Research Database

We study financial shocks to households’ ability to borrow in an economy that quantitatively replicates U.S. earnings, financial, and housing wealth distributions and the main macro aggregates. Such shocks generate large recessions via the negative wealth effect associated with the large drop in house prices triggered by the reduced access to credit of a large number of households. The model incorporates additional margins that are crucial for a large recession to occur: that it is difficult to reallocate production from consumption to investment or net exports, and that the reductions in consumption contribute to reductions in measured TFP.

We elaborate on the business cycle accounting method proposed by Chari, Kehoe, and McGrattan (2007), clear up some misconceptions about the method, and then apply it to compare the Great Recession across OECD countries as well as to the recessions of the 1980s in these countries. We have four main …findings. First, with the notable exception of the United States, Spain, Ireland, and Iceland, the Great Recession was driven primarily by the efficiency wedge. Second, in the Great Recession, the labor wedge plays a dominant role only in the United States, and the investment wedge plays a dominant role in Spain, Ireland, and Iceland. Third, in the recessions of the 1980s, the labor wedge played a dominant role only in France, the United Kingdom, Belgium, and New Zealand. Finally, overall in the Great Recession the efficiency wedge played a more important role and the investment wedge played a less important role than they did in the recessions of the 1980s.

This paper constructs a dynamic model in which fiscal restrictions interact with government borrowing and default. The government faces fiscal constraints; it cannot adjust tax rates or impose lump-sum taxes on the private sector, but it can adjust public consumption and foreign debt. When foreign debt is sufficiently high, however, the government can choose to default to increase domestic public and private consumption by freeing up the resources used to pay the debt. Two types of defaults arise in this environment: fiscal defaults and aggregate defaults. Fiscal defaults occur because of the government's inability to raise tax revenues. Aggregate defaults occur even if the government could raise tax revenues; debt is simply too high to be sustainable. In a quantitative exercise calibrated to Greece, we find that our model can predict the recent default, but that increasing taxes would not have prevented it. In fact, increasing taxes would have made the recession deeper because of the distortionary effects of taxation.

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.

In January 2015, in the face of sustained capital inflows, the Swiss National Bank abandoned the floor for the Swiss Franc against the Euro, a decision which led to the appreciation of the Swiss Franc. The objective of this paper is to present a simple framework that helps to better understand the timing of this episode, which we label a “reverse speculative attack". We model a central bank which wishes to maintain a peg, and responds to increases in demand for domestic currency by expanding its balance sheet. In contrast to the classic speculative attacks, which are triggered by the depletion of foreign assets, reverse attacks are triggered by the concern of future balance sheet losses. Our key result is that the interaction between the desire to maintain the peg and the concern about future losses, can lead the central bank to first accumulate a large amount of reserves, and then to abandon the peg, just as we have observed in the Swiss case.

We explore monetary policy in a world without currency. In our world, money is a form of government debt that bears interest, which can be negative as well as positive. Services of money are a factor of production. We show that the national accounts must be revised in this world. Using our baseline economy, we determine the balanced growth paths for a set of money interest rate target policy regimes. Besides this interest rate, the only policy variable that differs across regimes is either the labor income tax rate or the inflation rate. We find that Friedman monetary satiation without deflation is possible. We also examine a set of inflation rate targeting regimes. Here, the only other policy variable that differs across policy regimes is the tax rate. There is a sequence of markets with outcome in each market being a Debreu valuation equilibrium, which determines the vector of assets and liabilities households take into the subsequent period. Evaluating a policy regime is an advanced exercise in public finance. Monetary satiation is not optimal even though money is costless to produce. A preliminary version of this paper circulated under the title “Monetary Policy with 100 Percent Reserve Banking: An Exploration.”

The goal of this chapter is to study how, and by how much, household income, wealth, and preference heterogeneity amplify and propagate a macroeconomic shock. We focus on the U.S. Great Recession of 2007-2009 and proceed in two steps. First, using data from the Panel Study of Income Dynamics, we document the patterns of household income, consumption and wealth inequality before and during the Great Recession. We then investigate how households in different segments of the wealth distribution were affected by income declines, and how they changed their expenditures differentially during the aggregate downturn. Motivated by this evidence, we study several variants of a standard heterogeneous household model with aggregate shocks and an endogenous cross-sectional wealth distribution. Our key finding is that wealth inequality can significantly amplify the impact of an aggregate shock, and it does so if the distribution features a sufficiently large fraction of households with very little net worth that sharply increase their saving (i.e. they are not hand-to mouth) as the recession hits. We document that both these features are observed in the PSID. We also investigate the role that social insurance policies, such as unemployment insurance, play in shaping the cross-sectional income and wealth distribution, and through it, the dynamics of business cycles.

In this paper, we study the optimal design of financial safety nets under limited private credit. We ask when it is optimal to restrict ex ante the set of investors that can receive public liquidity support ex post. When the government can commit, the optimal safety net covers all investors. Introducing a wedge between identical investors is inefficient. Without commitment, an optimally designed financial safety net covers only a subset of investors. Compared to an economy where all investors are protected, this results in more liquid portfolios, better social insurance, and higher ex ante welfare. Our result can rationalize the prevalent limited coverage of safety nets, such as the lender of last resort facilities.

By how much does an extension of unemployment benefits affect macroeconomic outcomes such as unemployment? Answering this question is challenging because U.S. law extends benefits for states experiencing high unemployment. We use data revisions to decompose the variation in the duration of benefits into the part coming from actual differences in economic conditions and the part coming from measurement error in the real-time data used to determine benefit extensions. Using only the variation coming from measurement error, we find that benefit extensions have a limited influence on state-level macroeconomic outcomes. We use our estimates to quantify the effects of the increase in the duration of benefits during the Great Recession and find that they increased the unemployment rate by at most 0.3 percentage point.

A standard approach to estimating structural parameters in life-cycle models imposes sufficient assumptions on the data to identify the "age profile" of outcomes, then chooses model parameters so that the model's age profile matches this empirical age profile. I show that this approach is both incorrect and unnecessary: incorrect, because it generally produces inconsistent estimators of the structural parameters, and unnecessary, because consistent estimators can be obtained under weaker assumptions. I derive an estimation method that avoids the problems of the standard approach. I illustrate the method's benefits analytically in a simple model of consumption inequality and numerically by reestimating the classic life-cycle consumption model of Gourinchas and Parker (2002).