Christopher J. Nekarda, Federal Reserve Board; and Valerie A. Ramey, University of California, San Diego and NBER
The Cyclical Behavior of the Price-Cost Markup
Countercyclical markups constitute the key transmission mechanism for monetary and other demand shocks in textbook New Keynesian models. Nekarda and Ramey test the foundation of those models by studying the cyclical properties of the markup of price over marginal cost. They first focus on markups in the aggregate economy and the manufacturing sector. They use Bilsas (1987) insights for converting average cost to marginal cost, but do so with richer data. They find that all measures of markups are either procyclical or acyclical. Moreover, they show that monetary shocks lead markups to fall with output. Then they merge input-output information on shipments to the government with detailed industry data to study the effect of demand changes on industry-level markups. They find that Industry-level markups are acyclical in response to demand changes.
Olivier Coibion, College of William and Mary; Yuriy Gorodnichenko and Johannes F. Wieland, University of California, Berkeley and NBER
The optimal inflation rate in New Keynesian models(NBER Working Paper No. 16093)
Coibion, Gorodnichenko, and Wieland study the effects of positive steady-state inflation in New Keynesian models subject to the zero bound on interest rates. They derive the utility-based welfare loss function, taking into account the effects of positive steady-state inflation. They show that steady-state inflation affects welfare through three distinct channels: steady-state effects, the magnitude of the coefficients in the utility-function approximation, and the dynamics of the model. They solve for the optimal level of inflation in the model and find that, for plausible calibrations, the optimal inflation rate is low, less than 2 percent, even after considering a variety of extensions, including price indexation, endogenous price stickiness, capital formation, model uncertainty, and downward nominal wage rigidities. On the normative side, price level targeting delivers large welfare gains and a very low optimal inflation rate consistent with price stability.
Jeremy C. Stein, Harvard University and NBER
Monetary Policy as Financial-Stability Regulation
Stein develops a model that speaks to the goals and methods of financial stability policies. He makes three main points. First, from a normative perspective, the model defines the fundamental market failure to be addressed, namely that unregulated private money creation can lead to an externality in which intermediaries issue too much short-term debt and leave the system excessively vulnerable to costly financial crises. Second, in a simple economy where commercial banks are the only lenders, conventional monetary-policy tools such as open-market operations can be used to regulate this externality, but in more advanced economies it may be helpful to supplement monetary policy with other measures. Third, from a positive perspective, Stein's model provides an account of how monetary policy can influence bank lending and real activity, even in a world where prices adjust without frictions and there are other transactions media besides bank-created money that are outside the control of the central bank.
Raj Chetty, Harvard University and NBER
Bounds on Elasticities with Optimization Frictions: A Synthesis of Micro and Macro Evidence on Labor Supply
Chetty derives bounds on price elasticities in a dynamic model that is mis-specified because of optimization frictions, such as adjustment costs, or inattention. The bounds are a function of the observed effect of a price change on demand, the size of the price change, and the degree of frictions. Chetty measures the degree of frictions by the utility losses that agents tolerate to make choices that deviate from the frictionless optimum. He applies these bounds to the literature on taxation and labor supply, allowing for frictions of 1 percent of consumption in choosing labor supply. Such small frictions reconcile the difference between micro and macro elasticities, extensive and intensive margin elasticities, and several other disparate findings. Pooling estimates from twenty existing studies yields bounds on the intensive margin Hicksian labor supply elasticity of (0:47; 0:54).
Jonathan Eaton, Pennsylvania State University and NBER, and Samuel S. Kortum, Brent Neiman, and John Romalis, University of Chicago and NBER
Trade and the Global Recession
The ratio of global trade to GDP declined by nearly 30 percent during the global recession of 2008-9. This large drop in international trade has generated significant attention and concern. Did the decline simply reflect the severity of the recession for traded goods industries? Or, did international trade shrink because of factors unique to cross border transactions? Eaton, Kortum, Neiman, and Romalis merge an input-output framework with a gravity trade model and numerically solve several general equilibrium counterfactual scenarios which quantify the relative importance for the decline in trade of the changing composition of global GDP and of changes in trade frictions. Their results suggest that the relative decline in demand for manufactures was the most important driver of the decline in manufacturing trade. Changes in demand for durable manufactures alone accounted for 65 percent of the cross-country variation in changes in manufacturing trade/GDP. The decline in total manufacturing demand (durables and nondurables) accounted for more than 80 percent of the global decline in trade/GDP. Trade frictions increased and played an important role in reducing trade in some countries, notably China and Japan, but decreased or remained relatively stable in others. Globally, the impact of these changes in trade at frictions largely cancel each other out.
Charles I. Jones, Stanford University and NBER; and Peter J. Klenow, Stanford University and NBER
Beyond GDP? Welfare across Countries and Time
Jones and Klenow propose a simple summary statistic for a nation's inflow of welfare, measured as a consumption equivalent, and compute its level and growth rate for a broad set of countries. This welfare index combines data on consumption, leisure, inequality, and mortality. Although the index is highly correlated with per capita GDP, deviations are often economically significant: Western Europe looks considerably closer to U.S. living standard; emerging Asia has not caught up as much; and many African and Latin American countries are farther behind because of lower levels of life expectancy and higher levels of inequality. In recent decades, rising life expectancy boosts annual growth in welfare by more than a full percentage point throughout much of the world. The notable exception is sub-Saharan Africa, where life expectancy actually declines.