Research Database

We show that optimal monetary and fiscal policies are time consistent for a class of economies often used in applied work, economies appealing because they are consistent with the growth facts. We establish our results in two steps. We first show that for this class of economies, the Friedman rule of setting nominal interest rates to zero is optimal under commitment. We then show that optimal policies are time consistent if the Friedman rule is optimal. For our benchmark economy in which the time consistency problem is most severe, the converse also holds: if optimal policies are time consistent, then the Friedman rule is optimal.

This paper studies the impact of cross-country variation in financial market development on firms’ financing choices and growth rates using comprehensive firm-level datasets. We document that in less financially developed economies, small firms grow faster and have lower debt to asset ratios than large firms. We then develop a quantitative model where financial frictions drive firm growth and debt financing through the availability of credit and default risk. We parameterize the model to the firms’ financial structure in the data and show that financial restrictions can account for the majority of the difference in growth rates between firms of different sizes across countries.

Between 2007 and 2013, U.S. households experienced a large and persistent decline in net worth. The objective of this paper is to study the business cycle implications of such a decline. We first develop a tractable monetary model in which households face idiosyncratic unemployment risk that they can partially self-insure using savings. A low level of liquid household wealth opens the door to self-fullfilling fluctuations: if wealth-poor households expect high unemployment, they have a strong precautionary incentive to cut spending, which can make the expectation of high unemployment a reality. Monetary policy, because of the zero lower bound, cannot rule out such expectations-driven recessions. In contrast, when wealth is sufficiently high, an aggressive monetary policy can keep the economy at full employment. Finally, we document that during the U.S. Great Recession wealth-poor households increased saving more sharply than richer households, pointing towards the importance of the precautionary channel over this period.

We use a simple random growth model to study the role of changing dynamics of family firms in shaping the evolution of top wealth shares in the United States over the course of the past century. Our model generates a time path for top wealth shares. The path is remarkably similar to those found by Saez and Zucman (2016) and Gomez (2019) when the volatility of idiosyncratic shocks to the value of family firms is similar to that found for public firms by Herskovic, Kelly, Lustig, and Van Nieuwerburgh (2016). We also show that consideration of family firms contributes not only to overall wealth inequality but also to considerable upward and downward mobility of families within the distribution of wealth. We interpret our results as indicating that improving our understanding of how families found new firms and eventually diversify their wealth is central to improving our understanding of the distribution of great wealth and its evolution over time.

This paper by Baxter and Kouparitsas is an ambitious attempt to explore which variables are robust in explaining the correlations of bilateral GDP between countries at business cycle frequencies. Most of the variables turned out to be fragile. The main contribution is to show that countries with large amounts of bilateral trade tend to have robustly higher business cycle correlations. Another interesting finding is that neither currency unions nor industrial structure are robustly related to business cycle correlations.

It is well documented that on average, stock prices drop by less than the value of the dividend on ex-dividend days. This has commonly been attributed to the effect of tax clienteles. We use data from the Hong Kong stock market where neither dividends nor capital gains are taxed. As in the U.S.A. the average stock price drop is less than the value of the dividend; specifically, in Hong Kong the average dividend was HK $0.12 and the average price drop was HK $0.06. We are able to account for this both theoretically and empirically through market microstructure based arguments.

During the financial crisis, life insurers sold long-term policies at deep discounts relative to actuarial value. The average markup was as low as −19 percent for annuities and −57 percent for life insurance. This extraordinary pricing behavior was due to financial and product market frictions, interacting with statutory reserve regulation that allowed life insurers to record far less than a dollar of reserve per dollar of future insurance liability. We identify the shadow cost of capital through exogenous variation in required reserves across different types of policies. The shadow cost was $0.96 per dollar of statutory capital for the average company in November 2008.

There is an old wisdom that reductions in tariffs force changes on producers that lead to costless, or nearly so, increases in productivity. We construct a technology-ladder model that captures this wisdom. As in other technology-ladder models, time spent in research helps propel an industry up a technology-ladder. In contrast to the literature, we include another activity that plays a role in determining an industry's position on the technology-ladder: attempts to obstruct the research program of rivals (through regulations, for example). In this world, reductions in tariffs between countries lead producers to spend more time in research and less in obstruction of rivals.

We study the U.S. sugar manufacturing cartel that was created during the New Deal. This was a legal-cartel that lasted 40 years (1934-74). As a legal-cartel, the industry was assured widespread adherence to domestic and import sales quotas (given it had access to government enforcement powers). But it also meant accepting government-sponsored cartel-provisions. These provisions significantly distorted production at each factory and also where the industry was located. These distortions were reflected in, for example, a declining industry recovery rate, that is, the pounds of white sugar produced per ton of beets. It declined from about 310 pounds in 1934 to 240 pounds in 1974. The cartel provisions also distorted the location of industry. For example, it kept production in California and the Far West. Since the cartel ended in 1974, California's share of sugar production has dropped dramatically.

How big are the welfare losses from severe economic downturns, such as the U.S. Great Recession? How are those losses distributed across the population? In this paper we answer these questions using a canonical business cycle model featuring household income and wealth heterogeneity that matches micro data from the Panel Study of Income Dynamics (PSID). We document how these losses are distributed across households and how they are affected by social insurance policies. We find that the welfare cost of losing one’s job in a severe recession ranges from 2% of lifetime consumption for the wealthiest households to 5% for low-wealth households. The cost increases to approximately 8% for low-wealth households if unemployment insurance benefits are cut from 50% to 10%. The fact that welfare losses fall with wealth, and that in our model (as in the data) a large fraction of households has very low wealth, implies that the impact of a severe recession, once aggregated across all households, is very significant (2.2% of lifetime consumption). We finally show that a more generous unemployment insurance system unequivocally helps low-wealth job losers, but hurts households that keep their job, even in a version of the model in which output is partly demand determined, and therefore unemployment insurance stabilizes aggregate demand and output.