Macro Final 5.6

McCandless and Weber: "Some Monetary Facts"

- Money Growth and Inflation: A High, Positive Correlation - Money and Real Output Growth: No Correlation in the Full Sample But a Positive Correlation in the OECD Subsample - Inflation and Real Output Growth: No Correlation

Greenwood: What explains the productivity slowdown of the 1970s?

Adopting new technologies like IT involved a significant cost in terms of learning and re-training workers, the advance in technology will be associated with an increased demand for those skills will increase, and wages of skilled labor relative to unskilled labor will rise. Productivity growth seemed to stall as the economy makes the investment in knowledge needed to exploit the new technologies' potential.

Diamond, Mortensen, and Pissarides: Labor market search theory

Applied the theory of search to labor markets: the search process to find requires time and resources, creating frictions in the market. In the labor market context, some firms will not find workers, and some workers will not find jobs, leading to both job vacancies and unemployment on the labor market. The theory predicts that unemployment, job vacancies, and wages are affected by regulation and economic policy, e.g. that more generous unemployment benefits give rise to higher unemployment and longer search times.

Robert Hall: "Intertemporal Substitution in Consumption"

Estimated the parameter [1/theta], or the "intertemporal elasticity of consumption". Hall estimated that this elasticity was about zero, and which implied that the gross growth rate in consumption [C'/C] was largely unresponsive to the interest rate. The data also did not show consumption growth as responsive.

Hamilton: Oil shocks predict recessions

Every postwar recession (with one exception) was preceded by an increase in oil prices, and every oil market disruption (with one exception) was followed by an economic recession. The conclusion is that oil shocks were a contributing factor in at least some postwar recessions.

Mark Gertler: Financial Accelerators & Causes of the Financial Crisis

Financial Accelerators: The mutual feedback between the real sector and the financial sector: when balance sheets weaken, that causes credit to tighten, leading to downward pressure on the real economy, which further weakens balance sheets. There are other implications, like the role of credit spreads: when balance sheets weaken, credit spreads increase, and the real economy goes down. Financial Crisis: The biggest mistake involved regulation in the subprime lending market. Individuals were just concerned about his or her welfare, not about the market as a whole or the exposure of the market as a whole.

Niskanen: "Starve the Beast Does Not Work"

Found no evidence that "starving the beast" worked to reduce the growth of federal spending: there was a strong negative relation between the relative level of federal spending and tax revenues from 1981 to 2000. Thus, reducing tax revenues only shifts part of the burden of government spending to future generations.

Kydland and Prescott: "Time to Build and Aggregate Fluctuations"

Foundational paper of Real Business Cycle theory. Authors found that if elasticity of substitution of labor supply is 3 and TFP shocks are highly persistent and of the right magnitude, then business cycles are what the neoclassical growth model predicts. Conditional on a labor supply elasticity close to 3, TFP shocks are the major contributor to fluctuations in the period 1954-1981 in the United States.

Prescott Nobel Prize Speech

Frisch labor supply elasticity is about 3

Jones on the "Puritan Party"

If one political "team" gets what they want (e.g. the sequester) then the other team also gets something that it wants (e.g. repeal of the Bush tax cuts).

Al Roth: Applying matching functions to labor markets

Labor markets are like courtship and marriage: a two-sided matching market that involves searching and wooing on both sides. There is the potential for "clogging" - hard to search through and find good matches.

Kimball and Shapiro: "Labor Supply: Are the Income and Substitution Effects Both Large or Both Small?"

Labor supply appears unresponsive to permanent changes in the wage rate, and thus the income and substitution effects of a wage change cancel out. The equality of income and substitution effects implies that one can infer the size of the substitution effect from the size of the income effect. The authors look at people who received large permanent income shocks to infer large substitution effects. They estimated that Frisch labor supply elasticity is about one.

Ramey: "Can Government Purchases Stimulate the Economy?"

Looked at announcements of increases in government/military spending and found large expectation effects. She estimated that the U.S. aggregate multiplier for a temporary, deficit-financed increase in government purchases was between 0.8 and 1.5, but there was no way to know whether this was utility-increasing.

Lilien: "Sectoral Shifts and Cyclical Unemployment"

Much of "cyclical" unemployment is better described as fluctuations of the natural rate itself:as much as half of the variance of unemployment over the postwar period can be attributed to fluctuations of the natural rate brought about by the slow adjustment of labor to exogenous shifts of employment demand between sectors of the economy—there is a "mismatch" between the sectors where the workers are and the sectors that need workers, and job-skill mismatch leads to inefficient search.

