Economic Fluctuations and Growth Research Meeting

February 8, 2013
Matthias Doepke, Northwestern University, and Emmanuel Farhi, Harvard University, Organizers

Zhen Huo, University of Minnesota, and Jose-Victor Rios-Rull, University of Minnesota and NBER

Engineering a Paradox of Thrift Recession

Huo and Rios-Rull build a variation of the neoclassical growth model in which financial shocks to households or wealth shocks (in the sense of wealth destruction) generate recessions. Two standard ingredients that are necessary are the existence of adjustment costs that make the expansion of the tradable goods sector difficult and the existence of some frictions in the labor market that prevent enormous reductions in real wages (Nash bargaining in Mortensen-Pissarides labor markets is enough). The authors pose a new ingredient that greatly magnifies the recession: a reduction in consumption expenditures reduces measured productivity while technology is unchanged because of lower utilization of production capacity. This model provides a novel, quantitative theory of the current recessions in southern Europe.

Simeon Alder, University of Notre Dame; David Lagakos, Arizona State University; and Lee Ohanian, University of California, Los Angeles and NBER

The Decline of the U.S. Rust Belt: A Macroeconomic Analysis

The region of the United States that arguably fared worst over the post-war period is the "Rust Belt," the heavy manufacturing zone near the Great Lakes. Alder, Lagakos, and Ohanian argue that a lack of competition in labor and output markets in the Rust Belt were responsible for much of the region's decline. They formalize this theory in a dynamic general equilibrium model in which productivity growth and regional employment shares are determined by the extent of competition. When plausibly calibrated, the model explains roughly one third of the decline in the Rust Belt's employment share. Evidence from prominent Rust Belt industries support the model's predictions that investment and productivity growth rates were relatively low in the Rust Belt. In addition, evidence from the cross-section of metropolitan areas shows that areas that paid workers the highest wage premiums in 1950 had the lowest employment growth from 1950 to 2000, supporting the theory.

Raj Chetty and John Friedman, Harvard University and NBER; Soren Leth-Petersen, University of Copenhagen; Torben Nielsen, The Danish National Center for Social Research; and Tore Olsen, Harvard University

Active vs. Passive Decisions and Crowdout in Retirement Savings Accounts: Evidence from Denmark (NBER Working Paper No. 18565)

Do retirement savings policies -- such as tax subsidies or employer-provided pension plans -- increase total saving for retirement or simply induce shifting across accounts? Chetty and his co-authors revisit this classic question using 45 million observations on wealth for the population of Denmark. They find that a policy's impact on wealth accumulation depends on whether it changes savings rates by active or passive choice. Tax subsidies, which rely upon individuals to take an action to raise savings, have small impacts on total wealth. These researchers estimate that each $1 of tax expenditure on subsidies increases total saving by 1 cent. In contrast, policies that raise retirement contributions if individuals take no action -- such as automatic employer contributions to retirement accounts -- increase wealth accumulation substantially. Price subsidies only affect the behavior of active savers who respond to incentives, whereas automatic contributions increase the savings of passive individuals who do not re-optimize. They estimate that approximately 85 percent of individuals are passive savers. The 15 percent of active savers who respond to price subsidies do so primarily by shifting assets across accounts rather than reducing consumption. These individuals are also more likely to offset changes in automatic contributions and have higher wealth-income ratios. They conclude that automatic contributions are more effective than price subsidies at increasing savings rates for three reasons: 1) subsidies induce relatively few individuals to respond; 2) they generate substantial crowd-out conditional on response; and 3) they do not influence the savings behavior of passive individuals, who are least prepared for retirement.

Lawrence Christiano and Martin S. Eichenbaum, Northwestern University and NBER, and Mathias Trabandt, Federal Reserve Board

Unemployment and Business Cycles

Christiano, Eichenbaum, and Trabandt develop and estimate a general equilibrium model that accounts for key business cycle properties of labor market variables. In sharp contrast to leading New Keynesian models, wages are not subject to exogenous nominal rigidities. Instead, they derive inertial wages from their specification of how firms and laborers interact when negotiating wages. Their model outperforms the canonical Diamond-Mortensen-Pissarides model, both in a statistical sense and in terms of the plausibility of the estimated structural parameter values. The model also outperforms an estimated sticky wage model.

Andrew Atkeson and Pierre-Olivier Weill, University of California at Los Angeles and NBER, and Andrea Eisfeldt, University of California at Los Angeles

The Market for OTC Derivatives

Over-the-counter (OTC) derivatives markets are very large relative to banks' trading assets, and gross notionals are highly concentrated on the balance sheets of only a few large dealer banks. Moreover, the large volume of varied bilateral trades creates an intricate system of liability linkages between participating banks. These stylized observations have drawn the attention of policy makers and the public alike. They also clearly illustrate that trading patterns in OTC derivatives markets differ greatly from the Walrasian benchmark of centralized trading at a common price. Atkeson, Eisfeldt, and Weill develop a model of equilibrium entry, trade, and prices, in order to formally analyze positive and normative issues surrounding OTC derivatives markets. Their model illustrates the extent to which standard trading frictions, along with the standard risk sharing motive for trade, lead to a realistic market structure.

Guido Menzio, University of Pennsylvania and NBER, and Greg Kaplan, Princeton University and NBER

Shopping Externalities and Self-Fulfilling Unemployment Fluctuations

Menzio and Kaplan propose a novel theory of self-fulfilling fluctuations in the labor market. A firm employing an additional worker generates positive externalities on other firms, because employed workers have more income to spend and less time to shop for low prices than unemployed workers. The authors quantify these shopping externalities and show that they are sufficiently strong to create strategic complementarities in the employment decisions of different firms and to generate multiple rational expectations equilibria. Equilibria differ with respect to the agents' (rational) expectations about future unemployment. The authors show that negative shocks to the agents' expectations lead to fluctuations in vacancies, unemployment, labor productivity and the stock market that closely resemble those observed in the United States during the Great Recession.