Research Database

Common statistical measures of bond risk premia are volatile and countercyclical. This paper uses survey data on interest rate forecasts to construct subjective bond risk premia. Subjective premia are less volatile and not very cyclical; instead they are high, only around the early 1980s. The reason for the discrepancy is that survey forecasts of interest rates are made as if both the level and the slope of the yield curve are more persistent than under common statistical models. The paper then proposes a consumption based asset pricing model with learning to explain jointly the difference between survey and statistical forecasts, and the evolution of subjective premia. Adaptive learning gives rise to inertia in forecasts, as well as changes in conditional volatility that help understand both features.

This paper is an extension of Monika Piazzesi's and Martin Schneider's work while they were in the Research Department of the Federal Reserve Bank of Minneapolis.

In this paper, we employ both calibration and modern (Bayesian) estimation methods to assess the role of neutral and investment-specific technology shocks in generating fluctuations in hours. Using a neoclassical stochastic growth model, we show how answers are shaped by the identification strategies and not by the statistical approaches. The crucial parameter is the labor supply elasticity. Both a calibration procedure that uses modern assessments of the Frisch elasticity and the estimation procedures result in technology shocks accounting for 2% to 9% of the variation in hours worked in the data. We infer that we should be talking more about identification and less about the choice of particular quantitative approaches.

Macroeconomics is evolving from the study of aggregate dynamics to the study of the dynamics of the entire equilibrium distribution of allocations across individual economic actors. This article reviews the quantitative macroeconomic literature that focuses on household heterogeneity, with a special emphasis on the “standard” incomplete markets model. We organize the vast literature according to three themes that are central to understanding how inequality matters for macroeconomics. First, what are the most important sources of individual risk and cross-sectional heterogeneity? Second, what are individuals’ key channels of insurance? Third, how does idiosyncratic risk interact with aggregate risk?

I study asset prices in a two-agent macroeconomic model with two key features: limited stock market participation and heterogeneity in the elasticity of intertemporal substitution in consumption (EIS). The model is consistent with some prominent features of asset prices, such as a high equity premium; relatively smooth interest rates; procyclical stock prices; and countercyclical variation in the equity premium, its volatility, and in the Sharpe ratio. In this model, the risk-free asset market plays a central role by allowing non-stockholders (with low EIS) to smooth the fluctuations in their labor income. This process concentrates non-stockholders’ labor income risk among a small group of stockholders, who then demand a high premium for bearing the aggregate equity risk. Furthermore, this mechanism is consistent with the very small share of aggregate wealth held by non-stockholders in the US data, which has proved problematic for previous models with limited participation. I show that this large wealth inequality is also important for the model’s ability to generate a countercyclical equity premium. When it comes to business cycle performance the model’s progress has been more limited: consumption is still too volatile compared to the data, whereas investment is still too smooth. These are important areas for potential improvement in this framework.

Studying the experience of countries that have experienced great depressions during the twentieth century teaches us that massive public interventions in the economy to maintain employment and investment during a financial crisis can, if they distort incentives enough, lead to a great depression.

It is well known that movements in lending rates are asymmetric; they rise quickly and sharply, but fall slowly and gradually. Not known is the fact that the asymmetry is stronger the less developed a country’s financial system is. This new fact is here documented and explained in a model with an endogenous flow of information about economic conditions. The stronger asymmetry in less developed countries stems from their greater financial system frictions, such as monitoring and bankruptcy costs, which first magnify jumps of lending rates and then delay their recoveries by restricting the generation of information after the crisis. A quantitative exploration of the model shows the data are consistent with this explanation.

The U.S. Bureau of Economic Analysis (BEA) estimates the return on investments of foreign subsidiaries of U.S. multinational companies over the period 1982–2006 averaged 9.4 percent annually after taxes; U.S. subsidiaries of foreign multinationals averaged only 3.2 percent. Two factors distort BEA returns: technology capital and plant-specific intangible capital. Technology capital is accumulated know-how from intangible investments in R&D, brands, and organizations that can be used in foreign and domestic locations. Used abroad, it generates profits for foreign subsidiaries with no foreign direct investment (FDI). Plant-specific intangible capital in foreign subsidiaries is expensed abroad, lowering current profits on FDI and increasing future profits. We develop a multicountry general equilibrium model with an essential role for FDI and apply the BEA’s methodology to construct economic statistics for the model economy. We estimate that mismeasurement of intangible investments accounts for over 60 percent of the difference in BEA returns.

