Creator: Perri, Fabrizio and Quadrini, Vincenzo Series: Great depressions of the twentieth century Abstract:
We analyze the Italian economy in the interwar years. In Italy, as in many other countries, the years immmediately after 1929 were characterized by a major slowdown in economic activity as non farm output declined almost 12. We argue that the slowdown cannot be explained solely by productivity shocks and that other factors must have contributed to the depth and duration of the the 1929 crisis. We present a model in which trade restrictions together with wage rigidities produce a slowdown in economic activity that is consistent with the one observed in the data. The model is also consistent with evidence from sectorial disaggregated data. Our model predicts that trade restrictions can account for about 3/4 of the observed slowdown while wage rigidity (monetary shocks) can account for the remaining fourth.
Keyword: Wage rigidity, Italy, Depressions, and Trade restrictions Subject (JEL): N14 - Economic History: Macroeconomics and Monetary Economics; Industrial Structure; Growth; Fluctuations: Europe: 1913- and E32 - Business Fluctuations; Cycles
Creator: Fogli, Alessandra and Perri, Fabrizio Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 512 Abstract:
Does macroeconomic volatility/uncertainty affect accumulation of net foreign assets? In OECD economies over the period 1970-2012, changes in country specific aggregate volatility are, after controlling for a wide array of factors, significantly positively associated with net foreign asset position. An increase in volatility (measured as the standard deviation of GDP growth) of 0.5% over period of 10 years is associated with an increase in the net foreign assets of around 8% of GDP. A standard open economy model with time varying aggregate uncertainty can quantitatively account for this relationship. The key mechanism is precautionary motive: more uncertainty induces residents to save more, and higher savings are in part channeled into foreign assets. We conclude that both data and theory suggest uncertainty/volatility is an important determinant of the medium/long run evolution of external imbalances in developed countries.
Keyword: Uncertainty, Business cycles, Global imbalances, Current account, and Precautionary saving Subject (JEL): F32 - Current Account Adjustment; Short-term Capital Movements, F34 - International Lending and Debt Problems, and F41 - Open Economy Macroeconomics
Creator: Heathcote, Jonathan and Perri, Fabrizio Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 508 Abstract:
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.
Keyword: Aggregate demand, Precautionary saving, Business cycles, Self-fulfilling crises, Multiple equilibria, and Zero lower bound Subject (JEL): E52 - Monetary Policy, E21 - Macroeconomics: Consumption; Saving; Wealth, and E12 - General Aggregative Models: Keynes; Keynesian; Post-Keynesian
Creator: Heathcote, Jonathan and Perri, Fabrizio Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 480 Abstract:
This chapter is structured in three parts. The first part outlines the methodological steps, involving both theoretical and empirical work, for assessing whether an observed allocation of resources across countries is efficient. The second part applies the methodology to the long-run allocation of capital and consumption in a large cross section of countries. We find that countries that grow faster in the long run also tend to save more both domestically and internationally. These facts suggest that either the long-run allocation of resources across countries is inefficient, or that there is a systematic relation between fast growth and preference for delayed consumption. The third part applies the methodology to the allocation of resources across developed countries at the business cycle frequency. Here we discuss how evidence on international quantity comovement, exchange rates, asset prices, and international portfolio holdings can be used to assess efficiency. Overall, quantities and portfolios appear consistent with efficiency, while evidence from prices is difficult to interpret using standard models. The welfare costs associated with an inefficient allocation of resources over the business cycle can be significant if shocks to relative country permanent income are large. In those cases partial financial liberalization can lower welfare.
Keyword: International risk sharing, Real exchange rate, International business cycles, Long-run growth, and Long-run risk Subject (JEL): F36 - Financial Aspects of Economic Integration and F41 - Open Economy Macroeconomics
Creator: Perri, Fabrizio and Quadrini, Vincenzo Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 463 Abstract:
The 2007–2009 crisis was characterized by an unprecedented degree of international synchronization as all major industrialized countries experienced large macroeconomic contractions around the date of Lehman bankruptcy. At the same time countries also experienced large and synchronized tightening of credit conditions. We present a two-country model with financial market frictions where a credit tightening can emerge as a self-fulfilling equilibrium caused by pessimistic but fully rational expectations. As a result of the credit tightening, countries experience large and endogenously synchronized declines in asset prices and economic activity (international recessions). The model suggests that these recessions are more severe if they happen after a prolonged period of credit expansion.
