How does wealth taxation differ from capital income taxation? When the return on investment is equal across individuals, a well-known result is that the two tax systems are equivalent. Motivated by recent empirical evidence documenting persistent heterogeneity in rates of return across individuals, we revisit this question. With such heterogeneity, the two tax systems have opposite implications for both efficiency and inequality. Under capital income taxation, entrepreneurs who are more productive, and therefore generate more income, pay higher taxes. Under wealth taxation, entrepreneurs who have similar wealth levels pay similar taxes regardless of their productivity, which expands the tax base, shifts the tax burden toward unproductive entrepreneurs, and raises the savings rate of productive ones. This reallocation increases aggregate productivity and output. In the simulated model parameterized to match the US data, replacing the capital income tax with a wealth tax in a revenue-neutral fashion delivers a significantly higher average lifetime utility to a newborn (about 7.5% in consumption-equivalent terms). Turning to optimal taxation, the optimal wealth tax (OWT) in a stationary equilibrium is positive and yields even larger welfare gains. In contrast, the optimal capital income tax (OCIT) is negative—a subsidy—and large, and it delivers lower welfare gains than the wealth tax. Furthermore, the subsidy policy increases consumption inequality, whereas the wealth tax reduces it slightly. We also consider an extension that models the transition path and find that individuals who are alive at the time of the policy change, on average, would incur large welfare losses if the new policy is OCIT but would experience large welfare gains if the new policy is an OWT. We conclude that wealth taxation has the potential to raise productivity while simultaneously reducing consumption inequality.
During the past two decades, households experienced increases in their average wages and expenditures alongside with divergent trends in their wages, expenditures, and time allocation. We develop a model with incomplete asset markets and household heterogeneity in market and home technologies and preferences to account for these labor market trends and assess their welfare consequences. Using micro data on expenditures and time use, we identify the sources of heterogeneity across households, document how these sources have changed over time, and perform counterfactual analyses. Given the observed increase in leisure expenditures relative to leisure time and the complementarity of these inputs in leisure technology, we infer a significant increase in the average productivity of time spent on leisure. The increasing productivity of leisure time generates significant welfare gains for the average household and moderates negative welfare effects from the rising dispersion of expenditures and time allocation across households.
The excess procyclicality of fiscal policy is commonly viewed as a central malaise in emerging economies. We document that procyclicality is more pervasive in countries with higher sovereign risk and provide a model of optimal fiscal policy with nominal rigidities and endogenous sovereign default that can account for this empirical pattern. Financing a fiscal stimulus is costly for risky countries and can render countercyclical policies undesirable, even in the presence of large Keynesian stabilization gains. We also show that imposing austerity can backfire by exacerbating the exposure to default, but a well-designed "fiscal forward guidance" can help reduce the excess procyclicality.
This paper proposes a theory of foreign reserves as macroprudential policy. We study an open economy model of financial crises, in which pecuniary externalities lead to over-borrowing, and show that by accumulating international reserves, the government can achieve the constrained-efficient allocation. The optimal reserve accumulation policy leans against the wind and significantly reduces the exposure to financial crises. The theory is consistent with the joint dynamics of private and official capital flows, both over time and in the cross section, and can quantitatively account for the recent upward trend in international reserves.
Following the sovereign debt crisis of 2012, some southern European countries have debated proposals to leave the Euro. We evaluate this policy change in a standard monetary model with seigniorage financing of the deficit. The main novel feature is that we depart from rational expectations while maintaining full rationality of agents in a sense made very precise. Our first contribution is to show that small departures from rational expectations imply that inflation upon exit can be orders of magnitude higher than under rational expectations. Our second contribution is to provide a framework for policy analysis in models without rational expectations.
Sovereign governments owe debt to many foreign creditors and can choose which creditors to favor when making payments. This paper documents the de facto seniority structure of sovereign debt using new data on defaults (missed payments or arrears) and creditor losses in debt restructuring (haircuts). We overturn conventional wisdom by showing that official bilateral (government-to-government) debt is junior, or at least not senior, to private sovereign debt such as bank loans and bonds. Private creditors are typically paid first and lose less than bilateral official creditors. We confirm that multilateral institutions like the IMF and World Bank are senior creditors.
The Greek economy experienced a boom until 2007, followed by a prolonged depression resulting in a 25 percent shortfall of GDP by 2016. Informed by a detailed analysis of macroeconomic patterns in Greece, we estimate a rich dynamic general equilibrium model to assess quantitatively the sources of the boom and bust. Lower external demand for traded goods and contractionary fiscal policies account for the largest fraction of the Greek depression. A decline in total factor productivity, due primarily to lower factor utilization, substantially amplifies the depression. Given the significant adjustment of prices and wages observed throughout the cycle, a nominal devaluation would only have short-lived stabilizing effects. By contrast, shifting the burden of adjustment away from taxes toward spending or away from capital taxes toward other taxes would generate longer-term production and consumption gains. Eliminating the rise in transfers to households during the boom would significantly reduce the burden of tax adjustment in the bust and the magnitude of the depression.
We explore quantitatively the possibility of multiple equilibria in a model of sovereign debt crises. The source of multiplicity is the one identified by Calvo (1988). This type of multiplicity has been at the heart of the policy debate through the recent European sovereign debt crisis. Key for multiplicity in the model is a stochastic process for output featuring long periods of either high or low growth. We calibrate the output process in the model using data for the southern European countries that were exposed to the debt crisis. We find that expectations-driven sovereign debt crises are empirically plausible, but only in periods of stagnation. Multiplicity is state dependent: in periods of stagnation and for intermediate levels of debt, interest rates may be high for reasons unrelated to fundamentals.
I develop an idea flows theory of firm and worker dynamics in order to assess the consequences of population aging. Older people are less likely to attempt entrepreneurship and switch employers because they have found better jobs. Consequently, aging reduces entry and worker mobility through a composition effect. In equilibrium, the lower entry rate implies fewer new, better job opportunities for workers, while the better matched labor market dissuades job creation and entry. Aging accounts for a large share of substantial declines in firm and worker dynamics since the 1980s, primarily due to equilibrium forces. Cross-state evidence supports these predictions.
This paper shows that the inability to use monetary policy for macroeconomic stabilization leaves a government more vulnerable to a rollover crisis. We study a sovereign default model with self-fulfilling rollover crises, foreign currency debt, and nominal rigidities. When the government lacks monetary autonomy, lenders anticipate that the government will face a severe recession in the event of a liquidity crisis, and are therefore more prone to run on government bonds. By contrast, a government with monetary autonomy can stabilize the economy and can easily remain immune to a rollover crisis. In a quantitative application, we find that the lack of monetary autonomy played a central role in making the Eurozone vulnerable to a rollover crisis. A lender of last resort can help ease the costs from giving up monetary independence.
