Working Papers

  1. Last updated 12/15/2012. The Inefficient Markets Hypothesis: Why Financial Markets Do Not Work Well in the Real World.   Joint with Carine Nourry and Alain Venditti. Existing literature continues to be unable to offer a convincing explanation for the volatility of the stochastic discount factor in real world data. Our work provides such an explanation. We do not rely on frictions, market incompleteness or transactions costs of any kind. Instead, we modify a simple stochastic representative agent model by allowing for birth and death and by allowing for heterogeneity in agents’ discount factors. We show that these two minor and realistic changes to the timeless Arrow-Debreu paradigm are sufficient to invalidate the implication that competitive financial markets efficiently allocate risk. Our work demonstrates that financial markets, by their very nature, cannot be Pareto efficient, except by chance. Although individuals in our model are rational; markets are not. CEPR discussion paper available soon. NBER Working Paper HERE, available on my website HERE.

  2. Last updated 10/01/2012. Qualitative Easing: How it Works and Why it Matters.  This paper is about the effectiveness of qualitative easing; a government policy that is designed to mitigate risk through central bank purchases of privately held risky assets and their replacement by government debt, with a return that is guaranteed by the taxpayer. Policies of this kind have recently been carried out by national central banks, backed by implicit guarantees from national treasuries. I construct a general equilibrium model where agents have rational expectations and there is a complete set of financial securities, but where agents are unable to participate in financial markets that open before they are born. I show that a change in the asset composition of the central bank’s balance sheet will change equilibrium asset prices. Further, I prove that a policy in which the central bank stabilizes fluctuations in the stock market is Pareto improving and is costless to implement. The paper is published as NBER working paper 18421  HERE, CEPR discussion paper, HERE, and my website HERE.

  3. Last updated 10/01/2012. The Evolution of Endogenous Business Cycles.  This paper was prepared as an invited submission for a forthcoming special issue of Macroeconomic Dynamics on 'Complexity in Economic Systems'. The paper defines two classes of endogenous business cycle models. First generation EBC1 models rely on dynamic indeterminacy; second generation EBC2 models rely on steady state indeterminacy. I discuss how these models are related to each other and where they fit in the development of macroeconomic ideas. The paper is published as CEPR discussion paper 9080, HERE and NBER Working Paper 18284, HERE.  My website link HERE.

  4. Last updated 11/03/10. Animal Spirits, Persistent Unemployment and the Belief Function. This paper was prepared for the “Microfoundations for Modern Macroeconomics Conference” hosted by Columbia University’s Center on Capitalism and Society, November 19th - 20th, 2010 in New York City.  The paper is published as NBER working paper #16522, as CEPR Discussion Paper # 8100 and is forthcoming in Rethinking Expectations: The Way Forward for Macroeconomics, Roman Frydman and Edmund Phelps, eds, Princeton University Press, Princeton NJ, 2013.  It is available from my website HERE.

  5. Last updated 09/07/10. Debt, Deficits and Finite Horizons: A Stochastic Dynamic Analysis.  Joint with Alain Venditti and Carine Nourry. We introduce aggregate uncertainty and complete markets into Blanchard’s (1985) perpetual youth model. We provide a simple formula for the pricing kernel in terms of observable aggregate variables, and we study a pure trade version of our model. We show that it behaves much like the two-period overlapping generations model. Our methods should prove useful to researchers who seek a tractable stochastic model in which fiscal policy has real effects on aggregate allocations.

  6. Last updated 06/05/08. The Great Depression . This is a working paper version of material from my completed and forthcoming book, Expectations Employment and Prices. It uses a search model of the labor market to provide a micro-founded interpretation of Keynes' explanation of the Great Depression.

  7. Last updated 09/21/06. Old Keynesian Economics. This is the working paper version of a paper prepared for a conference in honor of Axel Leijonhufvud, held at UCLA on August 30th and 31st 2006. The paper is published in Macroeconomics in the Small and the Large , Roger E. A Farmer ed., Edward Elgar, London, 2008

  8. Last updated 09/21/06. A method to generate structural impulse-responses for measuring the effects of shocks in structural macro models. Joint with Andreas Beyer, ECB working paper #586, February 2006. We develop a technique for analyzing the response dynamics of economic variables to structural shocks in linear rational expectations models.

  9. Last updated 09/05/06. Shooting the Auctioneer. Joint with Andrew Hollenhorst. This paper uses a relatively standard DSGE model with sticky wages to account for labor market facts. Using a second-order approximation to the policy function we simulate moments of an artificial economy with and without sticky wages. We compute the welfare costs of the sticky wage equilibrium and find them to be small.

  10. On the Indeterminacy of New-Keynesian Economics. Joint with Andreas Beyer, ECB working paper #323. This is an extension of On the Indeterminacy of Determinacy and Indeterminacy American Economic Review, 97(1) 2007, pp. 524-529. It generalizes the argument to a class of three equation linear models. A version of the working paper is published in Macroeconomics Dynamics 12, S1, 2008 pp 60-74 under the title What we Don't Know about The Monetary Transmission Mechanism and why we Don't Know it”.

  11. Business Cycles with Heterogeneous Agents. May 2002. This is part of a project that studies the implications of long-lived stochastic overlapping generations models. The main contribution of the paper is a method for solving these models in closed form. I haven't revised the paper in a while although it is still on my agenda.

  12. Fiscal Policy, Equity Premia and Heterogeneous Agents, May 2002. This paper explores the equity premium puzzle in a long-lived agent model and it argues that market incompleteness can be captured by rapid change in the traders who participate in the equity markets.