Learning asymmetries in real business cycles

When a boom ends, the downturn is generally sharp and short. When growth resumes, the boom is more gradual. Our explanation rests on learning about productivity. When agents believe productivity is high, they work, invest, and produce more. More production generates higher precision information. When the boom ends, precise estimates of the slowdown prompt decisive reactions: investment and labor fall sharply. When growth resumes, low production yields noisy estimates of recovery. Noise impedes learning, slows recovery, and makes booms more gradual than downturns. A calibrated model generates growth rate asymmetry similar to macroeconomic aggregates. Fluctuations in agents’ forecast precision match observed countercyclical errors of forecasters.“There is, however, another characteristic of what we call the trade cycle that our explanation must cover; namely, the phenomenon of the crisis—the fact that the substitution of a downward for an upward tendency often takes place suddenly and violently, whereas there is, as a rule, no such sharp turning point when an upward is substituted for a downward tendency.” J.M. Keynes (1936)     

Overaccumulation,Interest, and Prices

I use a financial accelerator model to study interest and prices under boom–busts driven by changes in expectations about total factor productivity (TFP) and credit. I show that inflation falls in the boom phase of the TFP episode and then recovers during the bust, yet rises in the boom phase of the credit episode and then falls during the bust. Furthermore, for both episodes, the overaccumulation of debt relative to capital during the boom is critical for the busts since it implies a fall in credit worthiness. Finally, I show that stricter inflation targeting reduces inefficiencies in all instances but the boom phase of the TFP episode.     

Anticipated growth and business cycles in matching models

In a business cycle model that incorporates a standard matching framework, employment increases in response to news shocks, even though the wealth effect associated with the increase in expected productivity reduces labor force participation. The reason is that the matching friction induces entrepreneurs to increase investment in new projects and vacancies early. If there is underinvestment in new projects in the competitive equilibrium, then the efficiency gains associated with an increase in employment make it possible that consumption, employment, output, as well as the investment in new and existing projects jointly increase long before the actual increase in productivity materializes. If there is no underinvestment, then investment in existing projects decreases, but total investment, consumption, employment, and output still jointly increase.     

On the optimal progressivity of the income tax code

This paper computes the optimal progressivity of the income tax code in a dynamic general equilibrium model with household heterogeneity in which uninsurable labor productivity risk gives rise to a nontrivial income and wealth distribution. A progressive tax system serves as a partial substitute for missing insurance markets and enhances an equal distribution of economic welfare. These beneficial effects of a progressive tax system have to be traded off against the efficiency loss arising from distorting endogenous labor supply and capital accumulation decisions.Using a utilitarian steady state social welfare criterion we find that the optimal US income tax is well approximated by a flat tax rate of 17.2% and a fixed deduction of about $9,400. The steady state welfare gains from a fundamental tax reform towards this tax system are equivalent to 1.7% higher consumption in each state of the world. An explicit computation of the transition path induced by a reform of the current towards the optimal tax system indicates that a majority of the population currently alive (roughly 62%) would experience welfare gains, suggesting that such fundamental income tax reform is not only desirable, but may also be politically feasible.     

Quantifying and sustaining welfare gains from monetary commitment

Our objectives are: to quantify the stabilization welfare gains from commitment; to examine how commitment to an optimal rule can be sustained as an equilibrium; to find a simple interest rate rule that approximates the optimal commitment one. We utilize an empirical micro-founded euro-area DSGE model, a quadratic approximation of household utility as the welfare criterion, employing a nominal interest rate lower bound. In contrast to previous studies, we find significant commitment stabilization gains of around a 0.4-0.5% equivalent permanent consumption increase, and with higher price stickiness gains over 2%. We find that a simple optimized commitment rule responding to inflation and the real wage mimics the optimal one.     

Eyes on the prize: How did the fed respond to the stock market?

Since the stock market boom of the 1990s, many have suggested the Federal Open Market Committee (FOMC) has adopted an unannounced policy goal of supporting equity values. This paper offers a new approach to disentangle the relationship between changes in equity values and monetary policy. Specifically, the paper distinguishes the FOMC's reaction to forecasts of traditional goal variables, which may depend on equity prices, from the FOMC's independent reaction to changes in equity prices. By using actual forward-looking variables examined by the FOMC before each action (the “Greenbook” forecasts), the authors find little evidence to support the proposition that the FOMC responds to stock values, except as filtered through a forecast of accepted monetary policy goal variables.     

A further contribution towards explaining why disinflation through currency pegging may cause a boom

We revisit the question of why exchange-rate-based (ERB) disinflation is often expansionary. We use an analytical DGE model in discrete time with staggered wages. If the policy is unanticipated, and if the currency is pegged at the level it would have reached under unchanged policies, then a boom occurs. For preannounced ERB disinflation, our model also predicts a boom. The explanation for both is that when wages are staggered, wage-setters have to be forward-looking. Anticipating lower future inflation, they reduce wages before the change in the exchange rate, causing a favourable supply-side effect on output.     

