Creator: Amador, Manuel, Bianchi, Javier, Bocola, Luigi, and Perri, Fabrizio Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 740 Abstract:
Recently, several economies with interest rates close to zero have received large capital inflows while their central banks accumulated large foreign reserves. Concurrently, significant deviations from covered interest parity have appeared. We show that, with limited international arbitrage, a central bank's pursuit of an exchange rate policy at the ZLB can explain these facts. We provide a measure of the costs associated with this policy and show they can be sizable. Changes in external conditions that increase capital inflows are detrimental, even when they are beneficial away from the ZLB. Negative nominal rates and capital controls can reduce the costs.
Keyword: Negative interest rates, Foreign exchange interventions, CIP deviations, Currency pegs, Capital flows, and International reserves Subject (JEL): F41 - Open Economy Macroeconomics, F31 - Foreign Exchange, and F32 - Current Account Adjustment; Short-term Capital Movements
Creator: Beauchemin, Kenneth Ronald Abstract:
This memo describes a revision to the mixed-frequency vector autoregression (MF-VAR) model originally constructed by Schorfheide and Song (2012) and subsequently revised by Beauchemin (2013). In this most recent version, the 14-variable model is expanded to include nonfarm payroll employment. The forecast performance of the augmented model is compared with that of its predecessor.
Monthly forecast charts from November 2013 to June 2016. Charts include Real GDP Growth, PCE Inflation, Core PCE Inflation, and Unemployment Rate.
Creator: Kehoe, Patrick J. and Midrigan, Virgiliu Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 413 Abstract:
Recent studies say prices change about every four months. Economists have interpreted this high frequency as evidence against the importance of sticky prices for the real effects of monetary policy. Theory implies that this interpretation is correct if most price changes are regular, but not if most are temporary, as in the data. Temporary changes have a striking feature: after such a change, the nominal price tends to return exactly to its preexisting level. We study versions of Calvo and menu cost models that replicate this feature. Both models predict that the degree of aggregate price stickiness is determined mostly by the frequency of regular price changes, not by the combined frequency of temporary and regular price changes. Since regular prices are sticky in the data, the models predict a substantial degree of aggregate price stickiness even though micro prices change frequently. In particular, the aggregate price level in our models is as sticky as in standard models in which micro prices change about once a year. In this sense, prices are sticky after all.
Keyword: Menu costs, Sticky prices, and Sales Subject (JEL): E24 - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity, E32 - Business Fluctuations; Cycles, and E30 - Prices, Business Fluctuations, and Cycles: General (includes Measurement and Data)
Creator: Guler, Bulent, Guvenen, Fatih, and Violante, Giovanni L. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 426 Abstract:
Search theory routinely assumes that decisions about the acceptance/rejection of job offers (and, hence, about labor market movements between jobs or across employment states) are made by individuals acting in isolation. In reality, the vast majority of workers are somewhat tied to their partners—in couples and families—and decisions are made jointly. This paper studies, from a theoretical viewpoint, the joint job-search and location problem of a household formed by a couple (e.g., husband and wife) who perfectly pools income. The objective of the exercise, very much in the spirit of standard search theory, is to characterize the reservation wage behavior of the couple and compare it to the single-agent search model in order to understand the ramifications of partnerships for individual labor market outcomes and wage dynamics. We focus on two main cases. First, when couples are risk averse and pool income, joint search yields new opportunities—similar to on-the-job search—relative to the single-agent search. Second, when the two spouses in a couple face job offers from multiple locations and a cost of living apart, joint search features new frictions and can lead to significantly worse outcomes than single-agent search.
Subject (JEL): E24 - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity, J64 - Unemployment: Models, Duration, Incidence, and Job Search, and J61 - Geographic Labor Mobility; Immigrant Workers
Creator: Guerrieri, Veronica and Kondor, Péter Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 446 Abstract:
We propose a model of delegated portfolio management with career concerns. Investors hire fund managers to invest their capital either in risky bonds or in riskless assets. Some managers have superior information on the default probability. Looking at the past performance, investors update beliefs on their managers and make firing decisions. This leads to career concerns which affect investment decisions, generating a positive or negative “reputational premium.” For example, when the default probability is high, the return on the risky bond has to be high to compensate the uninformed managers for the high risk of being fired. As the default probability changes over time, the reputational premium amplifies price volatility.
Creator: Kaplan, Greg Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 449 Abstract:
This paper uses an estimated structural model to argue that the option to move in and out of the parental home is an important insurance channel against labor market risk for youths who do not attend college. Using data from the NLSY97, I construct a new monthly panel of parent-youth coresidence outcomes and use it to document an empirical relationship between these movements and individual labor market events. The data is then used to estimate the parameters of a dynamic game between youths and their altruistic parents, featuring coresidence, labor supply and savings decisions. Parents can provide both monetary support through explicit financial transfers, and non-monetary support in the form of shared residence. To account for the data, two types of exogenous shocks are needed. Preference shocks are found to explain most of the cross-section of living arrangements, while labor market shocks account for individual movements in and out of the parental home. I use the model to show that coresidence is a valuable form of insurance, particularly for youths from poorer families. The option to live at home also helps to explain features of aggregate data for low-skilled young workers: their low savings rates and their relatively small consumption responses to labor market shocks. An important implication is that movements in and out of home can reduce the consumption smoothing benefits of social insurance programs.
