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Volume 1, issue 1, November 1999

The Research Agenda: Larry Christiano and Martin Eichenbaum write about their current research program on the monetary transmission mechanism

Lawrence J. Christiano and Martin Eichenbaum are both Professors of Economics at Northwestern University. They have collaborated for many years studying the impact of monetary and fiscal policies on business cycles and linking empirical results to rigorous dynamic models. Here, they write about their current research agenda. Christiano's RePEc/IDEAS entry and Eichenbaum's RePEc/IDEAS entry.

Much of our research focuses on the nature of the monetary transmission mechanism. In part this reflects our desire to understand the interaction between real and monetary phenomena. And in part, this reflects our interest in policy questions, such as: what causes periodic outbreaks of high inflation and what are the causes of currency and banking crises? Making progress on questions like these requires empirically plausible models of the monetary transmission mechanism. To construct such models, we have looked at two types of evidence: US time series data, as well as evidence from countries that have experienced currency crises. In what follows we discuss what we have learned from these two types of data and our ongoing efforts to model the monetary transmission mechanism.

Evidence From US Time Series

One branch of our work develops and implements econometric strategies for selecting between competing models of the monetary transmission mechanism. In working with US data, the strategy that we have emphasized is a limited information one. Specifically, it involves comparing the response of a model economy and the actual economy to a particular shock. To be useful for diagnostic purposes, the shock must satisfy two properties: different model economies must react differently to it, and we must know how the actual economy responds to it. In our view, monetary policy shocks satisfy both properties. This strategy has been implemented using other kinds of shocks. For example, Gali (1999) studies the effects of technology shocks, while Burnside, Eichenbaum & Fisher (1999a,b), Edelberg, Eichenbaum & Fischer (1999), Ramey & Shapiro (1999) and Rotemberg & Woodford (1992) consider the effects of shocks to government purchases. It is well known that different model economies react differently to monetary policy shocks, see Christiano, Eichenbaum & Evans [thereafter CEE] (1997). Moreover, much progress has been made in understanding the economic impact of a monetary policy shock. As a result, we know a great deal about what it will take to have an empirically plausible model of the monetary transmission mechanism.

A second branch of work focuses more narrowly on particular episodes such as the high inflation in the 1970's. Our work on this begins with Chari, Christiano & Eichenbaum (1998). Christiano has pursued this line further with co-authors.

The Facts

In a series of papers, we have argued that the key consequences of a contractionary monetary policy shock are as follows: (i) interest rates, unemployment and inventories rise; (ii) real wages fall, though by a small amount; (iii) the price level falls by a small amount, after a substantial delay; (iv) there is a persistent decline in profits and the growth rate of various monetary aggregates; (v) there is a hump-shaped decline in consumption and output; and (vi) the US exchange rate appreciates and there is an increase in the differential between US and foreign interest rates. See CEE (1998b) for a discussion of the literature and the role of identifying assumptions that lie at the core of these claims.

Implications for Models

What kind of models are consistent with the facts? Some models obviously are not.
Monetized RBC, Misperception and Pure Sticky Wage Models
By a monetized Real Buiness Cycle (RBC) model, we mean an RBC model with no frictions other than a cash in advance constraint or a transactions technology for purchases that involves real balances. Simple monetized RBC models cannot account for the sluggish response of prices or the rise in the nominal interest rate that follow in the wake of a contractionary policy shock. The `monetary misperception' model (Lucas, 1972) is also inconsistent with the facts. Its problem is that movements in the price level are central to the mechanism by which a monetary shock is transmitted to the real economy. In reality, the price level isn't the first thing to move. It's the last thing. Models in which sticky nominal wages are the sole friction also run afoul of this last observation. In those models, output falls after a contractionary monetary policy shock because a fall in the price level raises the real wage. There are two problems with this story: prices don't fall and the real wage doesn't rise.
Pure Sticky Price Models
What about models in which the only friction is stickiness in goods prices? These models too, cannot account for the facts. In our work, we have emphasized the failings of these models for profits, prices, output and interest rates. In CEE (1997) we argued that these models predict that profits rise after contractionary monetary policy shocks. In effect, these models imply that business people should be crying out for a surprise monetary contraction! This peculiar implication for profits reflects the sharp fall in wages and capital costs that occurs as output falls.