Appendix A provides firm-level and industry-level evidence that is consistent with several key features of our model, including the predictions that rates of return increase with a firm’s intangible investments and foreign affiliate rates of return increase with age and with their parents’ R&D intensity. Appendix B provides details for the computation of our model’s equilibrium paths, the construction of model national and international accounts, and the sensitivity of our main findings to alternative parameterizations of the model. We demonstrate that the main finding of our paper—namely, that the mismeasurement of capital accounts for roughly 60 percent of the gap in FDI returns—is robust to alternative choices of income shares, depreciation rates, and tax rates, assuming the same procedure is followed in setting exogenous parameters governing the model’s current account. Appendix C demonstrates that adding technology capital and locations to an otherwise standard two-country general equilibrium model has a large impact on the predicted behavior of labor productivity and net exports.

Concerns about constructing and maintaining good reputations are known to reduce borrowers’ excessive risk-taking. However, I find that the self-discipline induced by these concerns is fragile, and can break down without obvious changes in economic fundamentals. Furthermore, in the aggregate, breakdowns are clustered among borrowers with intermediate and good reputations, which can exacerbate an economy’s weakness and contribute to a broad economic crisis. These results come from an aggregate dynamic global game analysis of reputation formation in credit markets. The selection of a unique equilibrium is accomplished by assuming that borrowers have incomplete information about economic fundamentals.

In this paper, we construct a parsimonious overlapping-generations model of human capital accumulation and study its quantitative implications for the evolution of the U.S. wage distribution from 1970 to 2000. A key feature of the model is that individuals differ in their ability to accumulate human capital, which is the main source of wage inequality in this model. We examine the response of this model to skill-biased technical change (SBTC), which is modeled as an increase in the trend growth rate of the price of human capital starting in the early 1970s. The model displays behavior that is consistent with several important trends observed in the US data, including the rise in overall wage inequality; the fall and subsequent rise in the college premium, as well as the fact that this behavior was most pronounced for younger workers; the rise in within-group inequality; the stagnation in median wage growth; and the small rise in consumption inequality despite the large rise in wage inequality. We consider different scenarios regarding how individuals’ expectations evolve during SBTC. Specifically, we study the case where individuals immediately realize the advent of SBTC (perfect foresight), and the case where they initially underestimate the future growth of the price of human capital (pessimistic priors), but learn the truth in a Bayesian fashion over time. Lack of perfect foresight appears to have little effect on the main results of the paper. Overall, the model shows promise for explaining a diverse set of wage distribution trends observed since the 1970s in a unifying human capital framework.

We study the effects of large transportation costs on economic development. We argue that the Midwest and the Northeast of the U.S. is a natural case because starting from 1840 decent data is available showing that the two regions shared key characteristics with today’s developing countries and that transportation costs were large and then came way down. To disentangle the effects of the large reduction in transportation costs from those of other changes that happened during 1840–1860, we build a model that speaks to the distribution of people across regions and across the sectors of production. We find that the large reduction in transportation costs was a quantitatively important force behind the settlement of the Midwest and the regional specialization that concentrated agriculture in the Midwest and industry in the Northeast. Moreover, we find that it led to the convergence of the regional per capita incomes measured in current regional prices and that it increased real GDP per capita. However, the increase in real GDP per capita is considerably smaller than that resulting from the productivity growth in the nontransportation sectors.

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.

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.

In standard approaches to monetary policy, interest rate rules often lead to indeterminacy. Sophisticated policies, which depend on the history of private actions and can differ on and off the equilibrium path, can eliminate indeterminacy and uniquely implement any desired competitive equilibrium. Two types of sophisticated policies illustrate our approach. Both use interest rates as the policy instrument along the equilibrium path. But when agents deviate from that path, the regime switches, in one example to money; in the other, to a hybrid rule. Both lead to unique implementation, while pure interest rate rules do not. We argue that adherence to the Taylor principle is neither necessary nor sufficient for unique implementation with pure interest rate rules but is sufficient with hybrid rules. Our results are robust to imperfect information and may provide a rationale for empirical work on monetary policy rules and determinacy.