Creator: Beauchemin, Kenneth Ronald Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 493 Abstract:
This paper describes recent modifications to the mixed-frequency model vector autoregression (MF-VAR) constructed by Schorfheide and Song (2012). The changes to the model are restricted solely to the set of variables included in the model; all other aspects of the model remain unchanged. Forecast evaluations are conducted to gauge the accuracy of the revised model to standard benchmarks and the original model.
Keyword: Bayesian Vector Autoregression and Forecasting Subject (JEL): C11 - Bayesian Analysis: General, C32 - Multiple or Simultaneous Equation Models: Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models, and C53 - Forecasting Models; Simulation Methods
Creator: Schorfheide, Frank and Song, Dongho Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 701 Abstract:
This paper develops a vector autoregression (VAR) for macroeconomic time series which are observed at mixed frequencies – quarterly and monthly. The mixed-frequency VAR is cast in state-space form and estimated with Bayesian methods under a Minnesota-style prior. Using a real-time data set, we generate and evaluate forecasts from the mixed-frequency VAR and compare them to forecasts from a VAR that is estimated based on data time-aggregated to quarterly frequency. We document how information that becomes available within the quarter improves the forecasts in real time.
Keyword: Vector autoregressions, Real-time data, Bayesian methods, and Macroeconomic forecasting Subject (JEL): C11 - Bayesian Analysis: General, C32 - Multiple or Simultaneous Equation Models: Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models, and C53 - Forecasting Models; Simulation Methods
Creator: Schulhofer-Wohl, Sam Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 462 Abstract:
This appendix contains seven sections. Section A reports results from running regressions of labor earnings on GDP using data from the PSID, for comparison with the results using HRS data in the body of the paper. Section B examines the relationship between family income, aggregate shocks, and risk preferences in the PSID. Section C gives technical details on the Markov Chain Monte Carlo estimation employed in table 1 of the paper and reports the complete parameter estimates for the regressions summarized in that table. Section D reports results when the relationship between earnings and aggregate shocks is estimated with individual-specific coecients rather than common coecients for each risk-tolerance group. Section E reports results comparable to table 1 of the paper and table D.1 of this appendix using only Social Security covered earnings instead of the combination of Social Security and W-2 earnings. Section F reports robustness checks for tables 2 and 3 of the paper under alternative definitions of the household and the consumption and income variables. Section G reports robustness checks for tables 2 and 3 under an alternative definition of the leisure variable.
Keyword: Heterogeneity, Imperfect insurance, Risk preferences, and Risk sharing Subject (JEL): E21 - Macroeconomics : Consumption, saving, production, employment, and investment - Consumption ; Saving ; Wealth and E24 - Macroeconomics : Consumption, saving, production, employment, and investment - Employment ; Unemployment ; Wages ; Intergenerational income distribution ; Aggregate human capital
Creator: Bhandari, Anmol, Birinci, Serdar, McGrattan, Ellen R., and See, Kurt Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 578 Abstract:
In this appendix, we provide details on the data sources and construction of variables for our analysis in "What Do Survey Data Tell Us about U.S. Businesses?" We also include the auxiliary tables and figures omitted from the main text.
Keyword: Survey data Subject (JEL): C83 - Survey Methods; Sampling Methods
Creator: Arellano, Cristina, Bai, Yan, and Kehoe, Patrick J. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 466 Abstract:
The U.S. Great Recession featured a large decline in output and labor, tighter financial conditions, and a large increase in firm growth dispersion. We build a model in which increased volatility at the firm level generates a downturn and worsened credit conditions. The key idea is that hiring inputs is risky because financial frictions limit firms' ability to insure against shocks. An increase in volatility induces firms to reduce their inputs to reduce such risk. Out model can generate most of the decline in output and labor in the Great Recession and the observed increase in firms' interest rate spreads.
Keyword: Credit crunch, Credit constraints, Uncertainty shocks, Firm heterogeneity, Firm credit spreads, Labor wedge, and Great Recession Subject (JEL): E44 - Financial Markets and the Macroeconomy, E32 - Business Fluctuations; Cycles, E23 - Macroeconomics: Production, E24 - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity, D53 - General Equilibrium and Disequilibrium: Financial Markets, and D52 - Incomplete Markets
Creator: Pijoan-Mas, Josep and Ríos-Rull, José-Víctor Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 471 Abstract:
We develop a new methodology to compute differences in the expected longevity of individuals who are in different socioeconomic groups at age 50. We deal with two main problems associated with the standard use of life expectancy: that people’s socioeconomic characteristics evolve over time and that there is a time trend that reduces mortality over time. Using HRS data for individuals from different cohorts, we estimate a hazard model for survival with time-varying stochastic endogenous covariates that yields the desired expected durations. We uncover an enormous amount of heterogeneity in expected longevities between individuals in different socioeconomic groups, albeit less than implied by a naive (static) use of socioeconomic characteristics. Our analysis allows us to decompose the longevity differentials into differences in health at age 50, differences in mortality conditional on health, and differences in the evolution of health with age. Remarkably, it is the latter that is the most important for most socioeconomic characteristics. For instance, education and wealth are health protecting but have little impact on two-year mortality rates conditional on health. Finally, we document an increasing time trend of all these differentials in the period 1992–2008, and a likely increase in the socioeconomic gradient in mortality rates in the near future. The mortality differences that we find have huge welfare implications that dwarf the differences in consumption accruing to people in different socioeconomic groups.
