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This PDF is a selection from a published volume from the National Bureau of Economic Research Volume Title: NBER Macroeconomics Annual 2007, Volume 22 Volume Author/Editor: Daron Acemoglu, Kenneth Rogoff and Michael Woodford, editors Volume Publisher: University of Chicago Press Volume ISBN: 978-0-226-00202-6 Volume URL: http://www.nber.org/books/acem07-1 Conference Date: March 30-31, 2007 Publication Date: June 2008 Chapter Title: Frontmatter, editorial and abstracts in "NBER Macroeconomics Annual 2007, Volume 22" Chapter Author: Daron Acemoglu, Kenneth Rogoff, Michael Woodford Chapter URL: http://www.nber.org/chapters/c6398 NBER Macroeconomics Annual 2007 National Bureau of Economic Research I NBER Macroeconomics Annual 2007 NBER Macroeconomics Edited by Daron Acemoglu, Annual Kenneth Rogoff, 2007 and Michael Woodford NBER/Macroeconomics Published annually 2008 by ? Annual, Number by The University the National Bureau 22,2008 of Chicago of Economic Press Research. 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The President the internal manuscript tors before publication about 6. Publications of the NBER issued or issued ing the work of the Bureau, ties at the Bureau, including shall be consistent porter, shall contain a but not with concern purposes the public of the activi for informational to inform limited the object disclaimer noting to the NBER Digest in paragraph stated and Re 1. They not passed The Execu that they have specific in the review this resolution. procedures required through tive Committee of the Board is charged with the review of all such pub lications from time to time. on the Bureau's 7. NBER working distributed papers and manuscripts are not deemed to be publications for the purpose of this reso web site 1. lution, but they shall be consistent with the object stated in paragraph a have that disclaimer shall contain papers noting they Working specific in this resolution. not passed required through the review procedures a The President similar disclaimer. The NBER's web site shall contain to ensure that the working shall establish an internal review process pa pers and the web report annually connection with site do not contain to the Board policy recommendations, on this process and any concerns and shall raised in it. or exempted determined 8. Unless otherwise by the terms by the Board in each shall be printed 6 and 7, a copy of this resolution of paragraphs as 2 in paragraph above. NBER publication described Contents xi Editorial Kenneth Acemoglu, xvii Abstracts Daron 1 Aggregate Kiminori Implications Rogoff, and Michael of Credit Market Woodford Imperfections Matsuyama Comments 61 Mark Gertler Nobuhiro Kiyotaki Discussion 2 How 79 Are Structural Structural Jesus Fernandez-Villaverde Comments 139 TimothyCogley Frank Schorfheide Discussion 165 Parameters? 83 and Juan F. Rubio-Ramirez 1 x Contents 3 In Search Roberto of the Transmission Mechanism of Fiscal Policy 169 Perotti Comments 227 Ricardo Reis Valerie Ramey Discussion 247 4 Cyclical Budgetary Learn from OECD Philippe Policy and Economic 251 Panel Data? Growth: What Do We and Ioana Marinescu Aghion 279 Comments Ricardo }. Caballero Anil K Kashyap Discussion 295 5 Monetary Product and Business Policy with Endogenous Entry 299 Variety Florin O. Bilbiie, Comments Cycles Fabio Ghironi, and Marc J.Melitz 355 VirgiliuMidrigan Julio J. Rotemberg 377 Discussion Rate Models 6 Exchange Charles Engel, Nelson Comments 443 Kenneth Rogoff Barbara Rossi Discussion 471 Are Not As Bad As You Think C. Mark, and Kenneth D. West 381 and Editorial Daron Acemoglu, Kenneth Rogoff, and Michael Woodford The twenty-second volume of the NBER Macroeconomics Annual contin ues its tradition of featuring macro in debates important present-day economics and presenting major developments in the theory of macro economic The market economic witnessed shaping business and policy. in this volume, imperfections/' by Kiminori analysis first paper "Aggregate of credit implications the macro Matsuyama, investigates of credit market frictions. Recent years have implications both a recognition of the importance in of credit constraints a number of macroeconomic from major phenomena, ranging and a flurry of cycles to growth and economic development, on of models credit markets. of these models papers imperfect Many make different assumptions about how the economy works and they of ten reach different, a useful per provides of credit market ferent models framework and even starting conflicting, conclusions. Matsuyama's point for understanding and why the predictions imperfections are sometimes conflicting. Matsuyama based on a simple and common model pa the implications of various dif a unified presents of individual credit market feature the standard inability to borrow by in constraints, which unless have sufficient collateral. This constraint creates they the well-known net worth balance effect. This (or sheet) partial equilib rium model is familiar to most macroeconomists and features inmany dividuals papers in the literature. Where the use of a unified framework becomes is in showing the importance of general equilib important particularly rium effects. The paper illustrates how general and macro equilibrium features of models influence the implications of the standard net worth effect for business on how cycles and growth. For example, depending and are the interaction modeled, endogenous savings among projects can lead to greater credit market in macro imperfections persistence xii Acemoglu, Rogoff, and Woodford fluctuations. At the same time, they may introduce greater sometimes also shows how (and self-sustaining) volatility. Matsuyama credit market influence the direction of international cap imperfections ital flows, the distribution of income in society, cross-country income economic and international trade. The framework