Economic Dynamics Newsletter

Volume 5, Issue 1 (November 2003)

The EconomicDynamics Newsletter is a free supplement to the Review of Economic Dynamics (RED). It is published twice a year in April and November.

In this issue

Kjetil Storesletten on Inequality in Macroeconomics

Kjetil Storesletten is Professor of Economics at the University of Oslo, Norway. He is interested in heterogeneity in macroeconomics, in particular political economy and the impact of aggregate and individual risk on economic allocations. Storesletten’s RePEc/IDEAS entry.

Over the last decade or so, economists have made substantial effort departing from the representative agent framework and exploring the role of heterogeneity in macroeconomics. The central insight is that uninsurable risk and heterogeneity can have substantial impact on aggregate economic outcomes, the impact of government policies, and the mere choice of such policies. In this vein of research I have focused on three broad questions:

  1. How important is risk on the household-level?
  2. What are the implications of this risk for government policy and
  3. How does this heterogeneity shape political conflict and policy outcomes?

Quantifying risk on the household-level

One of the most divisive and politically loaded questions in economics is whether cross-sectional dispersion and changes over time in income and labor earnings are driven by luck — shocks exogenous and unexpected to the household –, or by effort and innate ability — factors endogenous and known to the agents at birth. Individual data exhibit large dispersion in wages and earnings, and the within-cohort earnings-dispersion (measured as variance of logs) is increasing sharply with age. However, as econometricians know less than the agents in their data samples, data on earnings alone do not suffice to address this question. One way to bring theory to bear on this issue is to consider data on consumption. Deaton and Paxson (1994) document that within-cohort consumption dispersion is also linearly increasing over the life-cycle, albeit not as steeply as earnings dispersion. In Storesletten, Telmer and Yaron (2004a), we show that these facts are quantitatively consistent with a standard life-cycle model with incomplete markets, provided that a substantial fraction — roughly half — of the labor-market uncertainty people face must be realized throughout the working years, as opposed to early in life, before entering the labor market. Without shocks during working years, the theory can account for increasing inequality in income, but not consumption. Moreover, the joint behavior of income and consumption inequality implies that idiosyncratic shocks must be highly persistent. These results have strong implications for policies such as unemployment insurance and social security and for theories of savings and portfolio choice.One alternative explanation of this evidence on earnings and consumption dispersion, one consistent with complete markets, could be that agents’ preferences were not separable between consumption and leisure. The more productive agents would then work harder and be compensated with higher consumption. As wage dispersion increases with age, so would dispersion in both consumption and leisure. That implication is testable: Storesletten, Telmer, and Yaron (2001a) argues that empirical evidence on labor supply makes this story implausible, since the dispersion in labor supply is roughly constant over the life-cycle. This is inconsistent with a standard model of complete risk sharing — there are no “plausible” combinations of attitudes toward risk and substitutability between consumption and leisure simultaneously generating a non-increasing dispersion in hours worked and an increasing dispersion in consumption and labor earnings. I interpret this as further evidence of substantial uninsurable risk at the household level.

While the above studies focus on inequality over the life-cycle, one important reason for the recent awareness of inequality and heterogeneity in economics is the sharp increase in cross-sectional dispersion in wages and earnings over time — the trend in inequality over the 1970-2000 period (see Katz and Autor, 1999, for a survey). Concern for the surge in inequality is, arguably, driven by the presumption that these changes are associated with dire welfare consequences. However, dispersion of hours worked, consumption and wealth (excluding the top 1%) have remained roughly constant through time, while the wage-hour correlation has risen sharply. In Heathcote, Storesletten and Violante (2003), we decompose the rise in wage inequality over time into changes in the variance of permanent, persistent and transitory shocks. With the estimated changes in the wage process as the only primitive, we show that a standard calibrated life-cycle model with incomplete markets can successfully account for all these changes over time in cross-sectional U.S. data.