The outreach of macroprudential policies is likely limited in practice by imperfect regulation enforcement, whether due to shadow banking, regulatory arbitrage, or other regulation circumvention schemes. We study how such concerns affect the design of optimal regulatory policy in a workhorse model in which pecuniary externalities call for macroprudential taxes on debt, but with the addition of a novel constraint that financial regulators lack the ability to enforce taxes on a subset of agents. While regulated agents reduce risk taking in response to debt taxes, unregulated agents react to the safer environment by taking on more risk. These leakages undermine the effectiveness of macroprudential taxes but do not necessarily call for weaker interventions. A quantitative analysis of the model suggests that aggregate welfare gains and reductions in the severity and frequency of financial crises remain, on average, largely unaffected by even significant leakages.
Negotiations to restructure sovereign debt are time consuming, taking almost a decade on average to resolve. In this paper, we analyze a class of widely used complete information models of delays in sovereign debt restructuring and show that, despite superficial similarities, there are major differences across models in the driving force for equilibrium delay, the circumstances in which delay occurs, and the efficiency of the debt restructuring process. We focus on three key assumptions. First, if delay has a permanent effect on economic activity in the defaulting country, equilibrium delay often occurs; this delay can sometimes be socially efficient. Second, prohibiting debt issuance as part of a settlement makes delay less likely to occur in equilibrium. Third, when debt issuance is not fully state contingent, delay can arise because of the risk that the sovereign will default on any debt issued as part of the settlement.
We revisit the question of how capital should be taxed, arguing that if governments are allowed to use the kinds of tax instruments widely used in practice, for preferences that are standard in the macroeconomic literature, the optimal approach is to never distort capital accumulation. We show that the results in the literature that lead to the presumption that capital ought to be taxed for some time arise because of the initial confiscation of wealth and because the tax system is restricted.
Official statistics display a significant slowdown in U.S. aggregate productivity growth that begins in 2004. We show how offshore profit shifting by U.S. multinational enterprises affects GDP and, thus, productivity measurement. Under international statistical guidelines, profit shifting causes part of U.S. production generated by multinationals to be excluded from official measures of U.S. production. Profit shifting has increased significantly since the mid-1990s, resulting in lower measures of U.S. aggregate productivity growth. We construct an alternative measure of value added that adjusts for profit shifting. The adjustments raise aggregate productivity growth rates by 0.09 percent annually for 1994-2004, 0.24 percent annually for 2004-2008, and lowers annual aggregate productivity growth rates by 0.09 percent after 2008. Our adjustments mitigate, but do not eliminate, the measured productivity slowdown. The adjustments are especially large in R&D-intensive industries, which most likely produce intangible assets that facilitate profit shifting. The adjustments boost value added in these industries by as much as 8 percent in the mid-2000s.
We use a massive, matched employer-employee database for the United States to analyze the contribution of firms to the rise in earnings inequality from 1978 to 2013. We ﬁnd that one-third of the rise in the variance of (log) earnings occurred within firms, whereas two-thirds of the rise occurred between firms. However, this rising between-firm variance is not accounted for by the firms themselves: the firm-related rise in the variance can be decomposed into two roughly equally important forces—a rise in the sorting of high-wage workers to high-wage firms and a rise in the segregation of similar workers between firms. In contrast, we do not ﬁnd a rise in the variance of firm-speciﬁc pay once we control for worker composition. Instead, we see a substantial rise in dispersion of person-speciﬁc pay, accounting for 68% of rising inequality, potentially due to rising returns to skill. The rise in between-firm variance, mostly due to worker sorting and segregation, accounted for a particularly large share of the total increase in inequality in smaller and medium firms (explaining 84% for firms with fewer than 10,000 employees). In contrast, in the very largest firms with 10,000+ employees, 42% of the increase in the variance of earnings took place within firms, driven by both declines in earnings for employees below the median and a substantial rise in earnings for the 10% best-paid employees. However, because of their small number, the contribution of the very top 50 or so earners at large firms to the overall increase in within-firm earnings inequality is small.
Comparing U.S. GDP to the sum of measured payments to labor and imputed rental payments to capital results in a large and volatile residual or “factorless income.” We analyze three common strategies of allocating and interpreting factorless income, speciﬁcally that it arises from economic proﬁts (Case Π), unmeasured capital (Case K), or deviations of the rental rate of capital from standard measures based on bond returns (Case R). We are skeptical of Case Π as it reveals a tight negative relationship between real interest rates and markups, leads to large ﬂuctuations in inferred factor-augmenting technologies, and results in markups that have risen since the early 1980s but that remain lower today than in the 1960s and 1970s. Case K shows how unmeasured capital plausibly accounts for all factorless income in recent decades, but its value in the 1960s would have to be more than half of the capital stock, which we ﬁnd less plausible. We view Case R as most promising as it leads to more stable factor shares and technology growth than the other cases, though we acknowledge that it requires an explanation for the pattern of deviations from common measures of the rental rate. Using a model with multiple sectors and types of capital, we show that our assessment of the drivers of changes in output, factor shares, and functional inequality depends critically on the interpretation of factorless income.
Most firms begin very small, and large firms are the result of typically decades of persistent growth. This growth can be understood as the result of some form of capital accumulation-organization capital. In the US, the distribution of firm size k has a right tail only slightly thinner than 1/k. This means that most capital accumulation must be accounted for by incumbent fi rms. This paper describes a range of circumstances in which this implies aggregate convergence rates that are only about half of what they are in the standard Cass-Koopmans economy. Through the lens of the models described in this paper, the aftermath of the Great Recession of 2008 is unsurprising if the events of late 2008 and early 2009 are interpreted as a destruction of organization capital.
The paper surveys the recent literature on the fiscal implications of central bank balance sheets, with a special focus on political economy issues. It then presents the results of simulations that describe the effects of different scenarios for the Federal Reserve's longer-run balance sheet on its earnings remittances to the U.S. Treasury and, more broadly, on the government's overall fiscal position. We find that reducing longer-run reserve balances from $2.3 trillion (roughly the current amount) to $1 trillion reduces the likelihood of posting a quarterly net loss in the future from 30 percent to under 5 percent. Further reducing longer-run reserve balances from $1 trillion to pre-crisis levels has little effect on the likelihood of net losses.
We revisit the causes, welfare consequences, and policy implications of the dispersion in households' labor market outcomes using a model with uninsurable risk, incomplete asset markets, and home production. Accounting for home production amplifies welfare-based differences across households meaning that inequality is larger than we thought. Home production does not offset differences that originate in the market sector because productivity differences in the home sector are significant and the time input in home production does not covary with consumption expenditures and wages in the cross section of households. The optimal tax system should feature more progressivity taking into account home production.
We study cooperative optimal Ramsey equilibria in the open economy addressing classic policy questions: Should restrictions be placed to free trade and capital mobility? Should capital income be taxed? Should goods be taxed based on origin or destination? What are desirable border adjustments? How can a Ramsey allocation be implemented with residence-based taxes on assets? We characterize optimal wedges and analyze alternative policy implementations.
In this paper, we use a simple model of money demand to characterize the behavior of monetary aggregates in the United States from 1960 to 2016. We argue that the demand for the currency component of the monetary base has been remarkably stable during this period. We use the model to make projections of the nominal quantity of cash in circulation under alternative future paths for the federal funds rate. Our calculations suggest that if the federal funds rate is lifted up as suggested by the survey of economic projections made by the members of the Federal Open Market Committee (FOMC), the fall in total currency demanded in the next two years ranges between 50 and 200 billion. Our discussion suggests that specific measures by the Federal Reserve to absorb that cash could be worth considering to make the future path of the price level consistent with the price stability mandate.
