Creator: Khan, Aubhik and Thomas, Julia Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 352 Abstract:
We solve equilibrium models of lumpy investment wherein establishments face persistent shocks to common and plant-specific productivity. Nonconvex adjustment costs lead plants to pursue generalized (S, s) rules with respect to capital; thus, their investments are lumpy. In partial equilibrium, this yields substantial skewness and kurtosis in aggregate investment, though, with differences in plant-level productivity, these nonlinearities are far less pronounced. Moreover, nonconvex costs, like quadratic adjustment costs, increase the persistence of aggregate investment, yielding a better match with the data. In general equilibrium, aggregate nonlinearities disappear, and investment rates are very persistent, regardless of adjustment costs. While the aggregate implications of lumpy investment change substantially in equilibrium, the inclusion of fixed costs or idiosyncratic shocks makes the average distribution of plant investment rates largely invariant to market-clearing movements in real wages and interest rates. Nonetheless, we find that understanding the dynamics of plant-level investment requires general equilibrium analysis.
Keyword: Establishment investment, (S,s), Lumpy investment, Nonlinearities, and Policies Subject (JEL): E32 - Business Fluctuations; Cycles and E22 - Investment; Capital; Intangible Capital; Capacity
Creator: Neumeyer, Pablo Andrés and Perri, Fabrizio Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 335 Abstract:
We find that in a sample of emerging economies business cycles are more volatile than in developed ones, real interest rates are countercyclical and lead the cycle, consumption is more volatile than output and net exports are strongly countercyclical. We present a model of a small open economy, where the real interest rate is decomposed in an international rate and a country risk component. Country risk is affected by fundamental shocks but, through the presence of working capital, also amplifies the effects of those shocks. The model generates business cycles consistent with Argentine data. Eliminating country risk lowers Argentine output volatility by 27% while stabilizing international rates lowers it by less than 3%.
Keyword: Working capital, International business cycles, Financial crises, Country risk, and Sudden stops Subject (JEL): F32 - Current Account Adjustment; Short-term Capital Movements, F41 - Open Economy Macroeconomics, and E32 - Business Fluctuations; Cycles
Creator: Atkeson, Andrew and Kehoe, Patrick J. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 331 Abstract:
Are deflation and depression empirically linked? No, concludes a broad historical study of inflation and real output growth rates. Deflation and depression do seem to have been linked during the 1930s. But in the rest of the data for 17 countries and more than 100 years, there is virtually no evidence of such a link.
Subject (JEL): E31 - Price Level; Inflation; Deflation, E32 - Business Fluctuations; Cycles, and N10 - Economic History: Macroeconomics and Monetary Economics; Industrial Structure; Growth; Fluctuations: General, International, or Comparative
Creator: Khan, Aubhik and Thomas, Julia Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 329 Abstract:
We develop an equilibrium business cycle model where producers of final goods pursue generalized (S,s) inventory policies with respect to intermediate goods due to nonconvex factor adjustment costs. When calibrated to reproduce the average inventory-to-sales ratio in postwar U.S. data, our model explains over half of the cyclical variability of inventory investment. Moreover, inventory accumulation is strongly procyclical, and production is more volatile than sales, as in the data.
The comovement between inventory investment and final sales is often interpreted as evidence that inventories amplify aggregate fluctuations. In contrast, our model economy exhibits a business cycle similar to that of a comparable benchmark without inventories, though we do observe somewhat higher variability in employment, and lower variability in consumption and investment. Thus, our equilibrium analysis reveals that the presence of inventories does not substantially raise the cyclical variability of production, because it dampens movements in final sales.
Keyword: (S,s) inventories and Business cycles Subject (JEL): E32 - Business Fluctuations; Cycles and E22 - Investment; Capital; Intangible Capital; Capacity
Creator: Kehoe, Patrick J. and Perri, Fabrizio Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 307 Abstract:
We show how to decentralize constrained efficient allocations that arise from enforcement constraints between sovereign nations. In a pure exchange economy, these allocations can be decentralized with private agents acting competitively and taking as given government default decisions on foreign debt. In an economy with capital, these allocations can be decentralized if the government can tax capital income as well as default on foreign debt. The tax on capital income is needed to make private agents internalize a subtle externality. The decisions of the government can arise as an equilibrium of a dynamic game between governments.