Monetary policy, taxes, and the business cycle

This paper analyzes the interaction of inflation with the tax code and its contribution to aggregate fluctuations. We find significant effects operating through the tax on realized nominal capital gains. A tax on nominal bond income magnifies these effects. Our innovation is to combine monetary policy shocks with non-indexed taxes in a model where the central bank implements policy using an interest rate rule. Monetary policy had important effects on the behavior of the business cycle before 1980 because policymakers did not exert effective control over inflation. Monetary policy reform around 1980 led to better control, and with more stable inflation, the effect of the interaction between monetary policy and the nominal capital gains tax has become negligible.     

Productivity, tradability, and the long-run price puzzle

Long-run cross-country price data exhibit a puzzle. Today, richer countries exhibit higher price levels than poorer countries, a stylized fact usually attributed to the Balassa-Samuelson (BS) effect. But looking back 50 years, this effect virtually disappears from the data. What is often assumed to be a universal property is actually quite specific to recent times, emerging a half century ago and growing steadily over time. What might potentially explain this historical pattern? We develop an updated BS model inspired by recent developments in trade theory, where a continuum of goods are differentiated by productivity, and where tradability is endogenously determined. Firms experiencing productivity gains are more likely to become tradable and crowd out firms not experiencing productivity gains. As a result the usual BS assumption—that productivity gains be concentrated in the traded goods sector—emerges endogenously, and the BS effect on relative price levels likewise evolves gradually over time.     

The spirit of capitalism and expectation-driven business cycles

While news shocks are believed to be instrumental in explaining business cycles, many existing models fail to predict a boom in consumption, investment, employment, output and asset prices in response to good news about future productivity. A model with the intrinsic desire for wealth is shown to generate the aforementioned responses. A news-driven boom is explained predominantly by an expansion of labor supply and is characterized by the falling real wage. The simulated model not only captures well conventional business cycle statistics, but also reproduces countercyclical real returns and hump-shaped responses of hours and output to an unexpected technology shock.     

The Most Beautiful Variations on Fair Wages and the Phillips Curve

This paper explores the connection between inflation and unemployment in two different models with fair wages in both the short and the long runs. Under customary assumptions regarding the sign of the parameters of the effort function, more inflation lowers the unemployment rate, albeit to a declining extent. This is because firms respond to inflation—which spurs effort by decreasing the reference wage—by increasing employment, thus maintaining the effort level constant as implied by the Solow condition. A stronger short‐run effect of inflation on unemployment is produced under varying as opposed to fixed capital, given that in the former case the boom produced by a monetary expansion is reinforced by an increase in investment. Therefore, I provide a new theoretical foundation for recent empirical contributions that find negative long‐ and short‐run effects of inflation on unemployment.     

Effects of Private Ownership,Trade, and Foreign Direct Investment on Labor Productivity Growth in Transition Economies: Evidence from the Croatian Manufacturing Industry

In this study, we investigate the determinants of labor productivity dynamics in transition economies using data from Croatian manufacturing industries. Capital intensity growth and human capital accumulation have been significant contributors to stronger productivity gains. Private-sector development has positively affected productivity growth—but mostly through the increasing role of new private companies. Still, unfinished privatization represents a significant obstacle to stronger productivity gains. The effect of increasing trade openness is significant but negative, most likely owing to weak export competitiveness of Croatian companies. Neither greenfield nor (predominant) brownfield foreign direct investment inflows have contributed to higher labor productivity growth. Further privatization and structural reforms seem to be the most promising policy measures that need to be undertaken in order to achieve higher productivity gains.     

Share Holder Wealth Effects of Corporate Selloffs: Impact of Growth Opportunities, Economic Cycle and Bargaining Power

Most of the existing empirical evidence on corporate selloffs documents significant wealth gains for the seller's shareholders. We investigate the sources of these wealth gains by examining the impact of business and financial strategy, the economic environment during selloff, and the bargaining advantages of the seller including information asymmetry. We find evidence that sellers with growth opportunities and financially strong sellers enjoy higher returns. Selloffs during recessions generate larger wealth gains than those during economic boom. Information asymmetry due to the buyer's location being different from the purchased division's gives the seller a bargaining advantage leading to larger wealth gains. Relatively large divestments are more beneficial to seller shareholders than small ones. The study highlights the importance of both firm specific and environmental factors in explaining the wealth gains associated with corporate selloffs.     

