Costly external finance,reallocation, and aggregate productivity

Empirical studies document that resource reallocation across production units plays an important role in accounting for aggregate productivity growth in the US manufacturing. Financial market frictions could distort the reallocation process and hence may hinder aggregate productivity growth. This paper studies the quantitative impact of costly external finance on aggregate productivity through resource reallocation across firms with idiosyncratic productivity shocks. A partial equilibrium model calibrated to the US manufacturing data shows that costly external finance causes inefficient output reallocation from high productivity firms to low productivity firms and as a result leads to a 1 percent loss in aggregate TFP.     

Labor and investment frictions in a real business cycle model

This paper develops a prototype real business cycle model in which labor and investment frictions may compete directly with technology shocks in accounting for fluctuations in the postwar US economy. Using Ireland's [2004a. A method for taking models to the data. Journal of Economic Dynamics and Control 28, 1205–1226] methodology, we establish that both types of friction are quantitatively important. Technology shocks still explain a substantial fraction of the fluctuations in aggregate output, as the baseline real business cycle model predicts. Formal hypothesis tests suggest that changes in the recurrence of shocks, frictions, and structural parameters all play a role in accounting for the shift in the time series properties of the data between the periods before and after 1980.     

Aggregation in economies with search frictions

We derive an aggregation result in economies with indivisible labor supply choices and frictional labor markets, obtaining a tractable model of gross worker flows in aggregate labor markets with search frictions. Our result explores the fact that economies with non-convex choice sets and idiosyncratic shocks allow for sunspot equilibria à la Kehoe et al. (2002). We use comparative steady state analysis to demonstrate the applicability of our aggregation result. Our framework reconciles the neoclassical growth model with search frictions with a mildly procyclical participation rate and matches the gross worker flows underpinning those dynamics.     

Endogenous business cycle propagation and the persistence problem: The role of labor-market frictions

Contrasting sharply with a recent trend in DSGE modeling, we propose a business cycle model where frictions and shocks are chosen with parsimony. The model emphasizes a few labor-market frictions and shocks to monetary policy and technology. The model, estimated from U.S. quarterly postwar data, accounts well for important differences in the serial correlation of the growth rates of aggregate quantities, the size of aggregate fluctuations and key comovements, including the correlation between hours and labor productivity. Despite its simplicity, the model offers an answer to the persistence problem (Chari et al., 2000) that does not rely on multiple frictions and adjustment lags or ad hoc backward-looking components. We conclude modern DSGE models need not embed large batteries of frictions and shocks to account for the salient features of postwar business cycles.     

On firm-level,industry-level,and aggregate employment fluctuations

Employment fluctuations are examined, at different levels of aggregation, in a model with firm-specific hiring decisions due to search frictions and sticky pricing. The results indicate that firm-level employment dispersion rises with higher price stickiness and higher demand elasticity, whereas it falls with more convexity of search costs and with a higher labor supply elasticity. Industry-level employment is more volatile and less procyclical than aggregate employment, and a larger industry size reduces volatility and raises co-movement with output. The calibrated model is able to match the volatility, autocorrelation and cyclical correlation of US industry-level employment when incorporating firm-specific technology shocks.     

Organizational dynamics and aggregate fluctuations: The role of financial relationships

This paper constructs an estimated dynamic stochastic general equilibrium model to study the role of labor reallocation between production and organizational tasks within a firm in movements in measured TFP in Japan. Allocating more labor to organizational tasks strengthens the financial relationship with financial intermediaries and helps firms to mitigate a widening in credit spread during financial difficulties. However, doing so reduces the labor allocated to production tasks and hence the measured TFP. Our quantitative analysis indicates that labor reallocation contributes to the observed procyclicality in measured TFP. We also find that this mechanism amplifies and propagates the effects of exogenous shocks on aggregate activity.     

Euro area real-time density forecasting with financial or labor market frictions

We compare real-time density forecasts for the euro area using three DSGE models. The benchmark is the Smets and Wouters model, and its forecasts of real GDP growth and inflation are compared with those from two extensions. The first adds financial frictions and expands the observables to include a measure of the external finance premium. The second allows for the extensive labor-market margin and adds the unemployment rate to the observables. The main question that we address is whether these extensions improve the density forecasts of real GDP and inflation and their joint forecasts up to an eight-quarter horizon. We find that adding financial frictions leads to a deterioration in the forecasts, with the exception of longer-term inflation forecasts and the period around the Great Recession. The labor market extension improves the medium- to longer-term real GDP growth and shorter- to medium-term inflation forecasts weakly compared with the benchmark model.     

Introducing financial frictions and unemployment into a small open economy model

Which are the main frictions and the driving forces of business cycle dynamics in an open economy? To answer this question we extend the standard new Keynesian model in three dimensions: we incorporate financing frictions for capital, employment frictions for labor and extend the model into a small open economy setting. We estimate the model on Swedish data. Our main results are that (i) a financial shock is pivotal for explaining fluctuations in investment and GDP. (ii) The marginal efficiency of investment shock has negligible importance. (iii) The labor supply shock is unimportant in explaining GDP and no high frequency wage markup shock is needed.     