In this paper, we show that a substantial fraction of the volatility of real exchange rates between developed economies such as Germany, Japan, and the United Kingdom against the US dollar can be accounted for by shocks that affect the prices of primary commodities such as oil, aluminum, maize, or copper. Our analysis implies that existing models used to analyze real exchange rates between large economies that mostly focus on trade between differentiated ﬁnal goods could benefit, in terms of matching the behavior of real exchange rates, by also considering trade in primary commodities.
This paper formalizes and quantifies the secular stagnation hypothesis, defined as a persistently low or negative natural rate of interest leading to a chronically binding zero lower bound (ZLB). Output-inflation dynamics and policy prescriptions are fundamentally different from those in the standard New Keynesian framework. Using a 56-period quantitative life cycle model, a standard calibration to US data delivers a natural rate ranging from -1.5% to -2%, implying an elevated risk of ZLB episodes for the foreseeable future. We decompose the contribution of demographic and technological factors to the decline in interest rates since 1970 and quantify changes required to restore higher rates.
Drawing from confidential firm-level data of US manufacturing firms, we provide new evidence on the cyclicality of small and large firms. We show that the cyclicality of sales and investment declines with firm size. The effect is primarily driven by differences between the top 0.5% of firms and the rest. Moreover, we show that, due to the skewness of sales and investment, the higher cyclicality of small firms has a negligible influence on the behavior of aggregates. We argue that the size asymmetry is unlikely to be driven by financial frictions given 1) the absence of statistically significant differences in the behavior of production inputs or debt in recessions, 2) the survival of the size effect after directly controlling for proxies of financial strength, and 3) the predictions of a simple financial frictions model, in which unconstrained (large) firms contract more in recessions than constrained (small) firms.
Recently, several economies with interest rates close to zero have received large capital inflows while their central banks accumulated large foreign reserves. Concurrently, significant deviations from covered interest parity have appeared. We show that, with limited international arbitrage, a central bank's pursuit of an exchange rate policy at the ZLB can explain these facts. We provide a measure of the costs associated with this policy and show they can be sizable. Changes in external conditions that increase capital inflows are detrimental, even when they are beneficial away from the ZLB. Negative nominal rates and capital controls can reduce the costs.
This paper develops and estimates a model of indivisibilities in shipping and economies of scale in consolidation. It uses highly detailed data on imports where it is possible to observe the contents of individual containers. In the model, ﬁrms are able to adapt to indivisibility constraints by using consolidation strategies and by making adjustments to shipment size. The ﬁrm determines the optimal number of domestic ports to use, taking into account that adding more ports lowers inland freight cost, at the expense of a higher indivisibility cost. The estimated model is able to roughly account for Walmart’s port choice behavior. The model estimates are used to evaluate how mergers or dissolutions of ﬁrms or countries, and changes in variety, affect indivisibility costs and inland freight costs.
We explore the long-run demand for M1 based on a data set that has comprised 32 countries since 1851. In many cases, cointegration tests identify a long-run equilibrium relationship between either velocity and the short rate or M1, GDP, and the short rate. Evidence is especially strong for the United States and the United Kingdom over the entire period since World War I and for moderate and high-inflation countries.
With the exception of high-inflation countries–for which a “log-log” specification is preferred–the data often prefer the specification in the levels of velocity and the short rate originally estimated by Selden (1956) and Latané (1960). This is especially clear for the United States and other low-inflation countries.
The sectoral composition of global saving changed dramatically during the last three decades. Whereas in the early 1980s most of global investment was funded by household saving, nowadays nearly two-thirds of global investment is funded by corporate saving. This shift in the sectoral composition of saving was not accompanied by changes in the sectoral composition of investment, implying an improvement in the corporate net lending position. We characterize the behavior of corporate saving using both national income accounts and firm-level data and clarify its relationship with the global decline in labor share, the accumulation of corporate cash stocks, and the greater propensity for equity buybacks. We develop a general equilibrium model with product and capital market imperfections to explore quantitatively the determination of the flow of funds across sectors. Changes including declines in the real interest rate, the price of investment, and corporate income taxes generate increases in corporate profits and shifts in the supply of sectoral saving that are of similar magnitude to those observed in the data.
We study the optimal accumulation of international reserves in a quantitative model of sovereign default with long-term debt and a risk-free asset. Keeping higher levels of reserves provides a hedge against rollover risk, but this is costly because using reserves to pay down debt allows the government to reduce sovereign spreads. Our model, parameterized to mimic salient features of a typical emerging economy, can account for a significant fraction of the holdings of international reserves, and the larger accumulation of both debt and reserves in periods of low spreads and high income. We also show that income windfalls, improved policy frameworks, larger contingent liabilities, and an increase in the importance of rollover risk imply increases in the optimal holdings of reserves that are consistent with the upward trend in reserves in emerging economies. It is essential for our results that debt maturity exceeds one period.
We provide empirical evidence of a novel liquidity-based transmission mechanism through which monetary policy influences asset markets, develop a model of this mechanism, and assess the ability of the quantitative theory to match the evidence.
By how much does an extension of unemployment benefits affect macroeconomic outcomes such as unemployment? Answering this question is challenging because U.S. law extends benefits for states experiencing high unemployment. We use data revisions to decompose the variation in the duration of benefits into the part coming from actual differences in economic conditions and the part coming from measurement error in the real-time data used to determine benefit extensions. Using only the variation coming from measurement error, we find that benefit extensions have a limited influence on state-level macroeconomic outcomes. We use our estimates to quantify the effects of the increase in the duration of benefits during the Great Recession and find that they increased the unemployment rate by at most 0.3 percentage point.
This appendix contains additional results on using scanner data to estimate inflation rates at the household level. There are three sections. Section 1 shows cross-sectional distributions of Fisher and Paasche inflation rates. Section 2 shows the evolution over time of measures of dispersion of Fisher and Paasche inflation rates. Section 3 shows cross-sectional distributions of two-year inflation rates measured with Fisher and Paasche indexes.
We use scanner data to estimate inflation rates at the household level. Households' inflation rates are remarkably heterogeneous, with an interquartile range of 6.2 to 9.0 percentage points on an annual basis. Most of the heterogeneity comes not from variation in broadly defined consumption bundles but from variation in prices paid for the same types of goods - a source of variation that previous research has not measured. The entire distribution of household inflation rates shifts in parallel with aggregate inflation. Deviations from aggregate inflation exhibit only slightly negative serial correlation within each household over time, implying that the difference between a household's price level and the aggregate price level is persistent. Together, the large cross-sectional dispersion and low serial correlation of household-level inflation rates mean that almost all of the variability in a household's inflation rate over time comes from variability in household-level prices relative to average prices for the same goods, not from variability in the aggregate inflation rate. We provide a characterization of the stochastic process for household inflation that can be used to calibrate models of household decisions.