Now what about short-term fluctuations in cross-sectional inequality? In Storesletten, Telmer, and Yaron (2004b), we explore if household-level earnings risk vary over the business cycle and to what extent this risk is persistent. The answer influences our understanding of economic short-term fluctuations, something I return to below. The main statistical problem is that available panel data-sets have a very limited time dimension. For example, the Panel Study on Income Dynamics starts in 1968. As there are at most 5 business cycles during the available panel years 1968-1993, it is difficult to identify how cross-sectional variation interacts with business cycles. In this work, we overcome this by conditioning on household age and the macroeconomic history during which a household has worked. We combine the individual earnings data with business-cycle regimes identified using aggregate data. Thus, we can use aggregate data going back as far as 1930. The main empirical findings are that idiosyncratic risk is persistent and increases significantly in downturns.

Economic implications of heterogeneity and risk

Now, given the above evidence of risk on the household-level, should we, as macro-economists, care? Below I argue risk and heterogeneity shapes our view on core macro issues such as fiscal policy, asset prices, portfolio choice, and the cost of aggregate short-term fluctuations.Starting with the latter, in Storesletten, Telmer and Yaron (2001b), we ask whether the welfare costs of business cycles depend on how aggregate shocks interact with idiosyncratic shocks. We find that if eliminating business cycles amounts to eliminating the negative correlation between the variability of idiosyncratic shocks and the overall level of economic activity (which we documented in our 2004b work), then the welfare costs of business cycles are much larger than previous work has suggested. These results support the popular view that distributional effects are an important aspect of understanding the welfare cost of business cycles.

What about asset prices and portfolio choices? While financial advisors often argue that young workers should hold stocks older workers should hold bonds, empirical evidence suggest that in reality people do exactly the opposite (Ameriks and Zeldes, 2001). Could individual earnings risk shed light on this apparent puzzle? A different, but related argument is due to Mankiw (1986) and Constantinides and Duffie (1996). They have suggested that individual labor-income risk could potentially resolve the “equity premium puzzle” — the statement that it is difficult to reconcile the historical return-premium of stocks over bonds with a standard calibrated representative-agent model with time-additive preferences. The key condition is, they argue, that this risk is counter-cyclical — large individual shocks when returns are low (i.e., in recessions) and small when returns are high (i.e., in booms). Such process is precisely what we recovered in our 2004b work I described above. In Storesletten, Telmer and Yaron (2002), we incorporate that individual earnings process into a standard life-cycle model and inquire about portfolio holdings over the life-cycle and its implications for the equity premium. Absent individual risks, our model suggests that young households should hold most of their financial wealth as stocks, whereas old ones should hold mostly bonds, consistent with Jagannathan and Kocherlakota (1996) and the standard financial advisor’s advice. Young households have far more human wealth than financial wealth, and since wages are far less variable than stock returns, human wealth is like a non-traded bond. Getting older means having less non-traded bonds and, therefore, maintaining an overall balanced portfolio requires increasing the bond share. This can be thought of as the intergenerational sharing of aggregate risk: aggregate risk is transferred from the old to the young via stock ownership. Idiosyncratic risk changes all this. It means that human wealth is risky and it deters those who have the most of it, the young, from holding stocks. The net effect is that idiosyncratic risk inhibits the intergenerational sharing of aggregate risk and, thus, drives up the reward to bearing aggregate risk: the equity premium. In this life-cycle model the wealthy middle aged are most suited to handle both aggregate and idiosyncratic shocks. Therefore, they end up holding more of their per-capita share of stocks, consistent with the empirical portfolio profile. Moreover, they demand a premium to these stocks, which drives up the equilibrium equity premium.

Given the above empirical evidence of substantial household-level risk, it is interesting to examine the scope of using government redistribution policies as an (ex-ante) vehicle of insurance. Such an exercise is of particular interest in light of the recent debate on reforming Social Security, the largest U.S. redistribution. Most proposals for reform involve less redistribution, moving from a benefit-defined system towards a contribution-defined system. In Storesletten, Telmer and Yaron (1999) we use a calibrated life-cycle model with incomplete markets to quantify the value of insurance, under the veil of ignorance, implicit in the current U.S. system. We find it to be worth 1.5% of lifetime income, given a risk aversion of 2. This is a large number, compared with other welfare assessments of risk in the quantitative macro literature (cf. Rios-Rull, 1994). However, when trading off the insurance value with the distortions of the pension system on aggregate savings, we find that privatization schemes contained in the proposals might still be welfare improving.

