Both Sides of the Story: Skill-biased Technological Change, Labour Market Frictions, and Endogenous Two-Sided Heterogeneity

This paper presents a stylised framework to examine how skill-biased technological change and labour market frictions affect the relationship between economic expansion and unskilled unemployment. The first part of the analysis focuses on the investment decisions in skill-acquisition and technology adoption activities faced by workers and firms in response to the introduction of an innovative technology. The second part examines how endogenous two-sided heterogeneity in the labour market affects the macroeconomic outcomes in terms of unemployment, technological diffusion, and economic expansion. To conclude, the framework is used to discuss the effects of alternative forms of policy intervention on agents' investment decisions and on the macroeconomic outcomes.

Endogenous Price Flexibility and Optimal Monetary Policy

Much of the literature on optimal monetary policy uses models in which the degree of nominal price flexibility is exogenous. There are, however, good reasons to suppose that the degree of price flexibility adjusts endogenously to changes in monetary conditions. This paper extends the standard New Keynesian model to incorporate an endogenous degree of price flexibility. The model shows that endogenising the degree of price flexibility tends to shift optimal monetary policy towards complete inflation stabilisation, even when shocks take the form of cost-push disturbances. This contrasts with the standard result obtained in models with exogenous price flexibility, which show that optimal monetary policy should allow some degree of inflation volatility in order to stabilise the welfarerelevant output gap.

Trade in bilateral oligopoly with endogenous market formation

We study a strategic market game in which traders are endowed with both a good and money and can choose whether to buy or sell the good. We derive conditions under which a non-autarkic equilibrium exists and when the only equilibrium is autarky. Autarky is ‘nice’ (robust to small perturbations in the game) when it is the only equilibrium, and ‘very nice’ (robust to large perturbations) when no gains from trade exist. We characterize economies where autarky is nice but not very nice; that is, when gains from trade exist and yet no trade takes place.

Productivity shocks and aggregate fluctuations in an estimated endogenous growth model with human capital

Employing an endogenous growth model with human capital, this paper explores how productivity shocks in the goods and human capital producing sectors contribute to explaining aggregate fluctuations in output, consumption, investment and hours. Given the importance of accounting for both the dynamics and the trends in the data not captured by the theoretical growth model, we introduce a vector error correction model (VECM) of the measurement errors and estimate the model’s posterior density function using Bayesian methods. To contextualize our findings with those in the literature, we also assess whether the endogenous growth model or the standard real business cycle model better explains the observed variation in these aggregates. In addressing these issues we contribute to both the methods of analysis and the ongoing debate regarding the effects of innovations to productivity on macroeconomic activity.

Optimal progressive taxation in a model with endogenous skill supply.

This paper examines whether efficiency considerations require that optimal labour income taxation is progressive or regressive in a model with skill heterogeneity, endogenous skill acquisition and a production sector with capital-skill complementarity. We find that wage inequality driven by the resource requirements of skill-creation implies progressive labour income taxation in the steady-state as well as along the transition path from the exogenous to optimal policy steady-state. We find that these results are explained by a lower labour supply elasticity for skilled versus unskilled labour which results from the introduction of the skill acquisition technology.

Unemployment and Endogenous Reallocation over the Business Cycle

This paper studies unemployed workers’ decisions to change occupations, and their impact on fluctuations in aggregate unemployment and its underlying duration distribution. We develop an analytically and computationally tractable stochastic equilibrium model with heterogenous labor markets. In this model three different types of unemployment arise: search, rest and reallocation unemployment. We document new evidence on unemployed workers’ gross occupational mobility and use it to calibrate the model. We show that rest unemployment is the main driver of unemployment fluctuations over the business cycle and causes cyclical unemployment to be highly volatile. The resulting unemployment duration distribution generated by the model responds realistically to the business cycle, creating substantial longer-term unemployment in downturns. Finally, rest unemployment also makes our model simultaneously consistent with procyclical occupational mobility of the unemployed, countercyclical job separations into unemployment and a negatively-sloped Beveridge curve.

Tax Structure, Growth and Welfare in the UK

This paper studies the quantitative implications of changes in the composition of taxes for long-run growth and expected lifetime utility in the UK economy over 1970-2005. Our setup is a dynamic stochastic general equilibrium model incorporating a detailed scal policy struc- ture, and where the engine of endogenous growth is human capital accumulation. The government s spending instruments include pub- lic consumption, investment and education spending. On the revenue side, labour, capital and consumption taxes are employed. Our results suggest that if the goal of tax policy is to promote long-run growth by altering relative tax rates, then it should reduce labour taxes while simultaneously increasing capital or consumption taxes to make up for the loss in labour tax revenue. In contrast, a welfare promoting policy would be to cut capital taxes, while concurrently increasing labour or consumption taxes to make up for the loss in capital tax revenue.

Optimal Monetary Policy in a New Keynesian Model with Habits in Consumption

While consumption habits have been utilised as a means of generating a humpshaped output response to monetary policy shocks in sticky-price New Keynesian economies, there is relatively little analysis of the impact of habits (particularly,external habits) on optimal policy. In this paper we consider the implications of external habits for optimal monetary policy, when those habits either exist at the level of the aggregate basket of consumption goods (‘superficial’ habits) or at the level of individual goods (‘deep’ habits: see Ravn, Schmitt-Grohe, and Uribe (2006)). External habits generate an additional distortion in the economy, which implies that the flex-price equilibrium will no longer be efficient and that policy faces interesting new trade-offs and potential stabilisation biases. Furthermore, the endogenous mark-up behaviour, which emerges when habits are deep, can also significantly affect the optimal policy response to shocks, as well as dramatically affecting the stabilising properties of standard simple rules.

