Chao Gu, Han Han, and Randall Wright
The effects of news (i.e., information innovations) are studied in dynamic general equilibrium models where liquidity matters. As a leading example, news can be announcements about monetary policy directions. In three standard theoretical environments—an overlapping generations model of fiat currency, a new monetarist model accommodating multiple payment methods, and a model of unsecured credit—transition paths are constructed between an announcement and the date at which events are realized. Although the economics is different, in each case, news about monetary policy can induce volatility in financial and other markets, with transitions displaying booms, crashes, and cycles in prices, quantities, and welfare. This is not the same as volatility based on self-fulfilling prophecies (e.g., cyclic or sunspot equilibria) studied elsewhere. Instead, the focus is on the unique equilibrium that is stationary when parameters are constant but still delivers complicated dynamics in simple environments due to information and liquidity effects. This is true even for classically-neutral policy changes. The induced volatility can be bad or good for welfare, but using policy to exploit this in practice seems difficult because outcomes are very sensitive to timing and parameters. The approach can be extended to include news of real factors, as seen in examples.
High-Dimensional Dynamic Factor Models have their origin in macroeconomics, precisely in empirical research on Business Cycles. The central idea, going back to the work of Burns and Mitchell in the years 1940, is that the fluctuations of all the macro and sectoral variables in the economy are driven by a “reference cycle,” that is, a one-dimensional latent cause of variation. After a fairly long process of generalization and formalization, the literature settled at the beginning of the year 2000 on a model in which (1) both the number of variables in the dataset and , the number of observations for each variable, may be large, and (2) all the variables in the dataset depend dynamically on a fixed independent of , a number of “common factors,” plus variable-specific, usually called “idiosyncratic,” components. The structure of the model can be exemplified as follows:
where the observable variables are driven by the white noise , which is common to all the variables, the common factor, and by the idiosyncratic component . The common factor is orthogonal to the idiosyncratic components , the idiosyncratic components are mutually orthogonal (or weakly correlated). Lastly, the variations of the common factor affect the variable dynamically, that is through the lag polynomial . Asymptotic results for High-Dimensional Factor Models, particularly consistency of estimators of the common factors, are obtained for both and tending to infinity.
Model , generalized to allow for more than one common factor and a rich dynamic loading of the factors, has been studied in a fairly vast literature, with many applications based on macroeconomic datasets: (a) forecasting of inflation, industrial production, and unemployment; (b) structural macroeconomic analysis; and (c) construction of indicators of the Business Cycle. This literature can be broadly classified as belonging to the time- or the frequency-domain approach. The works based on the second are the subject of the present chapter.
We start with a brief description of early work on Dynamic Factor Models. Formal definitions and the main Representation Theorem follow. The latter determines the number of common factors in the model by means of the spectral density matrix of the vector . Dynamic principal components, based on the spectral density of the ’s, are then used to construct estimators of the common factors.
These results, obtained in early 2000, are compared to the literature based on the time-domain approach, in which the covariance matrix of the ’s and its (static) principal components are used instead of the spectral density and dynamic principal components. Dynamic principal components produce two-sided estimators, which are good within the sample but unfit for forecasting. The estimators based on the time-domain approach are simple and one-sided. However, they require the restriction of finite dimension for the space spanned by the factors.
Recent papers have constructed one-sided estimators based on the frequency-domain method for the unrestricted model. These results exploit results on stochastic processes of dimension that are driven by a -dimensional white noise, with , that is, singular vector stochastic processes. The main features of this literature are described with some detail.
Lastly, we report and comment the results of an empirical paper, the last in a long list, comparing predictions obtained with time- and frequency-domain methods. The paper uses a large monthly U.S. dataset including the Great Moderation and the Great Recession.
Economists have long regarded health care as a unique and challenging area of economic activity on account of the specialized knowledge of health care professionals (HCPs) and the relatively weak market mechanisms that operate. This places a consideration of how motivation and incentives might influence performance at the center of research. As in other domains economists have tended to focus on financial mechanisms and when considering HCPs have therefore examined how existing payment systems and potential alternatives might impact on behavior. There has long been a concern that simple arrangements such as fee-for-service, capitation, and salary payments might induce poor performance, and that has led to extensive investigation, both theoretical and empirical, on the linkage between payment and performance. An extensive and rapidly expanded field in economics, contract theory and mechanism design, had been applied to study these issues. The theory has highlighted both the potential benefits and the risks of incentive schemes to deal with the information asymmetries that abound in health care. There has been some expansion of such schemes in practice but these are often limited in application and the evidence for their effectiveness is mixed. Understanding why there is this relatively large gap between concept and application gives a guide to where future research can most productively be focused.