Keyword: Heterogeneity in mortality rates, Inequality in health, and Life expectancies Subject (JEL): I24 - Education and Inequality, J12 - Marriage; Marital Dissolution; Family Structure; Domestic Abuse, I14 - Health and Inequality, and J14 - Economics of the Elderly; Economics of the Handicapped; Non-labor Market Discrimination
Creator: Anderson, Eric, Malin, Benjamin A., Nakamura, Emi, Simester, Duncan, and Steinsson, Jón, 1976- Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 513 Abstract:
We use unique price data to study how retailers react to underlying cost changes. Temporary sales account for 95% of price changes in our data. Simple models would, therefore, suggest that temporary sales play a central role in price responses to cost shocks. We find, however, that, in response to a wholesale cost increase, the entire increase in retail prices comes through regular price increases. Sales actually respond temporarily in the opposite direction from regular prices, as though to conceal the price hike. Additional evidence from responses to commodity cost and local unemployment shocks, as well as broader evidence from BLS data reinforces these findings. We present institutional evidence that sales are complex contingent contracts, determined substantially in advance. We show theoretically that these institutional practices leave little money “on the table”: in a price-discrimination model of sales, dynamically adjusting the size of sales yields only a tiny increase in profits.
Keyword: Regular Retail Prices, Retail Sales, and Trade Deals Subject (JEL): M30 - Marketing and Advertising: General, E30 - Prices, Business Fluctuations, and Cycles: General (includes Measurement and Data), and L11 - Production, Pricing, and Market Structure; Size Distribution of Firms
Creator: Chodorow-Reich, Gabriel and Karabarbounis, Loukas Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 514 Abstract:
The flow opportunity cost of moving from unemployment to employment consists of foregone public benefits and the foregone value of non-working time in units of consumption. We construct a time series of the opportunity cost of employment using detailed microdata and administrative or national accounts data to estimate benefit levels, eligibility and take-up of benefits, consumption by labor force status, hours per worker, taxes, and preference parameters. Our estimated opportunity cost is procyclical and volatile over the business cycle. The estimated cyclicality implies far less unemployment volatility in many leading models of the labor market than that observed in the data, irrespective of the level of the opportunity cost.
Keyword: Opportunity cost of employment and Unemployment fluctuations Subject (JEL): E32 - Business Fluctuations; Cycles, E24 - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity, and J64 - Unemployment: Models, Duration, Incidence, and Job Search
Creator: Stevens, Lacramioara Luminita Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 520 Abstract:
The puzzling behavior of inflation in the Great Recession and its aftermath has increased the need to better understand the constraints that firms face when setting prices. Using new data and theory, I demonstrate that each firm's choice of how much information to acquire to set prices determines aggregate price dynamics through the patterns of pricing at the micro level, and through the large heterogeneity in pricing policies across firms. Viewed through this lens, the behavior of prices in recent years becomes less puzzling, as firms endogenously adjust their information acquisition strategies. In support of this mechanism, I present micro evidence that firms price goods using plans that are sticky, coarse, and volatile. A theory of information-constrained price setting generates such policies endogenously, and quantitatively matches the discreteness, duration, volatility, and heterogeneity of policies in the data. Policies track the state noisily, resulting in sluggish adjustment to shocks. A higher volatility of shocks does not reduce monetary non-neutrality and generates slight inflation, while progress in the technology to acquire information results in deflation.
Keyword: Rational inattention, Inflation dynamics, and Rigid prices Subject (JEL): E30 - Prices, Business Fluctuations, and Cycles: General (includes Measurement and Data) and E50 - Monetary Policy, Central Banking, and the Supply of Money and Credit: General
Creator: McGrattan, Ellen R. and Prescott, Edward C. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 534 Abstract:
Many countries are facing challenging fiscal financing issues as their populations age and the number of workers per retiree falls. Policymakers need transparent and robust analyses of alternative policies to deal with demographic changes. In this paper, we propose a simple framework that can easily be matched to aggregate data from the national accounts. We demonstrate the usefulness of our framework by comparing quantitative results for our aggregate model with those of a related model that includes within-age-cohort heterogeneity through productivity differences. When we assess proposals to switch from the current tax and transfer system in the United States to a mandatory saving-for-retirement system with no payroll taxation, we find that the aggregate predictions for the two models are close.
