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Creator: Holmes, Thomas J. and Thornton Snider, Julia Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 669 Abstract:
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.
Tema: L22 - Firm Organization and Market Structure, J31 - Wage Level and Structure; Wage Differentials, and L23 - Organization of Production
Creator: Holmes, Thomas J. and Lee, Sanghoon Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 668 Abstract:
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.
Tema: R12 - Size and Spatial Distributions of Regional Economic Activity, R14 - Land Use Pattern, and Q10 - Agriculture: General
Creator: Troshkin, Maxim Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 667 Abstract:
Technical details and specific data sources are provided for “Facts and Myths about the Financial Crisis of 2008” by V. V. Chari, Lawrence Christiano, and Patrick J. Kehoe.
Creator: Chari, V. V., Christiano, Lawrence J., and Kehoe, Patrick J. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 666 Abstract:
The United States is indisputably undergoing a financial crisis and is perhaps headed for a deep recession. Here we examine three claims about the way the financial crisis is affecting the economy as a whole and argue that all three claims are myths. We also present three underappreciated facts about how the financial system intermediates funds between households and corporate businesses. Conventional analyses of the financial crisis focus on interest rate spreads. We argue that such analyses may lead to mistaken inferences about the real costs of borrowing and argue that, during financial crises, variations in the levels of nominal interest rates might lead to better inferences about variations in the real costs of borrowing. Moreover, we argue that even if current increase in spreads indicate increases in the riskiness of the underlying projects, by itself, this increase does not necessarily indicate the need for massive government intervention. We call for policymakers to articulate the precise nature of the market failure they see, to present hard evidence that differentiates their view of the data from other views which would not require such intervention, and to share with the public the logic and evidence that burnishes the case that the particular intervention they are advocating will fix this market failure.
Creator: Yazici, Hakki Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 665 Abstract:
This paper studies efficient allocation of resources in an economy in which agents are initially heterogeneous with regard to their wealth levels and whether they have ideas or not. An agent with an idea can start a business that generates random returns. Agents have private information about (1) their initial types, (2) how they allocate their resources, and (3) the realized returns. The unobservability of returns creates a novel motive for subsidizing agents who have ideas but lack resources to invest in them. To analyze this motive in isolation, the paper assumes that agents are risk-neutral and abstracts away from equality and insurance considerations. The unobservability of initial types and actions implies that the subsidy that poor agents with ideas receive is limited by incentive compatibility: the society should provide other agents with enough incentives so that they do not claim to be poor and have ideas. The paper then provides an implementation of the constrained-efficient allocation in an incomplete markets setup that is similar to the U.S. Small Business Administration’s Business Loan Program. Finally, the paper extends the model in several dimensions to show that the results are robust to these generalizations of the model.
Creator: Chari, V. V., Kehoe, Patrick J., and McGrattan, Ellen R. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 664 Abstract:
In the 1970s macroeconomists often disagreed bitterly. Macroeconomists have now largely converged on method, model design, and macroeconomic policy advice. The disagreements that remain all stem from the practical implementation of the methodology. Some macroeconomists think that New Keynesian models are on the verge of being useful for quarter-to-quarter quantitative policy advice. We do not. We argue that the shocks in these models are dubiously structural and show that many of the features of the model as well as the implications due to these features are inconsistent with microeconomic evidence. These arguments lead us to conclude that New Keynesian models are not yet useful for policy analysis.
Tema: E32 - Business Fluctuations; Cycles and E58 - Central Banks and Their Policies
Creator: Ales, Laurence and Maziero, Pricila Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 663 Abstract:
We study the quantitative properties of constrained efficient allocations in an environment where risk sharing is limited by the presence of private information. We consider a life cycle version of a standard Mirrlees economy where shocks to labor productivity have a component that is public information and one that is private information. The presence of private shocks has important implications for the age profiles of consumption and income. First, they introduce an endogenous dispersion of continuation utilities. As a result, consumption inequality rises with age even if the variance of the shocks does not. Second, they introduce an endogenous rise of the distortion on the marginal rate of substitution between consumption and leisure over the life cycle. This is because, as agents age, the ability to properly provide incentives for work must become less and less tied to promises of benefits (through either increased leisure or consumption) in future periods. Both of these features are also present in the data. We look at the data through the lens of our model and estimate the fraction of labor productivity that is private information. We find that for the model and data to be consistent, a large fraction of shocks to labor productivities must be private information.