We conduct a systematic empirical study of cross-sectional inequality in the United States, integrating data from the Current Population Survey, the Panel Study of Income Dynamics, the Consumer Expenditure Survey, and the Survey of Consumer Finances. In order to understand how different dimensions of inequality are related via choices, markets, and institutions, we follow the mapping suggested by the household budget constraint from individual wages to individual earnings, to household earnings, to disposable income, and, ultimately, to consumption and wealth. We document a continuous and sizable increase in wage inequality over the sample period. Changes in the distribution of hours worked sharpen the rise in earnings inequality before 1982, but mitigate its increase thereafter. Taxes and transfers compress the level of income inequality, especially at the bottom of the distribution, but have little effect on the overall trend. Finally, access to financial markets has limited both the level and growth of consumption inequality.

I document that cross-country productivity differences in retail trade, which employs around 20% of workers, are accounted for in large part by compositional differences. In richer countries, most retailing is done in modern stores, with high measured output per worker, whereas in developing countries, retail trade is dominated by less-productive traditional stores. I hypothesize that developing countries rationally adopt few modern stores since car ownership rates are low. A simple quantitative model of home production supports the role of cars in determining the composition of retail technologies used and retail-sector productivity differences across countries.

Wage inequality has been significantly higher in the United States than in continental European countries (CEU) since the 1970s. Moreover, this inequality gap has further widened during this period as the US has experienced a large increase in wage inequality, whereas the CEU has seen only modest changes. This paper studies the role of labor income tax policies for understanding these facts. We begin by documenting two new empirical facts that link these inequality differences to tax policies. First, we show that countries with more progressive labor income tax schedules have significantly lower before-tax wage inequality at different points in time. Second, progressivity is also negatively correlated with the rise in wage inequality during this period. We then construct a life cycle model in which individuals decide each period whether to go to school, work, or be unemployed. Individuals can accumulate skills either in school or while working. Wage inequality arises from differences across individuals in their ability to learn new skills as well as from idiosyncratic shocks. Progressive taxation compresses the (after-tax) wage structure, thereby distorting the incentives to accumulate human capital, in turn reducing the cross-sectional dispersion of (before-tax) wages. We find that these policies can account for half of the difference between the US and the CEU in overall wage inequality and 76% of the difference in inequality at the upper end (log 90-50 differential). When this economy experiences skill-biased technological change, progressivity also dampens the rise in wage dispersion over time. The model explains 41% of the difference in the total rise in inequality and 58% of the difference at the upper end.

In the 1970s, U.S. asset markets witnessed (i) a 25% dip in the ratio of aggregate household wealth relative to GDP and (ii) negative comovement of house and stock prices that drove a 20% portfolio shift out of equity into real estate. This study uses an overlapping generations model with uninsurable nominal risk to quantify the role of structural change in these events. We attribute the dip in wealth to the entry of baby boomers into asset markets, and to the erosion of bond portfolios by surprise inflation, both of which lowered the overall propensity to save. We also show that the Great Inflation led to a portfolio shift by making housing more attractive than equity. Apart from tax effects, a new channel is that disagreement about inflation across age groups drives up collateral prices when credit is nominal.

This paper is an extension of Monika Piazzesi's and Martin Schneider's work while they were in the Research Department of the Federal Reserve Bank of Minneapolis.

This paper studies household beliefs during the recent US housing boom. To characterize the heterogeneity in households’ views about housing and the economy, we perform a cluster analysis on survey responses at different stages of the boom. The estimation always finds a small cluster of households who believe it is a good time to buy a house because house prices will rise further. The size of this “momentum” cluster doubled towards the end of the boom. We also provide a simple search model of the housing market to show how a small number of optimistic investors can have a large effect on prices without buying a large share of the housing stock.

This paper is an extension of Monika Piazzesi's and Martin Schneider's work while they were in the Research Department of the Federal Reserve Bank of Minneapolis.

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.

Scapegoating is often said to be a source of inefficiency in organizations. In this paper, I analyze the consequences of scapegoating within a firm in a model where reputation concerns drive the actions of superiors. Consider delegation choices, for example. Hiring efficient workers may be a good idea if successful production is the only way to build reputation. But if successful scapegoating also increases reputation, superiors will tend to hire less efficient workers and will eventually blame them for failures. I characterize scapegoating as an activity “nested” after failures. Even though the results of scapegoating do not affect welfare directly, they do so indirectly through the decisions governing the probability of success in production. We examine how activities “nested” after good results may increase efficiency without relying on costly incentives and why superiors tend to hire better workers during good times.

No abstract available. Introduction: This paper considers the question, Does the limited liability associated with banking make it necessary for a government to regulate bank employee compensation? It attempts to shed light on this question by considering a mechanism design framework. In it, a single risk averse employee must be induced to search for good investment opportunities and turn down bad investment opportunities.