A closely related problem is the inability of sticky goods price models to reproduce the observed degree of price inertia and persistence in output after a monetary policy shock. In CEE (1997) we argued that both shortcomings reflect the absence of strategic complementarity in price setting. To be specific, imagine that an expansionary monetary policy shock occurs in a particular period. If all prices are sticky, then the shock will have no effect on the price level and a large effect on output. Now consider the next period, and imagine that a fraction x of the firms can reset their prices. If x were unity, prices would fully adjust and output would revert to its pre-shock level. It turns out that the outcome is not very different when x is small. The reason is simple.

The 1-x firms with preset prices must expand output. In the act of doing so, they drive up factor prices and, therefore, marginal costs. The x firms resetting prices, respond to the higher marginal costs by raising prices substantially and reducing output. This effect is greater, the smaller is x. Put differently, the lower is x, the less is the incentive of flexible price firms to act like the firms with preset prices. This absence of strategic complementarity among price setters means that the response of aggregate prices and output in the period after a shock is roughly the same whether x is unity or smaller.

An additional problem with sticky goods price models is that they have difficulty accounting both for the liquidity effect and the hump-shaped fall in consumption that are associated with a contractionary monetary policy shock. This is because, absent asset market frictions, the standard intertemporal Euler equation holds in these models. For standard specifications of utility, this implies that a hump-shaped fall in consumption is associated with an immediate fall in the real interest rate. With persistently sticky prices, this translates into an immediate fall in the nominal interest rate. But, in the data monetary contractions are associated with a rise in the nominal interest rate.

Limited Participation Models
A different class of models that we have considered stress frictions in households' portfolio decisions (see Lucas (1990) and Fuerst (1992)). The effect of this friction is that a monetary contraction creates a shortage of liquidity in the financial sector, reducing the supply of loanable funds. The resulting rise in interest rates induces firms who need working capital to cut back on their scale of operations and aggregate output declines. In many ways, these models can be thought of as stylized representations of the type of credit market frictions emphasized in the lending channel model of the monetary transmission mechanism, see for example Kashyap, Stein & Wilcox (1993) and Bernanke, Gertler & Gilchrist (1999). In effect, these credit market frictions mean that a contractionary monetary policy shock acts on the economy like a negative supply shock. Of course, the model also imbeds the standard channel of monetary policy, which operates via demand.

Versions of these models that we have worked with can reproduce a number of features of the stylized facts discussed above. Because they break the standard intertemporal Euler equation they are in principle compatible with the liquidity effect and hump shaped decline in consumption after a contractionary monetary policy shock. These models can generate some sluggishness in prices and persistent movements in output. To see this, think of a contractionary monetary policy shock as a negative shift to the nominal demand for goods. Other things equal, this reduces the price level. But, it also reduces the supply of goods. Other things equal, this raises the price level. So, if the demand and supply effects are equally strong, there is a substantial decline in output and little movement in the price level, see CEE (1997).

This being said, there are at least two important problems with such models: for the supply side effect to be strong enough to cancel the demand side effect one must appeal to a counterfactually large labor supply elasticity and markup. And even then, these models cannot account for the observed degree of sluggishness in the price level.

Implications for Future Research

The discussion above suggests that single friction models will not provide a convincing account of what happens after a monetary policy shock. The obvious question is: what combination of frictions will? To provide a quantitative answer to this question, we are constructing and estimating a model which incorporates limited participation constraints and sticky prices. To place these on a symmetric footing, we do two things. First, we model sticky prices in the way suggested by Calvo (1983). Second, we capture the portfolio restrictions implicit in the limited participation assumption in the same way. Specifically, we imagine that households can change their money holdings at stochastic intervals of time.

We also think it is important to allow for labor market frictions into this extended framework. This is because the problems of both the limited participation and sticky goods price models revolve in part around their labor market implications. The first model relied on implausibly high labor supply elasticities, while the second model foundered on the rock of highly cyclical marginal costs.

One way to deal with both problems is to assume that wages are sticky too. In practice, we will model these using Calvo-style wage contracts. Perhaps a more interesting route is to allow for efficiency wages, modeled along the line of the general equilibrium shirking model in Alexopoulous (1998). An attractive feature of that framework is that real wages do not move in response to a monetary policy shock, and changes in employment involve only the extensive margin of unemployed workers.

The Causes of High Inflation

An important policy question is, why has inflation alternated between periods of being high and periods of being low. Christiano has studied this question in recent work with co-authors (Stefania Albanesi and V.V. Chari in one case, Christopher Gust in another).

Christiano & Gust (1999) are studying the Great Inflation of the 1970s. They consider the hypothesis that this episode was due to an increase in expected inflation that became self-fulfilling because of the nature of monetary policy. They explore this hypothesis in the context of two models, a sticky price model constructed by Clarida, Gali & Gertler and the limited participation model of CEE (1998a). Christiano & Gust (1999) find that the limited participation model is a more reasonable explanation of this episode because it is also consistent with the stagflation of the time: inflation was high and output and employment were low.

