fully operative.

In a Samuelson overlapping-generations model, conditions for an operative interegenerational transfer motive are derived without special assumptions about the form of the utility function. Crucial in determining if transfers will be positive is the rate at which individuals discount heirs' utility relative to the market interest rate. It is also shown that transfers of human capital (such as investment in education) are not equivalent to ordinary bequests for the bonds-as-net-wealth controversy. If intergenerational transfers take the form of human capital, issuance of government bonds or social security can affect the equilibrium solution, even if the transfer motive is fully operative.

Budget deficits implying an unbounded present value of government debt are infeasible and, hence, induce expectations of a future policy change. The authors study how expectations of a policy switch, whose timing or mix between expenditure cuts, tax increases, or increases in money growth rates may be uncertain, affect economic dynamics before the switch takes place. They are especially concerned with the correlation between changes in the deficit and inflation. Of particular interest is their finding that timing uncertainty may induce fluctuations in the rate of inflation that seem to be unrelated to the budget deficit, at a time when the budget deficit is responsible for inflation. Copyright 1990 by The Review of Economic Studies Limited.

Stabilization programs in open economies typically consist of two stages. In the first stage the rate of currency devaluation is reduced, but the fiscal adjustment does not eliminate the fiscal deficit that causes growth of debt and loss of reserves, making a future policy change necessary. Only later, at a second stage, is this followed by either an abandonment of exchange rate management or by a sufficiently large cut in the fiscal deficit. We study how different second-stage policy changes affect economic dynamics during the first stage. These changes include tax increases, budget cuts on traded and nontraded goods, and increases in the growth rate of money.

Adi Brender Allan DrazenDecember 2008When democracy is new it is often fragile or unconsolidated, meaning that importantpolitical groups lack full commitment to the democratic process, so that its survival is notassured. What economic policies can a government use to try to prevent a reversion toautocracy?One answer to this question begins with the argument that the threat to democracycomes from anti-democratic elites Œthe army, groups such as the wealthy who bene–ttedmost under the old regime, the fioligarchsflŒwho are seen as basically anti-democratic andwho have the power to overthrow the new democratic regime. The fimassesflare seen asunambiguously pro-democratic. Under this view, policy to consolidate democracy shouldfocus on placating the anti-democratic elites, or, colloquially but not inaccurately, to fibuythem o⁄.flThis approach has received a superb treatment in Daron Acemoglu and JamesA. Robinson (2005).Targeted economic policy to consolidate democracy can be viewed more generally. Sur-vival of democracy (and policy to enhance that) can be thought of in terms of two fun-damental questions. The –rst is: How does the support of di⁄erent actors a⁄ect theprobability that democracy survives? The second is then: How do these important actorschoose whether or not to support the continuation of democracy or its overthrow? Thedesign of policy to address democratic fragility depends on the answers to these two basicquestions. The policy prescription in the previous paragraph, for example, follows from theanswers: it is the elites alone who are determinate; and, their support depends on givingthem enough that they are content not to overthrow democracy.Our research on the fragility of new democracies focusses on di⁄erent, but complemen-tary issues. While we agree that anti-democratic elites pose a serious threat to fragile1

We test whether good economic conditions and expansionary fiscal policy help incumbents get reelected in a large panel of democracies. We find no evidence that deficits help reelection in any group of countries independent of income level, level of democracy, or government or electoral system. In developed countries and old democracies, deficits in election years or over the term of office reduce reelection probabilities. Higher growth rates over the term raise reelection probabilities only in developing countries and new democracies. Low inflation is rewarded by voters only in developed countries. These effects are both statistically significant and quite substantial quantitatively. (JEL D72, E62, H62, O47)