http://www.frbsf.org/publications/economics/papers/index.php FRBSF Working Paper Series http://www.frbsf.org/publications/economics/papers/2009/wp09-26bk.pdf In dynamic stochastic general equilibrium (DSGE) models, the household’s labor margin as well as consumption margin affects Arrow-Pratt risk aversion. This paper derives simple, closed-form expressions for risk aversion that take into account the household’s labor margin. Ignoring the labor margin can lead to wildly inaccurate measures of the household’s true attitudes toward risk. We show that risk premia on assets computed using the stochastic discount factor are proportional to Arrow-Pratt risk aversion, so that measuring risk aversion correctly is crucial for understanding asset prices. Closed-form expressions for risk aversion in DSGE models with generalized recursive preferences and internal and external habits are also derived. FRBSF Working Paper Series Thu, 15 Oct 2009 07:00:00 GMT http://www.frbsf.org/publications/economics/papers/2009/wp09-26bk.pdf http://www.frbsf.org/publications/economics/papers/2009/wp09-25bk.pdf We draw on stylized facts from the finance literature to build a model where altering the relative costs of bank and bond financing changes the entire distribution of firm size, with implications for the aggregate capital stock, output, and welfare. Reducing transactions costs in the bond market increases the output and profits of mid-sized firms at the expense of both the largest and smallest firms. In contrast, reducing the frictions involved in bank lending promotes the expansion of the smallest firms while all other firms shrink, even as it increases the profitability of both small and mid-size firms. Although both policies increase aggregate output and welfare, they have opposite effects on the extensive margin of production--promoting bond issuance causes exit while cheaper bank credit induces entry. When reducing transactions costs in one market, the resulting increase in output and welfare are largest when transactions costs in the other market are very high. FRBSF Working Paper Series Thu, 15 Oct 2009 07:00:00 GMT http://www.frbsf.org/publications/economics/papers/2009/wp09-25bk.pdf http://www.frbsf.org/publications/economics/papers/2009/wp09-24bk.pdf We examine how the economy responds to both disembodied and embodied technology shocks in a model with vintage capital. We focus on what happens when there is a change in the number of vintages of capital that are in use at any one time and on what happens when there is a change in the persistence of the shocks hitting the economy. The data suggest that these kinds of changes took place in the U.S. economy in the 1990s, when the pace of embodied technical progress appears to have accelerated. We find that embodied technology shocks lead to greater variability (of output, investment and labor allocations) than disembodied shocks of the same size. On the other hand, a decrease in the number of vintages in use at any time (such as is likely to occur when the pace of technical progress accelerates) tends to reduce the volatility of output and also to differentiate the initial response of the economy to the two shocks. FRBSF Working Paper Series Thu, 15 Oct 2009 07:00:00 GMT http://www.frbsf.org/publications/economics/papers/2009/wp09-24bk.pdf http://www.frbsf.org/publications/economics/papers/2009/wp09-23bk.pdf This paper reexamines the implications of the zero lower bound on interest rates for monetary policy and the optimal choice of steady-state inflation in light of the experience of the recent global recession. There are two main findings. First, the zero lower bound did not materially contribute to the sharp declines in output in the United States and many other economies through the end of 2008, but it is a significant factor slowing recovery. Model simulations imply that an additional 4 percentage points of rate cuts would have kept the unemployment rate from rising as much as it has and would bring the unemployment and inflation rates more quickly to steady-state values, but the zero bound precludes these actions. This inability to lower interest rates comes at the cost of $1.7 trillion of foregone output over four years. Second, if recent events are a harbinger of a significantly more adverse macroeconomic climate than experienced over the preceding two decades, then a 2 percent steady-state inflation rate may provide an inadequate buffer to keep the zero bound from having noticeable deleterious effects on the macroeconomy assuming the central bank follows the standard Taylor Rule. In such an adverse environment, stronger systematic countercyclical fiscal policy and/or alternative monetary policy strategies can mitigate the harmful effects of the zero bound with a 2 percent inflation target. However, even with such policies, an inflation target of 1 percent or lower could entail significant costs in terms of macroeconomic volatility. FRBSF Working Paper Series Thu, 15 Oct 2009 07:00:00 GMT http://www.frbsf.org/publications/economics/papers/2009/wp09-23bk.pdf