We develop a quantitative equilibrium model of financial crises to assess the interaction between ex-post interventions in credit markets and the buildup of risk ex ante. During a systemic crisis, bailouts relax balance sheet constraints and mitigate the severity of the recession. Ex ante, the anticipation of such bailouts leads to an increase in risk-taking, making the economy more vulnerable to a financial crisis. We find that moral hazard effects are limited if bailouts are systemic and broad-based. If bailouts are idiosyncratic and targeted, however, this makes the economy significantly more exposed to financial crises.
What determines the earnings of a worker relative to his peers in the same occupation? What makes a worker fail in one occupation but succeed in another? More broadly, what are the factors that determine the productivity of a worker-occupation match? In this paper, we propose an empirical measure of skill mismatch for a worker-occupation match, which sheds light on these questions. This measure is based on the discrepancy between the portfolio of skills required by an occupation and the portfolio of abilities possessed by a worker for learning those skills. This measure arises naturally in a dynamic model of occupational choice and human capital accumulation with multidimensional skills and Bayesian learning about one’s ability to learn these skills. In this model, mismatch is central to the career outcomes of workers: it reduces the returns to occupational tenure, and it predicts occupational switching behavior. We construct our empirical analog by combining data from the National Longitudinal Survey of Youth 1979 (NLSY79), the Armed Services Vocational Aptitude Battery (ASVAB) on workers, and the O*NET on occupations. Our empirical results show that the effects of mismatch on wages are large and persistent: mismatch in occupations held early in life has a strong negative effect on wages in future occupations. Skill mismatch also significantly increases the probability of an occupational switch and predicts its direction in the skill space. These results provide fresh evidence on the importance of skill mismatch for the job search process.
Starting in the early 1990s, countries in southern Europe experienced low productivity growth alongside declining real interest rates. We use data for manufacturing ﬁrms in Spain between 1999 and 2012 to document a signiﬁcant increase in the dispersion of the return to capital across ﬁrms, a stable dispersion of the return to labor, and a signiﬁcant increase in productivity losses from capital misallocation over time. We develop a model with size-dependent ﬁnancial frictions that is consistent with important aspects of ﬁrms’ behavior in production and balance sheet data. We illustrate how the decline in the real interest rate, often attributed to the euro convergence process, leads to a signiﬁcant decline in sectoral total factor productivity as capital inﬂows are misallocated toward ﬁrms that have higher net worth but are not necessarily more productive. We show that similar trends in dispersion and productivity losses are observed in Italy and Portugal but not in Germany, France, and Norway.
We present and empirically implement an equilibrium labor market search model where risk averse workers facing medical expenditure shocks are matched with firms making health insurance coverage decisions. Our model delivers a rich set of predictions that can account for a wide variety of phenomenon observed in the data including the correlations among firm sizes, wages, health insurance offering rates, turnover rates and workers’ health compositions. We estimate our model by Generalized Method of Moments using a combination of micro datasets including Survey of Income and Program Participation, Medical Expenditure Panel Survey and Robert Wood Johnson Foundation Employer Health Insurance Survey. We use our estimated model to evaluate the equilibrium impact of the 2010 Affordable Care Act (ACA) and find that it would reduce the uninsured rate among the workers in our estimation sample from about 22% in the pre-ACA benchmark economy to less than 4%. We also find that income-based premium subsidies for health insurance purchases from the exchange play an important role for the sustainability of the ACA; without the premium subsidies, the uninsured rate would be around 18%. In contrast, as long as premium subsidies and health insurance exchanges with community ratings stay intact, ACA without the individual mandate, or without the employer mandate, or without both mandates, could still succeed in reducing the uninsured rates to 7.34%, 4.63% and 9.22% respectively.
We study a model of a small open economy that specializes in the production of commodities and that exhibits frictions in the setting of both prices and wages. We study the optimal response of monetary and exchange rate policy following a positive (negative) shock to the price of the exportable that generates an appreciation (depreciation) of the local currency. According to the calibrated version of the model, deviations from full price stability can generate welfare gains that are equivalent to almost 0.5% of lifetime consumption, as long as there is a significant degree of rigidity in nominal wages. On the other hand, if the rigidity is concentrated in prices, the welfare gains can be at most 0.1% of lifetime consumption. We also show that a rule - formally defined in the paper - that resembles a "dirty floating" regime can approximate the optimal policy remarkably well.
This appendix contains eight sections. Section 1 gives technical details of how we calculate standard errors in the CPS data. Section 2 discusses changes in the ACS procedures before 2005. Section 3 examines demographic and economic patterns in migration over the past two decades, in more detail than in the main paper. Section 4 examines the cross-sectional variance of location-occupation interactions in earnings when we define locations by MSAs instead of states. Section 5 describes alternative methods to estimate the variance of location-occupation interactions in income. Section 6 measures the segregation of industries across states and of occupations and industries across MSAs. Section 7 gives technical details on the use of SIPP and census data to calculate repeat and return migration rates. Section 8 discusses transition dynamics in the model.
This paper describes how long-run growth emerges in four closely related models that combine individual discovery with some form of social learning. In a large economy, there is a continuum of long-run growth rates and associated stationary distributions when it is possible to learn from individuals in the right tail of the productivity distribution. What happens in the long run depends on initial conditions. Two distinct literatures, one on reaction-diffusion equations, and another on quasi-stationary distributions suggest a unique long-run outcome when the initial productivity distribution has bounded support.
We study a variation of the standard model of sovereign default, as in Aguiar and Gopinath (2006) or Arellano (2008), and show that this variation is consistent with multiple interest rate equilibria. Some of those equilibria correspond to the ones identified by Calvo (1988), where default is likely because rates are high, and rates are high because default is likely. The model is used to simulate equilibrium movements in sovereign bond spreads that resemble sovereign debt crises. It is also used to discuss lending policies similar to the ones announced by the European Central Bank in 2012.
This paper examines the macroeconomic implications of sovereign credit risk in a business cycle model where banks are exposed to domestic government debt. The news of a future sovereign default hampers financial intermediation. First, it tightens the funding constraints of banks, reducing their available resources to finance firms (liquidity channel). Second, it generates a precautionary motive for banks to deleverage (risk channel). I estimate the model using Italian data, finding that i) sovereign credit risk was recessionary and that ii) the risk channel was sizable. I then use the model to evaluate the effects of subsidized long term loans to banks, calibrated to the ECB’s longer-term refinancing operations. The presence of strong precautionary motives at the time of policy enactment implies that bank lending to firms is not very sensitive to these credit market interventions.
Matching efficiency is the productivity of the process for matching jobseekers to available jobs. Job-finding is the output; vacant jobs and active jobseekers are the inputs. Measurement of matching efficiency follows the same principles as measuring a Hicks-neutral index of productivity of production. We develop a framework for measuring matching productivity when the population of jobseekers is heterogeneous. The efficiency index for each type of jobseeker is the monthly job-finding rate for the type adjusted for the overall tightness of the labor market. We find that overall matching efficiency declined over the period, at just below its earlier downward trend. We develop a new approach to measuring matching rates that avoids counting short-duration jobs as successes. And we show that the outward shift in the Beveridge curve in the post-crisis period is the result of pre-crisis trends, not a downward shift in matching efficiency attributable to the crisis.