Prescott: "Why Do Americans Work So Much More Than Europeans?"

Observed that Americans work more hours than Europeans, though output per hour worked did not vary much between them. Prescott compared tax rates across nations and found that countries that had the lowest taxes had the highest hours worked, even given a perfectly efficient welfare state where the government takes a fraction of a worker's income and at the end of the year all taxed income is redistributed equally back to all people. This was a new phenomenon: in the 1970s Europeans had lower taxes and worked more like Americans.

Blanchard and Portugal: "What Hides Behind an Unemployment Rate: Comparing Portuguese and U.S. Labor Markets"

Observed that Portugal and the US have the same unemployment rate but different job breakup rates and job finding rates. The authors concluded that Portugal's breakup and finding rates were three times lower than in the US because of Portugal's unemployment protection, which made it harder to fire people. This led to higher unemployment duration (lower job finding rate), as employers were more cautious about who to hire, though not a higher unemployment rate. Workers tended to be a better match for the jobs they did find (lower breakup rate).

Clark: "Fairwell to Alms"

Observed that consumption change is basically zero throughout history, and also observed a falling real interest rate over time. Given these two observations, Clark used the equation [r=p+%dC] to infer that p, or impatience, was falling. The argument goes that deep cultural changes encouraged people to become more patient and thus adopt good economic habits, which led to development.

Jones: Precautionary Savings

Optimal first period consumption: c* = 0.75y -0.25(y^2 + 8σ^2)^(1/2) This implies that, when future income is wildly uncertain (high standard deviation of future income σ^2), consumption increases greatly over the life cycle: if standard deviation is half of income, expected income rises by about 115% over a lifetime. So precautionary savings matter enormously when people face a de facto positive consumption constraint each period and a lifetime income that is highly uncertain.

Blanchard and Fisher on Precautionary Savings

People appear unable to solve optimization models of current vs. future consumption in the presence of uncertainty: people know that there is some chance that they will end up in a low-probability disaster situation, and thus hedge against that risk with an additional precautionary savings motive.

Franco Modigliani on the "Life Cycle Hypothesis"

People peak consumption around middle age, while Friedman's Permanent Income Hypothesis predicts flat consumption. But during those peak years there are more people in the household (spouse/children), and when you divide by the number of people in the household people's consumption looks a lot flatter.

Jones: "Why Economies Boom"

RBC claims that a lot of year-to-year economic volatility is caused by changes to the supply side of the economy: perhaps tax and regulatory changes, bad weather in farm economies, spikes in oil prices, and above all, the mysterious force known as the "technology shock." Executives and managers are constantly in the hunt for new ideas, the next big thing, pushing up the demand for excellent labor and new capital when a promising idea arises. And the downside is grim as well. Innovation droughts usually mean stagnation: Less work, less investment, less output.

Jones on the Chamley-Judd Theorem

Rational workers prefer to tax workers, not capitalists. Any capital tax-and-transfer to workers reduces the stock of capital so much that wages fall by more than the amount of the transfer: Redistribution that raises the income of workers as a whole is impossible. If you tax capital income and hand all of the tax revenue to workers, then in the long run (or the "steady state") you'll wind up with a smaller capital stock. And since workers use the capital stock to earn their wages, the capital tax pushes down their wages.

Friedman on the Permanent Income Hypothesis

Retort to the Keynesian claim that to boost current consumption people should be given a tax cut or extra cash today. Friedman argued that current and future consumption depend on lifetime wealth, not when income is actually received. When people receive their income they do not spend it all immediately; they only spend a small fraction of that extra money each year forever.

Chang-Tai Hsieh: "Do Consumers React to Anticipated Income Changes? Evidence from the Alaska Permanent Fund"

Sought to test Friedman's Permanent Income Hypothesis by examining the behavior of Alaskans who regularly receive a portion of Alaska's oil revenue. The author found no change in non-durable consumer spending immediatelyafter receiving the check. Instead, people used the money to pay down debt and put money in savings accounts, exactly as Friedman predicted. Tested the theory further by examining how Alaskans spent their tax returns, the amount of which they do not know in advance. Found that 30% of the return was spent on non-durables that month, which doesn't fit PIH or Keynesian story.

Jones: "Sticky-Wage Keynesianism is a Supply Side Theory"

Sticky wage Keynesianism says workers hate wage cuts so much that businesses dare not cut wages, even in a competitive market. So if demand for goods falls and businesses still want to sell stuff, rational individual firms cut their prices in response to bad news. But if firms cut their prices while keeping worker wages fixed, firms find workers more expensive than before--workers become more expensive in terms of goods. Because workers become more expensive, firms rationally decide to produce less stuff. So the reason there's so little output during a recession is because high wages make output too expensive to produce.

