I am delighted to be able to present this lecture before so many people. I’m also very happy when I get to work with models inhabited by many people. That is the key to the framework for which Ed Prescott and I were cited by the Nobel Committee: Individuals are introduced explicitly in the models. Their decision problems are fully dynamic—they are forward looking. That is one of the prerequisites for what we ultimately seek, which is a framework we can use to evaluate economic policy. The eminent researcher and 1995 Nobel laureate in economics, Bob Lucas, from whom I have learned a great deal, wrote: “One of the functions of theoretical economics is to provide fully articulated, artificial economic systems that can serve as laboratories in which policies that would be prohibitively expensive to experiment with in actual economies can be tested out at much lower cost ... (Lucas, 1980, p. 696). Our task, as I see it ... is to write a FORTRAN program that will accept specific economic policy rules as ‘input’ and will generate as ‘output’ statistics describing the operating characteristics of time series we care about, which are predicted to result from these policies” (pp. 709–10). The desired environments to which Lucas refers would make use of information on “individual responses [that] can be documented relatively cheaply ... by means of ... censuses, panels [and] other surveys ...” (p. 710). Lucas seems to suggest that economic researchers place people in desired model environments and record how they behave under alternative policy rules. In practice, that is easier said than done. The key tool macroeconomists use is the computational experiment. With its help, the researcher performs exactly what I just described—places the model’s people in the desired environment and records their behavior. But the purpose of the computational experiment is broader than only to evaluate policy rules. The computational experiment is useful for answering a host of quantitative questions, that is, those for which we seek numerical answers. When evaluating government policy, the policy is stated in the form of a rule that specifies how the government will behave—what action to take under various contingencies—today and in the indefinite future. That is one reason it would be so difficult and prohibitively expensive to perform the alternative Lucas mentions, namely, to test the policies in actual economies.

The equilibrium growth model is modified and used to explain the cyclical variances of a set of economic time series, the covariances between real output and the other series, and the autocovariance of output. The model is fitted to quarterly data for the post-war U.S. economy. Crucial features of the model are the assumption that more than one time period is required for the construction of new productive capital, and the non-time-separable utility function that admits greater intertemporal substitution of leisure. The fit is surprisingly good in light of the model's simplicity and the small number of free parameters. THAT WINE IS NOT MADE in a day has long been recognized by economists (e.g., Bdhm-Bawerk [6]). But, neither are ships nor factories built in a day. A thesis of this essay is that the assumption of multiple-period construction is crucial for explaining aggregate fluctuations. A general equilibrium model is developed and fitted to U.S. quarterly data for the post-war period. The co-movements of the fluctuations for the fitted model are quantitatively consistent with the corresponding co-movements for U.S. data. In addition, the serial correlations of cyclical output for the model match well with those observed. Our approach integrates growth and business cycle theory. Like standard growth theory, a representative infinitely-lived household is assumed. As fluctuations in employment are central to the business cycle, the stand-in consumer values not only consumption but also leisure. One very important modification to the standard growth model is that multiple periods are required to build new capital goods and only finished capital goods are part of the productive capital stock. Each stage of production requires a period and utilizes resources. Halffinished ships and factories are not part of the productive capital stock. Section 2 contains a short critique of the commonly used investment technologies, and presents evidence that single-period production, even with adjustment costs, is inadequate. The preference-technology-information structure of the model is presented in Section 3. A crucial feature of preferences is the non-time-separable utility function that admits greater intertemporal substitution of leisure. The exogenous stochastic components in the model are shocks to technology and imperfect indicators of productivity. The two technology shocks differ in their persistence.

Even if there is an agreed-upon, fixed social objective function and policymakers know the timing and magnitude of the effects of their actions, discretionary policy, namely, the selection of that decision which is best, given the current situation and a correct evaluation of the end-of-period position, does not result in the social objective function being maximized. The reason for this apparent paradox is that economic planning is not a game against nature but, rather, a game against rational economic agents. We conclude that there is no way control theory can be made applicable to economic planning when expectations are rational.

Even if there is an agreed-upon, fixed social objective function and policymakers know the timing and magnitude of the effects of their actions, discretionary policy, namely, the selection of that decision which is best, given the current situation and a correct evaluation of the end-of-period position, does not result in the social objective function being maximized. The reason for this apparent paradox is that economic planning is not a game against nature but, rather, a game against rational economic agents. We conclude that there is no way control theory can be made applicable to economic planning when expectations are rational.

Mortgages are long-term loans with nominal payments. Consequently, in incomplete asset markets, monetary policy can affect housing investment and the economy through the cost of new mortgage borrowing and real payments on outstanding debt. These channels, distinct from the traditional real rate channel, are embedded in a general equilibrium model. The transmission mechanism is stronger under adjustable-rate mortgages compared with fixed-rate mortgages. Further, persistent monetary policy shocks affecting the level of the nominal yield curve have larger real effects compared with transitory shocks. Persistently higher inflation gradually benefits homeowners under FRMs, but hurts them immediately under ARMs.

We ask whether the following observations may result from endogenously determined fluctuations in the money multiplier rather than a causal influence of money on output: (i) M1 is positively correlated with real output; (ii) the money multiplier and deposit-to-currency ratio are positively correlated with output; (iii) the price level is negatively correlated with output; (iv) the correlation of M1 with contemporaneous prices is substantially weaker than the correlation of M1 with real output; (v) correlations among real variables are essentially unchanged under different monetary-policy regimes; and (vi) real money balances are smoother than money-demand equations would predict.

We provide a theoretical interpretation of two features of international data: the countercyclical movements in net exports and the tendency for the trade balance to be negatively correlated with current and future movements in the terms of trade, but positively correlated with past movements. We document the same properties in a two-country stochastic growth model in which trade fluctuations reflect, in large part, the dynamics of capital formation. We find that our general-equilibrium perspective is essential: the relation between the trade balance and the terms of trade depends critically on the source of fluctuations.

Mortgages are long-term loans with nominal payments. Consequently, under incomplete asset markets, monetary policy can affect housing investment and the economy through the cost of new mortgage borrowing and real payments on outstanding debt. These channels, distinct from traditional real rate channels, are embedded in a general equilibrium model. The transmission mechanism is found to be stronger under adjustable-than fixed-rate mortgages. Further, monetary policy shocks affecting the level of the nominal yield curve have larger real effects than transitory shocks, affecting its slope. Persistently higher inflation gradually benefits homeowners under FRMs, but hurts them immediately under ARMs.

An innovation in this paper is to introduce a time‐to‐build technology for the production of market capital into a model with home production. Our main finding is that the two anomalies that have plagued all household production models—the positive correlation between business and household investment, and household investment's leading business investment over the business cycle—are resolved when time to build is added.

Recently, several authors have argued for the use for the use of dynamic preference structures for leisure which incorporate forms of intertemporally nonseparable utility in the analysis of intertemporal labor supply decisions. In this paper, we examine whether such nonseparable utility functions are important in characterizing microdata on life-cycle labor supply. Using longitudinal data on males from the Panel Study of Income Dynamics, we estimate a model of life-cycle labor supply and consumption under uncertainty in which the structure of intertemporal leisure preferences is allowed to be nonseparable in leisure. Our model nests as special cases a number of alternative specifications considered in the literature. We investigate the robustness of our findings to certain forms of population heterogeneity and to some types of model misspecification. Across a number of alternative specifications, we find evidence that the standard assumption of intertemporally separable preferences for leisure is not consistent with data for prime-age males.