The overall aim of introducing heterogeneity in macroeconomics is, in addition to further our understanding of how the economy works, to provide tools for actual policy analysis. The area where this agenda has had the most influence is, perhaps, the analysis of future fiscal policy in light of the aging of the baby-boom generation (cf. Auerbach and Kotlikoff, 1987). The main insight of this literature has been that most Western economies, including the U.S., should expect large future tax increases or substantial reductions in expenditures. However, this literature has usually abstracted from an important component of demographic change: immigration. Using a calibrated general equilibrium life-cycle model, which explicitly accounts for differences between immigrants and natives, I investigated whether an immigration policy reform alone could resolve the fiscal problems associated with the ageing of the baby boom generation (Storesletten, 2000). Such policies exist and are characterized by increased inflow of working-age high- and medium-skilled immigrants. One particular feasible policy involves admitting 1.6 million middle-aged high-skilled immigrants annually. Moreover, I find that high-skilled immigrants are a huge fiscal gain to the U.S. government, while low-skilled immigrants represent a net loss.

Political economy

So far I have described my research on the economic consequences of heterogeneity taking government policies are exogenous. For example, in Storesletten (2000), I derived the implications of different immigration policies. However, in recognizing the importance of heterogeneity across households, one opens up an important tension in economics: political conflict over government policies implies that the set of politically feasible policies is more restricted than the set of economically feasible ones. There is now a growing literature bringing politico-economic aspects into macroeconomics, describing government policies as endogenous outcomes collectively determined by rational self-interested individuals. While many important politico-economic issues are dynamic in nature, technical limitations have, however, so far prevented a thorough investigation of dynamic political choices in macroeconomics. Put bluntly, the main reason why the theoretical literature is scant on dynamics, is a lack of convenient analytical tools. The study of economic dynamics is perhaps hard, but there is a large body of work on the subject: for a given policy environment, it is textbook material how to analyze an economy’s behavior over time when the economic actors are fully rational. Similarly, pure political theory has worked on dynamic policy determination (although this literature is less well developed). The combination of politics and economics is what poses a difficulty; one needs to model strategic voting interactions, where political agents consider the consequences of their choice on future political outcomes, as well as appeal to dynamic (usually competitive) equilibrium theory to ensure that all economic agents consumers, firms and government maximize their respective objective functions under rational expectations, and resource constraints.Prior to Hassler, Rodriguez-Mora, Storesletten and Zilibotti (2003a), the only nontrivial dynamic models (that is, that are not repeated static frameworks or purely backward-looking setups) relied essentially on numerical solution (see, e.g., Krusell and Rios-Rull (1999) and the discussions therein). In this work, we provide a tractable framework where voters are influenced both by the state of the economy, the current income distribution and foresee effects of the current policy outcomes on both future income distributions and future voting outcomes, which they care about and therefore take into account when they vote. A key result is that the future constituency for redistributive policies depends positively on current redistribution, since this affects both private investments and the future distribution of voters. The model features multiple equilibria. In some equilibria, positive redistribution persists forever. In others, even a majority of beneficiaries of redistribution vote strategically so as to induce the end of the welfare state next period. Skill-biased technical change makes the survival of the welfare state less likely.