Palabra clave: Risk sharing, Private information, and Consumption inequality Tema: D91 - Micro-Based Behavioral Economics: Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making, H21 - Taxation and Subsidies: Efficiency; Optimal Taxation, D11 - Consumer Economics: Theory, D58 - Computable and Other Applied General Equilibrium Models, D86 - Economics of Contract: Theory, and D82 - Asymmetric and Private Information; Mechanism Design
Creator: Kehoe, Patrick J. and Midrigan, Virgiliu Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 661 Abstract:
In the data, a large fraction of price changes are temporary. We provide a simple menu cost model which explicitly includes a motive for temporary price changes. We show that this simple model can account for the main regularities concerning temporary and permanent price changes. We use the model as a benchmark to evaluate existing shortcuts that do not explicitly model temporary price changes. One shortcut is to take the temporary changes out of the data and fit a simple Calvo model to it. If we do so prices change only every 50 weeks and the Calvo model overestimates the real effects of monetary shocks by almost 70%. A second shortcut is to leave the temporary changes in the data. If we do so prices change every 3 weeks and the Calvo model produces only 1/9 of the real effects of money as in our benchmark. We show that a simple Calvo model can generate the same real effects as our benchmark model if we set parameters so that prices change every 17 weeks.
Tema: E12 - General Aggregative Models: Keynes; Keynesian; Post-Keynesian, E50 - Monetary Policy, Central Banking, and the Supply of Money and Credit: General, and E58 - Central Banks and Their Policies
Creator: Guner, Nezih, Kaygusuz, Remzi, and Ventura, Gustavo Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 660 Abstract:
We evaluate reforms to the U.S. tax system in a dynamic setup with heterogeneous married and single households, and with an operative extensive margin in labor supply. We restrict our model with observations on gender and skill premia, labor force participation of married females across skill groups, and the structure of marital sorting. We study four revenue-neutral tax reforms: a proportional consumption tax, a proportional income tax, a progressive consumption tax, and a reform in which married individuals file taxes separately. Our findings indicate that tax reforms are accompanied by large and differential effects on labor supply: while hours per-worker display small increases, total hours and female labor force participation increase substantially. Married females account for more than 50% of the changes in hours associated to reforms, and their importance increases sharply for values of the intertemporal labor supply elasticity on the low side of empirical estimates. Tax reforms in a standard version of the model result in output gains that are up to 15% lower than in our benchmark economy.
Palabra clave: Taxation, Two-earner households, and Labor force participation Tema: E62 - Fiscal Policy, H31 - Fiscal Policies and Behavior of Economic Agents: Household, J22 - Time Allocation and Labor Supply, and J12 - Marriage; Marital Dissolution; Family Structure; Domestic Abuse
Creator: Atkeson, Andrew, Chari, V. V., and Kehoe, Patrick J. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 659 Abstract:
The Ramsey approach to policy analysis finds the best competitive equilibrium given a set of available instruments. This approach is silent about unique implementation, namely designing policies so that the associated competitive equilibrium is unique. This silence is particularly problematic in monetary policy environments where many ways of specifying policy lead to indeterminacy. We show that sophisticated policies which depend on the history of private actions and which can differ on and off the equilibrium path can uniquely implement any desired competitive equilibrium. A large literature has argued that monetary policy should adhere to the Taylor principle to eliminate indeterminacy. Our findings say that adherence to the Taylor principle on these grounds is unnecessary. Finally, we show that sophisticated policies are robust to imperfect information.
Tema: E60 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook: General, E61 - Policy Objectives; Policy Designs and Consistency; Policy Coordination, E50 - Monetary Policy, Central Banking, and the Supply of Money and Credit: General, E58 - Central Banks and Their Policies, and E52 - Monetary Policy
Creator: Redish, Angela, 1952- and Weber, Warren E. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 658 Abstract:
Commodity money standards in medieval and early modern Europe were characterized by recurring complaints of small change shortages and by numerous debasements of the coinage. To confront these facts, we build a random matching monetary model with two indivisible coins with different intrinsic values. The model shows that small change shortages can exist in the sense that changes in the size of the small coin affect ex ante welfare. Further, the optimal ratio of coin sizes is shown to depend upon the trading opportunities in a country and a country’s wealth. Thus, coinage debasements can be interpreted as optimal responses to changes in fundamentals. Further, the model shows that replacing full-bodied small coins with tokens is not necessarily welfare-improving.
Palabra clave: Random matching, Commodity money, Optimal denominations, and Gresham's Law
Creator: Luttmer, Erzo G. J. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 657 Abstract:
Given a common technology for replicating blueprints, high-quality blueprints will be replicated more quickly than low-quality blueprints. If quality begets quality, and firms are identified with collections of blueprints derived from the same initial blueprint, then, along a balanced growth path, Gibrat’s Law holds for every type of firm. A firm size distribution with the thick right tail observed in the data can then arise only when the number of blueprints in the economy grows over time, or else firms cannot grow at a positive rate on average. But when calibrated to match the observed firm entry rate and the right tail of the size distribution, this model implies that the median age among firms with more than 10,000 employees is about 750 years. The problem is Gibrat’s Law. If the relative quality of a firm’s blueprints depreciates as the firm ages, then the firm’s growth rate slows down over time. By allowing for rapid and noisy initial growth, this version of the model can explain high observed entry rates, a thick-tailed size distribution, and the relatively young age of large U.S. corporations.