Keyword: Retirement, Medicare, Social Security, and Taxation Subject (JEL): H55 - Social Security and Public Pensions, I13 - Health Insurance, Public and Private, and E13 - General Aggregative Models: Neoclassical
Creator: Kehoe, Patrick J., Midrigan, Virgiliu, and Pastorino, Elena Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 536 Abstract:
During the Great Recession, regions of the United States that experienced the largest declines in household debt also experienced the largest drops in consumption, employment, and wages. Employment declines were larger in the nontradable sector and for firms that were facing the worst credit conditions. Motivated by these findings, we develop a search and matching model with credit frictions that affect both consumers and firms. In the model, tighter debt constraints raise the cost of investing in new job vacancies and thus reduce worker job finding rates and employment. Two key features of our model, on-the-job human capital accumulation and consumer-side credit frictions, are critical to generating sizable drops in employment. On-the-job human capital accumulation makes the flows of benefits from posting vacancies long-lived and so greatly amplifies the sensitivity of such investments to credit frictions. Consumer-side credit frictions further magnify these effects by leading wages to fall only modestly. We show that the model reproduces well the salient cross-regional features of the U.S. data during the Great Recession.
Keyword: Search and matching, Human capital, Employment, and Debt constraints Subject (JEL): E21 - Macroeconomics: Consumption; Saving; Wealth, E32 - Business Fluctuations; Cycles, E24 - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity, J21 - Labor Force and Employment, Size, and Structure, and J64 - Unemployment: Models, Duration, Incidence, and Job Search
Creator: Mercenier, Jean and Schmitt, Nicolas Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 188 Abstract:
We argue that the rationalization gains often predicted by static applied general equilibrium models with imperfect competition and scale economies are artificially boosted by an unrealistic treatment of fixed costs. We introduce sunk costs into one such model calibrated with real-world data. We show how this changes the oligopoly game in a way significant enough to affect, both qualitatively and quantitatively, the outcome of a trade liberalization exercise.
Keyword: Market structure, Applied general equilibrium, Sunk costs, and Trade liberalization Subject (JEL): D58 - Computable and Other Applied General Equilibrium Models, C68 - Computable General Equilibrium Models, F17 - Trade: Forecasting and Simulation, and F12 - Models of Trade with Imperfect Competition and Scale Economies; Fragmentation
Creator: Luttmer, Erzo G. J. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 585 Abstract:
Most firms begin very small, and large firms are the result of typically decades of persistent growth. This growth can be understood as the result of some form of organization capital accumulation. In the US, the distribution of firm size k has a right tail only slightly thinner than 1/k. This is shown to imply that incumbent firms account for most aggregate organization capital accumulation. And it implies potentially extremely slow aggregate convergence rates. A benchmark model is proposed in which managers can use incumbent organization capital to create new organization capital. Workers are a specific factor for producing consumption, and they require managerial supervision. Through the lens of the model, the aftermath of the Great Recession of 2008 is unsurprising if the events of late 2008 and early 2009 are interpreted as a destruction of organization capital, or as a belief shock that made consumers want to reduce consumption and accumulate more wealth instead.
Keyword: Zipf's law, Business cycles, Firm size distribution, and Slow recoveries Subject (JEL): L11 - Production, Pricing, and Market Structure; Size Distribution of Firms and E32 - Business Fluctuations; Cycles
Creator: Ohanian, Lee E., Restrepo-Echavarria, Paulina, and Wright, Mark L. J. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 563 Abstract:
After World War II, international capital flowed into slow-growing Latin America rather than fast-growing Asia. This is surprising as, everything else equal, fast growth should imply high capital returns. This paper develops a capital flow accounting framework to quantify the role of different factor market distortions in producing these patterns. Surprisingly, we find that distortions in labor markets — rather than domestic or international capital markets — account for the bulk of these flows. Labor market distortions that indirectly depress investment incentives by lowering equilibrium labor supply explain two-thirds of observed flows, while improvement in these distortions over time accounts for much of Asia’s rapid growth.
Keyword: Labor markets, Domestic capital markets, Capital flows, and International capital markets Subject (JEL): E21 - Macroeconomics: Consumption; Saving; Wealth, F41 - Open Economy Macroeconomics, F21 - International Investment; Long-term Capital Movements, and J20 - Demand and Supply of Labor: General
Creator: Ai, Hengjie and Bhandari, Anmol Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 570 Abstract:
This paper studies asset pricing in a setting in which idiosyncratic risk in human capital is not fully insurable. Firms use long-term contracts to provide insurance to workers, but neither side can commit to these contracts; furthermore, worker-firm relationships have endogenous durations owing to costly and unobservable effort. Uninsured tail risk in labor earnings arises as a part of an optimal risk-sharing scheme. In the general equilibrium, exposure to the resulting tail risk generates higher risk premia, more volatile returns, and variations in expected returns across firms. Model outcomes are consistent with the cyclicality of factor shares in the aggregate, and the heterogeneity in exposures to idiosyncratic and aggregate shocks in the cross section.