Can this line of research shed light on more applied politico-economic issues such as unemployment and the choice of unemployment benefits? There has emerged a consensus among economists that the high level of unemployment in Europe relative to the U.S. is caused by the generous unemployment benefits and, to a lesser extent, firing restrictions in Europe (cf. Ljungqvist and Sargent, 1998). But why then don’t European countries reform their welfare system in order to bring down unemployment? In Hassler, Rodriguez Mora, Storesletten and Zilibotti (2001), we argue that the cross-country empirical regularities in geographical mobility, unemployment and labor market institutions can be explained in a model with endogenous mobility and rational voting over unemployment insurance (UI). Agents with higher cost of moving, i.e., more attached to their current location, prefer more generous UI. The key assumption is that an agent’s attachment to a location increases the longer she has resided there. UI reduces the incentive for labor mobility and increases therefore the fraction of attached agents and the political support for UI. The main result is that this self-reinforcing mechanism can give rise to multiple steady-states: one “European” steady-state featuring high unemployment, low geographical mobility and high UI, and one “American” steady-state featuring low unemployment, high mobility and UI.


Ameriks, John, and Stephen P. Zeldes (2001): How Do Household Portfolio Shares Vary with Age?, Unpublished manuscript, Columbia University.
Auerbach, Alan J., and Lawrence J. Kotlikoff (1987): Dynamic Fiscal Policy, Cambridge University Press, Cambridge.
Constantinides, George M., and Darrell Duffie, (1996), Asset Pricing with Heterogeneous Consumers, Journal of Political Economy, vol. 104, pages 219-240.
Deaton, Angus, and Christina Paxson, (1994): Intertemporal Choice and Inequality, Journal of Political Economy, vol. 102, pages 437-467.
Hassler, John, José V. Rodríguez Mora, Kjetil Storesletten, and Fabrizio Zilibotti (2001): A Positive Theory of Geographical Mobility and Social Insurance, CEPR Discussion Paper No. 2964.
Hassler, John, Kjetil Storesletten, and Fabrizio Zilibotti (2003): Democratic Public Good Provision, CEPR Discussion Paper No. 4044.
Heathcote, Jonathan, Kjetil Storesletten, and Gianluca Violante (2003): The Macroeconomic Implications of Rising Wage Inequality in the United States, Mimeo, Georgetown University.
Jagannathan, Ravi, and Narayana Kocherlakota (1996): Why Should Older People Invest Less in Stocks than Younger People?, Federal Reserve Bank of Minneapolis Quarterly Review vol. 20, pages 11-23.
Katz, Lawrence F., and David H. Autor (1999): Changes in the Wage Structure and Earnings Inequality, in Orley Ashenfelter and David Card (eds.), Handbook of Labor Economics, volume 3A, pages 1463-1555, North-Holland.
Krusell, Per, and José-Víctor Ríos-Rull (1999): On the Size of the U.S. Government: Political Economy in the Neoclassical Growth Model, American Economic Review, vol. 89, pages 1156-1181.
Ljungqvist, Lars, and Thomas J. Sargent (1998): The European Unemployment Dilemma, Journal of Political Economy, vol. 106, pages 514-550.
Mankiw, Neil G. (1986): The Equity Premium and the Concentration of Aggregate Shocks, Journal of Financial Economics, vol. 17, pages 211-219.
Ríos-Rull, José-Víctor (1994): On the Quantitative Importance of Market Completeness, Journal of Monetary Economics, vol. 34, pages 463-496.
Storesletten, Kjetil (2000): Sustaining Fiscal Policy through Immigration, Journal of Political Economy, vol. 108, pages 300-323.
Storesletten, Kjetil, Chris I. Telmer, and Amir Yaron (1999): The Risk Sharing Implications of Alternative Social Security Arrangements, Carnegie-Rochester Conference Series on Public Policy, vol. 50, pages 213-259.
Storesletten, Kjetil, Chris I. Telmer, and Amir Yaron (2001a): How Important Are Idiosyncratic Shocks? Evidence from Labor Supply, American Economic Review, vol. 91, pages 413-417.
Storesletten, Kjetil, Chris I. Telmer, and Amir Yaron (2001b): The Welfare Cost of Business Cycles Revisited: Finite Lives and Cyclical Variation in Idiosyncratic Risk, European Economic Review, vol 45, pages 1311-1339.
Storesletten, Kjetil, Chris I. Telmer, and Amir Yaron (2002): Asset Pricing with Idiosyncratic Risk and Overlapping Generations, Working paper, Carnegie Mellon University.
Storesletten, Kjetil, Chris I. Telmer, and Amir Yaron (2001b): The Welfare Cost of Business Cycles Revisited: Finite Lives and Cyclical Variation in Idiosyncratic Risk, European Economic Review, vol. 45, pages 1311-1339.
Storesletten, Kjetil, Chris I. Telmer, and Amir Yaron (2004a): Consumption and Risk Sharing over the Life Cycle, Journal of Monetary Economics, forthcoming.
Storesletten, Kjetil, Chris I. Telmer, and Amir Yaron (2004b): Cyclical Dynamics in Idiosyncratic Labor-market Risk, Journal of Political Economy, forthcoming.