Palabra clave: Gibrat's Law, Firm age and size distribution, and Capital accumulation Tema: L11 - Production, Pricing, and Market Structure; Size Distribution of Firms and O40 - Economic Growth and Aggregate Productivity: General
Creator: Kehoe, Patrick J. and Midrigan, Virgiliu Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 656 Abstract:
The classic explanation for the persistence and volatility of real exchange rates is that they are the result of nominal shocks in an economy with sticky goods prices. A key implication of this explanation is that if goods have differing degrees of price stickiness then relatively more sticky goods tend to have relatively more persistent and volatile good-level real exchange rates. Using panel data, we find only modest support for these key implications. The predictions of the theory for persistence have some modest support: in the data, the stickier is the price of a good the more persistent is its real exchange rate, but the theory predicts much more variation in persistence than is in the data. The predictions of the theory for volatility fare less well: in the data, the stickier is the price of a good the smaller is its conditional variance while in the theory the opposite holds. We show that allowing for pricing complementarities leads to a modest improvement in the theory’s predictions for persistence but little improvement in the theory’s predictions for conditional variances.
Tema: F00 - International Economics: General and F40 - Macroeconomic Aspects of International Trade and Finance: General
Creator: Mehra, Rajnish, Piguillem, Facundo, and Prescott, Edward C. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 655 Abstract:
There is a large amount of intermediated borrowing and lending between households. Some of it is intergenerational, but most is between older households. The average difference in borrowing and lending rates is over 2 percent. In this paper, we develop a model economy that displays these facts and matches not only the returns on assets but also their quantities. The heterogeneity giving rise to borrowing and lending and differences in equity holdings depends on differences in the strength of the bequest motive. In equilibrium, the lenders are annuity holders and the borrowers are those who have equity holdings, who live off its income when retired, and who leave a bequest. The borrowing rate and return on equity are the same in the absence of aggregate uncertainty. The divergence between borrowing and lending rates can thus give rise to an equity premium, even in a world without aggregate uncertainty.
Palabra clave: Government debt, Equity premium, Retirement, Aggregate intermediation, Life cycle savings, Borrowing, and Lending Tema: E44 - Financial Markets and the Macroeconomy, G23 - Pension Funds; Non-bank Financial Institutions; Financial Instruments; Institutional Investors, H62 - National Deficit; Surplus, G10 - General Financial Markets: General (includes Measurement and Data), E20 - Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy: General (includes Measurement and Data), G11 - Portfolio Choice; Investment Decisions, D31 - Personal Income, Wealth, and Their Distributions, H00 - Public Economics: General, G12 - Asset Pricing; Trading Volume; Bond Interest Rates, and E21 - Macroeconomics: Consumption; Saving; Wealth
Creator: Chari, V. V. and Kehoe, Patrick J. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 654 Abstract:
Here we reply to Robert Solow’s comment on our work, Modern Macroeconomics in Practice: How Theory is Shaping Policy.
Creator: Liu, Zheng, Waggoner, Daniel F., and Zha, Tao Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 653 Abstract:
The possibility of regime shifts in monetary policy can have important effects on rational agents’ expectation formation and equilibrium dynamics. In a DSGE model where the monetary policy rule switches between a dovish regime that accommodates inflation and a hawkish regime that stabilizes inflation, the expectation effect is asymmetric across regimes. Such an asymmetric effect makes it difficult, but still possible, to generate substantial reductions in the volatilities of inflation and output as the monetary policy switches from the dovish regime to the hawkish regime.
Palabra clave: Structural breaks, Monetary policy regime, Expectations formation, Lucas critique, and Macroeconomic volatility Tema: E32 - Business Fluctuations; Cycles, E42 - Monetary Systems; Standards; Regimes; Government and the Monetary System; Payment Systems, and E52 - Monetary Policy
Creator: Kehoe, Patrick J. and Midrigan, Virgiliu Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 652 Abstract:
In the data, a sizable fraction of price changes are temporary price reductions referred to as sales. Existing models include no role for sales. Hence, when confronted with data in which a large fraction of price changes are sales related, the models must either exclude sales from the data or leave them in and implicitly treat sales like any other price change. When sales are included, prices change frequently and standard sticky price models with this high frequency of price changes predict small effects from money shocks. If sales are excluded, prices change much less frequently and a standard sticky price model with this low frequency of price changes predict much larger effects of money shocks. This paper adds a motive for sales in a parsimonious extension of existing sticky price models. We show that the model can account for most of the patterns of sales in the data. Using our model as the data generating process, we evaluate the existing approaches and find that neither well approximates the real effects of money in our economy in which sales are explicitly modeled.