Albanesi Chari & Christiano (1999) study the potential for the Inflation Bias Hypothesis to account for the high and variable inflation that has been observed. This hypothesis, originally due to Kydland & Prescott and Barro & Gordon, is that high inflation reflects a lack of commitment in monetary institutions. Albanesi, Chari & Christiano begin by exploring the magnitude of this bias in standard sticky price and limited participation models. They find that, for a surprisingly wide range of parameter values, the models predict that the inflation bias is zero: models with and without commitment predict the same inflation. So, these models imply that the inflation bias hypothesis is rejected: it cannot account for the high observed inflation rates. They argue that this result reflects in part the poor implications of these models for money demand. When money demand is modified in a plausible direction, the model has the potential to resolve several classic, outstanding puzzles in the money demand literature. At the same time, the inflation bias hypothesis is restored with these modifications. In ongoing work, the authors are exploring in greater detail the empirical implications for money demand of their model. They are also exploring the empirical performance of the version of their model that is potentially consistent with the volatility of inflation.

Evidence From Currency Crisis Countries

Another strand of our research is motivated by evidence on the nature of currency crises in the post-Bretton Woods era. In our view, the key characteristics of these crises are: (i) they have increasingly coincided with banking crises, (ii) there are implicit government guarantees to domestic and foreign bank creditors prior to these crises, (iii) banks generally do not hedge exchange rate risk and many go bankrupt following a currency devaluation, (iv) a lending boom precedes the crises, (v) after twin banking and currency crises, domestic interest rates and the current account rise sharply, while output declines dramatically. Accounting for these observations is obviously an important task. At the same time, any theory which can account for these facts may also shed light on the monetary transmission in countries like the US. In ongoing work, Eichenbaum and co-authors (Craig Burnside and Sergio Rebelo) have been exploring the role of government guarantees to foreign and domestic bank creditors in precipitating twin banking and currency crises. They proceed in three stages. First they have explored the effects of banking crises on currency crises. Second they study the effects of currency crises on banking crises. Finally in ongoing work they are endogenizing both types of crises as reflecting government policy vis a vis the banking system.

Burnside Eichenbaum & Rebelo [thereafter BER] (1998) argues that banking crises caused the recent currency crises in Southeast Asia. It begins from the assumption that the banks were in trouble in Southeast Asia prior to the currency crises. According the BER model, private agents realized this and assumed that governments would eventually fund bank bailouts at least in part via seigniorage. It implies that the fixed exchange rate regime should have collapsed after agents understood that the banks were failing, but before governments actually started to monetize their deficits. In this way, their explanation of the Asian crisis lays the blame at the feet of bad government policy. Yet, the model is also consistent with the fact that standard indicators of bad government policy - high deficits, excessive money growth, etc. - were not observed prior to the crises.

BER (1999a) takes as given the probability of an exchange rate collapse and investigates how government guarantees to domestic and foreign bank creditors can convert a currency crisis into a banking crisis. According to BER's model, when there are government guarantees, it is optimal for banks to not hedge foreign exchange risk. Indeed, it may be optimal for banks to magnify their exchange rate exposure. According to their analysis, prior to an exchange rate collapse, government guarantees act like a subsidy to domestic loans and reduce the interest rate that firms must pay to fund their ongoing operations. This leads to higher levels of output and economic activity than would be the case absent government guarantees. But, if there is a currency devaluation, it is optimal for banks to declare bankruptcy and renege on their foreign debt. Moreover, domestic interest rates rise and there is a permanent decline in wages, employment and output. In short, a currency crisis leads to a banking crisis and a permanent decline in aggregate economic activity.

Finally, BER (1999b) endogenizes both types of crises as arising from government guarantees to banks' creditors. The key argument is that in the presence of government guarantees to banks' creditors, a currency crisis transforms potential government liabilities into actual government liabilities. This opens up the possibility of self-fulfilling currency attacks. In BER's model self-fulfilling currency attacks are not possible in the absence of government guarantees. But, in the presence of such guarantees, self-fulfilling currency attacks occur almost surely. So, both fundamentals and expectations play important roles in currency crises. The former determine whether twin currency/banking crises can occur. But, the latter determine the precise timing of the crises.