Q&A: Jordi Galí on Price Rigidities

Jordi Galí is Director of the Centre de Recerca en Economia Internacional (CREI), and Professor at Universitat Pompeu Fabra. His recent research has focused on the analysis of the interaction of monetary policy with various shocks and its role in determining the real and nominal features of the business cycle. Galí’s RePEc/IDEAS entry.
EconomicDynamics: Do price rigidities matter for business cycles?
Jordi Galí: I would say that nominal rigidities, understood as less-than-fully-flexible prices and wages, are an important element of any realistic theory of the business cycle. It is hard to make sense of the key role played by central banks in modern economies unless one recognizes the presence of some nominal frictions. Such frictions make it possible for a changes in the short term nominal interest rate to have an effect on intertemporal relative prices, and hence on consumption, investment and output decisions. There exist frictions other than nominal rigidities that can in principle account for the non-neutrality of money, but none of them seems to match the existing evidence so well as the presence of nominal rigidities of some sort.This is very different from saying that nominal rigidities play an important role, always and everywhere, in determining the observed properties of the business cycle. Instead, I would say monetary factors and, most importantly, monetary policy, can potentially have that role. Somewhat ironically, however, many of our models imply that the optimal monetary policy is one that seeks to replicate the equilibrium allocations generated by a frictionless RBC model. If the central bank follows that policy the economy may end up behaving like one that did not have any nominal rigidities. A recent paper of mine with López-Salido and Vallés argues that, far from being a theoretical curiosity, something close to this may have actually happened in the US during the Volcker-Greenspan era. Of course, the equivalence is only observational (not structural), and conditional on the monetary policy in place. Things may be very different in the future if the monetary regime changes, precisely because of the presence of nominal rigidities (possibly exacerbated by a period of low and steady inflation). By contrast, someone who takes RBC or flexible price models seriously should not be too concerned about who may end up replacing Greenspan.

ED: You imply that there is currently something of an observational equivalence between models with flexible and rigid prices. This implies that we should be able to find some independent evidence of substantial nominal price rigidity. How could you convince those who doubt about that?
JG: I would point to three different sources of evidence. First, direct evidence on price and wage setting based on micro-level data. That research, surveyed by John Taylor in his macro handbook article, indicates the existence of substantial rigidity in individual prices and wages (reflected in long spells without adjustment) as well as a lack of synchronization of adjustments. It also points to a great deal of heterogeneity across goods and sectors (groceries vs. magazines), as Bils and Klenow have highlighted in their recent work. Unfortunately, the latter feature is not easy to incorporate in our models.A second source of evidence is more indirect, and requires a bit more structure. But the basic argument can be summarized as follows. Inflation (and its changes) is the result of firms resetting their prices at each point in time. If firms find it too costly to adjust prices continuously, they will tend to do so to a larger extent when their markups are more out of line, relative to their desired markups. But if that is the case one should detect some negative relationship between economy-wide measures of markups and inflation. In recent work of Mark Gertler and myself, as well as in that of Argia Sbordone, we uncover such relationship in the data, and show that the cross-correlations between those variables are largely consistent with price-setting being forward.looking (a property that should hold in any model with price rigidities and profit-maximizing firms).

