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We propose an extension of the incomplete markets general equilibrium model with production to situations in which firms can default (bankruptcy). In the model, firms are owned by a single individual whose roles as entrepreneur and consumer are anonymous. Assets are exogenously collateralised and are seized together with future output in case of default. Default is thus endogenous as output determines the deliveries from the assets issued. In turn, the receipts from each asset purchased are assumed to depend on a fraction of the firm’s output. This fraction is anonymous and is treated as given by individuals who will anticipate it, in equilibrium, as a proportion of aggregate output, generating counter-cyclical default. We show that, in this context, the financial policies of the firm are, in general, not irrelevant. We establish the existence of equilibria and discuss the nature of the inefficiencies introduced by the presence of bankruptcy.

We investigate the effect of structural transformation on the process of economic growth. Using a two-sector growth model we show that, in addition to Baumol’s cost disease, structural transformation from goods to services generates other predictions that are in line with cross-country growth facts: an increase in the real investment rate, a decline in the real interest rate and the marginal product of capital, and an acceleration of investment-specific technological change as the share of services increases. The model calibrated to US data can account for the elasticity of real investment rates to the share of services measured in cross-country data. (JEL E22, E23, E43, L16, O33, O41, O47)

The textbook New Keynesian (NK) model implies that the labor share is procyclical conditional on a monetary policy shock. We present evidence that a monetary policy tightening robustly increased the labor share and decreased real wages during the Great Moderation period in the United States, the Euro Area, the United Kingdom, Australia, and Canada. We show that this is inconsistent not only with the basic NK model, but also with medium-scale NK models commonly used for monetary policy analysis and where it is possible to break the direct link between the labor share and the inverse markup. Our results imply that either NK models are unable to separate the dynamics of the labor share from the markup or markups do not respond in the way NK models predict.

Dynamic stochastic general equilibrium (DSGE) models are typically estimated assuming the existence of certain structural shocks that drive macroeconomic fluctuations. We analyze the consequences of estimating shocks that are “nonexistent” and propose a method to select the economic shocks driving macroeconomic uncertainty. Forcing these nonexisting shocks in estimation produces a downward bias in the estimated internal persistence of the model. We show how these distortions can be reduced by using priors for standard deviations whose support includes zero. The method allows us to accurately select shocks and estimate model parameters with high precision. We revisit the empirical evidence on an industry standard medium‐scale DSGE model and find that government and price markup shocks are innovations that do not generate statistically significant dynamics.

We provide new estimates of the elasticity of capital-labor substitution ( σ ) and the bias in technical change allowing price markups to change over time as shown in De Loecker and Eeckhout (2017). Our estimate of σ is in the region of 0.8 and technical change is net capital-augmenting.

Using a database of 23,000 firms in 45 economies, we test the quantitative\ud importance of access to finance and access to public and private credit for the\ud determination of misallocation. We first derive measures of factor market and\ud size distortions, and then use these measures within a regression framework to\ud test the significance of self-declared access-to-finance obstacles as well as the\ud effect of access to a credit line issued by either a government-owned or private\ud bank. We find that access-to-finance obstacles and private credit increase the\ud dispersion of distortions. Public credit has a very small effect. For firms that do\ud not face financial obstacles, public credit increases the dispersion of distortions;\ud for firms that face financial obstacles, it slightly decreases dispersion. Public\ud credit does not appear to compensate for the distortions that exist in private\ud credit markets. Quantitatively, however, financial variables explain a very small\ud part of the dispersion of factor market and size distortions.

We provide a general theoretical characterization of how firms’ technology choice on a technology frontier determines the long-run elasticity of substitution between capital and labour. We show that the shape of the frontier determines factor shares and the elasticity of substitution between capital and labour. If there are adjustment costs to technology choice, the short- and long-run elasticities differ, with the long-run always higher. If the technology frontier is log-linear, the production function becomes Cobb–Douglas in the long run but, consistent with empirical evidence, short-run dynamics are characterized by gross complementarity. The approach is easily implementable and yields a powerful way to introduce CES-type production functions in macroeconomic models. We provide an illustration within an estimated dynamic general equilibrium model and show that the use of our production technology provides a good match for the short- and medium-run behaviour of the U.S. labour share.