Consumption-based asset pricing models with time-separable preferences can generate realistic amounts of stock price volatility if one allows for small deviations from rational expectations. We consider rational investors who entertain subjective prior beliefs about price behavior that are not equal but close to rational expectations. Optimal behavior then dictates that investors learn about price behavior from past price observations. We show that this imparts momentum and mean reversion into the equilibrium behavior of the price-dividend ratio, similar to what can be observed in the data. When estimating the model on U.S. stock price data using the method of simulated moments, we find that it can quantitatively account for the observed volatility of returns, the volatility and persistence of the price-dividend ratio, and the predictability of long-horizon returns. For reasonable degrees of risk aversion, the model generates up to one-half of the equity premium observed in the data. It also passes a formal statistical test for the overall goodness of fit, provided one excludes the equity premium from the set of moments to be matched.
We study the evolution of individual labor earnings over the life cycle using a large panel data set of earnings histories drawn from U.S. administrative records. Using fully nonparametric methods, our analysis reaches two broad conclusions. First, earnings shocks display substantial deviations from lognormality–the standard assumption in the incomplete markets literature. In particular, earnings shocks display strong negative skewness and extremely high kurtosis–as high as 30 compared with 3 for a Gaussian distribution. The high kurtosis implies that in a given year, most individuals experience very small earnings shocks, and a small but non-negligible number experience very large shocks. Second, these statistical properties vary significantly both over the life cycle and with the earnings level of individuals. We also estimate impulse response functions of earnings shocks and find important asymmetries: positive shocks to high-income individuals are quite transitory, whereas negative shocks are very persistent; the opposite is true for low-income individuals. Finally, we use these rich sets of moments to estimate econometric processes with increasing generality to capture these salient features of earnings dynamics.
We show that regulatory changes that occurred in the banking sector in the early eighties, which considerably weakened Regulation Q, can explain the apparent instability of money demand during the same period. We evaluate the effects of the regulatory changes using a model that goes beyond aggregates as M1 and treats currency and different deposit types as alternative means of payments. We use the model to construct a new monetary aggregate that performs remarkably well for the entire period 1915-2012.
We develop an equilibrium concept in the Debreu (1954) theory of value tradition for a class of adverse selection economies which includes the Spence (1973) signaling and Rothschild-Stiglitz (1976) insurance environments. The equilibrium exists and is optimal. Further, all equilibria have the same individual type utility vector. The economies are large with a finite number of types that maximize expected utility on an underlying commodity space. An implication of the analysis is that the invisible hand works for this class of adverse selection economies.
We analyze changes in the gender structure at the top of the earnings distribution in the United States over the last 30 years using a 10% sample of individual earnings histories from the Social Security Administration. Despite making large inroads, females still constitute a small proportion of the top percentiles: the glass ceiling, albeit a thinner one, remains. We measure the contribution of changes in labor force participation, changes in the persistence of top earnings, and changes in industry and age composition to the change in the gender composition of top earners. A large proportion of the increased share of females among top earners is accounted for by the mending of, what we refer to as, the paper floor – the phenomenon whereby female top earners were much more likely than male top earners to drop out of the top percentiles. We also provide new evidence at the top of the earnings distribution for both genders: the rising share of top earnings accruing to workers in the Finance and Insurance industry, the relative transitory status of top earners, the emergence of top earnings gender gaps over the life cycle, and gender differences among lifetime top earners.
Randomness in individual discovery tends to spread out productivities in a population, while learning from others keeps productivities together. In combination, these two mechanisms for knowledge accumulation give rise to long-term growth and persistent income inequality. This paper considers a world in which those with more useful knowledge can teach those with less useful knowledge, with competitive markets assigning students to teachers. In equilibrium, students who are able to learn quickly are assigned to teachers with the most productive knowledge. The long-run growth rate of this economy is governed by the rate at which the fastest learners can learn. The income distribution reflects learning ability and serendipity, both in individual discovery and in the assignment of students to teachers. Because of naturally arising indeterminacies in this assignment, payoff irrelevant characteristics can be predictors of individual income growth. Ability rents can be large when fast learners are scarce, when the process of individual discovery is not too noisy, and when overhead labor costs are low.
We study a model with heterogeneous producers that face collateral and cash-in-advance constraints. These two frictions give rise to a nontrivial financial market in a monetary economy. A tightening of the collateral constraint results in a recession generated by a credit crunch. The model can be used to study the effects on the main macroeconomic variables, and on the welfare of each individual of alternative monetary and fiscal policies following the credit crunch. The model reproduces several features of the recent financial crisis, such as the persistent negative real interest rates, the prolonged period at the zero bound for the nominal interest rate, and the collapse in investment and low inflation in spite of the very large increases in liquidity adopted by the government. The policy implications are in sharp contrast to the prevalent view in most central banks, which is based on the New Keynesian explanation of the liquidity trap.
This paper makes two straightforward points that we argue are central to understanding the literature and debate surrounding the stability of the Phillips curve. First, the endogeneity of monetary policy implies that aggregate data are largely uninformative as to the existence of a stable relationship between unemployment and future inflation. Second, if the NAIRU model is assumed to be true, regional data can be used to identify the structural relationship between unemployment and future inflation. We find that a 1 percentage point increase in the unemployment rate is associated with a roughly 0.3 percentage point decline in inflation over the next year.
The Boston mechanism is a school allocation procedure that is widely used around the world. To resolve overdemands, priority is often given to families who live in the neighborhood school. We note that such priorities define some schools as being safer. We exploit an unexpected change in the definition of neighborhood in Barcelona to show that when allowing school choice under the BM with priorities: (1) the resulting allocation is not very different from a neighborhood-based assignment, and (2) important inequalities emerge beyond parents’ naivete found in the literature.
We present a dynamic over-the-counter model of the fed funds market and use it to study the determination of the fed funds rate, the volume of loans traded, and the intraday evolution of the distribution of reserve balances across banks. We also investigate the implications of changes in the market structure, as well as the effects of central bank policy instruments such as open market operations, the discount window lending rate, and the interest rate on bank reserves.
We develop a model of the market for federal funds that explicitly accounts for its two distinctive features: banks have to search for a suitable counterparty, and once they meet, both parties negotiate the size of the loan and the repayment. The theory is used to answer a number of positive and normative questions: What are the determinants of the fed funds rate? How does the market reallocate funds? Is the market able to achieve an efficient reallocation of funds? We also use the model for theoretical and quantitative analyses of policy issues facing modern central banks.
Many applications of search theory in monetary economics use the Shi-Trejos-Wright model, hereafter STW, while applications in finance use Duffie-Gârleanu-Pederson, hereafter DGP. These approaches have much in common, and both claim to be about liquidity, but the models also differ in a fundamental way: in STW agents use assets as payment instruments when trading goods; in DGP there are no gains from exchanging goods, but agents trade because they value assets differently with goods serving as payment instruments. We develop a framework nesting the two. This clarifies the connection between the literatures, and generates new insights and applications. Even in the special cases of the baseline STW and DGP models, we provide propositions generalizing and strengthening what is currently known, and rederiving some existing results using more tractable arguments.