differences, ful in its simplicity and clarity. Itwill enable future use is particularly to more researchers of credit market clearly isolate the features of their models that lead to specific predictions and outcomes. The in the volume, "How by Jesus Fernandez-Villaverde debate light on an important second rameters?" sheds new Robert Lucas's distinguishing reduced-form paper structural imperfections are structural pa and Juan Rubio-Ramirez, in macroeconomics. Since have been careful in critique, macroeconomists structural parameters from their of dynamic models An important reason for doing so is that representations. famous the economy undergoes important policy or technology changes, will reduced-form representations change. Truly structural parameters will A major area in which remain invariant, however. the focus on structural parameters has been central is the development and applica when tion of dynamic which stochastic general equilibrium (DSGE) models, are estimated a in order to provide to and calibrated business fit good cycles in fluctuations the United States and other advanced economies. are also used to investigate op parameters that many timal monetary and fiscal policy. This paper shows, however, assume constant parameters, of the simpler models of DSGE, which and less for the analysis of busi be thus be useful may may misspecified ness cycles and optimal policy than previously thought. It calls for richer These estimates theoretical parameters of structural and empirical models that allow for dynamically to these individual reaction and incorporate changing parameter that prom new empirical methods changes. The paper also showcases more of this kind ise to allow DSGE models with complex specifications a constructive to be estimated. toward a This paper provides approach models and is likely of dynamic macroeconomic in this exciting area. Our next two papers deal with fiscal policy. The paper by Roberto Per of fiscal policy," turns to otti, "In search of the transmission mechanism richer understanding to spur new research what are the impacts of shocks to on and employment? real wages, consumption, government spending This question is not only amajor one for macroeconomic analysis, but it in today's environment, fiscal re where major relevant is particularly in the government's of forms and important changes goods purchases a basic question of macroeconomics: xiii Editorial and services demands are taking place because of reforms of Social Security and services. The answer to this ques for additional government between also be important in distinguishing of leading models tion may short-run macroeconomic fluctuations. While the standard neoclassical that an increase in government should lead to predicts spending a decline in private real (and many Keynesian consumption wages), Thus a careful identification of the im the opposite. models predict on of the economy may help us dis government plications spending of short-run fluctuations. The paper leading models tinguish between model notes used in the literature in the past have methodologies answers to these important questions. Studies exploiting to government spending driven by the Korean War, the Vietnam that different led to different shocks War, and the first IraqWar have found evidence broadly the neoclassical while vector autoregression predictions, results more often produced rent paper tries to reconcile in line with these results consistent with analyses have view. The cur the Keynesian and argues that the vector au are more robust. predictions and the Keynesian evidence toregression The discussion the paper questions whether these strong surrounding on are the role of fiscal policy conclusions warranted. This paper and its associated discussion will certainly lead tomore detailed investigations and the channels of fiscal policy on the economy through fiscal policy influences economic activity. The second paper on fiscal policy, by Philippe Aghion and Ioana and economic Marinescu, "Cyclical budgetary policy growth: What do we learn from OECD panel data?" investigates the implications of the of deficit. models government sug cyclicality budget Many Keynesian should pursue a countercyclical gest that the government budget deficit in order to smooth business with the Euro However, cycle fluctuations. of the effects which countries have moved pean Fiscal Stability Pact the European away from countercyclical fiscal policy because of the need to contain their a more whether budget deficits. This paper investigates cyclical fiscal in more lead to out policy Europe would positive macroeconomic more economic The authors comes, including rapid growth. suggest that countercyclical budget deficits may have an impact on growth by on firms and thus credit constraints them not to cut relaxing allowing a range of as such in re investments investments, growth-enhancing search and development, downturns. then during They investigate how important these effects might be using panel data from the OECD. They first construct measures of the countercyclicality of the budget deficit for each economy. Using these measures, they then investigate the effect of xiv Acemoglu, Rogoff, and Woodford fiscal policy on economic growth. The results suggest countercyclical an important positive deficits have effect on that countercyclical budget that this effect ismore economic growth, and perhaps more importantly, in societies with less-developed pronounced is indirect evidence that the cyclical behavior On credit market behavior). teracting with deficits note that European economies fiscal policy, both because growth-promoting the authors more financial markets (which of fiscal policy may be in the basis of these results, could have a significantly are quite levels of financial countercyclical their current budget low they have relatively to the United States (and thus and because compared