Economic Fluctuations and Growth

October 1, 2010
John Haltiwanger, University of Maryland, and Sergio Rebelo, Northwestern University, Organizers

Jonathan Parker, Northwestern University and NBER; Nicholas S. Souleles, University of Pennsylvania and NBER; David Johnson, Bureau of the Census; and Robert McClelland, Bureau of Labor Statistics
Consumer Spending and the Economic Stimulus Payments of 2008

Parke, Souleles, Johnson, and McClelland measure the response of household spending to the economic stimulus payments (ESPs) disbursed in mid-2008, using special questions added to the Consumer Expenditure Survey and variation arising from the randomized timing of when the payments were disbursed. They find that, on average, households spent about 12-30 percent (depending on the specification) of their stimulus payments on nondurable expenditures during the three-month period in which the payments were received. Further, there was also a substantial and significant increase in spending on durable goods, in particular vehicles, bringing the average total spending response to about 50-90 percent of the payments. Relative to research on the 2001 tax rebates, these spending responses are estimated with greater precision using the randomized timing variation. The estimated responses are substantial and significant for older, lower-income, and home-owning households. The authors further extend the literature in two ways. First, they find little evidence that the propensity to spend varies with the means of delivery (paper check versus electronic transfer). Second, they evaluate a complementary methodology for quantifying the impact of tax cuts, which asks consumers to self-report whether they spent their tax cuts. The response of spending to the ESPs is indeed largest for self-reported spenders. However, self-reported savers also spent a significant fraction of the payments.

Lubos Pastor and Pietro Veronesi, University of Chicago and NBER
Uncertainty about Government Policy and Stock Prices

Pastor and Veronesi analyze how changes in government policy affect stock prices. Their general equilibrium model features uncertainty about government policy and a government that has both economic and non-economic motives. The government tends to change its policy after performance downturns in the private sector. Stock prices fall at the announcements of policy changes, on average. The price fall is expected to be large if uncertainty about government policy is large, as well as if the policy change is preceded by a short or shallow downturn. Policy changes increase volatility, risk premiums, and correlations among stocks. The jump risk premium associated with policy decisions is positive, on average.

Lutz Kilian and Dan Murphy, University of Michigan
The Role of Inventories and Speculative Trading in the Global Market for Crude Oil

Kilian and Murphy develop a structural model of the global market for crude oil that for the first time explicitly allows for shocks to the speculative demand for oil as well as shocks to the flow demand and flow supply. The forward-looking element of the real price of oil is identified with the help of data on oil inventories. The model estimates rule out explanations of the 2003-8 oil price surge based on unexpectedly diminishing oil supplies and based on speculative trading. Instead, the authors find that this surge was caused by fluctuations in the flow demand for oil driven by the global business cycle. There is evidence, however, that speculative demand shifts played an important role during earlier oil price shock episodes including 1979, 1986, and 1990. The researchers also show that, even after accounting for the role of inventories in smoothing oil consumption, their estimate of the short-run price elasticity of oil demand is much higher than traditional estimates from dynamic models that do not account for price endogeneity. They conclude that additional regulation of oil markets would not have prevented the 2003-8 oil price surge.

Gadi Barlevy and Jonas Fisher, Federal Reserve Bank of Chicago
Mortgage Choices and Housing Speculation

Barlevy and Fisher describe a rational expectations model in which speculative bubbles in house prices can emerge. Within this model, both speculators and their lenders use interest-only mortgages (IOs) rather than traditional mortgages when there is a bubble. Absent a bubble, there is no tendency for IOs to be used. These insights are used to assess the extent to which house prices in U.S. cities were driven by speculative bubbles over the period 2000-2008. The authors find that IOs were used sparingly in cities where elastic housing supply precludes speculation from arising. In cities with inelastic supply, where speculation is possible, there was heavy use of IOs, but only in cities that had boom-bust cycles. Peak IO usage predicts rapid appreciations that cannot be explained by standard correlates and this variable is more robustly correlated with rapid appreciations than other mortgage characteristics, including sub-prime, securitization, and leverage. Where IOs were popular, their use does not appear to have been a response to houses becoming more expensive. Indeed, their use anticipated future appreciation. Finally, consistent with the reason why lenders prefer IOs, these mortgages are more likely to be repaid earlier or foreclose. Combined with the model here, this evidence suggests that speculative bubbles were an important factor driving prices in cities with boom-bust cycles.

Zhiguo He, University of Chicago, and Arvind Krishnamurthy, Northwestern University and NBER
Intermediary Asset Pricing

He and Krishnamurthy present a model for studying the dynamics of risk premiums during crises in asset markets where the marginal investor is a financial intermediary. Intermediaries face a constraint on raising equity capital. When the constraint binds, so that intermediaries' equity capital is scarce, risk premiums rise to reflect the capital scarcity. The researchers calibrate the model and show that it does well in matching two aspects of crises: the nonlinearity of risk premiums during crisis episodes; and, the speed of adjustment in risk premiums from a crisis back to pre-crisis levels. They then use the model to quantitatively evaluate the effectiveness of a variety of central bank policies, including reducing intermediaries' borrowing costs, infusing equity capital, and directly intervening in distressed asset markets. All of these policies are effective in aiding the recovery from a crisis. Infusing equity capital into intermediaries is particularly effective because it attacks the equity capital constraint that is at the root of the crisis in their model.

Francois Gourio, Boston University and NBER, and Leena Rudanko, Boston University
Customer Capital

Firms spend substantial resources on creating and maintaining customer relationships. Gourio and Rudanko explore the role of this customer capital for firm level and aggregate dynamics. Building on the neoclassical adjustment cost model of investment, they propose a tractable search theoretic general equilibrium model of long-term customer relationships. Frictional product markets require firms to spend resources on sales efforts, and cause existing customers to be partially locked-in. The model implies that in more frictional product markets, where firms selling expenses are higher, measured profit rates, Tobin's Q, and markups are all higher. Sales and investment are less volatile and exhibit hump-shaped responses to shocks. As a result, the model also reproduces the well-documented failure of investment-Q regressions. The authors document that these patterns are present in Compustat data.

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