Paul A. Gomme

Date of Award


Degree Type


Degree Name

Doctor of Philosophy


In the first chapter, a real business cycle model with heterogeneous agents is parameterized, calibrated, and simulated to see if it can account for some stylized facts characterizing postwar U.S. business cycle fluctuations, such as the countercyclical movement of labour's share of income, and the acyclical behaviour of real wages. There are two types of agents in the model, workers and entrepreneurs, who participate on an economy-wide market for contingent claims. On this market workers purchase insurance from entrepreneurs, through optimal labour contracts, against losses in income due to business cycle fluctuations. Optimal labour contracting is found to account, quantitatively, for the observed pattern of fluctuations in labour income. The insurance and savings components in measured labour income tend to move countercyclically over the business cycle, counterbalancing the strong procyclical behaviour of the marginal product of labour. The flow of transactions involving insurance against cyclical risk is measured to be about 1 to 4 percent of worker's wealth. The upper end of this range is obtained when workers are much more risk averse than entrepreneurs, and entrepreneurs and sufficiently numerous to allow a reasonably large insurance market to operate.;Results in Lucas (1987) suggest that if public policy can affect the growth rate of the economy, the welfare implications of alternative policies will be large. The question asked in the second chapter is whether large welfare costs are associated with inflation in an environment with endogenous growth. To answer this question, an economy with endogenous growth, arising through human capital accumulation, is examined. Money enters via a cash-in-advance constraint on purchases of the consumption good. In this setting, higher inflation lowers real growth through its effect on the return to working. However, the welfare cost of moderate inflation rates is found to be modest. Since households in the model only really care about the paths of consumption and leisure, the low welfare costs can be understood as follows. First, a lower real growth rate means that less output needs to be devoted to physical capital accumulation. Consequently, the fall in consumption, in response to higher inflation is small. Second, the existence of two productive activities, physical output and human capital, augments the responsiveness of leisure to changes in the rate of inflation. The net result from these two effects is that small welfare costs are associated with moderate inflation rates.



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