Creator: McGrattan, Ellen R. and Prescott, Edward C. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 651 Abstract:
A framework is developed with what we call technology capital. A country is a measure of locations. Absent policy constraints, a firm owning a unit of technology capital can produce the composite output good using the unit of technology capital at as many locations as it chooses. But it can operate only one operation at a given location, so the number of locations is what constrains the number of units it operates using this unit of technology capital. If it has two units of technology capital, it can operate twice as many operations at every location. In this paper, aggregation is carried out and the aggregate production functions for the countries are derived. Our framework interacts well with the national accounts in the same way as does the neoclassical growth model. It also interacts well with the international accounts. There are constant returns to scale, and therefore no monopoly rents. Yet there are gains to being economically integrated. In the framework, a country’s openness is measured by the effect of its policies on the productivity of foreign operations. Our analysis indicates that there are large gains to this openness.
Palabra clave: Foreign direct investment and Openness Tema: F23 - Multinational Firms; International Business, F43 - Economic Growth of Open Economies, and O11 - Macroeconomic Analyses of Economic Development
Creator: Alvarez, Fernando, 1964-, Atkeson, Andrew, and Kehoe, Patrick J. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 650 Abstract:
The key question asked by standard monetary models used for policy analysis is, How do changes in short-term interest rates affect the economy? All of the standard models imply that such changes in interest rates affect the economy by altering the conditional means of the macroeconomic aggregates and have no effect on the conditional variances of these aggregates. We argue that the data on exchange rates imply nearly the opposite: the observation that exchange rates are approximately random walks implies that fluctuations in interest rates are associated with nearly one-for-one changes in conditional variances and nearly no changes in conditional means. In this sense, standard monetary models capture essentially none of what is going on in the data. We thus argue that almost everything we say about monetary policy using these models is wrong.
Creator: Luttmer, Erzo G. J. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 649 Abstract:
This paper describes a simple model of aggregate and firm growth based on the introduction of new goods. An incumbent firm can combine labor with blueprints for goods it already produces to develop new blueprints. Every worker in the economy is also a potential entrepreneur who can design a new blueprint from scratch and set up a new firm. The implied firm size distribution closely matches the fat tail observed in the data when the marginal entrepreneur is far out in the tail of the entrepreneurial skill distribution. The model produces a variance of firm growth that declines with size. But the decline is more rapid than suggested by the evidence. The model also predicts a new-firm entry rate equal to only 2.5% per annum, instead of the observed rate of 10% in U.S. data.
Creator: Birkeland, Kathryn and Prescott, Edward C. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 648 Abstract:
People are having longer retirement periods, and population growth is slowing and has even stopped in some countries. In this paper we determined the implications of these changes for the needed amount of government debt. The needed debt is near zero if there are high tax rates and the transfer share of gross national income (GNI) is high. But, with such a system there are huge dead-weight losses as the result of the high tax rate on labor income. With a savings system, a large government debt to annual GNI ratio is needed, as large as 5 times GNI, and welfare is as much as 24 percent higher in terms of lifetime consumption equivalents than the tax-and-transfer system.
Creator: Chari, V. V., Kehoe, Patrick J., and McGrattan, Ellen R. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 647 Abstract:
We make three comparisons relevant for the business cycle accounting approach. We show that in theory representing the investment wedge as a tax on investment is equivalent to representing this wedge as a tax on capital income as long as the probability distributions over this wedge in the two representations are the same. In practice, convenience dictates that the underlying probability distributions over the investment wedge are different in the two representations. Even so, the quantitative results under the two representations are essentially identical. We also compare our methodology, the CKM methodology, to an alternative one used in Christiano and Davis (2006) as well as by us in early incarnations of the business cycle accounting approach. We argue that the CKM methodology rests on more secure theoretical foundations. Finally, we show that the results from the VAR-style decomposition of Christiano and Davis reinforce the results of the business cycle decomposition of CKM.
Creator: McGrattan, Ellen R. and Prescott, Edward C. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 646 Abstract:
Over the period 1982–2006, the U.S. Bureau of Economic Analysis (BEA) estimates the return on investments of foreign subsidiaries of U.S. multinational companies averaged 9.4 percent per year after taxes while U.S. subsidiaries of foreign multinationals earned on average only 3.2 percent. We estimate the importance of two factors that 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. Technology capital used abroad generates profits for foreign subsidiaries with no foreign direct investment. Plant-specific intangible capital in foreign subsidiaries is expensed abroad, lowering current profits on foreign direct investment (FDI) and increasing future profits. We develop a multicountry general equilibrium model with an essential role for FDI and apply the same methodology as the BEA 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.
Tema: F32 - Current Account Adjustment; Short-term Capital Movements and F23 - Multinational Firms; International Business
Creator: Luttmer, Erzo G. J. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 645 Abstract:
This paper presents a simple model of search and matching between consumers and firms. The firm size distribution has a Pareto-like right tail if the population of consumers grows at a positive rate and the mean rate at which incumbent firms gain customers is also positive. This happens in equilibrium when entry is sufficiently costly. As entry costs grow without bound, the size distribution approaches Zipf’s law. The slow rate at which the right tail of the size distribution decays and the 10% annual gross entry rate of new firms observed in the data suggest that more than a third of all consumers must switch from one firm to another during a given year. A substantially lower consumer switching rate can be inferred only if part of the observed firm entry rate is attributed to factors outside the model. The realized growth rates of large firms in the model are too smooth.
