Pengfei Wang

Publications and Working Papers

• Expectation-Driven Fluctuations without Sunspots: A Labor-Market Approach, November 2007
  
  Abstract: This paper provides a unified analysis of neoclassical business cycle models that can generate expectation-driven business cycle under future technology shocks. We show that the ability or inability of various RBC models to generate positive comovement of aggregate variables hinges crucially on the structure of the labor market equilibrium. Our analysis provides a simple and intuitive guide to search for new models that can explain the data. We also point out the relationship between the class of models where news about the future can generate business cycles and the class of models where extrinsic uncertainty about the future can generate business cycles.

• A Defense of RBC: Understanding the Puzzling Effects of Technology Shocks (with Yi Wen), Updated July 2007
  
  Abstract: The research led by Gali(AER 1999) and Basu et al.(AER 2006) raises two important questions regarding the validity of the RBC theory: (i) How important are technology shocks in explaining the business cycle? (ii) Do impulse responses to technology shocks found in the data reject the assumption of flexible prices? This paper argues that the conditional impulse responses of the U.S. economy to technology shocks are not grounds to reject the notion that technology shocks are the main driving force of the business cycle and the assumption of flexible prices, in contrary to the conclusions reached by the literature. Our paper also provides a new approach to deriving aggregate production functions and TFP.

• Imperfect Competition and Output Indeterminacy (with Yi Wen), Forthcoming:Journal of the Economic Theory, updated October 2006.
  
  Abstract: This paper shows that imperfect competition can lead to indeterminacy in aggregate output in a standard DSGE model that features no distortions except imperfect competition. Indeterminacy arises in the model from the composition of aggregate output. In sharp contrast to the indeterminacy literature pioneered by Benhabib and Farmer (1994) and Gali (1994), indeterminacy in our model is global (i.e., independent of the eigenvalues near the steady state); hence it is robust to parameter values of the utility function and production technologies. In addition,sunspots shocks to expectations in our model can be autocorrelated. The paper provides a justification for exogenous variations over time in desired markups, which play an important role as a source of cost-push shocks in the monetary policy literature. Our model can explain procyclical marginal cost and procyclical labor productivity simultaneously, and it outperforms a standard RBC model driven by technology shocks in explaining fluctuations in the labor market.

• Inflation Dynamics: A Cross-Country Investigation (with Yi Wen), Forthcoming: Journal of Monetary Economics.”
  

  Abstract: We document that "persistent and lagged" inflation (with respect to output) is a world-wide phenomenon in that these short-run inflation dynamics are highly synchronized across countries. In particular, the average cross-country correlation of inflation is significantly and systematically stronger than that of output, while the cross-country correlation of money growth is essentially zero. We investigate whether standard monetary models driven by monetary shocks are consistent with the empirical facts. We find that neither the new Keynesian sticky-price model nor the sticky-information model can fully explain the data. An independent contribution of the paper is to provide a simple solution technique for solving general equilibrium models with sticky information.

• Another Look at Sticky Prices and Output Persistence (with Yi Wen),” Journal of the Economic Dynamics and Control. December 2006, 30(12), pp. 2533-52. A working paper version is available here.
  
  Abstract: Price rigidity is the key mechanism for propagating business cycles in traditional Keynesian theory. Yet the new Keynesian literature has failed to show that sticky prices by themselves can effectively propagate business cycles. We show that price rigidity in fact can (by itself) give rise to a strong propagation mechanism in standard models, provided that investment is also subject to a cash-in-advance constraint. Reasonable price stickiness can generate highly persistent, hump-shaped movements in output under either monetary or non-monetary shocks. Hence, whether or not price rigidity is responsible for output persistence is not a theoretical question, but an empirical one.
  

• Endogenous Money or Sticky Prices? Comment on Monetary Non-Neutrality and Inflation Dynamics (with Yi Wen),” Journal of the Economic Dynamics and Control, August 2005, 29(8), pp. 1361-83. A working pape version is available here.
  
  Abstract: We show that the highly persistent inflation dynamics and its lead-lag relationship with output can be explained by a standard flexible price RBC model augmented with endogenous monetary policy. Endogenous monetary policy acting upon the illusion that prices are sticky and money is effective can create price movements that appear to indicate price stickiness, although there is none in the economy.

• Incomplete Information and Self-fulfilling Prophecies(with Yi Wen), Re-submitted to International Economic Review .
  
  Abstract: This paper shows that incomplete information can be a rich source of sunspots equilibria. This is demonstrated in a standard dynamic general equilibrium model of monopolistic competition by Dixit-Stiglitz. In the absence of fundamental shocks, the model has a unique certainty (fundamental) equilibrium, but there are also multiple stochastic (sunspots) equilibria that are not mere randomizations over fundamental equilibria. In other words, sunspots can exist in infinite-horizon dynamic models with a unique saddle-path steady state. In contrast to the recent sunspots literature (e.g., Benhabib and Farmer 1994), sunspots arising under incomplete information can be serially correlated and are robust to parameters associated with production technologies and preferences. Markup is always countercyclical in sunspots equilibria (which is consistent with empirical evidence) and fluctuations driven by sunspots look very similar to fluctuations driven by technology shocks.

• Volatility, Growth, and Large Welfare Gains from Stabilization Policies (with Yi Wen), Submitted.
  
  Abstract: This paper makes three key contributions by showing: (i) imperfect information can cause coordination failures among imperfectly competitive firms and lead to endogenous fluctuations in economic growth; (ii) short-run volatilities can negatively affect long-run growth; and (iii) the welfare gain from further stabilizing the U.S. economy can be hundreds of times larger than that calculated by Lucas because policies designed to reduce fluctuations can generate permanently higher rates of growth.

• Solving Linear Difference Systems with Lagged Expectations by a Method of Undetermined Coefficients (with Yi Wen), Matlab Programs are avaialbe here.
  
  Abstract: This paper proposes a solution method to solve linear difference models with lagged expectations. Variables with lagged expectations expand the model's state space greatly when N is large; and getting the system into a canonical form solvable by the traditional methods involves substantial manual work (e.g., arranging the state vector and the associated coefficient matrices to accommodate variables with lagged expectations), which is prone to human errors. Our method voids the need of expanding the state space of the system and shifts the burden of analysis from the individual economist/model solver toward the computer. Hence it can be a very useful tool in practice, especially in testing and estimating economics models with a high order of lagged expectations. Examples are provided to demonstrate the usefulness of the method. We also discuss the implications of lagged expectations on the equilibrium properties of indeterminate DSGE models, such as the serial correlation properties of sunspots shocks in these models.