We study the relationship between hours worked and technology during the postwar period in the US. We show that the responses of hours to technological improvements have increased over time, and that the patterns captured by the SVAR are consistent with those obtained from an RBC model with a less than unitary elasticity of substitution between capital and labor. Data supports the hypothesis that the observed changes in the response of hours to a technology shock are attributable to changes in the magnitude of the degree of capital-labor substitution. We argue that the observed time-variation in can arise from changes in the structural composition of sectors (or factors) in a heterogeneous inputs production function or from biases in technological change

We study the main shocks driving current account fluctuations for the G6 economies. Our\ud theoretical framework features a standard two-goods inter-temporal model, which is specifically\ud designed to uncover the role of permanent and temporary output shocks and the relation between the\ud real exchange rate and the current account. We build a SVAR model including the world real interest\ud rate, net output, the real exchange rate, and the current account and identify four structural shocks.\ud Our results suggest four main conclusions: i) there is substantial support for the two-good\ud intertemporal model with time-varying interest rate, since both external supply and preference shocks\ud account for an important proportion of current account fluctuations; ii) temporary domestic shocks\ud account for a large proportion of current account fluctuations, but the excess response of the current\ud account is less pronounced than in previous studies; iii) our results alleviate the previous puzzle in the\ud literature that a shock that explains little about net output changes can explain a large proportion of\ud current account changes; iv) the nature of the shock matters to shape the relationship between the\ud current account and the real exchange rate, which explains why is it difficult to find a simple\ud statistical relationship between these two variables.

The response of hours to technology shocks is a key controversy in macroeconomics. We show that differences between RBC and NK models hinge on highly restrictive views of technology. We introduce CES production technologies and demonstrate that the response of hours depends on the factor-augmenting nature of shocks and the capital–labor substitution elasticity in both models. We develop analytical expressions to establish the thresholds determining its sign. This opens new margins for shock identification combining theory and VAR evidence. We discuss how our models provide new robust restrictions for empirical work, especially using the labor income share.

Do sector-specific factors common to all countries play an important role in explaining business cycle co-movement? We address this question by analyzing international co-movements of value added (VA) growth in a multi-sector dynamic factor model. The model contains a world factor, country-specific factors, sector-specific factors, and idiosyncratic components. We estimate the model using Bayesian methods for 30 disaggregated sectors in the G7 economies for the 1974–2004 period. Our findings show that, although there is a substantial role for sector-specific factors, fluctuations are dominated by country-factors. The world factor appears to play a minimal role because, when using aggregate data, the world factor captures both the factor common to all countries and industries and the factor common to the same industry across countries. We then examine how these factors evolved as globalization deepened over the past two decades. Our results suggest that business cycles at a disaggregate level have not become more synchronized internationally. This is mainly driven by a substantial fall in the volatility of world shocks during the globalization period, rather than a lower sensitivity of sectoral growth to world factors. Our results also reveal that world factors appear to be more important for industries with a higher level of international vertical integration.

The relationship between recessions and productivity growth has been the focus of an important body of theoretical and empirical research in the last two decades. We contribute to this literature by presenting new evidence on the evolution of productivity in the aftermath of recessions. Our method allows us to distinguish between frontier and (in-)efficiency effects of recessions. We present international evidence for a panel of 70 countries for the period 1960–2000. Our results reveal that the average cumulative impact of recessions on productivity up to four years after their end is negative and significant. This, however, results from a mixture of mechanisms. The level of frontier production increases, but the rate of technical progress decreases, leading to a fall in frontier production. Efficiency also falls, lending support to the idea that recessions tend to reduce, rather than increase, economic restructuring. Long and deep recessions are also shown to have distinctive impacts on productivity.