A third piece of evidence on the extent of nominal rigidities (and its practical relevance) is the one provided by Mussa and others, pointing to large differences in the behavior of real exchange rates across countries/historical periods characterized by different nominal exchange rate regimes. It is just very hard to look at a time series plot for the changes in nominal and real exchange rates between Germany and Italy throughout the postwar period without concluding that aggregates prices must display a lot of inertia.

ED: If there is evidence about price rigidities, then it begs the question why they exist. Menu costs have less support than before because they are too small to generate the large rigidities you describe. How could we then rationalize price rigidities?
JG: It is not obvious that menu costs, when understood in a broad sense (i.e., including the costs of re-computing optimal prices, conveying the information to the sales force, advertising, etc.) are as small as your question seems to imply. Furthermore those costs have to be compared to the profits that are foregone by not adjusting prices continuously. To the extent that marginal costs are stable at the firm level (largely because of sluggish wage adjustment and infrequent technical change) and close competitors do not adjust prices frequently, I do not see where those large foregone profits might come from. Some economists have argued that the observation of frequent price changes associated with week-end or one-day sales (or similar) is bad news for sticky price models. While that evidence may conflict with a narrow interpretation of menu costs, it may not be that relevant for the sort of nominal rigidities that may matter at business cycle frequencies: quite often those frequent price adjustments are easier to interpret as price discrimination devices, rather than price changes that mirror on a one-to-one basis any changes in marginal costs, as standard models with fully flexible prices would predict.


Bils, Mark, and Pete Klenow (2002): Some Evidence on the Importance of Sticky Prices, NBER working paper 9069.
Galí, Jordi, David López-Salido and Javier Vallés (2003): Technology Shocks and Monetary Policy: Assessing the Fed’s Performance, Journal of Monetary Economics, vol. 50, pages 723-743.
Galí, Jordi, and Mark Gertler (1999): Inflation Dynamics: A Structural Econometric Analysis, Journal of Monetary Economics, vol. 44, pages 195-222.
Mussa, Michael (1986): Nominal Exchange Rate Regimes and the Behavior of Real Exchange Rates: Evidence and Implications, Carnegie-Rochester Series on Public Policy, vol. 25, pages 117-214.
Sbordone, Argia (2002): Prices and Unit Labor Costs: A New Test of Price Stickiness, Journal of Monetary Economics, vol. 49, pages 265-292.Taylor, John (1999): Staggered Price and Wage Setting in Macroeconomics, in: John Taylor and Michael Woodford (eds.), Handbook of Macroeconomics, North-Holland, pages 1009-1050.

Q&A: Thomas Cooley (by J. Greenwood)

Thomas Cooley is past president of the Society for Economic Dynamics, past editor of the Review of Economics Dynamics, and Dean of the Stern Business School at New York University. The questions were prepared by Jeremy Greenwood (University of Rochester).
JG: You are the founding Editor of the Review of Economic Dynamics. What motivated you to start the Review, such an enormous undertaking?
TC: The idea of creating the Review of Economic Dynamics actually germinated several years before the first issue appeared in January of 1998. The historical context is kind of important. In the 1970’s a group of systems control engineers and economists began to hold meetings to discuss research problems in which they had a common interest and for which they used similar methods. Their view was that control theory could be used to design better economic policies. The conceit was to think that, if they could send rockets around the moon and back, they could do the same with economies. This led to the formation of the Society for Economic Dynamics and Control and eventually to a journal of the same name that was wholly owned by Elsevier the publisher. Over time the value of this collaboration between disciplines diminished, as did the interest in the annual meetings of that Society. Eventually Tom Sargent was induced to take over as president of the Society and he organized a series of annual meetings that were more focused on modern macroeconomics and he also revived interest in the journal. Roger Craine did a superb job of editing the JEDC and attracting good papers. But, it was still the case that the journal was intended to serve two audiences – economists and control theory types. Because of that it lacked coherence and it was the view of Tom and Ed Prescott who succeeded Tom as President, that the journal would never be recognized as a top tier publication unless it had editorial coherence. We had discussions with Elsevier about the direction of the journal and about the Society having more editorial control. I was the designated intermediary in these discussions and it fell to me to articulate what our vision for the journal would be.It eventually became clear that to have a journal that answered the needs of the growing ranks of outstanding economists who were engaged with the Society and that had a chance to be first rate meant having our own publication and having editorial control. When we decided on the structure of the journal and the governance procedures, our goal was to ensure editorial vitality. We did not want to fall into the trap of having the editors serve for decades. Our model was the Review of Economic Studies which was originally created to provide an outlet for rising young scholars who felt blocked out of the premier journals. Starting a journal from scratch is a lot of work and negotiating with publishers and putting it all together took a lot of time. And editing a journal takes a lot of time. But it was also rewarding to create something of lasting value to the profession and I feel pride every time a new issue arrives in my mail box. I think it is a pretty good journal!