In work with co-authors (Christopher Gust and Jorge Roldos), Christiano studies the nature of the monetary transmission mechanism in the aftermath of financial crises. This work does not investigate the causes of currency crises, and simply assumes that it is a time when international lenders suddenly impose binding collateral constraints. The collateral constraints specify that the stock of foreign debt cannot exceed the value of land and capital. They carry out their analysis in the context of a small 2-sector traded goods, non-traded goods model modified to incorporate features of the limited participation model. In particular, firms require two forms of working capital to conduct operations: domestic funds to finance the wage bill and foreign funds to pay for imports of an intermediate good. Just before the crisis the model economy is in a steady state with a zero current account balance, no collateral constraints and a large stock of foreign debt relative to the value of domestic assets. This steady state is hit by an unexpected imposition of collateral constraints. If monetary policy does not react, the current account responds by turning positive as the foreign debt is paid off, now with a high shadow cost because of the binding collateral constraint. At equilibrium the foreign debt is reduced to exactly the point where the collateral constraint becomes non-binding. During the transition, output and employment are low because the binding collateral constraint inhibits the import of the intermediate good.

Building on this baseline analysis, Christiano, Gust & Roldos [thereafter CGR] ask what is the economic effect of a monetary policy action which expands domestic liquidity and reduces the domestic nominal interest rate. They show that, under plausible circumstances, the policy causes an even greater fall in output and employment because the expansion of domestic liquidity operates on the wrong margin in an economy in the aftermath of a crisis. At a time like this, it is the shortage of foreign liquidity that holds back economic activity. Then, actions designed to expand domestic liquidity may paradoxically just serve to further tighten the constraint on foreign liquidity. The reasoning is simple. The expansion of domestic liquidity reduces the cost of labor. This has a relatively greater impact on the marginal cost of producing nontraded goods, because that sector is assumed to be relatively labor intensive. As a result, there is a fall in the price of nontraded versus traded goods. This in turn produces a real depreciation, and a fall in the international value of the economy's collateral. The latter causes the collateral constraint to bind even more strongly, so that imports of the intermediate good must be curtailed. The result is an amplification in the drop in employment and output.

This analysis is a response to observers who argue that the appropriate way to cushion the fall in output in the aftermath of a currency crisis is for the central bank to cut the domestic rate of interest. Those arguments appeal to the conventional wisdom, based on experience in countries like the US, that interest rate cuts stimulate economic activity. This holds in the CGR model, but only in the version with no collateral constraints. The imposition of binding collateral constraints fundamentally changes the nature of the monetary transmission mechanism in the model, reversing the conventional wisdom. This suggests that experience with the effects of policy actions in economies in `normal times', when collateral constraints are not binding, may have little relevance for predicting the effects of these actions in economies in `crisis times', when collateral constraints are binding. In continuing work, CGR are investigating the exact nature of international lending contracts and the role of collateral constraints in international lending during normal and crisis times. They are also studying the empirical plausibility of their model's assumptions required to guarantee the results on the effects of monetary policy with a binding collateral constraint. The key assumptions are limited substitutability between foreign intermediate goods and domestic factors in production and the relative importance of labor in the nontraded good sector.