Summers: "Some Skeptical Observations on Real Business Cycle Theory"

Summers noted that Prescott is unable to suggest any specific technological shock for an actual downturn apart from the oil price shock in the 1970s. Furthermore there is no microeconomic evidence for the large real shocks that need to drive these models: the "technology shocks" that RBC models assume drive the business cycle have never been found.

Foote, Girardi, and Willen: Why Did So Many People Make So Many Ex Post Bad Decisions? The Causes of the Foreclosure Crisis

The "bubble theory" therefore explains the foreclosure crisis as a natural consequence of overly optimistic price expectations for a particular asset class (homes). According to the conventional narrative, the bubble was a by-product of misaligned incentives (intermediaries who did not have skin in the game) and financial innovation (securitization). But higher house price expectations rationalize the decisions of borrowers, investors, and intermediaries—their embrace of high leverage when purchasing homes or funding mortgage investments, their failure to require rigorous documentation of income or assets before making loans, and their extension of credit to borrowers with histories of not repaying debt.

Prescott: "Theory Ahead of Business Cycle Measurement"

The match between theory and observation is close but not perfect; the key deviation is that the empirical labor elasticity of output is less than predicted by theory. Part of this deviation could disappear if the economic variables were measured more in conformity with theory. Argues that theory should be used to obtain better measures of the key economic time series by the government.

Appelbaum: "The Vanishing Male Worker: How America Fell Behind"

The share of prime-age men — those 25 to 54 years old — who are not working has more than tripled since the late 1960s, to 16 percent. Changes in American society have made it easier for men to live without working: the availability of federal disability benefits; the decline of marriage, which means fewer men provide for children; and the rise of the Internet, which has reduced the isolation of unemployment.At the same time, it has become harder for men to find higher-paying jobs.

Tyler Cown: "Average is Over" on labor markets

There is a "hollowing out" of middle-income jobs (like manufacturing), the result of owners cutting the fat out of their industries. These jobs do not come back and the result is a polarized labor market.

Hall: "Lost Jobs" and sticky wages

To explain sticky wages, Hall emphasizes the importance of costs borne by the employer. Firms benefit when times are good but are penalized when times are slim (because wages are usually fixed) and they pay for searching for a good employee/employer match. Thus, employers are more risk averse in hiring and have less incentive to engage in search. Hence employers simply do not hire in down times. This idea is reinforced because workers cannot collectively signal that they would work for less in down times, wages have a tendency to stick upwards.

Haltiwanger, Davis, and Schuh: "Job Creation and Destruction"

Used data on manufacturing plants from the 1970s to the 1980s to demonstrate a high rate of job creation and destruction—on average, about one in ten manufacturing jobs disappears in a given year, while the industry creates a new manufacturing job at about the same rate. This "churn" tends to be observed on net as the relatively smaller job flows observed. They found that job "churn" was concentrated at plants that experienced large changes in employment, implying that during recessions workers tended to be fired en mass and then re-hired during the recovery.

Delong and Summers on government spending

What if the increase in G leads to the employment of some people who would have never been hired otherwise? (Ramey found no evidence of this outcome)

Sargent and Ljungqvist: "The European Unemployment Dilemma"

Why did unemployment in Europe increase a lot since the 1980s? It cannot be because of more generous unemployment benefits, since benefits were already high in Europe. Instead, the high unemployment was caused by "turbulence": because of the decline of manufacturing and the introduction of IT, people who lost their jobs also found that their job skills were obsolete. Job-specific human capital depreciates rapidly, so there is a lot of variance in the wage that those workers can expect. This makes workers are more likely to take the generous benefit than a lower wage.

Autor on disability insurance

Workers who are deemed to be unable to work due to a disability can receive social security benefits. The program creates a very strong incentive against meaningfully participating in the formal labor market. A worker might be extremely reluctant to forgo that in order to enter the workforce, which would put those benefits in jeopardy. There are many people who apply for disability when they've been unemployed for a long time, often because they've exhausted all their other options. Since 1997, there was at least a 4 million person increase in the number of people receiving disability benefits.

Reichling and Whalen: "Review of Estimates of the Frisch Elasticity of Labor Supply"

Writing for the CBO, the authors estimate the Frisch elasticity within a range from 0.27 to 0.53, with a central estimate of 0.40.