One of the key determinants of potential growth are productivity gains. Total factor productivity (TFP) differences are the main determinant of per capita income differences between countries. A key factor to understand TFP is misallocation: the aggregate productivity loss from microeconomic distortions that prevent factors of production from being allocated to their optimal use. If misallocation is a key determinant of TFP differences, then reallocation of factors of production is a key driver of productivity gains. Since distortions preventing misallocation can be driven by institutional obstacles, then policies focused on the removal of these obstacles will affect potential growth. In this paper, we use a firm-level database for 62 developing countries to analyze which are the most important institutional obstacles driving misallocation. Our results highlight the importance of trade regulations, the functioning of courts, and access to finance as key determinants of misallocation within countries. Political instability, labor regulations, and access to infrastructure, appear as relevant obstacles explaining misallocation between countries.

Empirical evidence suggests that real exchange rates (RER) behave differently in developed and developing countries. We develop an exogenous 2-sector growth model in which RER determination depends on the country's capacity to borrow from international capital markets. The country faces a constraint on capital inflows. With high domestic savings, the country converges to the world per capita income and RER only depends on productivity spread between sectors (Balassa-Samuelson effect). If the constraint is too tight and/or domestic savings too low, RER depends on both net foreign assets (transfer effect) and productivity. We then analyze the empirical implications of the model and find that, in accordance with the theory, RER is mainly driven by productivity and net foreign assets in constrained countries and exclusively by productivity in unconstrained countries.

We argue that, theoretically, exchange rate pass-through (ERPT) into consumer prices may be nonlinear in contrast to standard linear estimates found in the literature. ERPT can be higher in periods of financial or confidence crises, when firms have no incentive to absorb cost increases in their margins. We test this hypothesis applying a logistic smooth transition (LSTR) model to Mexican data. Using two different measures of macroeconomic instability as transition variables, we find that ERPT does seem to increase in periods of macroeconomic distress, which highlights the importance of a stable macroeconomic environment in reducing ERPT in emerging markets.

The recent literature on Purchasing Power Parity (PPP) has emphasized the role of two phenomena that may lead to the rejection of the PPP hypothesis: structural breaks and non-linear adjustment induced by transaction costs. These two hypotheses are analyzed separately in the literature. We develop tests for unit roots that account jointly for structural breaks and non-linear adjustment. Structural breaks are modeled by means of a Fourier function that allows for infrequent smooth temporary mean changes and is hence compatible with long-run PPP. Nonlinear adjustment is modeled by means of an ESTAR model. Our tests present good finite sample properties. The tests are applied to a set of 15 OECD countries' RERs and are able to reject the null of a unit root in 14 cases. The breaks are usually associated with the great appreciation and later depreciation of the dollar in the 1980s and the ESTAR adjustment appears to play an important role.

We analyze the sustainability of the US current account (CA) deficit by means of unit-root tests. First, we argue that there are several reasons to believe that the CA may follow a non-linear mean-reversion behavior under the null of stationarity. Using a non-linear ESTAR model we can reject the null of non-stationarity favoring the sustainability hypothesis. Second, we ask whether unit-root tests are a useful indicator of sustainability by comparing in-sample results for the 1960–2004 period to the developments observed up to the end of 2008. We find that the non-linear model outperforms the linear and random walk models in terms of forecast performance. The large shocks to the CA observed in the last five years induced a faster speed of mean reversion, ensuring the necessary adjustment to meet the inter-temporal budget constraint.

The elasticity of substitution between capital and labor and the direction of technical change are key parameters in many areas of economics. However, little empirical consensus has emerged on the value of the substitution elasticity and arguably less on the nature of technical change. We present estimation of flexible production functions, utilizing Monte Carlo methods for different estimation and methodological strategies. We find that single equation methods (particularly in the presence of biased technical change) are chronically unsuitable for jointly uncovering technical characteristics. Direct estimation of the non-linear CES (particularly when merged with the “normalization” approach) proves to be an improvement, but still suffers identification problems for high elasticity assumptions. We also prove the unsuitability of the widely-used Kmenta approximation to uncover technical change. The key result that emerges is that the superiority of the system approach (i.e., modeling the production function alongside the first-order conditions) especially when merged with normalization.