JG: You were a graduate student at Penn in the late 60’s and early 70’s. In your career you have witnessed the rise of the rational expectations hypothesis, equilibrium modeling, and quantitative theory. What do you see in the future for macroeconomics?
TC: Your second question forced me to stop and think a bit about how the landscape has changed. One thing that is very clear is that the big questions macroeconomists address “why are some countries rich and he others not, why does our economic well-being fluctuate over time?” are the same. Nevertheless, economics is far more unified now than it was when I started because of the developments of the last twenty or thirty years. There is more agreement on what constitutes valid scientific method and formal reasoning and because of that the scope of the questions that an economist like you or I might tackle has expanded greatly. Public finance, industrial organization, labor economics, urban economics are all fair game for a well trained economist equipped with the methods of dynamic general equilibrium theory.That said, when you look at the broader picture of what is taking place in macroeconomic research these days, it is that we finally making progress at doing the things that economists started to talk about in the 1960’s. That is to provide microeconomic foundations to our understanding of macroeconomic issues. This is happening because we are better able to deal with heterogeneous agents and firms in our dynamic models. Understanding how those things aggregate to observed phenomena is verye revealing and will only become more so over time. It may well be too that the current fascination with behavioral economics and the puzzles that it uncovers will be addressed by thinking about heterogeneity more broadly.

Dear SED Members and Friends:

As the new President of the SED, I write to ask you to continue supporting our Society by submitting your papers to RED, by subscribing to RED, and by taking part in our annual conference which this year will be held in Florence, Italy. Also I will briefly report on a few new developments.

First, I would like to thank Tom Cooley for all he has done for our Society in his role as President and, before that, for launching our journal, the Review of Economic Dynamics, and serving as its managing editor. During Tom’s tenure, the journal has gained wider recognition and the SED meetings have become the summer meetings of the year. Rather than write more about Tom, I ask you instead to read the recent interview we did with him in this Newsletter issue.

Second, the 2003 meetings of the SED, held in Paris, France, were a big success. Ten parallel sessions ran at a time, with more than 300 papers presented during three full days. For the high quality of the content we should thank the program organizers Lee Ohanian and Franck Portier. For the superb local arrangements we must thank Hubert Kempf along with Jean-Olivier Hairault, and François Langot.

Third, the 2004 meetings. The meetings were originally planned for Istanbul, Turkey. Selo Imrohoroglu was the organizer with help from Nezih Guner and Insan Tunali. The arrangements were largely in place in mid-November, but then the organizers got worried about the recent bombings in Turkey. It was clear that we had to re-locate the meetings while there was still time. The hard part of that decision was that it frustrated the tireless efforts of the local organizers who had worked so hard to guarantee us a terrific set of meetings. I thank them warmly for their effort; in doing so I know that I speak for us all. Let us look forward to meeting in Istanbul some other summer.