development to gain from countercyclical fiscal policy). This paper may have more and empirical work future theoretical for have important implications in macroeconomics and for the conduct of macroeconomic policy. The focuses on the paper discussion surrounding lively and interesting in the paper are quantitatively whether the effects emphasized plausible data. from macroeconomic and whether such effects can be identified The with fifth paper in the volume, "Monetary policy and business entry and product variety," by Florin Bilbiie, endogenous and Marc Melitz, Ghironi, develops the role of cyclical entry of new study a rich macroeconomic cycles Fabio model to on the nature firms and products on the effects of monetary and of business policy. cycle fluctuations are also typically used for which of business Standard models cycles, or monop assume either perfect competition monetary policy analysis, olistic competition with a given number of firms and products. The cur in the economy with a the number of products rent paper endogenizes are predicted to economic of Periods condition. expansion free-entry is consistent with the avail lead to further entry by new products, which affects not only the real side of the economy able data. This entry margin condition the no-arbitrage For example, but also the inflation dynamics. a new creates between bonds and private equity in the asset markets the fact that the channel for the impact of monetary policy, incorporating on future entry and future interest rates. The price of equity will depend of the model with endogenous the authors show that entry implications traditional of those in from differ for business ways important cycles that the impact of and the this new model Moreover, suggests can be quite different. They for monetary transmission channels policy a toward first also take policy in this step optimal monetary analyzing and innovation context. The paper is an important methodological models. poses new questions conduct of monetary relevant policy. for macroeconomic theory and for the xv Editorial final paper, by Charles Engel, Nelson Mark, and Kenneth West, are not as bad as you think," turns to another models "Exchange-rate Our con research and policy debate. Despite major topic of macroeconomic on rates and financial flows international siderable research exchange across what countries, have macroeconomists not reached a consensus on rate are most promising for the of the exchange of international financial equilibria. The standard neoclassical class of models analysis models a rate are attractive because the exchange they provide rates to product prices, inter for linking exchange tractable framework a est rates, and output. However, with of papers, beginning plethora Meese and Rogoff (1993a, b), point out that these models do not perform of very well out of sample, either when measured by forecasting perfor or out-of-sample mance fit. In fact, they almost universally fail to im (with no drift) except at very prove on a simple random walk model tests This paper argues that these types of forecasting rate models, the failure of empirical exchange and pres ents a range of different that the models types of evidence suggesting more power than is commonly have at least modestly For appreciated. long horizons. may overstate that, consistent with theory, ex present evidence news indeed about future prices, interest incorporate change are flexible and and that the standard to models rates, output, enough account for the observed in rates. large volatility exchange They also the authors example, rates do can be of these models performance improved information from surveys, and by focus expectations by incorporating and long-horizon forecasts. The results in ing on panel data estimation the paper should lead to a reexamination of some of the most negative assessments of the standard exchange-rate and will certainly models, show how the forecasting stimulate new research in this important area. The insights of the paper are also likely to be useful in the recent policy debate concerning help the overvaluation and the National for theMacroeconomics particularly for outstanding conference undervaluation of certain rates. exchange to thank Martin Feldstein like to take this opportunity and Bureau of Economic Research for their continued support We would Annual like to thank logistical and the associated conference. We would the conference support Luminita to summarize rapporteurs, the discussions knowledge financial support staff, especially Rob Shannon, and organization and the throughout, Stevens and Justin Svec, for helping ac We also gratefully for this volume. from the National Science Foundation. Abstracts 1 Aggregate Implications Kiminori Matsuyama of Credit Market Credit market important ternational in its wake imperfections issues in business provide cycles, the key to understanding growth and development, many and in in these areas, however, has left progress of individual models with array bewildering seemingly results. This paper offers a road map. Using the same single economics. Recent a conflicting model of credit market imperfections a unified set of results within diverse Imperfections a coherent it brings together a throughout, In so doing, it aims to framework. is able to see close connections be picture, so that one these results, thereby showing how a wide range of aggregate common cause. to be attributed the may phenomena They include, other technical among things, endogenous investment-specific changes, recessions, traps, leapfrogging, development persistent recurring boom and-bust the rise and fall of cycles, reverse international capital flows, across and the of international trade. The nations, patterns inequality draw tween is also used some equilibrium to investigate and distribu of the of credit markets. One recur impacts improving efficiency is that the of often ring