S. Albanesi, V. V. Chari and L. Christiano, "How Big is the Time Consistency Problem in Monetary Policy?" manuscript, Northwestern University, 1999.
M. Alexopoulos, "Efficiency Wages, Unemployment and the Business Cycle", manuscript, Northwestern University, 1998.
B. Bernanke, M. Gertler and S. Gilchrist, "The Financial Accelerator in a Quantitative Business Cycle Framework", in: J. Taylor and M. Woodford (eds.), Handbook of Macroeconomics, forthcoming.
C. Burnside, M. Eichenbaum and J. Fisher, "Assessing the Effects of Fiscal Shocks", manuscript, Northwestern University, 1998a.
C. Burnside, M. Eichenbaum and J. Fisher, "Evaluating Efficiency Wage Models Using Fiscal Policy Shocks as Natural Experiments", in: Theory and Evidence in Macroeconomics, R. Backhouse and A. Salanti (eds.), Oxford University Press, forthcoming.
C. Burnside, M. Eichenbaum and S. Rebelo, "Prospective Deficits and the South East Asian Currency Crises", NBER Working paper, no. 6758, 1998.
C. Burnside, M. Eichenbaum and S. Rebelo, "Hedging and Financial Fragility in Fixed Exchange Rate Regimes", NBER Working paper no. 7143, 1999a.
C. Burnside, M. Eichenbaum and S. Rebelo, "On the Fundamentals of Self Fulfilling Currency Attacks: The Role of Government Guarantees to Foreign Bank Creditors", manuscript, Northwestern University, 1999b.
G. Calvo, "Staggered Contracts in a Utility - Maximizing Framework", Journal of Monetary Economics, Vol. 12 (3), pp. 383-398, 1983.
L. Christiano, V. V. Chari and M. Eichenbaum, "Expectation Traps and Discretion", Journal of Economic Theory, Vol. 81(2), pages 462-492, 1998.
L. Christiano, M. Eichenbaum and C. Evans, "Sticky Price and Limited Participation Models of Money: A Comparison", European Economic Review, Vol. 41(6), pages 1201-1249, 1997.
L. Christiano, M. Eichenbaum and C. Evans, "Modelling Money", NBER Working Paper no. 637, 1998a.
L. Christiano, M. Eichenbaum and C. Evans, "Monetary Policy Shocks: What Have We Learned and to What End?", Handbook of Monetary Economics, Michael Woodford and John Taylor (eds.), forthcoming.
L. Christiano and C. Gust, "The Great Inflation of the 1970s", manuscript, Northwestern University, 1999.
L. Christiano, C. Gust and J. Roldos, "Monetary Policy in the Aftermath of a Crisis", manuscript in process, 1999.
M. Eichenbaum, J. Fischer and W. Edelberg, "Understanding the Effects of Shocks to Government Purchases", Review of Economics Dynamics, Volume 2, pp. 166-206, 1999.
T. S. Fuerst, "Liquidity, Loanable Funds, and Real Activity", Journal of Monetary Economics, Vol. 29(1), pp. 3-24, 1992.
J. Gali, "Technology, Employment, and the Business Cycle: Do Technology Shocks Explain Aggregate Fluctuations?", American Economic Review, Vol. 89 (1), pages 249-271, 1999.
A. K. Kashyap, J. C. Stein and D. W. Wilcox, "Monetary Policy and Credit Conditions: Evidence from the Composition of External Finance", American Economic Review, Vol. 83(1), pp. 78-98, 1993.
R. E. Lucas Jr., "Expectations and the Neutrality of Money", Journal of Economic Theory, Vol. 4(2), pp. 103-124, 1972.
R. E. Lucas Jr., "Liquidity and Interest Rates", Journal of Economic Theory, Vol. 50(2), pp. 237-264, 1990.
V. A. Ramey and M. D. Shapiro, "Costly Capital Reallocation and the Effects of Government Spending", Carnegie - Rochester Conference Series on Public Policy, Vol. 48, pp. 145-194, 1999.
J. J. Rotemberg and M. Woodford, "Oligopolistic Pricing and the Effects of Aggregate Demand on Economic Activity", Journal of Political Economy, Vol. 100(6), pp. 1153-1207, 1992.

EconomicDynamics Interview: David Backus on international business cycles

David K. Backus is the Heinz Riehl Professor of Finance and Economics at the Stern Business School of New York University. He has published extensively on International Business Cycles as well as on Foreign Exchange Theory. In particular, he teamed with Patrick Kehoe and Finn Kydland to launch the current research agenda around international real business cycle (IRBC) models. Backus' RePEc/IDEAS entry.
EconomicDynamics: Can IRBC modeling shed its "R", that is say something about monetary phenomena, especially exchange rates?
David Backus: I don't think there's much question that RBC modeling shed its "R" long ago, and the same applies to IRBC modeling. There's been an absolute explosion of work on monetary policy, which I find really exciting. It's amazing that we finally seem to be getting to the point where practical policy can be based on serious dynamic models, rather than reduced form IS/LM or AS/AD constructs. Lots of people have been involved, but names that cross my mind are my colleagues Jordi Gali and Mark Gertler, their coauthor Rich Clarida, and the team of Julio Rotemberg and Mike Woodford.

So we really need a better term than RBC. Maybe you should take a poll.

ED: In 1980, Feldstein and Horioka argued that if the correlation of savings and investment rates was close to one, markets must be incomplete. Cardia (1991) and Baxter & Crucini (1993) showed that this correlation could be high even with complete markets. Do you think the issue is now closed?
DB: Not! (as Finn Kydland would say). I think it's very much an open issue, but let me explain why. What Baxter and Crucini, Cardia, and others established was a property of dynamic models with complete markets: that in an "artificial" time series for a specific country, saving and investment rates could be highly correlated. (The word "could" is important. Our initial paper showed, for example, that it depended on the process for technology shocks.) Feldstein and Horioka established a very different property of data: that over long periods (in their case 14 years), averages of saving and investment rates for OECD countries were pretty much the same. In other words, there was very little in the way of net international capital flows. This was surprising then, and remains surprising now. My guess is that you'd see greater flows over the last twenty years, particularly in emerging economies, but that the flows are still a lot less than you'd expect from theory.