Fortunately, we have found an excellent alternative site for the meetings. The 2004 meetings will now be held in Florence, Italy on July 1, 2, and 3. The venue will be La Pietra, a gorgeous historic villa within the city limits of Florence. The sessions will be held either in the villa or in classrooms that are also on the grounds. The program co-chairs are Jeremy Greenwood and Gianluca Violante. The call for papers is below.

Fourth, we have merged the SED membership with the subscription to RED. There will, in other words, be no distinction between the two. Every subscriber to RED automatically becomes a member of the SED. RED also has a new editor and several new co-editors and is now owned by Elsevier. Moreover, the delivery problems associated with RED have now been solved. Gary Hansen continues his dedicated and able management of RED.

Finally, the SED web page is now fully functional, I urge you to browse it.

Please continue supporting the advancement of Economic Dynamics! Instructions for subscribing are available here.

I hope to see all of you this July in Florence.


Boyan Jovanovic, President Society for Economic Dynamics

Call for Papers, 2004 Meetings

The 2004 meetings of the Society for Economic Dynamics will be held 1-3 July 2004 in Florence (Italy). The plenary speakers are Daron Acemoglu, Ariel Pakes, and Narayana Kocherlakota. The program co-chairs are Jeremy Greenwood and Gianluca Violante.

The program will be made up from a selection of invited and submitted papers. The Society welcomes submissions for the program. Submissions may be from any area in Economics. The program committee will select the papers for the conference. As well as considering individual papers for the conference, the program committee will also entertain suggestions for four-paper sessions. The deadline for submissions is February 15, 2004

Letter from the Coordinating Editor

I want to take this opportunity to tell you about a few changes to the RED Editorial Board. First, I am pleased to announce that Narayana Kocherlakota (Stanford University) has agreed to serve as an Editor of the journal. He replaces Boyan Jovanovic, who has stepped down due to the demands associated with being president of the Society. Jovanovic was one of the founding editors of RED, and he has had a huge impact on the development of this journal during its first six years. I am sure that the journal will continue to benefit from his influence in his capacity as president and as a member of RED’s Advisory Board.

I would also like to announce four new Associate Editors. Thomas Holmes (University of Minnesota) will add strength to the editorial board in the area of industrial organization. Urban Jermann (Wharton School, University of Pennsylvania) specializes in asset pricing. In addition, Kjetil Storesletten joins us from the University of Oslo and brings his expertise in political economy and social insurance. Finally, the journal will benefit from Harald Uhlig‘s (Humboldt University) broad knowledge of quantitative methods and macroeconomics. Their addition strengthens what is already a very impressive Editorial Board.

Finally, I want to urge you to subscribe to RED and to make sure that the library at your institution also subscribes. While there have been problems in the past associated with individual subscriptions, we are confident that those problems have now been solved. Information on subscriptions is available on the Society’s web pages. Note that there is a lower price for students.

Gary Hansen
RED Coordinating Editor

Economic Dynamics

Jerome Adda and Russell Cooper

Yet another book has been published that provides an introduction to dynamic methods in Economics, “Economic Dynamics” by Jerome Adda and Russell Cooper. Like its predecessors, it gives a overview of the main solution strategies to multiperiod models and their numerical analysis. But what distinguishes this book from others is its more extensive treatment of the estimation of the fundamental parameters of such economies. It goes through the particulars of maximum likelihood, GMM, and simulation-based estimation, thus providing a natural entry to empirical methods often neglected in textbooks.

Particular emphasis is put on linking solution procedures with estimation strategies by providing several simple examples that are examined repeatedly through the first half of the book. The second half covers more complex applications from the litterature, focusing on stochastic growth, the consumption of durables, and non-durables, investment, and employment adjustment. A concluding chapter discusses what the authors think are the most promising areas for future development in the field.

While the focus of the examples and applications is clearly macroeconomic, this book can be useful in introducing dynamic methods to graduate students in a more general context. The level of the material is not too high (and the authors refer to other textbooks for more formal presentations and proofs), which should make these techniques available to a much broader audience.

“Dynamics Economics” was published in October 2003 by MIT Press. Program codes and more information are available at