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: Hansen, Lars Peter and Jagannathan, Ravi Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 167 Abstract:
In this paper we develop alternative ways to compare asset pricing models when it is understood that their implied stochastic discount factors do not price all portfolios correctly. Unlike comparisons based on chi-squared statistics associated with null hypotheses that models are correct, our measures of model performance do not reward variability of discount factor proxies. One of our measures is designed to exploit fully the implications of arbitrage-free pricing of derivative claims. We demonstrate empirically the usefulness of methods in assessing some alternative stochastic factor models that have been proposed in asset pricing literature.
Subject (JEL): C13 - Estimation: General, E30 - Prices, Business Fluctuations, and Cycles: General (includes Measurement and Data), C12 - Hypothesis Testing: General, C10 - Econometric and Statistical Methods and Methodology: General, G10 - General Financial Markets: General (includes Measurement and Data), and G12 - Asset Pricing; Trading Volume; Bond Interest Rates
Creator: Williamson, Stephen D. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 119 Abstract:
During the period 1870–1913, Canada had a well-diversified branch banking system while banks in the U.S. unit banking system were less diversified. Canadian banks could issue large-denomination notes with no restrictions on their backing, while all U.S. currency was essentially an obligation of the U.S. government. Also, experience in the two countries with regard to bank failures and banking panics was quite different. A general equilibrium business cycle model with endogenous financial intermediation is constructed that captures these historical Canadian and American monetary and banking arrangements as special cases. The predictions of the model contradict conventional wisdom with regard to the cyclical effects of banking panics. Support for these predictions is found in aggregate annual time series data for Canada and the United States.
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: 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: 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: 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: Atkeson, Andrew, Eisfeldt, Andrea L., and Weill, Pierre-Olivier Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 484 Abstract:
Building on the Merton (1974) and Leland (1994) structural models of credit risk, we develop a simple, transparent, and robust method for measuring the financial soundness of individual firms using data on their equity volatility. We use this method to retrace quantitatively the history of firms’ financial soundness during U.S. business cycles over most of the last century. We highlight three main findings. First, the three worst recessions between 1926 and 2012 coincided with insolvency crises, but other recessions did not. Second, fluctuations in asset volatility appear to drive variation in firms’ financial soundness. Finally, the financial soundness of financial firms largely resembles that of nonfinancial firms.
Keyword: Distance to Default, Volatility, Financial Frictions and Business Cycles, and Credit Risk Modeling Subject (JEL): E44 - Financial Markets and the Macroeconomy, E32 - Business Fluctuations; Cycles, G32 - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill, and G01 - Financial Crises
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: Bhandari, Anmol, Birinci, Serdar, McGrattan, Ellen R., and See, Kurt Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 568 Abstract:
This paper examines the reliability of widely used surveys on U.S. businesses. We compare survey responses of business owners with administrative data and document large inconsistencies in business incomes, receipts, and the number of owners. We document problems due to nonrepresentative samples and measurement errors. Nonrepresentativeness is reflected in undersampling of owners with low incomes. Measurement errors arise because respondents do not refer to relevant documents and possibly because of framing issues. We discuss implications for statistics of interest, such as business valuations and returns. We conclude that predictions based on current survey data should be treated with caution.
Keyword: Survey data, Business taxes and valuation, and Intangibles Subject (JEL): H25 - Business Taxes and Subsidies including sales and value-added (VAT), C83 - Survey Methods; Sampling Methods, and E22 - Investment; Capital; Intangible Capital; Capacity