The role of banking regulation in an economy under credit risk and liquidity shock

This paper develops a Dynamic Stochastic General Equilibrium model which includes a financial sector to analyze the effects of liquidity shock and credit risk in the Brazilian economy. Banks use equity capital and deposits from agents to finance investments of the productive sector. The sources of financial frictions are default rate and liquidity shock, due to deposits withdrawn in advance. The banking supervisor injects liquidity in the deposit market. Using data for the Brazilian economy in the period from 1995 to 2009, the structural parameters are estimated by Bayesian methods. Impulse response functions are computed to describe the dynamic effects of exogenous shocks. The major results show that credit risk is pro-cyclical and default risk depends on structural features. The banking regulator is able to set up a policy to promote financial stability and efficiently reduce fluctuations in the output.     

Digital finance and misallocation of resources among firms: Evidence from China

The resources misallocation among firms is serious in China, our calculation shows it has resulted in the total factor productivity (hereafter, TFP) loss of over 200% and has been gradually increasing in recent years, based on the firm-level data from National Tax Survey database from 2007 to 2016. This paper further investigates empirically the impact of digital finance on resources misallocation, by measuring resources misallocation with firm’s capital deviation and labor deviation, as well as measuring digital finance with the number of searches for fintech keywords on Baidu's webpage. Results suggest that digital finance can significantly mitigate resources misallocation among firms to improve the aggregate TFP by redistributing resources from over-resourced firms to under-resourced firms, although it cannot improve the TFP within a representative firm. The findings remain robust after addressing the endogeneity and using alterative variables of digital finance and value of labor output elasticity. Moreover, digital finance can rectify the credit-market discrimination, where its mitigating effect on resources misallocation prefers to non-state-owned firms and small and medium-sized firms. However, traditional finance, as measured by the number of offline bank branches, can also optimize resources allocation, but this effect is gradually diminishing and it also fails to rectify the credit discrimination.     

Taking financial frictions to the data

We estimate a Dynamic Stochastic General Equilibrium (DSGE) model with various financial frictions and analyze how well the model explains the Great Recession. Predictive analysis shows that the model can only slightly better explain the large deviation from trend during the crisis relative to a model without financial frictions. Specifically, the risk premium shock, which is a shock to the external finance premium of the entrepreneurs׳ leverage, explains the largest part of the investment downfall during the crisis. However, the ‘balance sheet’ channel of financial frictions in the model, which structurally links balance sheet conditions of financial intermediaries and nonfinancial borrowers to their borrowing rates, is estimated to be weak. We examine alternative prior specifications for how the financial frictions enter the model and continue to find a limited role for these frictions. Rolling-window estimation provides evidence for substantial time variation in parameters governing financial frictions. We conclude that the well-known financial frictions studied in this paper are not able to explain the financial crisis in a linearized and estimated model.     

The (un)importance of unemployment fluctuations for the welfare cost of business cycles

This paper studies the cost of business cycles within a real business cycle model with search and matching frictions in the labor market. We endogenously link both the cyclical fluctuations and the mean level of unemployment to the aggregate business cycle risk. The key result of the paper is that business cycles are costly: fluctuations over the cycle induce a higher average unemployment rate since employment is nonlinear in the job-finding rate and the past unemployment rate. We show this analytically for a special case of the model. We then calibrate the model to U.S. data. For the calibrated model, too, business cycles cause higher average unemployment; the welfare cost of business cycles can easily be an order of magnitude larger than Lucas's (1987) estimate. The cost of business cycles is the higher the lower the value of nonemployment is, or, equivalently, the lower is the disutility of work. The ensuing cost of business cycles rises further when workers' skills depreciate during unemployment.     

Sharing risk within and across countries: the role of labor market institutions

This paper studies the effect of labor market institutions on within- and cross-country risk sharing, using a model of international trade in risky assets modified to include a subset of agents, labor-owners who do not access financial markets, and employment security provisions. Labor market, institutions, by promoting within-country risk-shifting arrangements between agents with or without, access to financial markets, reduce the fluctuations of non-tradable labor incomes and amplify the, fluctuations of capital incomes. Capital flows become more volatile across countries, and if the, configuration of labor markets differs across countries, capital-owners bear the burden of systematic, undiversifiable world aggregate uncertainty.     

Wage premia and skill upgrading in Italy: why didn't the hound bark?

This paper presents firm-level evidence on the change of the employment share and the wage premium of non-manual workers in Italian manufacturing during the nineties. We find that the relative stability of the aggregate wage premium and employment share hides offsetting disaggregate forces: technical progress raises the relative demand for skilled labor within firms, whereas demand changes associated with trade reduce the relative demand for skills. Moreover, it is within the class of non-manual workers that most of the action takes place: the wage premium and employment share of executives rise substantially, while those of clerks fall in a similar proportion. Finally, we find that the export status of firms plays a key role in explaining labor market dynamics: exporters account for most of both demand-related and technology-related shifts. Overall, our results for Italy question the conventional view that the labor market is “rigid” due to labor market institutions.     

