We study the importance of input-output (IO) linkages and sectoral productivity (TFP) in determining cross-country income differences. We find that while highly connected sectors are more productive than the typical sector in poor countries, the opposite is true in rich ones. To assess the quantitative role of linkages and sectoral TFP differences in cross-country income differences, we decompose cross-country income variation using a multi-sector general equilibrium model. We find that (i) IO linkages substantially amplify fundamental sectoral TFP variation but (ii) this amplification is significantly weaker than the one suggested by a simple IO model with an aggregate intermediate good.
This paper evaluates the empirical performance of a medium-scale DSGE model with agents forming expectations using small forecasting models updated by the Kalman filter. The adaptive learning model fits the data better than the rational expectations (RE) model. Beliefs about the inflation persistence explain the observed decline in the mean and the volatility of inflation as well as Phillips curve flattening. Learning about inflation results in lower estimates for the persistence of the exogenous shocks that drive price and wage dynamics in the RE version of the model. Expectations based on small forecasting models are closely related to the survey evidence on inflation expectations.