We examine the long-run real wages–unemployment relationship for five OECD countries over the period 1960:1–2001:4. Given the theoretical possibility of non-linear equilibrium due to downward real wage rigidity we employ econometric tests that allow for the presence of non-linearities in the long-run equilibrium. We adopt the notion of ‘hidden co-integration’ suggested by Granger and Yoon. This methodology has several advantages with respect to other non-linear models. We find statistical evidence that, in general, there is a long-run positive relation between real wages and unemployment only when both are affected by positive shocks. We also find a negative relationship between unemployment and productivity. The empirical analysis is complemented with the estimation of error correction models for all countries.

Brazil implemented Inflation Targeting (IT) after the breakdown of a managed floating regime, showing a similar pattern to most of the emerging markets that adopted this framework. This unplanned policy change has led to some disbelief regarding the country's commitment to its inflation objective and to a floating exchange rate. In this paper we analyse whether the adoption of IT has led to an actual shift in the country's approach to the exchange rate. We find greater exchange rate flexibility and milder interventions in the foreign exchange market after IT. We conclude that possible interventions should not be seen as Fear of Floating, but as a required policy for the attainment of the inflation targets.

International audience; The increase in oil prices in recent years has occurred concurrently with a rapid expansion of Chinese exports in the world markets, despite China being an oil importing country. In this paper we develop a theoretical model that explains the positive correlation between Chinese exports and the oil price. The model shows that Chinese growth can lead to an increase in oil prices that has a stronger impact on its export competitors. This is due to the large labor force surplus of China. We then examine this hypothesis by estimating a reduced form equation for Chinese exports using Rodrik (2006)'s measure of export competitiveness, together with the oil price, productivity, real exchange rate, and foreign industrial production over the monthly 1992-2005 period. The results suggest a stable relationship and yields slightly positive values for the price of oil and elastic coefficients for export competitiveness, along with the expected negative elasticity for the real exchange rate.

Summary There is considerable debate regarding the relative contribution of international migrants’ remittances to sustainable economic development. While officially recorded remittances to developing countries have increased over the last decade, research has not come to a consensus over whether remittances have a positive or negative impact on long-run growth. This paper argues that contradictory findings have emerged when looking at the remittances-growth link because of an omitted variable bias: specifically, remittances will be more likely to contribute to longer-term growth in countries with higher quality political and economic policies and institutions.

In this paper we propose Granger (non-)causality tests based on a VAR model allowing for time-varying coefficients. The functional form of the time-varying coefficients is a logistic smooth transition autoregressive (LSTAR) model using time as the transition variable. The model allows for testing Granger non-causality when the VAR is subject to a smooth break in the coefficients of the Granger causal variables. The proposed test then is applied to the money–output relationship using quarterly US data for the period 1952:2–2002:4. We find that causality from money to output becomes stronger after 1978:4 and the model is shown to have a good out-of-sample forecasting performance for output relative to a linear VAR model. Copyright © 2008 John Wiley & Sons, Ltd.

PurposeThe paper aims to re‐examine the stationarity properties of unemployment rates in 12 European Union (EU) countries over the period 1988: I‐1999: IV.Design/methodology/approachThis paper applies a battery of second‐generation panel unit root tests that allow for cross‐sectional correlation.FindingsThe study shows that, contrary to previous empirical literature, hysteresis does not characterise EU unemployment.Originality/valueThis paper uses recent advances in the econometrics of panel unit root tests. The new tests have more power than the traditional ones in detecting the null hypothesis of a unit root.

We present empirical evidence on the real interest parity hypothesis for a set of emerging and developed countries. This is done by carrying out a set of unit-root tests on the real interest differentials with respect to the US. Our results support the hypothesis of a rapid reversion towards a zero differential for developed countries and towards a positive one for emerging markets. Mean reversion is faster for emerging market economies. We also find that this adjustment tends to be highly asymmetric and markedly different for developed and emerging markets. Our evidence reveals a high degree of market integration for developed countries and highlights the importance of risk premia for emerging markets.

We argue that the empirical failure of the Fisher effect found in the literature may be due to the existence of non-linearities in the long-run relationship between interest rates and inflation. We present evidence that, for the U.S. during the 1960–2004 period, the Fisher relation presents important non-linearities. We model the long-run non-linear relationship and find that an ESTR model for the pre-Volcker era and an LSTR model for the post-Volcker era are able to control for non-linearities and constitute long-run co-integration vectors. Monte Carlo evidence produces support for the hypothesis that non-linearities may also be responsible for the less than proportional coefficients of inflation usually found in the linear specifications.

Capital-labour substitution and total factor productivity (TFP) estimates are essential features of many economic models. Such models typically embody a balanced growth path. This often leads researchers to estimate models imposing stringent prior choices on technical change. We demonstrate that estimation of the substitution elasticity and TFP growth can be substantially biased if technical progress is thereby mis-specified. We obtain analytical and simulation results in the context of a model consistent with balanced and near-balanced growth (i.e. departures from balanced growth but broadly stable factor shares). Given this evidence, a constant elasticity of substitution production function system is then estimated for the US economy. Results show that the estimated substitution elasticity tends to be significantly lower using a factor-augmenting specification (well below one). We are also able to reject conventional neutrality forms in favour of general factor augmentation with a non-negligible capital-augmenting component. Our work thus provides insights into production and supply-side estimation in balanced-growth frameworks.

German labor market reforms in the 1990s and 2000s are generally believed to have driven the large increase in the dispersion of current account balances in the Euro Area. We investigate this hypothesis quantitatively. We develop a 3-region open economy New Keynesian model with search and matching frictions from which we derive robust sign restrictions for wage bargaining and matching efficiency shocks which we term wage moderation shocks. We impose these restrictions on a Global VAR consisting of Germany and 8 EMU countries to identify a wage moderation shock in Germany. Our results show that, although the German current account was significantly affected by wage moderation shocks, their contribution to European current account imbalances was negligible. We conclude that the German labor market reforms cannot be the lone driver of European imbalances.

This note presents wide evidence on the relationship between population and income for 125 countries for which data was available for the period 1950–2000. The main result is that there is a weak but negative relationship between population growth and per capita GDP, as income increases population expands at a slower rate. This relationship appears to be stronger for African countries and for Asian countries before 1970.

ACL-2; International audience; Empirical evidence on the growth benefits of capital inflows is mixed. The growth benefits accruing from capital inflows also appear to be larger for high savings countries. We explain this phenomenon using an \OLG\ model of endogenous growth in open economies with borrowing constraints that can generate both positive and negative growth effects of capital inflows. The amount an economy can borrow is restricted by an endogenous enforcement constraint. In our setting, with physical capital and a pay-as-you-go pensions system, the steady state is unique. However, it can either be constrained or unconstrained. In a constrained economy, opening up to equity and \FDI\ inflows can be bad for growth because it makes the domestic interest rate too low, which endogenously tightens borrowing constraints. Agents decrease savings and investment in productivity-enhancing activities resulting in lower growth. Results are reversed in an unconstrained economy. We also provide a quantitative analysis of these constraints and some policy implications.

The usual neoclassical model of labor supply and employment determination has been based in closed economy models. This paper studies the effect of introducing open economy features on the determinants of equilibrium employment. It derives the long run employment level as a function of the real wage, real interest rate and real exchange rate from a standard open economy optimizing representative agent model. The paper tests the steady state solution of the model using US and UK data and, in order to avoid the Lucas' critique, it tests for the superexogeneity of the interest rate and exchange rate. The evidence shows a significant impact of the real exchange rate, real interest rate, and real wage only for the US, where it is also robust to the Lucas' critique.

Many studies have addressed the effect of migration on both home and host countries, but few have focused on the effect of the economic flows derived from migration, especially for the Central and East European (CEE) countries. In this paper we analyze the effect of remittances on employment performance for CEE economies. To model the macro effects of remittances on the source country we proceed along the lines of Mancellari et al (1996) who extended the model of Aghion and Blanchard (1994) by adding migration. The impact of remittances on unemployment depends on its effect on productivity growth and entrepreneurial investment. In order to empirically analyze the impact of remittances we estimated a productivity equation using a set of 11 transition countries during the 1990-1999 period. We also analyze the impact of remittances on investment and consumption. Our results show support for the view that remittances have a positive impact on productivity and employment both directly and indirectly through its effect on investment.

The derivation of the Balassa–Samuelson effect allows for different empirical specifications that may have important economic implications. Problems related to spurious regression could arise from the mixed order of integration of the series used and from the lack of long run stable relationship among the variables of the model. This paper addresses these problems by using the bounds testing approach developed by Pesaran et al. [J. Appl. Economet. 16 (2001) 289]. Our empirical results do not show supportive evidence for the Balassa–Samuelson effect in the long run. This seems to suggest the holding of the PPP. However, one of the implications of the PPP is that the real exchange rate does not have any real impact on the economy. Further empirical analysis rejects this last implication. In fact, real exchange rate seems to have a long run impact on relative growth rates.

The aim of this paper is to estimate the sensitivity of the natural rate of growth to the actual rate of growth for 15 OECD countries over the period 1961–95, on the hypothesis that the natural rate of growth is not exogenously given. To do this, we estimate the natural rate of growth and, then, how it changes when the actual growth rate is different from the natural rate. As a side test of the endogeneity hypothesis, we also test for the direction of causality between national output and factor inputs for the same set of countries. Our results support the idea that the natural rate of growth is not independent of the actual rate of growth and bring to the fore the importance of focusing on demand as well as supply for an understanding of long-run growthrate differences between countries.

This paper applies the panel unit root test proposed by Im, Pesaran and Shin (1997) to test for unemployment hysteresis in the US states and the EU countries against the alternative of a natural rate. The results show that hysteresis for the EU and the natural rate for the US states are the most plausible hypotheses.

This paper presents an extended model of cumulative growth in which the effects of innovation and catching-up are considered. Innovation adds another source of cumulative growth to that of traditional models and allows a consideration of the importance of non-price determinants of international competitiveness. Catching-up is the major force leading to convergence in productivity owing to the effect of the diffusion of technology. The model allows one to analyse whether cumulative forces may lead to stable growth and whether this solution generates convergence in productivity levels. The structural model is tested for a set of OECD countries over the period 1965–94.

The aim of this paper is to test for the presence of dynamic increasing returns to scale in the Spanish regions between 1962 and 1991.The framework in which this paper is based is the so-called Verdoorn's Law. Tests are carried out for the manufacturing sector, agriculture, construction, services and total value added. The results show substantial increasing returns for manufacturing, services sector and for total value added. The staticdynamic paradox found by McCombie (1982) is also discussed and tested. We find no support for the hypothesis of a Cobb-Douglas function as the underlying technical relationship of the law.

(1999). An Application of Thirlwall’s Law to the Spanish Economy. Journal of Post Keynesian Economics: Vol. 21, No. 3, pp. 431-439.

We present time-series evidence on output convergence for 14 OECD countries allowing for time-varying determinants of transitional dynamics. We develop a simple theoretical model and test for non-stationarity in relative outputs using stationary covariates finding strong support for convergence.

Empirical evidence on the growth benefits of capital inflows is mixed. The growth benefits accruing from capital inflows also appear to be larger for high savings countries. We explain this phenomenon using an OLG model of endogenous growth in open economies with borrowing constraints that can generate both positive and negative growth effects of capital inflows. The amount an economy can borrow is restricted by an endogenous enforcement constraint. In our setting, with physical capital and a pay-as-you-go pensions system, the steady state is unique. However, it can either be constrained or unconstrained. In a constrained economy, opening up to equity and FDI inflows can be bad for growth because it makes the domestic interest rate too low, which endogenously tightens borrowing constraints. Agents decrease savings and investment in productivity-enhancing activities resulting in lower growth. Results are reversed in an unconstrained economy. We also provide a quantitative analysis of these constraints and some policy implications.

We study the relationship between hours worked and technology during the postwar period in the US. We show that the responses of hours to technological improvements have increased over time, and that the patterns captured by the SVAR are consistent with those obtained from an RBC model with a less than unitary elasticity of substitution between capital and labor. Data supports the hypothesis that the observed changes in the response of hours to a technology shock are attributable to changes in the magnitude of the degree of capital-labor substitution, o. We argue that the observed time-variation in o can arise from changes in the structural composition of sectors (or factors) in a heterogeneous inputs production function or from biases in technological change.

We present time series evidence on output convergence for 14 countries relative to the US for the 1900-2000 period. We develop tests that allow for an unknown number of breaks in the series and also asymmetric convergence speed. We show that this asymmetry arises theoretically when the economy is not in the neighbourhood of the steady state. Breaks are modelled through a Fourier function fitted to the deterministic part of a time series and asymmetries are modelled as a smooth transition function that matches the theory predictions. The tests are shown to have good finite sample properties. The results support the existence of convergence towards a mean that displays a break around WWII. These breaks, in the majority of cases, appear to be permanent. Asymmetric mean reversion also appears to be an important feature driving convergence for most countries in the sample. These results emphasize the importance that disruptive historical events have on the dynamics of relative outputs.

We examine the two-level nested constant elasticity of substitution production function where both capital and labor are disaggregated in two classes. We propose a normalized system estimation method to retrieve estimates of the inter- and intra-class elasticities of substitution and factor-augmenting technical progress coefficients. The system is estimated for US data for the 1963–2006 period. Our findings reveal that skilled and unskilled labor classes are gross substitutes, capital structures and equipment are gross complements, and aggregate capital and aggregate labor are gross complements with an elasticity of substitution close to 0.5. We discuss the implications of our findings and methodology for the analysis of the causes of the increase in the skill premium and, by implication, inequality in a growing economy.

We investigate the time varying relation between hours and technology shocks using a structural business cycle model. We propose an RBC model with a Constant Elasticity of Substitution (CES) production function that allows for capital- and labor-augmenting technology shocks. We estimate the model with Bayesian techniques. In the full sample, we find (i) evidence in favor of a less than unitary elasticity of substitution (rejecting Cobb-Douglas) and (ii) a sizable role for capital augmenting shock for business cycles fluctuations. In rolling sub-samples, we document that the transmission of technology shocks to hours worked has been varying over time. We argue that this change is due to the increase of the elasticity of factor substitution. That is, labor and capital became less complementary throughout the sample inducing a change in the sign and size of the response of hours. We conjecture that this change may have been induced by a change in the skill composition of the labor input.

The famous Uzawa (1961) balanced growth theorem has exercised a tyranny of sorts over macroeconomics for decades. It is the prime reason why researchers use Cobb–Douglas production functions and abstract from considering movements in factor shares. Others have had to recourse to complex explanations for long-run labor augmentation in technical progress. In this chapter, we discuss the issues arising from this problem and propose a way of achieving balanced growth with a short-run production function where the elasticity of factor substitution is less than one, and capital augmenting technology shocks can be permanent. We do so by allowing firms to choose the relative reliance on capital in the production technology and introducing a suitable modification of the production function. We also provide some model simulations in the context of a simple deterministic neoclassical growth model.

The new EU member states (EU-9)1 have made remarkable progress in past years in terms of real economic convergence with the euro area, that is, their standards of living and income levels have gradually increased towards those of the euro area. Still, the EU-9 countries display GDP per capita and price levels which are considerably below those of the euro area. Thus, the catching-up process will need to continue for some time. Income level convergence is usually accompanied by a continuous rise in the price level, which under certain conditions and also depending on the underlying exchange rate regime implies a higher inflation rate than in the euro area. Thus, the process of real convergence in the EU-9 is expected to continue playing an important role for future inflation developments in these countries. The interdependence of real and nominal convergence becomes particularly relevant, as the EU-9 are expected to join the euro area, for which inter alia the Maastricht inflation criterion needs to be fulfilled in a sustainable manner. From the perspective of the euro area, potentially higher inflation rates in the EU-9 countries would imply higher inflation differentials. Although the impact on the euro area inflation rate will most likely be limited due to the relatively low economic weight of the EU-9 compared with the euro area, this may nevertheless complicate the conduct and communication of a common monetary policy within an enlarged euro area.