We use minute-by-minute daily transaction-level payments data to document the cross-sectional and time-series behavior of the estimated prices and quantities negotiated by commercial banks in the fed funds market. We study the frequency and volume of trade, the size distribution of loans, the distribution of bilateral fed funds rates, and the intraday dynamics of the reserve balances held by commercial banks. We find evidence of the importance of the liquidity provision achieved by commercial banks that act as de facto intermediaries of fed funds.
A standard approach to estimating structural parameters in life-cycle models imposes sufficient assumptions on the data to identify the "age profile" of outcomes, then chooses model parameters so that the model's age profile matches this empirical age profile. I show that this approach is both incorrect and unnecessary: incorrect, because it generally produces inconsistent estimators of the structural parameters, and unnecessary, because consistent estimators can be obtained under weaker assumptions. I derive an estimation method that avoids the problems of the standard approach. I illustrate the method's benefits analytically in a simple model of consumption inequality and numerically by reestimating the classic life-cycle consumption model of Gourinchas and Parker (2002).
We use a model of optimal portfolio choice to measure heterogeneity in risk aversion among households in Thai villages. There is substantial heterogeneity in risk preferences, positively correlated in most villages with alternative estimates based on a full risk-sharing model.
The rise in within-group consumption inequality in response to the increase in within-group income inequality over the last three decades in the U.S. is puzzling to expected-utility-based incomplete market models. The two-sided lack of commitment models exhibit too little consumption inequality while the standard incomplete markets models tend to predict too much consumption inequality. We show that a model with two-sided lack of commitment and chance attitudes, as emphasized by prospect theory, can explain the relationship and can avoid the systematic bias of the expected utility models. The chance attitudes, such as optimism and pessimism, imply that the households attribute a higher weight to high and low outcomes compared to their objective probabilities. For realistic values of risk aversion and of chance attitudes, the incentives for households to share the idiosyncratic risk decrease. The latter effect endogenously amplifies the increase in consumption inequality relative to the expected utility model, thereby improving the fit to the data.
In this paper, we study the role of education as insurance against a bad marriage. Historically, due to disparities in earning power and education across genders, married women often found themselves in an economically vulnerable position, and had to suffer one of two fates in a bad marriage: either they get divorced (assuming it is available) and struggle as low-income single mothers, or they remain trapped in the marriage. In both cases, education can provide a route to emancipation for women. To investigate this idea, we build and estimate an equilibrium search model with education, marriage/divorce/remarriage, and household labor supply decisions. A key feature of the model is that women bear a larger share of the divorce burden, mainly because they are more closely tied to their children relative to men. Our focus on education is motivated by the fact that divorce laws typically allow spouses to keep the future returns from their human capital upon divorce (unlike their physical assets), making education a good insurance against divorce risk. However, as women further their education, the earnings gap between spouses shrinks, leading to more unstable marriages and, in turn, further increasing demand for education. The framework generates powerful amplification mechanisms, which lead to a large rise in divorce rates and a decline in marriage rates (similar to those observed in the US data) from relatively modest exogenous driving forces. Further, in the model, women overtake men in college attainment during the 1990s, a feature of the data that has proved challenging to explain. Our counterfactual experiments indicate that the divorce law reform of the 1970s played an important role in all of these trends, explaining more than one-quarter of college attainment rate of women post-1970s and one-half of the rise in labor supply for married women.
Consider an economy in which various types of labor are used to produce consumption, but not all types of labor are useful for upgrading the stock of organization capital–that is, for replacing old projects with more productive new projects. When news induces consumers to want to save more, low-quality projects are destroyed across all sectors of the economy, even though the economy is set to increase its stock of new projects. Labor that can be used to create new projects becomes more expensive and labor that cannot becomes cheap. Average wages may not change at all, and the employment of workers who cannot invest in new projects will decline. If physical capital complements the inputs of these workers, investment in physical capital tends to move together with their employment. These results are derived analytically for a prototype economy that has the essential ingredients of empirically relevant equilibrium models of firm heterogeneity.
We analyze optimal policy in a simple small open economy model with price setting frictions. In particular, we study the optimal response of the nominal exchange rate following a terms of trade shock. We depart from the New Keynesian literature in that we explicitly model interna-tionally traded commodities as intermediate inputs in the production of local final goods and assume that the small open economy takes this price as given. This modification not only is in line with the long-standing tradition of small open economy models, but also changes the optimal movements in the exchange rate. In contrast with the recent small open economy New Keynesian literature, our model is able to reproduce the comovement between the nominal exchange rate and the price of exports, as it has been documented in the commodity currencies literature. Although we show there are preferences for which price stability is optimal even without flexible fiscal instruments, our model suggests that more attention should be given to the coordination between monetary and fiscal policy (taxes) in small open economies that are heavily dependent on exports of commodities. The model we propose is a useful framework in which to study fear of floating.
This paper develops a vector autoregression (VAR) for macroeconomic time series which are observed at mixed frequencies – quarterly and monthly. The mixed-frequency VAR is cast in state-space form and estimated with Bayesian methods under a Minnesota-style prior. Using a real-time data set, we generate and evaluate forecasts from the mixed-frequency VAR and compare them to forecasts from a VAR that is estimated based on data time-aggregated to quarterly frequency. We document how information that becomes available within the quarter improves the forecasts in real time.
The direct benefits of infrastructure in developing countries can be large, but if new infrastructure induces in-migration, congestion of other local publicly provided goods may offset the direct benefits. Using the example of rural household electrification in South Africa, we demonstrate the importance of accounting for migration when evaluating welfare gains of spatial programs. We also provide a practical approach to computing welfare gains that does not rely on land prices. We develop a location choice model that incorporates missing land markets and allows for congestion in local land. Using this model, we construct welfare bounds as a function of the income and population effects of the new electricity infrastructure. A novel prediction from the model is that migration elasticities and congestion effects are especially large when land markets are missing. We empirically estimate these welfare bounds for rural electrification in South Africa, and show that congestion externalities from program-induced migration reduced local welfare gains by about 40%.
This paper adds imitation by incumbent firms, and not just by new entrants, to the model of selection and growth developed in Luttmer . Noisy firm-level innovation and imitation give rise to a long-run growth rate that exceeds the average rate at which individual firms innovate. It can be shown, in simple examples, that the economy converges to a long-run balanced growth path from compactly supported initial productivity distributions. The right tail of the stationary distribution of de-trended productivity is approximately Pareto. The tail index of this distribution depends on the rate at which incumbents are able to imitate only indirectly, through general equilibrium effects of this parameter on the equilibrium growth rate.
When the zero lower bound on nominal interest rates binds, monetary policy cannot provide appropriate stimulus. We show that, in the standard New Keynesian model, tax policy can deliver such stimulus at no cost and in a time-consistent manner. There is no need to use inefficient policies such as wasteful public spending or future commitments to low interest rates.