Keyword: Dynamic contracting, Tail risk, Limited commitment, and Equity premium puzzle Subject (JEL): E30 - Prices, Business Fluctuations, and Cycles: General (includes Measurement and Data) and G10 - General Financial Markets: General (includes Measurement and Data)
Creator: Arellano, Cristina, Bai, Yan, Bocola, Luigi, and test Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 547 Abstract:
This paper measures the output costs of sovereign risk by combining a sovereign debt model with firm- and bank-level data. In our framework, an increase in sovereign risk lowers the price of government debt and has an adverse impact on banks’ balance sheets, disrupting their ability to finance firms. Importantly, firms are not equally affected by these developments: those that have greater financing needs and borrow from banks that are more exposed to government debt cut their production the most in a debt crisis. We measure the extent of this heterogeneity using Italian data and parameterize the model to match these cross-sectional facts. In counterfactual analysis, we find that heightened sovereign risk was responsible for one-third of the observed output decline during the 2011-2012 crisis in Italy.
Keyword: Micro data, Firm heterogeneity, Business cycles, Financial intermediation, and Sovereign debt crises Subject (JEL): E44 - Financial Markets and the Macroeconomy, F34 - International Lending and Debt Problems, G15 - International Financial Markets, and G12 - Asset Pricing; Trading Volume; Bond Interest Rates
Creator: Ayres, João, Garcia, Márcio Gomes Pinto, Guillen, Diogo, and Kehoe, Patrick J. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 575 Abstract:
Brazil has had a long period of high inflation. It peaked around 100 percent per year in 1964, decreased until the first oil shock (1973), but accelerated again afterward, reaching levels above 100 percent on average between 1980 and 1994. This last period coincided with severe balance of payments problems and economic stagnation that followed the external debt crisis in the early 1980s. We show that the high-inflation period (1960-1994) was characterized by a combination of fiscal deficits, passive monetary policy, and constraints on debt financing. The transition to the low-inflation period (1995-2016) was characterized by improvements in all of these features, but it did not lead to significant improvements in economic growth. In addition, we document a strong positive correlation between inflation rates and seigniorage revenues, although inflation rates are relatively high for modest levels of seigniorage revenues. Finally, we discuss the role of the weak institutional framework surrounding the fiscal and monetary authorities and the role of monetary passiveness and inflation indexation in accounting for the unique features of inflation dynamics in Brazil.
Keyword: Brazil's stagnation, Brazil's hyperinflation, Fiscal deficit, Stabilization plans, and Debt accounting Subject (JEL): E42 - Monetary Systems; Standards; Regimes; Government and the Monetary System; Payment Systems, H62 - National Deficit; Surplus, E63 - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy, and H63 - National Debt; Debt Management; Sovereign Debt
Creator: Chari, V. V., Jones, Larry E., and Manuelli, Rodolfo E. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 117 Abstract:
We propose a definition of involuntary unemployment which differs from that traditionally used in implicit labor contract theory. We say that a worker is involuntarily unemployed if the marginal wage implied by the optimal contract exceeds the marginal rate of substitution between leisure and consumption. We construct a model where risk-neutral firms have monopoly power and show that such monopoly power is necessary for involuntary unemployment to arise in the optimal contract. We numerically compute examples and show that such unemployment occurs for a wide range of parameter values.
Creator: Atkeson, Andrew and Kehoe, Patrick J. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 162 Abstract:
In this paper, we build a model of the transition following large-scale economic reforms that predicts both a substantial drop in output and a prolonged pause in physical investment as the initial phase of the optimal transition following the reform. We model reform as a change in policy which induces agents to close existing enterprises using old technologies of production and to open up new enterprises adopting new technologies of production. The central idea of our paper is that it is costly to close old enterprises and open new enterprises because, in doing so, information capital built up about old enterprises is lost and time must pass before information capital about new enterprises can be acquired. Thus, an acceleration of the pace of industry evolution leads in the short run to a net loss of information capital, a drop in productivity, a recession, and a fall in physical investment. We calibrate our model of industry evolution, information capital, and transition to match micro data on industry evolution in the United States and macro data from the United States, Japan, and the former communist countries of Europe. We find that the loss of information capital that accompanies a major acceleration in the pace of industry evolution in an economy leads initially to a decade of recession and a five year pause in physical investment before the benefits of reform are realized.
Keyword: Transition, Organization capital, and Eastern Europe Subject (JEL): F41 - Open Economy Macroeconomics, O31 - Innovation and Invention: Processes and Incentives, and J64 - Unemployment: Models, Duration, Incidence, and Job Search
Creator: Prescott, Edward C. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 321 Abstract:
Americans now work 50 percent more than do the Germans, French, and Italians. This was not the case in the early 1970s when the Western Europeans worked more than Americans. In this paper, I examine the role of taxes in accounting for the differences in labor supply across time and across countries, in particular, the effective marginal tax rate on labor income. The population of countries considered is that of the G-7 countries, which are major advanced industrial countries. The surprising finding is that this marginal tax rate accounts for the predominance of the differences at points in time and the large change in relative labor supply over time with the exception of the Italian labor supply in the early 1970s.