Keyword: Sovereign debt, Risk-sharing, Default, Incomplete markets, Enforcement constraints, Sustainable equilibrium, and Decentralization Subject (JEL): E21 - Macroeconomics: Consumption; Saving; Wealth, F30 - International Finance: General, F34 - International Lending and Debt Problems, E32 - Business Fluctuations; Cycles, D50 - General Equilibrium and Disequilibrium: General, and E44 - Financial Markets and the Macroeconomy
Creator: Chari, V. V. and Kehoe, Patrick J. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 316 Abstract:
Financial crises are widely argued to be due to herd behavior. Yet recently developed models of herd behavior have been subjected to two critiques which seem to make them inapplicable to financial crises. Herds disappear from these models if two of their unappealing assumptions are modified: if their zero-one investment decisions are made continuous and if their investors are allowed to trade assets with market-determined prices. However, both critiques are overturned—herds reappear in these models—once another of their unappealing assumptions is modified: if, instead of moving in a prespecified order, investors can move whenever they choose.
Keyword: Financial collapse, Information cascades, and Capital flows Subject (JEL): F32 - Current Account Adjustment; Short-term Capital Movements, E32 - Business Fluctuations; Cycles, F20 - International Factor Movements and International Business: General, F40 - Macroeconomic Aspects of International Trade and Finance: General, and G15 - International Financial Markets
Creator: Khan, Aubhik and Thomas, Julia Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 306 Abstract:
Recent empirical analysis has found nonlinearities to be important in understanding aggregated investment. Using an equilibrium business cycle model, we search for aggregate nonlinearities arising from the introduction of nonconvex capital adjustment costs. We find that, while such costs lead to nontrivial nonlinearities in aggregate investment demand, equilibrium investment is effectively unchanged. Our finding, based on a model in which aggregate fluctuations arise through exogenous changes in total factor productivity, is robust to the introduction of shocks to the relative price of investment goods.
Keyword: Adjustment costs, Lumpy investment, Nonlinearities, and Business cycles Subject (JEL): E32 - Business Fluctuations; Cycles and E22 - Investment; Capital; Intangible Capital; Capacity
Creator: Kehoe, Patrick J. and Perri, Fabrizio Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 621 Abstract:
Previous literature has shown that the study and characterization of constrained efficient allocations in economies with limited enforcement is useful to understand the limited risk sharing observed in many contexts, in particular between sovereign countries. In this paper we show that these constrained efficient allocations arise as equilibria in an economy in which private agents behave competitively, taking as given a set of taxes. We then show that these taxes, which end up limiting risk sharing, arise as an equilibrium of a dynamic game between governments. Our decentralization is different from the existing ones proposed in the literature. We find it intuitively appealing and we think it goes farther than the existing literature in endogenizing the primitive forces that lead to a lack of risk sharing in equilibrium.
Keyword: Sustainable equilibrium, Decentralization, Incomplete markets, Default, Enforcement constraints, Sovereign debt, and Risk-sharing Subject (JEL): E44 - Financial Markets and the Macroeconomy, D50 - General Equilibrium and Disequilibrium: General, E32 - Business Fluctuations; Cycles, F34 - International Lending and Debt Problems, E21 - Macroeconomics: Consumption; Saving; Wealth, and F30 - International Finance: General
Creator: Thomas, Julia Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 302 Abstract:
Previous research has suggested that discrete and occasional plant-level capital adjustments have significant aggregate implications. In particular, it has been argued that changes in plants’ willingness to invest in response to aggregate shocks can at times generate large movements in total investment demand. In this study, I re-assess these predictions in a general equilibrium environment. Specifically, assuming nonconvex costs of capital adjustment, I derive generalized (S,s) adjustment rules yielding lumpy plant-level investment within an otherwise standard equilibrium business cycle model. In contrast to previous partial equilibrium analyses, model results reveal that the aggregate effects of lumpy investment are negligible. In general equilibrium, households’ preference for relatively smooth consumption profiles offsets changes in aggregate investment demand implied by the introduction of lumpy plant-level investment. As a result, adjustments in wages and interest rates yield quantity dynamics that are virtually indistinguishable from the standard model.