We analyze the secular decline in interstate migration in the United States between 1991 and 2011. Gross flows of people across states are about 10 times larger than net flows, yet have declined by around 50 percent over the past 20 years. We argue that the fall in migration is due to a decline in the geographic specificity of returns to occupations, together with an increase in workers’ ability to learn about other locations before moving there, through information technology and inexpensive travel. These explanations find support in micro data on the distribution of earnings and occupations across space and on rates of repeat migration. Other explanations, including compositional changes, regional changes, and the rise in real incomes, do not fit the data. We develop a model to formalize the geographic-specificity and information mechanisms and show that a calibrated version is consistent with cross-sectional and time-series patterns of migration, occupations, and incomes. Our mechanisms can explain at least one-third and possibly all of the decline in gross migration since 1991.
This paper presents a simple formula that relates the tail index of the firm size distribution to the aggregate speed with which an economy converges to its balanced growth path. The fact that there are so many firms in the right tail implies that aggregate shocks that permanently destroy employment among incumbent firms, rather than cause these firms to scale back temporarily, are followed by slow recoveries. This is true despite the presence of many rapidly growing firms. Aggregate convergence rates are non-linear: they can be very high for economies far below the balanced growth path and very low for advanced economies.
This paper examines two different clearing arrangements for bank liabilities. One was a profit-maximizing private entity, the Suffolk Banking System. It cleared notes for New England banks between 1827 and 1858. The other was a nonprofit collective, the clearinghouses organized in many cities beginning in 1853. The paper examines how well these arrangements prevented bank failures and acted as lenders of last resort. It finds the Suffolk system had fewer failures but acted less like a lender of last resort. It argues that these differences can be explained by the different incentives facing the Suffolk Bank and the members of clearinghouses.
Prior to the mid-1980s, labor productivity growth was a useful barometer of the U.S. economy’s performance: it was low when the economy was depressed and high when it was booming. Since then, labor productivity has become significantly less procyclical. In the recent downturn of 2008–2009, labor productivity actually rose as GDP plummeted. These facts have motivated the development of new business cycle theories because the conventional view is that they are inconsistent with existing business cycle theory. In this paper, we analyze recent events with existing theory and find that the labor productivity puzzle is much less of a puzzle than previously thought. In light of these findings, we argue that policy agendas arising from new untested theories should be disregarded.
In 1950 Mexico entered an economic takeoff and grew rapidly for more than 30 years. Growth stopped during the crises of 1982–1995, despite major reforms, including liberalization of foreign trade and investment. Since then growth has been modest. We analyze the economic history of Mexico 1877–2010. We conclude that the growth 1950–1981 was driven by urbanization, industrialization, and education and that Mexico would have grown even more rapidly if trade and investment had been liberalized sooner. If Mexico is to resume rapid growth — so that it can approach U.S. levels of income — it needs further reforms.
A problem facing the United States and many other countries is how to finance retirement consumption as the number of their workers per retiree falls. The problem with a savings for retirement systems is that there is a shortage of good savings opportunities given the nature of most current tax systems and governments’ limited ability to honor the debt it issues. We find that eliminating capital income taxes will greatly increase saving opportunities and make a savings-for-retirement system feasible with only modest amount of government debt. The switch from a system close to the current U.S. retirement system, which relies heavily on taxing workers’ incomes and making lump-sum transfers to retirees, to one without income taxes will increase the welfare of all birth-year cohorts alive today and particularly the welfare of the yet unborn cohorts. The equilibrium paths for the current and alternative policies are computed.
We study bilateral exchange, both direct trade and indirect trade that happens through chains of intermediaries or middlemen. We develop a model of this activity and present applications. This illustrates how, and how many, intermediaries get involved, and how the terms of trade are determined. Bargaining with intermediaries depends on how they bargain with downstream intermediaries, leading to interesting holdup problems. We discuss the roles of buyers and sellers in bilateral exchange, and how to interpret prices. We develop a particular bargaining solution and relate it to other solutions. We also illustrate how bubbles can emerge in the value of inventories.
Why do some sellers set nominal prices that apparently do not respond to changes in the aggregate price level? In many models, prices are sticky by assumption; here it is a result. We use search theory, with two consequences: prices are set in dollars, since money is the medium of exchange; and equilibrium implies a nondegenerate price distribution. When the money supply increases, some sellers may keep prices constant, earning less per unit but making it up on volume, so profit stays constant. The calibrated model matches price-change data well. But, in contrast with other sticky-price models, money is neutral.
We study models of credit with limited commitment, which implies endogenous borrowing constraints. We show that there are multiple stationary equilibria, as well as nonstationary equilibria, including some that display deterministic cyclic and chaotic dynamics. There are also stochastic (sunspot) equilibria, in which credit conditions change randomly over time, even though fundamentals are deterministic and stationary. We show this can occur when the terms of trade are determined by Walrasian pricing or by Nash bargaining. The results illustrate how it is possible to generate equilibria with credit cycles (crunches, freezes, crises) in theory, and as recently observed in actual economies.
The generation and implementation of ideas, or knowledge, is crucial for economic performance. We study this process in a model of endogenous growth with frictions. Productivity increases with knowledge, which advances via innovation, and with the exchange of ideas from those who generate them to those best able to implement them (technology transfer). But frictions in this market, including search, bargaining, and commitment problems, impede exchange and thus slow growth. We characterize optimal policies to subsidize research and trade in ideas, given both knowledge and search externalities. We discuss the roles of liquidity and financial institutions, and show two ways in which intermediation can enhance efficiency and innovation. First, intermediation allows us to finance more transactions with fewer assets. Second, it ameliorates certain bargaining problems, by allowing entrepreneurs to undo otherwise sunk investments in liquidity. We also discuss some evidence, suggesting that technology transfer is a significant source of innovation and showing how it is affected by credit considerations.
It is widely believed that an important factor underlying the rapid growth in China is increased foreign direct investment (FDI) and the transfer of foreign technology capital, which is accumulated know-how from investment in research and development (R&D), brands, and organizations that is not specific to a plant. In this paper, we study two channels through which FDI can contribute to upgrading of the stock of technology capital: knowledge spillovers and appropriation. Knowledge spillovers lead to new ideas that do not directly compete or devalue the foreign affiliate's stock. Appropriation, on the other hand, implies a redistribution of property rights over patents and trademarks; the gain to domestic companies comes at a loss to the multinational company (MNC). In this paper we build these sources of technology capital transfer into the framework developed by McGrattan and Prescott (2009, 2010) and introduce an endogenously-chosen intensity margin for operating technology capital in order to capture the trade-offs MNCs face when expanding their markets internationally. We first demonstrate that abstracting from technology capital transfers results in predicted bilateral FDI inflows to China that are grossly at odds with the data. We then use the bilateral inflows to parameterize the model with technology capital transfers and compute the global economic impact of Chinese policies that encouraged greater inflows of FDI and technology capital transfers. Microevidence on automobile patents is used to support our parameter choices and main findings.