Keyword: International Labor Supply, International Tax Rates, and Social Security Reform Subject (JEL): H20 - Taxation, Subsidies, and Revenue: General, E24 - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity, E13 - General Aggregative Models: Neoclassical, and E62 - Fiscal Policy
Creator: Atkeson, Andrew and Kehoe, Patrick J. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 201 Abstract:
We use a calibrated model of the dynamics of organization capital and industry evolution to measure the size of investment in organization capital in the steady state and the dynamics of organization capital during the transition following a major reform. We find that, in the steady state, aggregate net investment in organization capital is roughly one-fifth of measured output. During the initial phase of transition, the failure rate of plants rises 200-400 percent, measured output and aggregate productivity stagnate, physical investment falls, and net investment in organization capital rises between 300 and 500 percent above its steady-state level.
Keyword: Transition, Organization capital, and Eastern Europe Subject (JEL): F41 - Open Economy Macroeconomics, O31 - Innovation and Invention: Processes and Incentives, and J64 - Unemployment: Models, Duration, Incidence, and Job Search
Creator: Holmes, Thomas J. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 205 Abstract:
This paper provides new evidence that state policies play a role in the location of industry. The paper classifies a state as pro-business or anti-business depending upon whether or not the state has a right-to-work law. The paper finds that, on average, there is a large abrupt increase in manufacturing activity when crossing a state border from an anti-business state into a pro-business state.
Subject (JEL): L60 - Industry Studies: Manufacturing: General, L52 - Industrial Policy; Sectoral Planning Methods, and R38 - Production Analysis and Firm Location: Government Policy
Creator: Mercenier, Jean and Yeldan, Erinç Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 207 Abstract:
We highlight an example of considerable bias in officially published input-output data (factor-income shares) by an LDC (Turkey), which many researchers use without question. We make use of an intertemporal general equilibrium model of trade and production to evaluate the dynamic gains for Turkey from currently debated trade policy options and compare the predictions using conservatively adjusted, rather than official, data on factor shares. We show that the predicted welfare gains are not only of a different order of magnitude, but in some cases, of a different sign, hence, suggesting contradictory policy recommendations.
Creator: Cole, Harold Linh, 1957- and Rogerson, Richard Donald Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 224 Abstract:
We examine whether the Mortensen-Pissarides matching model can account for the business cycle facts on employment, job creation, and job destruction. A novel feature of our analysis is its emphasis on the reduced-form implications of the matching model. Our main finding is that the model can account for the business cycle facts, but only if the average duration of a nonemployment spell is relatively high—about nine months or longer.
Creator: Fernandes, Ana and Phelan, Christopher Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 259 Abstract:
There is now an extensive literature regarding the efficient design of incentive mechanisms in dynamic environments. In this literature, there are no exogenous links across time periods because either privately observed shocks are assumed time independent or past private actions have no influence on the realizations of current variables. The absence of exogenous links across time periods ensures that preferences over continuation contracts are common knowledge, making the definition of incentive compatible contracts at a point in time a simple matter. In this paper, we present general recursive methods to handle environments where privately observed variables are linked over time. We show that incentive compatible contracts are implemented recursively with a threat keeping constraint in addition to the usual temporary incentive compatibility conditions.
Keyword: Mechanism design and Repeated agency Subject (JEL): D31 - Personal Income, Wealth, and Their Distributions, D82 - Asymmetric and Private Information; Mechanism Design, D30 - Distribution: General, and D80 - Information, Knowledge, and Uncertainty: General
Creator: Cole, Harold Linh, 1957- and Ohanian, Lee E. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 270 Abstract:
This paper quantitatively evaluates the hypothesis that deflation can account for much of the Great Depression (1929–33). We examine two popular explanations of the Depression: (1) The “high wage” story, according to which deflation, combined with imperfectly flexible wages, raised real wages and reduced employment and output. (2) The “bank failure” story, according to which deflationary money shocks contributed to bank failures and to a reduction in the efficiency of financial intermediation, which in turn reduced lending and output. We evaluate these stories using general equilibrium business cycle models, and find that wage shocks and banking shocks account for a small fraction of the Great Depression. We also find that some other predictions of the theories are at variance with the data.
Creator: Chin, Daniel M., Geweke, John, and Miller, Preston J. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 267 Abstract:
This paper presents a new method for predicting turning points. The paper formally defines a turning point; develops a probit model for estimating the probability of a turning point; and then examines both the in-sample and out-of-sample forecasting performance of the model. The model performs better than some other methods for predicting turning points.
Creator: McGrattan, Ellen R. and Prescott, Edward C. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 472 Abstract:
A problem that faces many countries including the United States is how to finance retirement consumption as the population ages. Proposals for switching to a saving-for-retirement system that do not rely on high payroll taxes have been challenged on the grounds that welfare would fall for some groups such as retirees or the working poor. We show how to devise a transition path from the current U.S. system to a saving-for-retirement system that increases the welfare of all current and future generations, with estimates of future gains higher than those found in typically used macroeconomic models. The gains are large because there is more productive capital than commonly assumed. Our quantitative results depend importantly on accounting for differences between actual government tax revenues and what revenues would be if all income were taxed at the income-weighted average marginal tax rates used in our analysis.