Keyword: International co-movement, Global liquidity, and Credit shocks Subject (JEL): G01 - Financial Crises, F41 - Open Economy Macroeconomics, and F44 - International Business Cycles
Creator: Heathcote, Jonathan and Perri, Fabrizio Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 398 Abstract:
In simple one-good international macro models, the presence of non-diversifiable labor income risk means that country portfolios should be heavily biased toward foreign assets. The fact that the opposite pattern of diversification is observed empirically constitutes the international diversification puzzle. We embed a portfolio choice decision in a frictionless two-country, two-good version of the stochastic growth model. In this environment, which is a workhorse for international business cycle research, we derive a closed-form expression for equilibrium country portfolios. These are biased towards domestic assets, as in the data. Home bias arises because endogenous international relative price fluctuations make domestic stocks a good hedge against non-diversifiable labor income risk. We then use our theory to link openness to trade to the level of diversification, and find that it offers a quantitatively compelling account for the patterns of international diversification observed across developed economies in recent years.
Subject (JEL): F36 - Financial Aspects of Economic Integration and F41 - Open Economy Macroeconomics
Creator: Perri, Fabrizio and Stefanidis, Georgios Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 554 Abstract:
We use balance sheet data and stock market data for the major U.S. banking institutions during and after the 2007-8 financial crisis to estimate the magnitude of the losses experienced by these institutions because of the crisis. We then use these estimates to assess the impact of the crisis under alternative, and higher, capital requirements. We find that substantially higher capital requirements (in the 20% to 30% range) would have substantially reduced the vulnerability of these financial institutions, and consequently they would have significantly reduced the need of a public bailout.
Keyword: Financial crises and Too big to fail Subject (JEL): G21 - Banks; Depository Institutions; Micro Finance Institutions; Mortgages and G01 - Financial Crises
Creator: Heathcote, Jonathan and Perri, Fabrizio Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 523 Abstract:
In a standard two-country international macro model, we ask whether imposing restrictions on international non contingent borrowing and lending is ever desirable. The answer is yes. If one country imposes capital controls unilaterally, it can generate favorable changes in the dynamics of equilibrium interest rates and the terms of trade, and thereby benefit at the expense of its trading partner. If both countries simultaneously impose capital controls, the welfare effects are ambiguous. We identify calibrations in which symmetric capital controls improve terms of trade insurance against country-specific shocks and thereby increase welfare for both countries.
Keyword: International risk sharing, Terms of trade, and Capital controls Subject (JEL): F32 - Current Account Adjustment; Short-term Capital Movements, F41 - Open Economy Macroeconomics, and F42 - International Policy Coordination and Transmission
Creator: Krueger, Dirk and Perri, Fabrizio Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 363 Abstract:
Using data from the Consumer Expenditure Survey, we first document that the recent increase in income inequality in the United States has not been accompanied by a corresponding rise in consumption inequality. Much of this divergence is due to different trends in within-group inequality, which has increased significantly for income but little for consumption. We then develop a simple framework that allows us to analytically characterize how within-group income inequality affects consumption inequality in a world in which agents can trade a full set of contingent consumption claims, subject to endogenous constraints emanating from the limited enforcement of intertemporal contracts (as in Kehoe and Levine, 1993). Finally, we quantitatively evaluate, in the context of a calibrated general equilibrium production economy, whether this setup, or alternatively a standard incomplete markets model (as in Aiyagari, 1994), can account for the documented stylized consumption inequality facts from the U.S. data.
Keyword: Limited Enforcement, Risk Sharing, and Consumption Inequality Subject (JEL): D31 - Personal Income, Wealth, and Their Distributions, E21 - Macroeconomics: Consumption; Saving; Wealth, D63 - Equity, Justice, Inequality, and Other Normative Criteria and Measurement, D91 - Micro-Based Behavioral Economics: Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making, and G22 - Insurance; Insurance Companies; Actuarial Studies
Creator: Krueger, Dirk and Perri, Fabrizio Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 262 Abstract:
We explore the welfare consequences of different taxation schemes in an economy where agents are debt-constrained. If agents default on their debt, they are banned from future credit markets, but retain their private endowments which are subject to income taxation. A change in the tax system changes the severity of punishment from default and, hence, leads to a limitation of possible risk sharing via private contracts. The welfare consequences of a change in the tax system depend on the relative magnitudes of increased risk sharing forced by the new tax system and the reduced risk sharing in private insurance markets. We quantitatively address this issue by calibrating an artificial economy to US income and tax data. We show that for a plausible selection of the structural parameters of our model, the change to a more redistributive tax system leads to less risk sharing among individuals and lower ex-ante welfare.
Keyword: Risk Sharing, Redistributive Taxation, and Incomplete Markets Subject (JEL): E62 - Fiscal Policy, D91 - Micro-Based Behavioral Economics: Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making, and H31 - Fiscal Policies and Behavior of Economic Agents: Household