Electoral Uncertainty and the Deficit Bias in a New Keynesian Economy

Recent attempts to incorporate optimal fiscal policy into New Keynesian models subject to nominal inertia, have tended to assume that policy makers are benevolent and have access to a commitment technology. A separate literature, on the New Political Economy, has focused on real economies where there is strategic use of policy instruments in a world of political conflict. In this paper we combine these literatures and assume that policy is set in a New Keynesian economy by one of two policy makers facing electoral uncertainty (in terms of infrequent elections and an endogenous voting mechanism). The policy makers generally share the social welfare function, but differ in their preferences over fiscal expenditure (in its size and/or composition). Given the environment, policy shall be realistically constrained to be time-consistent. In a sticky-price economy, such heterogeneity gives rise to the possibility of one policy maker utilising (nominal) debt strategically to tie the hands of the other party, and influence the outcome of any future elections. This can give rise to a deficit bias, implying a sub-optimally high level of steady-state debt, and can also imply a sub-optimal response to shocks. The steady-state distortions and inflation bias this generates, combined with the volatility induced by the electoral cycle in a sticky-price environment, can significantly

Solovian and New Growth Theory from the Perspective of Allyn Young on Macroeconomic Increasing Returns

This paper evaluates, from an Allyn Youngian perspective, the neoclassical Solow model of growth and the associated empirical estimates of the sources of growth based on it. It attempts to clarify Young’s particular concept of generalised or macroeconomic “increasing returns” to show the limitations of a model of growth based on an assumption that the aggregate production function is characterised by constant returns to scale but “augmented” by exogenous technical progress. Young’s concept of endogenous, self-sustaining growth is also shown to differ in important respects (including in its policy implications) from modern endogenous growth theory.

Shocks, Monetary Policy and Institutions: Explaining Unemployment Persistence in Persistence in “Europe” and the United States

This paper examines the rise in European unemployment since the 1970s by introducing endogenous growth into an otherwise standard New Keynesian model with capital accumulation and unemployment. We subject the model to an uncorrelated cost push shock, in order to mimic a scenario akin to the one faced by central banks at the end of the 1970s. Monetary policy implements a disinfl ation by following an interest feedback rule calibrated to an estimate of a Bundesbank reaction function. 40 quarters after the shock has vanished, unemployment is still about 1.8 percentage points above its steady state. Our model also broadly reproduces cross country differences in unemployment by drawing on cross country differences in the size of cost push shock and the associated disinfl ation, the monetary policy reaction function and the wage setting structure.

On Public Inefficiencies in a Mixed Duopoly

The aim of this paper is to investigate the welfare effect of a change in the public firms objective function in oligopoly when the government takes into account the distortionary effect of rising funds by taxation (shadow cost of public funds). We analyze the impact of a shift from welfare- to profit-maximizing behaviour of the public firm on the timing of competition by endogenizing the determination of simultaneous (Nash-Cournot) versus sequential (Stackelberg) games using the game with observable delay proposed by Hamilton and Slutsky (1990). Differently from previous work that assumed the timing of competition, we show that, absent efficiency gains, instructing the public firm to play as a private one never increases welfare. Moreover, even when large efficiency gains result from the shift in public firm's objective, an inefficient public firm that maximizes welfare may be preferred.

Infrastructure Finance and Industrial Takeoff in England

That financial matters did not constrain industrial takeoff in the UK is generally accepted in the historical literature; in contrast, contemporary empirical analyses have found evidence that financial development can be a causal determinant of economic growth. We look to reconcile these findings by concentrating on a particular aspect of industrialising UK where inefficiencies in finance could have had bite: The finance of physical infrastructures. We document the historical record and develop the importance of spatial disaggregation and spillovers in both technological and financial development. We develop a simple model that captures the nature of infrastructure finance within a theory of endogenous growth where financial costs are endogenous. We argue that the conception of the finance-growth nexus as a largely static, aggregative phenomenon misses out a good deal of complexity and we relate that complexity to a number of implications for regulation of both financial systems and the emergence of infrastructures

Learning about Risk and Return: A Simple Model of Bubbles and Crashes

This paper demonstrates that an asset pricing model with least-squares learning can lead to bubbles and crashes as endogenous responses to the fundamentals driving asset prices. When agents are risk-averse they need to make forecasts of the conditional variance of a stock’s return. Recursive updating of both the conditional variance and the expected return implies several mechanisms through which learning impacts stock prices. Extended periods of excess volatility, bubbles and crashes arise with a frequency that depends on the extent to which past data is discounted. A central role is played by changes over time in agents’ estimates of risk.

An HEI-Disaggregated Input-Output Table for Scotland

This paper describes how the education sector of the Scottish Input-Output tables is disaggregated to identify a separate sector for each of Scotland’s twenty Higher Education Institutions (HEIs). The process draws on accounting and survey data to accurately determine the incomes and expenditures of each institution. In particular we emphasise determining the HEIs incomes source of origin to inform their treatment, as endogenous or exogenous, in subsequent analyses. The HEI-disaggregated Input- Output table provides a useful descriptive snapshot of the Scottish economy and the role of HEIs within it for a particular year, 2006. The table can be used to derive multipliers and conduct various impact studies of each institution or the sector as a whole. The table is furthermore useful to calibrate other multi-sectoral, HEI disaggregated models of regional economies, including Social Accounting Matrix (SAM) and computable general equilibrium (CGE) models.