Tim Kehoe had a nice example a few years ago. He estimated how much the capital stock should increase in Mexico to equate the marginal product of capital to that of the US. The answer, as I recall, was about 50%, an enormous number relative to what was viewed as very large capital flows in the early 1990s.

ED: What do you see as the next challenge of IRBC modeling?
DB: I think you want to separate challenges from approaches. Although one's approach may suggest interesting questions, the best questions are often interesting from lots of perspectives, whether RBC or something else. As a profession we're probably better off diversifying, with different people attacking different problems with different methods, since we don't know a priori which directions will turn out to be the most fruitful.

On challenges, I'd list the many facts suggesting frictions to international capital flows (Feldstein and Horioka, Tesar and Werner on portfolio diversification) and the large question of how relative prices behave - the magnitude and persistence of real exchange rate movements and differences in behavior across goods (traded and nontraded, for example). These are classic issues, and I think they'll be with us for a while yet.

On approaches, I personally am fascinated by work on models with endogenous borrowing constraints. This started, I guess, with Eaton and Gersovitz, was applied to the 1980s debt crisis by Bulow and Rogoff, and has since been developed further along several directions by (among many others) Alvarez-Jermann and Kehoe-Perri. There's also been a lot of work on models with imperfectly competitive firms in goods markets, but I know a less about it.

ED: Do you think therefore that the quantity and price anomalies you have coined in the "Frontiers of Business Cycle Research" volume are not important? Or solved? [The quantity anomaly states that models cannot replicate the fact that cross-country correlations of output are higher than those of consumption, the price anomaly states that model cannot achieve the high volatility of the terms of trade observed in the data.]
DB: Honestly, I don't think they're solved, although we've certainly taken some large bites out of them. I'm extremely enthusiastic, though, about the state of the profession: the quality of work in international macroeconomics has never been higher. Given the pace of change in the world economy and the amount of human capital devoted to understanding it, I'm confident that the next ten years will be just as exciting as the last ten.


F. Alvarez and U. Jermann, "Quantitative Asset Pricing Implications of Endogeneous Solvency Constraints", NBER Working Paper No. 6953, 1999.
F. Alvarez and U. Jermann, "Efficiency, Equilibrium and Asset Prices with Risk of Default", University of Chicago Working Paper, 1999.
D. K. Backus, P. J. Kehoe, and F. E. Kydland, "International Real Business Cycles", Journal of Political Economy, vol. 100, pp. 745-775, 1992.
D. K. Backus, P. J. Kehoe, and F. E. Kydland, "Dynamics of the Trade Balance and the Terms of Trade: The J-Curve?" American Economic Review, vol. 84, pp. 84-103, 1994.
D. K. Backus, P. J. Kehoe, and F. E. Kydland, "International Business Cycles: Theory and Evidence", in: T. F. Cooley, ed., Frontiers of Business Cycle Research, Princeton University Press, pp. 331-356, 1995.
M. Baxter and M. J. Crucini, "Explaining Saving-Investment Correlations", American Economic Review, vol. 83, pp. 416-436, 1993.
J. Bulow and K. Rogoff, "A Constant Recontracting Model of Sovereign Debt", Journal of Political Economy, pp. 155-178, 1989.
E. Cardia, "The Dynamics of a Small Open Economy in Response to Monetary, Fiscal, and Productivity Shocks", Journal of Monetary Economics, vol. 28, no. 3, pp. 411-434, 1991.
R. Clarida, J. Gali and M. Gertler, "The Science of Monetary Policy: A New Keynesian Perspective", Journal of Economic Literature, forthcoming.
J. Eaton and M. Gersowitz, "LDC Participation in International Financial Markets: Debts and Reserves", Journal of Development Economics, pp. 3-21, 1980.
M. Feldstein and Horioka, "Domestic Saving and International Capital Flows", The Economic Journal, pp. 314-329, 1980.
P. J. Kehoe and F. Perri, "International Business Cycles with Endogenous Incomplete Markets", University of Pennsylvania Working Paper, 1998.
T. J. Kehoe, "What Happened in Mexico in 1994-95?" in P. J. Kehoe and T. J. Kehoe, eds., Modeling North American Economic Integration, Boston: Kluwer Academic Publishers, pp. 131-148, 1995.
J. J. Rotemberg and M. Woodford, "Oligopolistic Pricing and the Effects of Aggregate Demand on Economic Activity", Journal of Political Economy, vol. 100, pp. 1153-1207, 1992.
L. Tesar and I. M. Werner, "International Equity Transactions and U.S. Portfolio Choice", in J. A. Frankel, ed, The Internationalization of Equity Markets, University of Chicago Press, pp. 185-216, 1994.
L. Tesar and I. M. Werner, "Home Bias and the High Turnover", Journal of International Money and Finance, pp 467-492, 1995.