finding properties equilibrium respond to parameter nonmonotonically suggests some cautions changes, which for studying of credit market aggregate implications imperfections a narrow class or a within particular family of models. framework tional 2 How Structural Are Jesus Ferndndez-Villaverde This paper "structural studies Structural Parameters? and Juan F. Rubio-Ramirez the question of the stability over time of the so-called of dynamic stochastic parameters" general equilibrium xviii Abstracts To answer this question, we estimate a medium-scale (DSGE) models. our DSGE model with real and nominal rigidities, using U.S. data. In and rational the of model, we allow for parameter drifting expectations that there is strong evi agents with respect to this drift. We document our sample. We illustrate varia dence that parameters change within the tions in the parameters monetary describing policy reaction function the of firms and and in the parameters characterizing pricing behavior we show how the movements in the pricing pa Moreover, inflation. Thus, our results cast doubts on rameters are correlated with relevance of Calvo models. the empirical households. 3 In Search of the Transmission Mechanism of Fiscal Policy Roberto Perotti Most cause economists some would slowdown agree that a hike in the federal funds rate will in growth and inflation, and that the bulk of the rea this statement. But perfectly with even on the basic effects of a can and do disagree on goods and services: neoclassical shock to government spending and the real wage models predict that in general, private consumption some neo-Keynesian the opposite. This models will fall, while predict evidence empirical sonable economists is consistent alternative paper discusses shocks ernment spending to identify gov effects. Applying States and three other time series methodologies their and to estimate to data from the United these methodologies in favor of the neoclassical little evidence countries provides the paper then turns to the U.S. tables, input-output Using predictions. to shed two around evidence buildups major military industry-level OECD light on the effects of government spending shocks. Policy and Economic Growth: Cyclical Budgetary OECD Panel Data? Learn from Do We What 4 Philippe Aghion and IoanaMarinescu to analyze the re uses yearly panel data on OECD countries of the budget deficit. We lationship between growth and the cyclicality of the budget new yearly estimates of the countercyclicality develop coun deficit and show that the budget deficit has become increasingly over the past twenty years. How in most countries OECD tercyclical Union ever, European Monetary (EMU) countries did not become more with country- and year-fixed Using panel specifications countercyclical. This paper xix Abstracts a de effects, we show that: (a) an increase in financial development, crease in openness to trade, and the adoption of an inflation-targeting regime move countries toward amore countercyclical budget deficit; (b) amore countercyclical on economic growth, ment a positive and budget deficit has significant effect and this effect is larger when financial develop is lower. 5 Monetary and Business Cycles with Product and Endogenous Entry Variety Florin O. Bilbiie, Fabio Ghironi, andMarc J.Melitz Policy This paper studies the role of endogenous entry and product producer creation for monetary and in a business policy analysis cycle dynamics model with imperfect price adjustment. general equilibrium Optimal monetary policy stabilizes index vary to accommodate prices, but lets the consumer in the number of available changes product price prod ucts. The free-entry condition links the price of equity (the value of prod cost and markups and hence with inflation dynam ucts) with marginal ics. No-arbitrage return on between bonds and equity links the expected the return on shares, and thus the financing of product creation, with bonds, affected by monetary policy via interest rate setting. This new channel of monetary transmission policy through asset prices restores in the presence of capital accumulation the Taylor Principle (in the form of new production interest rate setting, un lines) and forward-looking like in models with traditional physical capital. We also study the im of for the New plications endogenous variety Keynesian Phillips curve and business fects of technology, the second moment more and we document the ef generally, as as and monetary well shocks, deregulation, policy our means ex of of numerical model, properties by cycle dynamics amples. 6 Exchange Rate Models Are Not As Bad As You Think Charles Engel, Nelson C. Mark, and Kenneth D. West models of exchange variables rates, based on macroeconomic as such prices, interest rates, output, and so forth, are thought by many to have failed empirically. We present evidence researchers to the con we a the that in walk" random trary. First, emphasize point "beating a too is an criterion for accepting rate forecasting strong exchange model. models low should have of this power Typically forecasting Standard xx Abstracts a number to evaluate models. We of alternative ways but the of the monetary fit, importance in-sample emphasize on expectations in determining rates. exchange policy rule and its effects rates incorporate news about that exchange Next we present evidence as the models future macroeconomic fundamentals, imply. We demon ex strate that the models for observed may well be able to account type. We examine propose rate volatility. We discuss rates to announcements exchange rate models estimates of exchange change are calculated studies that examine of economic in which data, expected forecasts. the response of then present and present values we from survey Finally, can of models be increased that out-of-sample forecasting power on and forecasts. estimation cusing panel long-horizon fundamentals of show by fo