Tema: D11 - Consumer Economics: Theory, L10 - Market Structure, Firm Strategy, and Market Performance: General, and O40 - Economic Growth and Aggregate Productivity: General
Creator: He, Hui and Liu, Zheng Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 644 Abstract:
Wage inequality between education groups in the United States has increased substantially since the early 1980s. The relative number of college-educated workers has also increased dramatically in the postwar period. This paper presents a unified framework where the dynamics of both skill accumulation and wage inequality arise as an equilibrium outcome driven by measured investment-specific technological change. Working through equipment-skill complementarity and endogenous skill accumulation, the model does well in capturing the steady growth in the relative quantity of skilled labor during the postwar period and the substantial rise in wage inequality after the early 1980s. Based on the calibrated model, we examine the quantitative effects of some hypothetical tax-policy reforms on skill accumulation, wage inequality, and welfare.
Palabra clave: Skill premium, Capital-skill complementarity, Investment-specific technological change, and Skill accumulation Tema: O33 - Technological Change: Choices and Consequences; Diffusion Processes, E25 - Aggregate Factor Income Distribution, J31 - Wage Level and Structure; Wage Differentials, and J24 - Human Capital; Skills; Occupational Choice; Labor Productivity
Creator: McGrattan, Ellen R. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 643 Abstract:
A central debate in applied macroeconomics is whether statistical tools that use minimal identifying assumptions are useful for isolating promising models within a broad class. In this paper, I compare three statistical models—a vector autoregressive moving average (VARMA) model, an unrestricted state space model, and a restricted state space model—that are all consistent with the same prototype business cycle model. The business cycle model is a prototype in the sense that many models, with various frictions and shocks, are observationally equivalent to it. The statistical models I consider differ in the amount of a priori theory that is imposed, with VARMAs imposing minimal assumptions and restricted state space models imposing the maximal. The objective is to determine if it is possible to successfully uncover statistics of interest for business cycle theorists with sample sizes used in practice and only minimal identifying assumptions imposed. I find that the identifying assumptions of VARMAs and unrestricted state space models are too minimal: The range of estimates are so large as to be uninformative for most statistics that business cycle researchers need to distinguish alternative theories.
Creator: Weber, Warren E. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 642 Abstract:
Prior to the Civil War there were three major differences among states in how U.S. banks were regulated: (1) Whether they were established by charter or under free-banking laws. (2) Whether they were permitted to branch. (3) Whether the state established a state-owned bank. I use a census of the state banks that existed in the United States prior to the Civil War that I recently constructed to determine how these differences in state regulation affected the banking outcomes in these states. Specifically, I determine differences in banks per capita by state over time; bank longevities (survival rates) by state, size, and type of organization; and bank failure probabilities also by state, size, and type of organization. In addition, I estimate the losses experienced by note holders and determine whether there were systematic differences in these depending on whether or not a bank was organized under a free banking law.
Tema: N22 - Economic History: Financial Markets and Institutions: U.S.; Canada: 1913-
Creator: Ales, Laurence, Carapella, Francesca, Maziero, Pricila, and Weber, Warren E. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 641 Abstract:
Prior to 1863, state-chartered banks in the United States issued notes–dollar-denominated promises to pay specie to the bearer on demand. Although these notes circulated at par locally, they usually were quoted at a discount outside the local area. These discounts varied by both the location of the bank and the location where the discount was being quoted. Further, these discounts were asymmetric across locations, meaning that the discounts quoted in location A on the notes of banks in location B generally differed from the discounts quoted in location B on the notes of banks in location A. Also, discounts generally increased when banks suspended payments on their notes. In this paper we construct a random matching model to qualitatively match these facts about banknote discounts. To attempt to account for locational differences, the model has agents that come from two distinct locations. Each location also has bankers that can issue notes. Banknotes are accepted in exchange because banks are required to produce when a banknote is presented for redemption and their past actions are public information. Overall, the model delivers predictions consistent with the behavior of discounts.