The Cincinnati Post published its last edition on New Year’s Eve 2007, leaving the Cincinnati Enquirer as the only daily newspaper in the market. The next year, fewer candidates ran for municipal office in the Kentucky suburbs most reliant on the Post, incumbents became more likely to win reelection, and voter turnout and campaign spending fell. These changes happened even though the Enquirer at least temporarily increased its coverage of the Post’s former strongholds. Voter turnout remained depressed through 2010, nearly three years after the Post closed, but the other effects diminished with time. We exploit a difference-in-differences strategy and the fact that the Post’s closing date was fixed 30 years in advance to rule out some non-causal explanations for our results. Although our findings are statistically imprecise, they demonstrate that newspapers—even underdogs such as the Post, which had a circulation of just 27,000 when it closed—can have a substantial and measurable impact on public life
The neoclassical growth model is extended to include costly intermediated borrowing and lending between households. This is an important extension as substantial resources are used in intermediating the large amount of borrowing and lending between households. In 2007, in the United States, the amount intermediated was 1.7 times GNP, and the resources used in this intermediation amounted to at least 3.4 percent of GNP. The theory implies that financial intermediation services are an intermediate good and that the spread between borrowing and lending rates measures the efficiency of the financial sector.
In this paper we construct a stochastic overlapping-generations general equilibrium model in which households are subject to aggregate shocks that affect both wages and asset prices. We use a calibrated version of the model to quantify how the welfare costs of severe recessions are distributed across different household age groups. The model predicts that younger cohorts fare better than older cohorts when the equilibrium decline in asset prices is large relative to the decline in wages, as observed in the data. Asset price declines hurt the old, who rely on asset sales to finance consumption, but benefit the young, who purchase assets at depressed prices. In our preferred calibration, asset prices decline more than twice as much as wages, consistent with the experience of the US economy in the Great Recession. A model recession is approximately welfare-neutral for households in the 20–29 age group, but translates into a large welfare loss of around 10% of lifetime consumption for households aged 70 and over.
We show how to use panel data on household consumption to directly estimate households’ risk preferences. Specifically, we measure heterogeneity in risk aversion among households in Thai villages using a full risk-sharing model, which we then test allowing for this heterogeneity. There is substantial, statistically significant heterogeneity in estimated risk preferences. Full insurance cannot be rejected. As the risk sharing, as-if-complete-markets theory might predict, estimated risk preferences are unrelated to wealth or other characteristics. The heterogeneity matters for policy: Although the average household would benefit from eliminating village-level risk, less-risk-averse households who are paid to absorb that risk would be worse off by several percent of household consumption.
Some commentators have argued that the housing crisis may harm labor markets because homeowners who owe more than their homes are worth are less likely to move to places that have productive job opportunities. I show that, in the available data, negative equity does not make homeowners less mobile. In fact, homeowners who have negative equity are slightly more likely to move than homeowners who have positive equity. Ferreira, Gyourko, and Tracy's (2010) contrasting result that negative equity reduces mobility arises because they systematically drop some negative-equity homeowners' moves from the data.
We show that much of the recent reported decrease in interstate migration is a statistical artifact. Before 2006, the Census Bureau's imputation procedure for dealing with missing data inflated the estimated interstate migration rate. An undocumented change in the procedure corrected the problem starting in 2006, thus reducing the estimated migration rate. The change in imputation procedures explains 90 percent of the reported decrease in interstate migration between 2005 and 2006, and 42 percent of the decrease between 2000 (the recent high-water mark) and 2010. After we remove the effect of the change in procedures, we find that the annual interstate migration rate follows a smooth downward trend from 1996 to 2010. Contrary to popular belief, the 2007–2009 recession is not associated with any additional decrease in interstate migration relative to trend.
We show that short and long nominal interest rates are independent monetary policy instruments. The pegging of both helps solving the problem of multiplicity that arises when only short rates are used as the instrument of policy. A peg of the nominal returns on assets of different maturities is equivalent to a peg of state-contingent interest rates. These are the rates that should be targeted in order to implement unique equilibria. At the zero bound, while it is still possible to target state-contingent interest rates, that is no longer equivalent to the target of the term structure.
Prior to 1861, several U.S. states established bank liability insurance schemes. One type was an insurance fund. Member banks paid into a state-run fund that paid bank creditors’ losses. A second scheme was a mutual guarantee system. Member banks were legally responsible for the liabilities of any insolvent bank. This paper’s hypothesis is that the moral hazard problem was controlled under a scheme to the degree that member banks had the power and incentive to control or modify others’ risk-taking behavior. Schemes that gave member banks both strong incentives and power were able to control the moral hazard problem better than schemes in which one or both features were weak. Empirical evidence on bank failures and losses on banks’ asset portfolios is consistent with this hypothesis.
Although employment at individual firms tends to be highly non-stationary, the employment size distribution of all firms in the United States appears to be stationary. It closely resembles a Pareto distribution. There is a lot of entry and exit, mostly of small firms. This paper surveys general equilibrium models that can be used to interpret these facts and explores the role of innovation by new and incumbent firms in determining aggregate growth. The existence of a balanced growth path with a stationary employment size distribution depends crucially on assumptions made about the cost of entry. Some type of labor must be an essential input in setting up new firms.
This paper uses an estimated structural model to argue that the option to move in and out of the parental home is an important insurance channel against labor market risk for youths who do not attend college. Using data from the NLSY97, I construct a new monthly panel of parent-youth coresidence outcomes and use it to document an empirical relationship between these movements and individual labor market events. The data is then used to estimate the parameters of a dynamic game between youths and their altruistic parents, featuring coresidence, labor supply and savings decisions. Parents can provide both monetary support through explicit financial transfers, and non-monetary support in the form of shared residence. To account for the data, two types of exogenous shocks are needed. Preference shocks are found to explain most of the cross-section of living arrangements, while labor market shocks account for individual movements in and out of the parental home. I use the model to show that coresidence is a valuable form of insurance, particularly for youths from poorer families. The option to live at home also helps to explain features of aggregate data for low-skilled young workers: their low savings rates and their relatively small consumption responses to labor market shocks. An important implication is that movements in and out of home can reduce the consumption smoothing benefits of social insurance programs.
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.
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 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.
Innovative activities have public good characteristics in the sense that the cost of producing the innovation is high compared to the cost of producing subsequent units. Moreover, knowledge of how to produce subsequent units is widely known once the innovation has occurred and is, therefore, non-rivalrous. The main question of this paper is whether mechanisms can be found which exploit market information to provide appropriate incentives for innovation. The ability of the mechanism designer to exploit such information depends crucially on the ability of the innovator to manipulate market signals. We show that if the innovator cannot manipulate market signals, then the efficient levels of innovation can be implemented without deadweight losses–for example, by using appropriately designed prizes. If the innovator can use bribes, buybacks, or other ways of manipulating market signals, patents are necessary.
Suppose firms are subject to decreasing returns and permanent idiosyncratic productivity shocks. Suppose also firms can only stay in business by continuously paying a fixed cost. New firms can enter. Firms with a history of relatively good productivity shocks tend to survive and others are forced to exit. This paper identifies assumptions about entry that guarantee a stationary firm size distribution and lead to balanced growth. The range of technology diffusion mechanisms that can be considered is greatly expanded relative to previous work. High entry costs slow down the selection process and imply slow aggregate growth. They also push the firm size distribution in the direction of Zipf’s law.
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.
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.