Keyword: Retirement, Medicare, Social Security, and Taxation Subject (JEL): H55 - Social Security and Public Pensions, I13 - Health Insurance, Public and Private, and E13 - General Aggregative Models: Neoclassical
Creator: Cole, Harold Linh, 1957- and Ohanian, Lee E. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 295 Abstract:
Between 1913 and 1929, real GDP per person in the UK fell 1 percent, while this same measure of economic activity rose about 25 percent in the rest of the world. Why was Britain so depressed in a decade of strong economic activity around the world? This paper argues that the standard explanations of contractionary monetary shocks and an overvalued nominal exchange rate are not the prime suspects for killing the British economy. Rather, we argue that large, negative sectoral shocks, coupled with generous unemployment benefits and housing subsidies, are the primary causes of this long and deep depression.
Keyword: Unemployment benefits, Workweek restriction, and Sectoral shocks Subject (JEL): E30 - Prices, Business Fluctuations, and Cycles: General (includes Measurement and Data) and E24 - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
Creator: Atkeson, Andrew and Kehoe, Patrick J. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 297 Abstract:
Monetary policy instruments differ in tightness—how closely they are linked to inflation—and transparency—how easily they can be monitored. Tightness is always desirable in a monetary policy instrument; when is transparency? When a government cannot commit to follow a given policy. We apply this argument to a classic question: Is the exchange rate or the money growth rate the better monetary policy instrument? We show that if the instruments are equally tight and a government cannot commit to a policy, then the exchange rate’s greater transparency gives it an advantage as a monetary policy instrument.
Keyword: Exchange Rate Regime, Fixed Exchange Rates, Time Consistency, Nominal Anchor, and Monetary Instrument Subject (JEL): F41 - Open Economy Macroeconomics, E52 - Monetary Policy, E50 - Monetary Policy, Central Banking, and the Supply of Money and Credit: General, F33 - International Monetary Arrangements and Institutions, and E61 - Policy Objectives; Policy Designs and Consistency; Policy Coordination
Creator: Heathcote, Jonathan, Storesletten, Kjetil, and Violante, Giovanni L. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 496 Abstract:
What shapes the optimal degree of progressivity of the tax and transfer system? On the one hand, a progressive tax system can counteract inequality in initial conditions and substitute for imperfect private insurance against idiosyncratic earnings risk. On the other hand, progressivity reduces incentives to work and to invest in skills, distortions that are especially costly when the government must finance public goods. We develop a tractable equilibrium model that features all of these trade-offs. The analytical expressions we derive for social welfare deliver a transparent understanding of how preference, technology, and market structure parameters influence the optimal degree of progressivity. A calibration for the U.S. economy indicates that endogenous skill investment, flexible labor supply, and the desire to finance government purchases play quantitatively similar roles in limiting optimal progressivity. In a version of the model where poverty constrains skill investment, optimal progressivity is close to the U.S. value. An empirical analysis on cross-country data offers support to the theory.
Keyword: Skill investment, Cross-country evidence, Partial insurance, Labor supply, Tax progressivity, Income distribution, Welfare, and Government expenditures Subject (JEL): E20 - Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy: General (includes Measurement and Data), H40 - Publicly Provided Goods: General, H20 - Taxation, Subsidies, and Revenue: General, D30 - Distribution: General, J24 - Human Capital; Skills; Occupational Choice; Labor Productivity, and J22 - Time Allocation and Labor Supply
Creator: Boldrin, Michele and Levine, David K. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 301 Abstract:
We study a simple model of factor saving technological innovation in a concave framework. Capital can be used either to reproduce itself or, at additional cost, to produce a higher quality of capital that requires less labor input. If higher quality capital can be produced quickly, we get a model of exogenous balanced growth as a special case. If, however, higher quality capital can be produced slowly, we get a model of endogenous growth in which the growth rate of the economy and the rate of adoption of new technologies are determined by preferences, technology, and initial conditions. Moreover, in the latter case, the process of growth is necessarily uneven, exhibiting a natural cycle with alternating periods of high and low growth. Growth paths and technological innovations also exhibit dependence upon initial conditions. The model provides a step toward a theory of endogenous innovation under conditions of perfect competition.
Keyword: Innovation and invention, One, two and multisector growth models, Measurement of economic growth, Choices and consequences, Technological change, Processes and incentives, and Aggregate productivity Subject (JEL): C61 - Optimization Techniques; Programming Models; Dynamic Analysis, O30 - Innovation; Research and Development; Technological Change; Intellectual Property Rights: General, D24 - Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity, O40 - Economic Growth and Aggregate Productivity: General, and D41 - Market Structure, Pricing, and Design: Perfect Competition
Creator: Chari, V. V. and Kehoe, Patrick J. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 308 Abstract:
We analyze the setting of monetary and nonmonetary policies in monetary unions. We show that in these unions a time inconsistency problem in monetary policy leads to a novel type of free-rider problem in the setting of nonmonetary policies, such as labor market policy, fiscal policy, and bank regulation. The free-rider problem leads the union’s members to pursue lax nonmonetary policies that induce the monetary authority to generate high inflation. The free-rider problem can be mitigated by imposing constraints on the nonmonetary policies, like unionwide rules on labor market policy, debt constraints on members’ fiscal policy, and unionwide regulation of banks. When there is no time inconsistency problem, there is no free-rider problem, and constraints on nonmonetary policies are unnecessary and possibly harmful.