Palabra clave: Banknotes, Random matching, and Banks Tema: G21 - Banks; Depository Institutions; Micro Finance Institutions; Mortgages, N21 - Economic History: Financial Markets and Institutions: U.S.; Canada: Pre-1913, and E50 - Monetary Policy, Central Banking, and the Supply of Money and Credit: General
Creator: Zhang, Yuzhe Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 640 Abstract:
In this paper I develop continuous-time methods for solving dynamic principal-agent problems in which the agent’s privately observed productivity shocks are persistent over time. I characterize the optimal contract as the solution to a system of ordinary differential equations, and show that, under this contract, the agent’s utility converges to its lower bound—immiseration occurs. I also show that, unlike in environments with i.i.d. shocks, the principal would like to renegotiate with the agent when the agent’s productivity is low—it is not renegotiation-proof. I apply the theoretical methods I have developed and numerically solve this (Mirrleesian) dynamic taxation model. I find that it is optimal to allow a wedge between the marginal rate of transformation and individuals’ marginal rate of substitution between consumption and leisure. This wedge is significantly higher than what is found in the i.i.d. case. Thus, using the i.i.d. assumption is not a good approximation quantitatively when there is persistence in productivity shocks.
Palabra clave: Principal-agent problem, Persistence, Efficiency lines, and Stochastic control problem Tema: E61 - Policy Objectives; Policy Designs and Consistency; Policy Coordination, D80 - Information, Knowledge, and Uncertainty: General, and D82 - Asymmetric and Private Information; Mechanism Design
Creator: Zhang, Yuzhe Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 639 Abstract:
This paper studies the stability of a stochastic optimal growth economy introduced by Brock and Mirman [J. Econ. Theory 4 (1972)] by utilizing stochastic monotonicity in a dynamic system. The construction of two boundary distributions leads to a new method of studying systems with non-compact state space. The paper shows the existence of a unique invariant distribution. It also shows the equivalence between the stability and the uniqueness of the invariant distribution in this dynamic system.
Palabra clave: Monotonic operator, Stochastic dominance, Stochastic growth, and Global stability Tema: O41 - One, Two, and Multisector Growth Models, C62 - Existence and Stability Conditions of Equilibrium, and C61 - Optimization Techniques; Programming Models; Dynamic Analysis
Creator: Yang, Fang Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 638 Abstract:
This paper studies a quantitative dynamic general equilibrium life-cycle model where parents and their children are linked by bequests, both voluntary and accidental, and by the transmission of earnings ability. This model is able to match very well the empirical observation that households with similar lifetime incomes hold very different amounts of wealth at retirement. Income heterogeneity and borrowing constraints are essential in generating the variation in retirement wealth among low lifetime income households, while the existence of intergenerational links is crucial in explaining the heterogeneity in retirement wealth among high lifetime income households.
Tema: E21 - Macroeconomics: Consumption; Saving; Wealth
Creator: Ai, Hengjie Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 637 Abstract:
We propose a notion of smoothness of nonexpected utility functions, which extends the variational analysis of nonexpected utility functions to more general settings. In particular, our theory applies to state dependent utilities, as well as the multiple prior expected utility model, both of which are not possible in previous literatures. Other nonexpected utility models are shown to satisfy smoothness under more general conditions than the Fréchet and Gateaux differentiability used in the literature. We give more general characterizations of monotonicity and risk aversion without assuming state independence of utility function.
Creator: McGrattan, Ellen R. and Prescott, Edward C. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 636 Abstract:
Expensed investments are expenditures financed by the owners of capital that increase future profits but, by national accounting rules, are treated as an operating expense rather than as a capital expenditure. Sweat investment is financed by worker-owners who allocate time to their business and receive compensation at less than their market rate. Such investments are made with the expectation of realizing capital gains when the business goes public or is sold. But these investments are not included in GDP. Taking into account hours spent building equity while ignoring the output introduces an error in measured productivity and distorts the picture of what is happening in the economy. In this paper, we incorporate expensed and sweat equity in an otherwise standard business cycle model. We use the model to analyze productivity in the United States during the 1990s boom. We find that expensed plus sweat investment was large during this period and critical for understanding the dramatic rise in hours and the modest growth in measured productivity.
Creator: Yang, Fang Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 635 Abstract:
Micro data over the life cycle shows two different patterns of consumption of housing and non-housing goods: the consumption profile of non-housing goods is hump-shaped while the consumption profile for housing first increases monotonically and then flattens out. These patterns hold true at each consumption quartile. This paper develops a quantitative, dynamic general equilibrium model of life cycle behavior, which generates consumption profiles consistent with the observed data. Borrowing constraints are essential in explaining the accumulation of housing assets early in life, while transaction costs are crucial in generating the slow downsizing of the housing assets later in life. The bequest motives play a role in determining total life time wealth, but not the housing profile.
Palabra clave: Life cycle, Consumption, Housing, and Distribution Tema: J14 - Economics of the Elderly; Economics of the Handicapped; Non-labor Market Discrimination, R21 - Urban, Rural, Regional, Real Estate, and Transportation Economics: Housing Demand, and E21 - Macroeconomics: Consumption; Saving; Wealth
Creator: Weber, Warren E. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 634 Abstract:
This paper describes a newly constructed data set of all U.S. state banks from 1782 to 1861. It contains the names and locations of all banks and branches that went into business and an estimate of when each operated. The compilation is based on reported balance sheets, listings in banknote reporters, and secondary sources. Based on these data, the paper presents a count of the number of banks and branches in business by state. I argue that my series are superior to previously existing ones for reasons of consistency, accuracy, and timing. The paper contains examples to support this argument.