Private Equity: Accomplishments and Challenges

The authors provide an overview of the main accomplishments of private equity since the emergence of leveraged buyouts in the 1980s, and of the challenges now facing the industry—challenges that have been encountered before during three major growth waves and two full boom‐and‐bust cycles. In so doing, the authors review a large and growing body of academic studies responding to questions like these:

• (1) How have PE buyout companies performed relative to their public counterparts? And to the extent there have been improvements in operating performance and productivity gains, how have such gains been achieved? What role have PE firms played in this process?
• (2) Especially in light of the large fees and profit shares paid to the PE firms, or GPs, and the significant “control” premiums over market paid to the selling companies, how have the returns to the LPs that provide the bulk of the funding for PE funds compared to the returns earned by the shareholders of comparable public companies?
• (3) Apart from the high fees earned by its GPs, why is PE so controversial? Beyond their effects on productivity and benefits for investors, what are the employment and other social effects of buyouts and PE?
• (4) What are the prospects for future PE returns to their LPs, especially in light of the volume of capital commitments and high purchase multiples that were being paid, at least until the onset of the COVID pandemic? And what role, if any, should PE activity be expected to play in the recovery from the pandemic?

     

On the aggregate welfare cost of Great Depression unemployment

The potential benefit of policies that eliminate a small likelihood of economic crises is calculated. An economic crisis is defined as an increase in unemployment of the magnitude observed during the Great Depression. For the U.S., the maximum likelihood estimate of entering a depression is found to be about once every 83 years. The welfare gain from setting this small probability to zero can range between 1% and 7% of annual consumption in perpetuity. For most estimates, more than half of these large gains results from a reduction in individual consumption volatility.     

Risk Premium Shocks and the Zero Bound on Nominal Interest Rates

Quantitative dynamic stochastic general equilibrium (DSGE) models often admit that the zero bound on nominal interest rates does not constrain (optimal) monetary policy. Recent economic events, however, have reinforced the relevance of the zero bound. This paper sheds some light on this disconnect by studying a broad range of shocks within a standard DSGE model. In contrast to earlier studies, we find that risk premium shocks are key to building quantitative models where the zero bound is relevant for monetary policy design. Other commonly included shocks, such as productivity, government spending, and money demand shocks, are unable to push nominal rates close to zero.     

Measuring aggregate risk: Can we robustly identify asset-price boom–bust cycles?

We investigate the extent to which it is possible to detect asset-price booms and banking crises according to alternative identification strategies and we assess their robustness. We find some evidence that house price-booms are more likely to turn into costly recession or to trigger a banking crisis than stock-price booms. Resorting both to a non-parametric approach and a discrete-choice (logit) model, we analyze the ability of a wide set of indicators to robustly explain costly asset-price booms. According to our results, real long-term interest rates and real stock prices tend to increase the probability of a costly housing-price boom, whereas real GDP tends to increase the probability of a costly stock-price boom. Interestingly, the credit-to-GDP gap indicator, sometimes put forward in the literature as a key reference for setting countercyclical capital buffers, does not seem to be a robust leading indicator of costly booms or banking crises.     

On the consequences of demographic change for rates of returns to capital, and the distribution of wealth and welfare

This paper employs a multi-country large-scale Overlapping Generations model with uninsurable labor productivity and mortality risk to quantify the impact of the demographic transition towards an older population in industrialized countries on world-wide rates of return, international capital flows and the distribution of wealth and welfare in the OECD. We find that for the U.S. as an open economy, rates of return are predicted to decline by 86 basis points between 2005 and 2080 and wages increase by about 4.1%. If the U.S. were a closed economy, rates of return would decline and wages increase by less. This is due to the fact that other regions in the OECD will age even more rapidly; therefore the U.S. is “importing” the more severe demographic transition from the rest of the OECD in the form of larger factor price changes. In terms of welfare, our model suggests that young agents with little assets and currently low labor productivity gain, up to 1% in consumption, from higher wages associated with population aging. Older, asset-rich households tend to lose, because of the predicted decline in real returns to capital.     

An investigation of the gains from commitment in monetary policy

We propose a simple framework for analyzing a continuum of monetary policy rules characterized by differing degrees of credibility, in which commitment and discretion become special cases of what we call quasi-commitment. The monetary policy authority is assumed to formulate optimal commitment plans, to be tempted to renege on them, and to succumb to this temptation with a constant exogenous probability known to the private sector. By interpreting this probability as a continuous measure of the (lack of) credibility of the monetary policy authority, we investigate the welfare effect of a marginal increase in credibility. Our main finding is that, in a simple model of the monetary transmission mechanism, most of the gains from commitment accrue at relatively low levels of credibility.     

Pricing Behavior and the Response of Hours to Productivity Shocks

Recent contributions have suggested that technology shocks have a negative impact on hours, contrary to the prediction of standard flexible-price models of the business cycle. Some authors have interpreted this finding as evidence in favor of sticky-price models, while others have either extended flexible-price models or disputed the empirical finding itself. In this paper, we estimate a variety of alternative total factor productivity measures for a representative sample of Italian manufacturing firms and on average find a negative effect of productivity shocks on hours growth. More interestingly, using the reported frequency of price reviews, we show that the contractionary effect is stronger for firms with stickier prices and weaker or not significant for firms with more flexible prices. Price stickiness remains a crucial factor in shaping the response of hours after controlling for product storability or market power.