Keyword: Business Cycles, Lumpy Investment, and (S,s) Adjustment Subject (JEL): E32 - Business Fluctuations; Cycles and E22 - Investment; Capital; Intangible Capital; Capacity
Creator: Bergoeing, Raphael, Kehoe, Patrick J., Kehoe, Timothy Jerome, 1953-, and Soto, Raimundo Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 292 Abstract:
Chile and Mexico experienced severe economic crises in the early 1980s. This paper analyzes four possible explanations for why Chile recovered much faster than did Mexico. Comparing data from the two countries allows us to rule out a monetarist explanation, an explanation based on falls in real wages and real exchange rates, and a debt overhang explanation. Using growth accounting, a calibrated growth model, and economic theory, we conclude that the crucial difference between the two countries was the earlier policy reforms in Chile that generated faster productivity growth. The most crucial of these reforms were in banking and bankruptcy procedures.
Keyword: Depression, Growth accounting, Chile, Total factor productivity, and Mexico Subject (JEL): N16 - Economic History: Macroeconomics and Monetary Economics; Industrial Structure; Growth; Fluctuations: Latin America; Caribbean, E32 - Business Fluctuations; Cycles, and O40 - Economic Growth and Aggregate Productivity: General
Creator: Ohanian, Lee E. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 285 Abstract:
Between 1929 and 1933, real output per adult fell over 30 percent and total factor productivity fell 18 percent. This productivity decrease is much larger than expected from just extrapolating the productivity decrease that typically occurs during recessions. This paper evaluates what factors may have caused this large decrease, including unmeasured factor utilization, changes in the composition of production, and increasing returns. I find that these factors combined explain less than one-third of the 18 percent decrease, and I conclude that the productivity decrease during the Great Depression remains a puzzle.
Subject (JEL): O47 - Empirical Studies of Economic Growth; Aggregate Productivity; Cross-Country Output Convergence, N12 - Economic History: Macroeconomics and Monetary Economics; Industrial Structure; Growth; Fluctuations: U.S.; Canada: 1913-, and E32 - Business Fluctuations; Cycles
Creator: Boldrin, Michele, Christiano, Lawrence J., and Fisher, Jonas D. M. (Jonas Daniel Maurice), 1965- Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 280 Abstract:
We introduce two modifications into the standard real business cycle model: habit persistence preferences and limitations on intersectoral factor mobility. The resulting model is consistent with the observed mean equity premium, mean risk free rate and Sharpe ratio on equity. The model does roughly as well as the standard real business cycle model with respect to standard measures. On four other dimensions its business cycle implications represent a substantial improvement. It accounts for (i) persistence in output, (ii) the observation that employment across different sectors moves together over the business cycle, (iii) the evidence of ‘excess sensitivity’ of consumption growth to output growth, and (iv) the ‘inverted leading indicator property of interest rates,’ that high interest rates are negatively correlated with future output.
Keyword: Capital gains, Risk aversion, Asset pricing , and Habit persistence Subject (JEL): E44 - Financial Markets and the Macroeconomy, E32 - Business Fluctuations; Cycles, and O41 - One, Two, and Multisector Growth Models
Creator: Jones, Larry E., Manuelli, Rodolfo E., and Siu, Henry E. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 271 Abstract:
We present a class of convex endogenous growth models and analyze their performance in terms of both growth and business cycle criteria. The models we study have close analogs in the real business cycle literature. We interpret the exogenous growth rate of productivity as an endogenous growth rate of human capital. This perspective allows us to compare the strengths of the two classes of models.
To highlight the mechanism that gives endogenous growth models the ability to improve upon their exogenous growth relatives, we study models that are symmetric in terms of human and physical capital formation—our two engines of growth. More precisely, we analyze models in which the technology used to produce human capital is identical to the technologies used to produce consumption and investment goods and in which the technology shocks in the two sectors are perfectly correlated.
Subject (JEL): D90 - Micro-Based Behavioral Economics: General and E32 - Business Fluctuations; Cycles
Creator: Cole, Harold Linh, 1957- and Ohanian, Lee E. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 246 Abstract:
Many economists have worried about changes in the demand for money, since money demand shocks can affect output variability and have implications for monetary policy. This paper studies the theoretical implications of changes in money demand for the nonneutrality of money in the limited participation (liquidity) model and the predetermined (sticky) price model. In the liquidity model, we find that an important connection exists between the nonneutrality of money and the relative money demands of households and firms. This model predicts that the real effect of a money shock rose by 100 percent between 1952 and 1980, and subsequently declined 65 percent. In contrast, we find that the nonneutrality of money in the sticky price model is invariant to changes in money demands or other monetary factors. Several researchers have concluded from VAR analyses that the effects of money shock over time are roughly stable. This view is consistent with the predictions of the sticky price model, but is harder to reconcile with the specific pattern of time variation predicted by the liquidity model.