Tema: N21 - Economic History: Financial Markets and Institutions: U.S.; Canada: Pre-1913
Creator: Luttmer, Erzo G. J. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 633 Abstract:
This paper describes an analytically tractable model of balanced growth that allows for extensive heterogeneity in the technologies used by firms. Firms enter with fixed characteristics that determine their initial technologies and the levels of fixed costs required to stay in business. Each firm produces a different good, and firms are subject to productivity and demand shocks that are independent across firms and over time. Firms exit when revenues are too low relative to fixed costs. Conditional on fixed firm characteristics, the stationary distribution of firm size satisfies a power law for all sizes above the size at which new firms enter. The tail of the size distribution decays very slowly if the growth rate of the initial productivity of potential entrants is not too far above the growth rate of productivity inside incumbent firms. In one interpretation, this difference in growth rates can be related to learning-by-doing inside firms and spillovers of the information generated as a result. As documented in a companion paper, heterogeneity in fixed firm characteristics together with idiosyncratic firm productivity growth can generate entry, exit, and growth rates, conditional on age and size, in line with what is observed in the data.
Creator: Cagetti, Marco and De Nardi, Mariacristina Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 632 Abstract:
Entrepreneurship is a key determinant of investment, saving, wealth holdings, and wealth inequality. We study the aggregate and the distributional effects of several tax reforms in a model that recognizes the key role played by the entrepreneurs, and that matches very well the extreme degree of wealth inequality observed in the U.S. data. We find that the effects of tax reforms on output and capital formation can be particularly large when they affect the majority of small and medium-size businesses, which face the most severe financial constraints, rather than a small number of big businesses. We show that the consequences of changes in the estate tax depend heavily on the size of its exemption level. The current effective estate tax system seems to insulate most of the businesses from the negative effects of estate taxation thus minimizing the aggregate costs of redistribution. Abolishing the current estate tax would generate a modest increase in wealth inequality and slightly reduce aggregate output. Decreasing progressivity of the income tax can generate large increases in output, as this stimulates entrepreneurial savings and capital formation, but at the cost of large increases in wealth concentration.
Palabra clave: Wealth, Taxation, and Entrepreneurship Tema: D91 - Micro-Based Behavioral Economics: Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making, E21 - Macroeconomics: Consumption; Saving; Wealth, and H20 - Taxation, Subsidies, and Revenue: General
Creator: Chari, V. V., Kehoe, Patrick J., and McGrattan, Ellen R. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 631 Abstract:
The main substantive finding of the recent structural vector autoregression literature with a differenced specification of hours (DSVAR) is that technology shocks lead to a fall in hours. Researchers have used these results to argue that business cycle models in which technology shocks lead to a rise in hours should be discarded. We evaluate the DSVAR approach by asking, is the specification derived from this approach misspecified when the data are generated by the very model the literature is trying to discard? We find that it is misspecified. Moreover, this misspecification is so great that it leads to mistaken inferences that are quantitatively large. We show that the other popular specification that uses the level of hours (LSVAR) is also misspecified. We argue that alternative state space approaches, including the business cycle accounting approach, are more fruitful techniques for guiding the development of business cycle theory.
Creator: Golosov, Mikhail, Jones, Larry E., and Tertilt, Michèle Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 630 Abstract:
In this paper, we generalize the notion of Pareto-efficiency to make it applicable to environments with endogenous populations. Two efficiency concepts are proposed, P-efficiency and A-efficiency. The two concepts differ in how they treat people who are not born. We show how these concepts relate to the notion of Pareto-efficiency when fertility is exogenous. We then prove versions of the first welfare theorem assuming that decision making is efficient within the dynasty. Finally, we give two sets of sufficient conditions for noncooperative equilibria of family decision problems to be efficient. These include the Barro and Becker model as a special case.
Palabra clave: First welfare theorem, Altruism, Dynasty, Pareto optimality, and Fertility
Creator: Weber, Warren E. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 629 Abstract:
This paper examines the pricing of statebank notes prior to 1860 using data on the discounts on these notes as quoted in New York, Philadelphia, Cincinnati, and Cleveland. The study is organized around determining whether these banknotes were priced consistent with their expected net redemption value. It finds a bank’s notes had higher prices when it was redeeming it notes for specie than when is was suspended. However, although prices generally varied inversely with redemption costs, the relationship was not tight and persistent arbitrage opportunities existed.