Firms' relative sensitivity to aggregate shocks and the dynamics of gross job flows

We propose the coefficient of variation as a measure of the cyclical volatility of gross job flows that is immune to trends in net job creation. In addition, we show that this measure is intrinsically related to the importance of aggregate shocks for fluctuations in job flows at the firm level. Using data for the Portuguese economy, we conclude that the coefficient of variation is a more robust measure for the underlying volatility of gross job flows. We also find that large and old firms exhibit higher relative sensitivity to aggregate shocks than small and young firms, and have a disproportional influence over the dynamics of aggregate job reallocation. In particular, since large and old firms tend to reallocate jobs less procyclically than small and young firms, job reallocation is less procyclical than if all firm classes were equally sensitive to aggregate shocks.     

Uncertainty-driven labor market fluctuations

This paper explores uncertainty shocks as a driving force in a search and matching model of the labor market. Uncertainty takes the form of a noisy component in a firm׳s initial signal about job productivity. Greater uncertainty dampens job creation by increasing the risk of making the costly mistake of investing in jobs that will turn out to be unprofitable. Thus, uncertainty shocks can cause labor market downturns: lower vacancy rates, lower job-finding rates, and higher unemployment. Numerical simulations examine the level of volatility and the cross-correlations and autocorrelations of key U.S. labor market indicators that result from fluctuations driven by changes in uncertainty.     

Wars and capital destruction

In this paper, we propose a theoretical framework to investigate the impact of conflicts and wars on key macroeconomic aggregates and welfare. Using a panel data with 9 countries from 1870 onwards, we first show that the consumption-to-output ratio is minimal during WWII for participants. While this can be explained by an increase in public spending in the USA, this cannot be the case in other countries that participated in WWII, as they experience a large fall in output during wartime. To account for this, we build a variation of a Real Business Cycle model first proposed by Hercowitz and Sampson (1991). We extend the initial model to account for specific shocks that destroy private and public capital stocks – as conflicts do – by assuming an (exogenously) time-varying parameter in the law of capital accumulation. In addition, the model imbeds generalized TFP shocks capturing standard technological factors as well as the potential effects of war on the labor force. The model is estimated and used (i) to assess the importance of capital shocks during war episodes, and (ii) to quantify the welfare effects of conflicts. We show that capital shocks are crucial to account for the macroeconomic dynamics of countries that have experienced large war-related destruction, and that the welfare losses from fluctuations can be quite large when considering data samples that include major war episodes.     

Misallocation,informality, and human capital: Understanding the role of institutions

The aim of this paper is to quantify the role of formal-sector institutions in shaping the demand for human capital and the level of informality. We propose a firm dynamics model where firms face capital market imperfections and costs of operating in the formal sector. Formal firms have a larger set of production opportunities and the ability to employ skilled workers, but informal firms can avoid the costs of formalization. These firm-level distortions give rise to endogenous formal and informal sectors and, more importantly, affect the demand for skilled workers. The model predicts that countries with a low degree of debt enforcement and high costs of formalization are characterized by relatively lower stocks of skilled workers, larger informal sectors, low allocative efficiency, and measured TFP. Moreover, we find that the interaction between entry costs and financial frictions (as opposed to the sum of their individual effects) is the main driver of these differences. This complementarity effect derives from the introduction of skilled workers, which prevents firms from substituting labor for capital and in turn moves them closer to the financial constraint.     

Informality in developing economies: Regulation and fiscal policies

This paper proposes a unified theoretical framework where formal and informal firms coexist and face the same type of product and labor market imperfections: they have monopoly power in the goods market, they are subject to matching frictions in the labor market, and wages are determined by bargaining between large firms and their workers, through either individual or collective bargaining. Our model matches the main stylized facts on informality for developing countries and appears to be a good candidate for policy analysis. In this framework, we study the impact on informality, wages and unemployment of policies that may be used to reduce informality. We consider changes in product market regulation (PMR) and in two types of fiscal policies, labor taxes and formality enforcement. We find that lessening PMR decreases informality and unemployment simultaneously, indicating that there is not necessarily a tradeoff between informality and unemployment. The tradeoff appears when fiscal policies are used, though. Moreover, the impacts of PMR on unemployment and on wages are larger under collective than individual bargaining. With respect to wage inequality, lessening PMR reduces it, while lower taxes tend to increase the formal sector wage premium.     

The cyclical upgrading of labor and on-the-job search

This paper examines patterns of worker reallocation in the search and matching model of the labor market. We show that on-the-job search is crucial for explaining the observed cyclical upgrading of workers to better employment opportunities in booms. This is due to the rising availability of employed searchers which facilitates recruitment for newly created high-wage jobs. The standard model fails to exhibit such behavior. At the same time, the model is consistent with salient features of labor market dynamics, such as the volatility of vacancies and unemployment, and a highly procyclical rate of job-to-job transitions. This suggests an important channel for the reallocation of workers across jobs as well as the propagation of aggregate shocks.