The Review of Economic Dynamics: A Progress Report

As coordinating editor, I am very happy to report that the Review of Economic Dynamics has been an enormous success since its inception. We have now published two complete volumes of very high quality papers. This past year we received an award from the American Association of Publishers, as the Best New Scholarly Academic Journal in Business, Social Sciences, and Humanities in 1998.

Since the journal's beginning, we have had several hundred submissions and have now just completed Volume 2. Our inaugural Volume (#1) appeared in 1998. There were three issues of contributed papers, and a special issue on Technology that honored the contributions of Michael Gort. Volume 2, 1999, included two issues of contributed papers, and two special issues, one in memory of the late S. Rao Aiyagari, and one on Social Security.

In the new year, Volume #3 Issue #1, will include : "Entrepreneurship, Saving and Social Mobility" (Vincenzo Quadrini); "Can Habit Formation be Reconciled with Business Cycle Facts?" (Martin Lettau and Harald Uhlig); "Investment-Saving Co-movement and Capital Mobility: Evidence from Century Long U.S. Time Series" (Daniel Levy); and "Human Capital and International Real Business Cycles" (Marco Maffezzoli) among others. We will have one special issues in Volume 3 (Issue #2, April 2000) focusing on Dynamic Games. Some of the papers to appear: "Implementation, Elimination of Weakly Dominated Strategies and Evolutionary Dynamics" (Antonio Cabrales & Giovanni Ponti); "Private Experience in Adaptive Learning Models" (Felipe Perez); "Equipment Investment and the Relative Demand for Skilled Labor: International Evidence" (Karnet Flug & Zvi Hercowitz); "Correlation, Learning and the Robustness of Cooperation" (Nicola Dimitri); "Mutual Insurance Individual Savings and Limited Commitment" (Ethan Ligon, Jonathan Thomas & Tim Worrall); and "Folk Theorem with One-Sided Information" (Harrison Cheng).

The success of the Review of Economic Dynamics is due entirely to the hard work of the editors and associate editors, and referees, and due to the willingness of the members of the Society to send us their outstanding research. The management of the Review is intended to be dynamic as the name would suggest. The initial editors included myself, Roger Craine, David Levine, Ramon Marimon, Dale Mortensen, Edward Prescott, and Thomas Sargent. Tom Sargent stepped down at the end of 1998 and Boyan Jovanovic joined us as an editor. This year Dale Mortensen and Roger Craine will step down and Gary Hansen (an Associate Editor since the beginning) and Timothy Kehoe will join as editors. Among those who have served as Associate Editors since 1996 are Michele Boldrin, VV Chari, Lawrence Christiano, Jeremy Greenwood, Nobuhiro Kiyotaki, Per Krusell, Wolfgang Pesendorfer, Richard Rogerson, Aldo Rustichini, Manuel Santos, and Randy Wright. In 1999, we added as new associate editors, Martin Eichenbaum, Jordi Gali, Lee Ohanian, and Jose Victor Rios-Rull. Beginning in the new year Christian Zimmermann will join us and will have a special focus on electronic publishing. In addition there will be some planned turnover among the Associate editors.

We have had a few lapses in our first two years but by and large we have provided swift service and careful, informed editing to authors. And of course, we are always on the lookout for outstanding papers to publish in future issues of RED. Please continue to support this terrific journal by subscribing to it and by sending us your outstanding papers.

Thomas F. Cooley
Coordinating Editor
Review of Economic Dynamics

Society for Economic Dynamics: Letter from the President

It is time again for a brief report on the activities of the Society for Economic Dynamics.

As many of you remember, the 1999 SED meeting was held on June 27-30 in Alghero, Sardinia, Italy. The meeting set new records both for the number of participants and the number of papers presented. The quality was pretty good too! Again I thank Tim Kehoe and Antonio Merlo for organizing an exciting meeting in a marvelous location. Particular thanks are also due to the Sardinians who made all of us so welcome.