Tema: N21 - Economic History: Financial Markets and Institutions: U.S.; Canada: Pre-1913
Creator: Golosov, Mikhail and Tsyvinski, Aleh Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 628 Abstract:
In this paper we describe how to optimally design a disability insurance system. The key friction in the model is imperfectly observable disability. We solve a dynamic mechanism design problem and provide a theoretical and numerical characterization of the social optimum. We then propose a simple tax system that implements an optimal allocation as a competitive equilibrium. The tax system that we propose includes only taxes and transfers that are similar to those already present in the U.S. tax code: a savings tax and an asset-tested transfer program. Using a numerical simulation, we compare our optimal disability system to the current disability system. Our results suggest a significant welfare gain from switching to an optimal system.
Tema: E60 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook: General, H20 - Taxation, Subsidies, and Revenue: General, and H30 - Fiscal Policies and Behavior of Economic Agents: General
Creator: Alvarez, Fernando, 1964-, Atkeson, Andrew, and Kehoe, Patrick J. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 627 Abstract:
Time-varying risk is the primary force driving nominal interest rate differentials on currency-denominated bonds. This finding is an immediate implication of the fact that exchange rates are roughly random walks. We show that a general equilibrium monetary model with an endogenous source of risk variation—a variable degree of asset market segmentation—can produce key features of actual interest rates and exchange rates. The endogenous segmentation arises from a fixed cost for agents to exchange money for assets. As inflation varies, the benefit of asset market participation varies, and that changes the fraction of agents participating. These effects lead the risk premium to vary systematically with the level of inflation. Our model produces variation in the risk premium even though the fundamental shocks have constant conditional variances.
Palabra clave: Time-varying conditional variances, Pricing kernel, Fama puzzle, Segmented markets, Forward premium anomaly, and Asset pricing-puzzle Tema: F31 - Foreign Exchange, F41 - Open Economy Macroeconomics, G15 - International Financial Markets, G12 - Asset Pricing; Trading Volume; Bond Interest Rates, F30 - International Finance: General, and E43 - Interest Rates: Determination, Term Structure, and Effects
Creator: Athey, Susan, Atkeson, Andrew, and Kehoe, Patrick J. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 626 Abstract:
How much discretion is it optimal to give the monetary authority in setting its policy? We analyze this mechanism design question in an economy with an agreed-upon social welfare function that depends on the randomly fluctuating state of the economy. The monetary authority has private information about that state. In the model, well-designed rules trade off society’s desire to give the monetary authority flexibility to react to its private information against society’s need to guard against the standard time inconsistency problem arising from the temptation to stimulate the economy with unexpected inflation. We find that the optimal degree of monetary policy discretion is decreasing in the severity of the time inconsistency problem. As this problem becomes sufficiently severe, the optimal degree of discretion is none at all. We also find that, despite the apparent complexity of this dynamic mechanism design problem, society can implement the optimal policy simply by legislating an inflation cap that specifies the highest allowable inflation rate.
Palabra clave: Rules vs. discretion, Activist monetary policy, Time inconsistency, Optimal monteary policy, Inflation targets, and Inflation caps Tema: E60 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook: General, E61 - Policy Objectives; Policy Designs and Consistency; Policy Coordination, E50 - Monetary Policy, Central Banking, and the Supply of Money and Credit: General, E58 - Central Banks and Their Policies, and E52 - Monetary Policy
Creator: Chari, V. V., Kehoe, Patrick J., and McGrattan, Ellen R. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 625 Abstract:
This paper proposes a simple method for guiding researchers in developing quantitative models of economic fluctuations. We show that a large class of models, including models with various frictions, are equivalent to a prototype growth model with time-varying wedges that, at least at face value, look like time-varying productivity, labor taxes, and capital income taxes. We label the time-varying wedges as efficiency wedges, labor wedges, and investment wedges. We use data to measure these wedges and then feed them back into the prototype growth model. We then assess the fraction of fluctuations accounted for by these wedges during the great depressions of the 1930s in the United States, Germany, and Canada. We find that the efficiency and labor wedges in combination account for essentially all of the declines and subsequent recoveries. Investment wedges play, at best, a minor role.
Palabra clave: Financial frictions, Great Depression, Sticky wages, Productivity decline, Equivalence theorems, and Capacity utilization Tema: E12 - General Aggregative Models: Keynes; Keynesian; Post-Keynesian and E10 - General Aggregative Models: General
Creator: Bassetto, Marco Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 624 Abstract:
How should a government use the power to commit to ensure a desirable equilibrium outcome? In this paper, I show a misleading aspect of what has become a standard approach to this question, and I propose an alternative. I show that the complete description of an optimal (indeed, of any) policy scheme requires outlining the consequences of paths that are often neglected. The specification of policy along those paths is crucial in determining which schemes implement a unique equilibrium and which ones leave room for multiple equilibria that depend on the expectations of the private sector.
Palabra clave: Government strategy, Implementation, Commitment, and Competitive equilibrium Tema: E61 - Policy Objectives; Policy Designs and Consistency; Policy Coordination, F34 - International Lending and Debt Problems, and C73 - Stochastic and Dynamic Games; Evolutionary Games; Repeated Games