Keyword: Fixed exchange rates, European Union, Maastricht Treaty, Dollarization, and Monetary regime Subject (JEL): F41 - Open Economy Macroeconomics, E58 - Central Banks and Their Policies, E42 - Monetary Systems; Standards; Regimes; Government and the Monetary System; Payment Systems, F30 - International Finance: General, E61 - Policy Objectives; Policy Designs and Consistency; Policy Coordination, F33 - International Monetary Arrangements and Institutions, E63 - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy, and F42 - International Policy Coordination and Transmission
Creator: Cooper, Russell and Willis, Jonathan L. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 310 Abstract:
We study inferences about the dynamics of labor adjustment obtained by the “gap methodology” of Caballero and Engel  and Caballero, Engel and Haltiwanger . In that approach, the policy function for employment growth is assumed to depend on an unobservable gap between the target and current levels of employment. Using time series observations, these studies reject the partial adjustment model and find that aggregate employment dynamics depend on the cross-sectional distribution of employment gaps. Thus, nonlinear adjustment at the plant level appears to have aggregate implications. We argue that this conclusion is not justified: these findings of nonlinearities in time series data may reflect mismeasurement of the gaps rather than the aggregation of plant-level nonlinearities.
Keyword: Aggregate Employment, Adjustment Costs, and Employment Subject (JEL): E24 - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity, J60 - Mobility, Unemployment, Vacancies, and Immigrant Workers: General, and J23 - Labor Demand
Creator: Cooper, Russell and Kempf, Hubert Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 311 Abstract:
Central to ongoing debates over the desirability of monetary unions is a supposed trade-off, outlined by Mundell : a monetary union reduces transactions costs but renders stabilization policy less effective. If shocks across countries are sufficiently correlated, then, according to this argument, delegating monetary policy to a single central bank is not very costly and a monetary union is desirable.
This paper explores this argument in a setting with both monetary and fiscal policies. In an economy with monetary policy alone, we confirm the presence of the trade-off and find that indeed a monetary union will not be welfare improving if the correlation of national shocks is too low. However, fiscal interventions by national governments, combined with a central bank that has the ability to commit to monetary policy, overturn these results. In equilibrium, such a monetary union will be welfare improving for any correlation of shocks.
Keyword: Stabilization policies, Unemployment, Monetary unions, Public assistance programs, Currency, Income taxes, and Central banks
Creator: Prescott, Edward C. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 312 Abstract:
This paper reviews the role of micro non-convexities in the study of business cycles. One important non-convexity arises because an individual can work only one workweek length in a given week. The implication of this non-convexity is that the aggregate intertemporal elasticity of labor supply is large and the principal margin of adjustment is in the number employed—not in the hours per person employed—as observed. The paper also reviews a business cycle model with an occasionally binding capacity constraint. This model better mimics business cycle fluctuations than the standard real business cycle model. Aggregation in the presence of micro non-convexities is key in the model.
Creator: Bils, Mark, Klenow, Peter J., and Malin, Benjamin A. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 516 Abstract:
Employment and hours appear far more cyclical than dictated by the behavior of productivity and consumption. This puzzle has been called “the labor wedge” — a cyclical intratemporal wedge between the marginal product of labor and the marginal rate of substitution of consumption for leisure. The intratemporal wedge can be broken into a product market wedge (price markup) and a labor market wedge (wage markup). Based on the wages of employees, the literature has attributed the intratemporal wedge almost entirely to labor market distortions. Because employee wages may be smoothed versions of the true cyclical price of labor, we instead examine the self-employed and intermediate inputs, respectively. Looking at the past quarter century in the United States, we find that price markup movements are at least as important as wage markup movements — including during the Great Recession and its aftermath. Thus, sticky prices and other forms of countercyclical markups deserve a central place in business cycle research, alongside sticky wages and matching frictions.
Keyword: Wage markups, Business cycles, Labor wedge, and Price markups Subject (JEL): E32 - Business Fluctuations; Cycles and E24 - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
Creator: Jones, Larry E., Manuelli, Rodolfo E., and McGrattan, Ellen R. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 317 Abstract:
We study the large observed changes in labor supply by married women in the United States over the post–World War II period, a period that saw little change in the labor supply by single women. We investigate the effects of changes in the gender wage gap, the quantitative impact of technological improvements in the production of nonmarket goods, and the potential inferiority of nonmarket goods in explaining the dramatic change in labor supply. We find that small decreases in the gender wage gap can simultaneously explain the significant increases in the average hours worked by married women and the relative constancy in the hours worked by single women and by single and married men. We also find that the impact of technological improvements in the household on married female hours and on the relative wage of females to males is too small for realistic values. Some specifications of the inferiority of home goods match the hours patterns, but they have counterfactual predictions for wages and expenditure patterns.
Keyword: Hours of work , Technological improvements, and Gender wage gap Subject (JEL): J22 - Time Allocation and Labor Supply and E24 - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity