We propose an exchange rate model that can explain both the observed volatility and the persistence of real and nominal exchange rate movements and thus in some measure resolves Rogoff’s (1996) purchasing power parity puzzle. Our analysis reconciles the well-known difficulties in beating the...

Tests of the null hypothesis of stationarity against the unit root alternative play an increasingly important role in empirical work in macroeconomics and in international finance. We show that the use of conventional asymptotic critical values for stationarity tests may cause extreme size...

This paper proposes a novel international transmission mechanism based on the assumption of deep habits. The term deep habits stands for a preference specification according to which consumers form habits on a good-by-good basis. Under deep habits, firms face more elastic demand functions in...

The half-life of deviations from purchasing power parity (PPP) plays a central role in the ongoing debate about the ability of macroeconomic models to account for the time series behaviour of the real exchange rate. The main contribution of this paper is a general framework in which alternative...

One of the central questions in recent macroeconomic history is to what extent monetary policy as opposed to oil price shocks contributed to the stagflation of the 1970s. Understanding what went wrong in the 1970s is the key to learning from the past. One explanation explored in Barsky and...

This paper identifies a new source of business-cycle fluctuations. Namely, a common stochastic trend in neutral and investment-specific productivity. We document that in U.S. postwar quarterly data total factor productivity (TFP) and the relative price of investment are cointegrated. We show...

Observed inflation targets around the industrial world are concentrated at two percent per year. This paper investigates the extent to which the observed magnitudes of inflation targets are consistent with the optimal rate of inflation predicted by leading theories of monetary non-neutrality. We...

Sign restrictions on the responses generated by structural vector autoregressive models have been proposed as an alternative approach to the use of exclusion restrictions on the impact multiplier matrix. In recent years such models have been increasingly used to identify demand and supply shocks...

In deciding a monetary policy stance, central bankers need to evaluate carefully the risks the current economic situation poses to price stability. We propose to regard the central banker as a risk manager who aims to contain inflation within pre-specified bounds. We develop formal tools of risk...

In this paper, we characterize conditions under which interest rate feedback rules that set the nominal interest rate as an increasing function of the inflation rate induce aggregate instability by generating multiple equilibria. We show that these conditions depend not only on the...