Empirical studies quantifying the benefits of increased foreign direct investment (FDI) have been unable to provide conclusive evidence of a positive impact on the host country’s economic performance. I show that the lack of robust evidence is not inconsistent with theory, even if the gains to FDI openness are large. Anticipated welfare gains to increased inward FDI should lead to immediate declines in domestic investment and employment and eventual increases. Furthermore, since part of FDI is intangible investment that is expensed from company profits, gross domestic product (GDP) and gross national product (GNP) should decline during periods of abnormally high FDI investment. Using the model of McGrattan and Prescott (2009) and data from the IMF Balance of Payments to parameterize the time paths of FDI openness for each country in the sample, I do not find an economically significant relationship between the amount of inward FDI a country did over the period 1980—2005 and the growth in real GDP predicted by the model. This finding rests crucially on the fact that most of these countries are still in transition to FDI openness.

This paper examines the relationship between the dynamics of parent-youth living arrangements and labor market outcomes for youths who do not go to college in the United States. The data come from a newly constructed panel data set based on retrospective monthly coresidence questions in the NLSY97. This is the first data set containing information on the labor market circumstances of youths at the time of movements in and out of the parental home. Based on estimates from duration models that allow for unobserved heterogeneity, I find that moving from employment to non-employment increases the hazard of moving back home in a given month by 64% for males and 71% for females. These results suggest that labor market factors play an important role in determining the dynamics of parent-youth living arrangements and that coresidence may be an important way in which insurance against labor market shocks takes place within the family.

We estimate the factors determining specialization of crop choice at the level of individual fields, distinguishing between the role of natural advantage (soil characteristics) and economies of density (scale economies achieved when farmers plant neighboring fields with the same crop). Using rich geographic data from North Dakota, including new data on crop choice collected by satellite, we estimate the analog of a social interactions econometric model for the planting decisions on neighboring fields. We find that planting decisions on a field are heavily dependent on the soil characteristics of the neighboring fields. Through this relationship, we back out the structural parameters of economies of density. Setting an Ellison-Glaeser dartboard level of specialization as a benchmark, we find that of the actual level of specialization achieved beyond this benchmark, approximately two-thirds can be attributed to natural advantage and one-third to density economies.

We develop a theory of outsourcing in which there is market power in one factor market (labor) and no market power in a second factor market (capital). There are two intermediate goods: one labor-intensive and the other capital-intensive. We show there is always outsourcing in the market allocation when a friction limiting outsourcing is not too big. The key factor underlying the result is that labor demand is more elastic, the greater the labor share. Integrated plants pay higher wages than the specialist producers of labor-intensive intermediates. We derive conditions under which there are multiple equilibria that vary in the degree of outsourcing. Across these equilibria, wages are lower the greater the degree of outsourcing. Wages fall when outsourcing increases in response to a decline in the outsourcing friction.

We use an extended Barro-Becker model of endogenous fertility, in which parents are heterogeneous in their labor productivity, to study the efficient degree of consumption inequality in the long run. In our environment a utilitarian planner allows for consumption inequality even when labor productivity is public information. We show that adding private information does not alter this result. We also show that the informationally constrained optimal insurance contract has a resetting property—whenever a family line experiences the highest shock, the continuation utility of each child is reset to a (high) level that is independent of history. This implies that there is a non-trivial, stationary distribution over continuation utilities and there is no mass at misery. The novelty of our approach is that the no-immiseration result is achieved without requiring that the objectives of the planner and the private agents disagree. Because there is no discrepancy between planner and private agents' objectives, the policy implications for implementation of the efficient allocation differ from previous results in the literature. Two examples of these are: 1) estate taxes are positive and 2) there are positive taxes on family size.

Previous studies quantifying the effects of increased taxation during the U.S. Great Depression find that its contribution is small, in accounting for both the downturn in the early 1930s and the slow recovery after 1934. This paper shows that this conclusion rests critically on the assumption that the only taxable capital income is business profits. Effects of capital taxation are much larger when taxes on property, capital stock, excess profits, undistributed profits, and dividends are included in the analysis. When fed into a general equilibrium model, the increased taxes imply significant declines in investment and equity values and nontrivial declines in gross domestic product (GDP) and hours of work. Of particular importance during the Great Depression was the dramatic rise in the effective tax rate on corporate dividends.