In my view, the best news from Sardinia was the election of Tom Cooley as the next President of the Society. Tom serves as President-elect until his inauguration at the 2000 meeting. The Council also endorsed a proposal to start an e-newsletter as a supplement to the Review of Economic Dynamics. Hopefully, you are reading this message in the first edition of The EconomicDynamics Newsletter. In addition to editing the Newsletter, its founder, Christian Zimmermann, has taken over responsibility for both the RED and SED web pages, now permanently located on the web at

The 2000 meeting, the last meeting of century as anyone who can count knows, will be held June 29 - July 1 in San Jose, Costa Rica. Per Krusell will act as Program Chairman, and Alberto Trejos is the organizer. INCAE is the hosting institution, with the co-sponsorship of the Costa Rican Central Bank. Information about submissions, hotels, and extracurricular activities can also be found at This one promises to be another blockbuster meeting. Don't miss it!

We are in the process of considering locations for the 2001 meeting. If you are interested in proposing a site and an organizing committee, please contact Tom Cooley at

Please join again in support of the advancement of Economic Dynamics. Information about how to pay your 2000 dues and your subscription to the RED, the "best academic journal of 1998", is available of the SED web site.


Dale T. Mortensen, President
Society for Economic Dynamics

Society for Economic Dynamics: 2000 Meetings in Costa Rica

The 2000 Meetings of the Society for Economic Dynamics will be held June 29-July 2 (Thursday-Sunday), 2000 in San José, Costa Rica. The conference is hosted by INCAE with the co-sponsorship of the Central Bank of Costa Rica. Registration and welcome reception will be held on Wednesday, June 28, 2000. The conference director is Alberto Trejos and the program organizer is Per Krusell.

The Society for Economic Dynamics solicits applications for papers in all areas of dynamic economics to be presented at this conference. Members and nonmembers are invited to participate. The deadline for submissions is February 15, 2000. Please send an abstract, and a paper if available, together with names, affiliations, addresses, and e-mail addresses of all authors, either by mail, to

SED Conference
Institute for International Economic Studies
Stockholm University
S-106 91 Stockholm

or electronically. Electronic submissions have to satisfy the following criteria in order to be considered:

(i) the file formats have to be postscript, pdf, dvi, or Word;
(ii) the abstract has to be submitted as a separate file, if a paper is also submitted; and
(iii) the file sizes are not to exceed 1 MB; file compression is accepted, but please specify the compression program.
The address for electronic submissions is Fax submissions will NOT be considered.

For further information about the conference, and submission and acceptance of papers, send an e-mail to (Alberto Trejos) or (Per Krusell), or check the conference web page at

Software: A new book on computational methods

While the numerical analysis of stochastic dynamic equilibrium models has made a lot of progress in the last decade or two, the dissemination of this methodology has traditionally been hampered by the relatively high investment necessary to master its tools. To lower this cost, several chapters in Thomas Cooley's "Frontiers of Business Cycle Research" have been devoted to surveying and detailing some of the computational methods available. The QM&RBC home page (http:/ makes available some source code, but without much explanations.

The recently published book entitled "Computational Methods for the Study of Dynamic Economies", edited by Ramon Marimon and Andrew Scott at Oxford University Press, is entirely devoted to describing these methods and in parallel provides example source codes on the web at This book as emerged from the 1996 European Economic Association Summer School and developed into a veritable toolkit for economic researchers. It covers a wide range of methods, from the standard iterative methods on linear quadratic approximations, nonlinear methods using discrete state-spaces or polynomials to solving highly complex heterogeneous agent models, all detailed with examples.

EconomicDynamics Links: The RePEc bibliographic database

RePEc is a loose organization of volunteers who thrive to increase the dissemination and availability of economic research through the Internet. Participating institutions contribute the data about their publications through their Internet sites, data that is then included in centralized databases. Currently, over 120 institutions contribute to RePEc, totalling about 70'000 items of research, 18'000 of which are available online. All this information is available for free through several popular services:
BibEc,, catalogs items that are not online;
WoPEc,, and Inomics,, catalog on line items;
IDEAS,, has all of them;
NEP,, is an email based notification service with about 40 field specific mailing lists, including one on dynamic general equilibrium.

Use these services and encourage your institution or your journal to have its research listed in RePEc!


The EconomicDynamics Newsletter is a free supplement to the Review of Economic Dynamics (RED). It is distributed through the EconomicDynamics mailing list and archived at The responsible editors are Christian Zimmermann (RED associate editor), and Thomas Cooley (RED coordinating editor), The EconomicDynamics Newsletter is published twice a year in April and November.

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