Keyword: Money shocks, Liquidity, Sticky prices, and Velocity Subject (JEL): E52 - Monetary Policy, E32 - Business Fluctuations; Cycles, and E41 - Demand for Money
Creator: Kilian, Lutz and Ohanian, Lee E. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 244 Abstract:
Unit root tests against trend break alternatives are based on the premise that the dating of the trend breaks coincides with major economic events with permanent effects on economic activity, such as wars and depressions. Standard economic theory, however, suggests that these events have large transitory, rather than permanent, effects on economic activity. Conventional unit root tests against trend break alternatives based on linear ARIMA models do not capture these transitory effects and can result in severely distorted inference. We quantify the size distortions for a simple model in which the effects of wars and depressions can reasonably be interpreted as transitory. Monte Carlo simulations show that in moderate samples, the widely used Zivot-Andrews (1992) test mistakes transitory dynamics for trend breaks with high probability. We conclude that these tests should be used only if there are no plausible economic explanations for apparent trend breaks in the data.
Keyword: Transitory Shocks, Unit Roots, and Trend-Breaks Subject (JEL): C15 - Statistical Simulation Methods: General, E32 - Business Fluctuations; Cycles, and C22 - Single Equation Models; Single Variables: Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
Creator: Christiano, Lawrence J. and Harrison, Sharon G. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 214 Abstract:
We study a one-sector growth model which is standard except for the presence of an externality in the production function. The set of competitive equilibria is large. It includes constant equilibria, sunspot equilibria, cyclical and chaotic equilibria, and equilibria with deterministic or stochastic regime switching. The efficient allocation is characterized by constant employment and a constant growth rate. We identify an income tax-subsidy schedule that supports the efficient allocation as the unique equilibrium outcome. That schedule has two properties: (i) it specifies the tax rate to be an increasing function of aggregate employment, and (ii) earnings are subsidized when aggregate employment is at its efficient level. The first feature eliminates inefficient, fluctuating equilibria, while the second induces agents to internalize the externality.
Keyword: Business cycle, Regime switching, Stabilization, Fiscal policy, and Multiple equilibria Subject (JEL): E62 - Fiscal Policy, E32 - Business Fluctuations; Cycles, and E13 - General Aggregative Models: Neoclassical
Creator: Backus, David and Kehoe, Patrick J. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 323 Abstract:
We examine deviations from trend of net exports and other components of GNP for the United States and attempt to build models consistent with their behavior. The most striking fact is that net exports have consistently been countercyclical. We show, first, that dynamic pure-exchange models can only produce a negative correlation between net exports and GNP if the variance of consumption exceeds that of output. In (he United Slates it does not, so this class of models cannot explain observed comovements between output and trade. We then examine government spending and nontraded goods as potential remedies, but show that their behavior is either inconsistent with the data or can be made consistent with any pattern of comovements. The most promising model introduces production and capital formation. Fluctuations are driven by country-specific productivity shocks, in which high productivity domestically leads to high domestic investment and a deficit in the balance of trade. This theory also receives support from the large negative covariance between net exports and investment in American data.
Keyword: Investment, Risk sharing, Non-traded goods, Government deficits, Competitive equilibrium, and Productivity Subject (JEL): F21 - International Investment; Long-term Capital Movements, F30 - International Finance: General, and E32 - Business Fluctuations; Cycles
Creator: Aiyagari, S. Rao Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 196 Abstract:
I argue that Farmer and Guo's one-sector real business cycle model with indeterminacy and sunspots fails empirically and that its failure is inherent in the logic of the model taken together with some simple labor market facts.
Keyword: Indeterminacy, Labor Market, Business cycles, and Sunspots Subject (JEL): E32 - Business Fluctuations; Cycles and C32 - Multiple or Simultaneous Equation Models: Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
Creator: Cooley, Thomas F., Hansen, Gary D. (Gary Duane), and Prescott, Edward C. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 535 Keyword: Equilibrium and Business cycle Subject (JEL): E13 - General Aggregative Models: Neoclassical and E32 - Business Fluctuations; Cycles