The present paper uses an analytical approach to derive approximate closed-form solutions for the asset moments of a real-business-cycle model with idiosyncratic risk. To preserve analytical tractability, risk sharing is completely shut down. Further, the firm is assumed to maximize a variant of value maximization, given that its usual objective is no longer well defined under market incompleteness. When idiosyncratic risk is incorporated into the model, the asset moments can be decomposed into their value under identical households plus a new idiosyncratic term. Under full constrained persistence, in which case the same household determines the asset moments every period, the model is able to generate the risk premium in the data with reasonable parameter values, but it cannot generate the risk return trade-off. While the quantitative impact of idiosyncratic risk is smaller when there is only some persistence in who is constrained, the qualitative predictions are unaltered.

Stochastic models with economywide shocks imply that the welfare costs of aggregate volatility are negligible. Empirical evidence suggests that the volatility of idiosyncratic shocks is several times that of aggregate shocks. This paper introduces both types of shocks. We find that if in the process of eliminating aggregate risk the policymaker can reduce idiosyncratic risk by an amount suggested by available empirical evidence, the welfare gains from stabilization can become significant. The introduction of idiosyncratic risk has important implications for asset pricing, and in particular may reduce the risk-free rate substantially, through the precautionary savings motive. Many of our results are sensitive both to the degree of risk aversion and to the flexibility of labor supply. The paper highlights the trade-offs involved in analyzing the effects of risk on growth and welfare and on asset pricing, clarifying the need to examine these issues within a unified stochastic general equilibrium framework.

This paper presents a dynamic specific-factors model with money introduced through a cash-in-advance constraint. Two types of consumption goods are produced, and three types of factors—labor, capital, and land—are used. The cash-in-advance constraint is imposed on different sets of goods. When the constraint is imposed exclusive of the investment, inflation affects the pattern (and volume) of trade through a commodity-substitution effect. When the constraint is imposed inclusive of the investment, inflation may affect the pattern of trade through both the commodity-substitution effect and the factor-supply effect. In each case, we examine and prove the dynamic stability property of the steady-state equilibrium.

This paper introduces a general procedure that tests the significance of the departures from utility maximization, departures defined as violations of the general axiom of revealed preference (GARP). This general procedure is based on (i) an adjustment procedure that computes the minimal perturbation in order to satisfy GARP by using the information content in the transitive closure matrix and (ii) a test procedure that checks the significance of the necessary adjustment. This procedure can be easily implemented and programmed, and we run Monte Carlo simulations to show that it is quite powerful.

We study the influence of wage differential on the emergence of endogenous fluctuations. In this way, we introduce a dual labor market, based on the Shapiro–Stiglitz efficiency wage theory in an overlapping generations model. We show that wage inequality is a source of endogenous fluctuations. Indeed, a sufficiently strong wage differential leads to the occurrence of cycles of period 2 and local indeterminacy. Moreover, in contrast to several existing contributions, these results depend neither on increasing returns to scale nor on the degree of capital–labor substitution.

Recent research shows that when commonly estimated dynamic Taylor rules, which are augmented with a lagged interest, are embedded in a variety of macroeconomic models, they imply a greater amount of predictable information about future movements in interest rates than is actually evident in the yield curve. We extend the analysis to consider more generally the predictability of the arguments of the Taylor rule—inflation and the output gap—in addition to the interest rate. Specifically, we compare the predictability of these three variables in a macroeconomic model with a dynamic Taylor rule to their predictability in real-time surveys of macroeconomic forecasters or a VAR model. We find that the strongest evidence against the dynamic Taylor rule is that while it is easy to predict the variables that enter the rule, it is very hard to predict actual interest rate changes. This disparity suggests that dynamic Taylor rules neglect important aspects of monetary policy behavior.

Jacques Drèze was born in Verviers, Belgium, in 1929 and completed his Ph.D. in Economics in 1958 at Columbia. His contribution to economics is exceptional, opening up new paths of research in various areas including general equilibrium, decision theory, game theory, econometrics (in particular, Bayesian econometrics), followed by contributions to macroeconomics and economic policy. Drèze has been president of the Econometric Society as well as associate editor and co-editor of Econometrica; founding member and first president of the European Economic Association; president of the International Economic Association and honorary member of the American Economic Association and the National Academy of Sciences. He has received 15 honorary doctorates, including one from the University of Chicago. He has engaged in the promotion and development of research and higher education in Europe, being a founding member of the Centre for Operations Research and Econometrics (CORE) and of the European Doctoral Program in Quantitative Economics (EDP). He has also actively participated in the most pressing economic problems in Europe.

The interview mainly aims at inviting Jacques Drèze to explain what have been his major contributions and what avenues he suggests for future research in macroeconomics. The interview has been conducted sequentially. It started in October 2002 at the European University Institute. The long material collected along these highly illuminating talks was polished and condensed in the following pages. They are organized in the following way. The first section refers to Jacques' initial experiences in Belgium followed by his study of economics in the United States. The second section is devoted to the unity underlying an apparent diversity in his research interests. The third section is devoted to his more recent contributions to macroeconomics, which may be stated as “incomplete markets drive multiplicity of equilibria, calling for active economic policies.” The interview concludes with his contribution to the promotion of research and, in particular, research institutions across Europe.

Both Pierre Dehez and Omar Licandro were students of Jacques Drèze. Dehez and Drèze co-authored several papers, some of which are mentioned in the interview.