Economic Fluctuations and Growth

July 12, 2014
Lawrence Christiano of Northwestern University and Charles Jones of Stanford University, Organizers

Gauti Eggertsson, Brown University and NBER, and Neil Mehrotra, Brown University

A Model of Secular Stagnation

In this paper, Eggertsson and Mehrotra propose a simple overlapping generations New Keynesian model in which a permanent (or very persistent) slump is possible with no self-correcting force to full employment. The trigger for the slump is a deleveraging shock which can create an oversupply of savings. Other forces that work in the same direction and can both create or exacerbate the problem are a drop in population growth and an increase in income inequality. High savings, in turn, may require a permanently negative real interest rate. In contrast to earlier work on deleveraging, the authors' model does not feature a strong self-correcting force back to full employment in the long run absent policy actions, which may include, among others, an increase in the inflation target and an increase in government spending. The authors also establish conditions under which an income redistribution can increase demand. However, policies such as committing to low nominal interest rates or temporary government spending are less powerful than in models with temporary slumps. The authors' model sheds light on the long persistence of the Japanese crisis, the Great Depression, and the slow recovery out of the Great Recession.

Simon Gilchrist, Boston University and NBER; Raphael Schoenle, Brandeis University; and Jae Sim and Egon Zakrajšek, Federal Reserve Board

Inflation Dynamics during the Financial Crisis

Using confidential product-level price data underlying the U.S. Producer Price Index (PPI), Gilchrist, Schoenle, Sim, and Zakrajšek analyze the effect of changes in firms' financial conditions on their price-setting behavior during the Great Recession that surrounds the financial crisis. The evidence indicates that during the height of the crisis in late 2008, firms with "weak" balance sheets increased prices significantly relative to industry averages, whereas firms with "strong" balance sheets lowered prices, a response consistent with an adverse demand shock. These stark differences in price-setting behavior are consistent with the notion that financial frictions may significantly influence the response of aggregate inflation to macroeconomic shocks. The authors explore the implications of these empirical findings within a general equilibrium framework that allows for customer markets and departures from the frictionless financial markets. In the model, firms have an incentive to set a low price to invest in market share, though when financial distortions are severe, firms forgo these investment opportunities and maintain high prices in an effort to preserve their balance sheet capacity. Consistent with the authors' empirical findings, the model with financial distortions, relative to the baseline model without such distortions, implies a substantial attenuation of price dynamics in response to contractionary demand shocks.

Roland Bénabou, Princeton University and NBER, and Davide Ticchi and Andrea Vindigni, IMT Institute for Advanced Studies Lucca

Forbidden Fruits: The Political Economy of Science, Religion and Growth

Bénabou, Ticchi, and Vindigni analyze the joint dynamics of religious beliefs and scientific-economic development. They emphasize in particular how this coevolution is shaped by (and feeds back on) political conflicts and coalition formation along both religious and income lines. As part of their motivating evidence, the authors also uncover a new fact: in both international and cross-state U.S. data, there is a significant negative relationship between religiosity and innovativeness (patents per capita), even after controlling for the standard empirical determinants of the latter. To shed light on the workings of the science-religion-politics nexus and its growth and distributional implications, the authors develop a model with three key features: 1, the recurrence of scientific discoveries which, if widely diffused and implemented, generate productivity gains but sometimes also erode existing religious beliefs (a source of utility for some agents) by contradicting important aspects of the doctrine; 2, a government that can allow such ideas and innovations to spread, or spend resources to censor them and impede their diffusion; and 3, a religious organization or sector (Church or churches) that can, at a cost, undertake an adaptation of the doctrine that renders it more compatible with the new knowledge. The model leads to the emergence of three types of long-term outcomes. The first is a "secularization" or "Western European" regime, with declining religiosity, unimpeded scientific progress, a passive Church, and high levels of taxes and secular public spending. The second is a "theocratic" regime with knowledge stagnation, extreme religiosity, a Church that makes no effort to adapt since its beliefs are protected by the state, and also high taxes but now used to subsidize the religious sector. Between these two is a third, an "American" regime, which generally (not always) succeeds in combining unimpeded scientific progress and stable religiosity within a range where the state does not block new discoveries and the religious sector finds it worthwhile to invest in doctrinal repair and adaptation. This regime features lower taxes than the other two, but with positive revenue or tax exemptions allocated to religious activities. The authors also show that in this "American" regime, a rise in income inequality can lead the religious rich to form a "religious-right" alliance with the religious poor and attempt to block belief-eroding discoveries and ideas. Inequality can thus hinder knowledge and growth by inducing obscurantist, anti-science attitudes and policies.

Valerie Ramey, University of California, San Diego and NBER, and Sarah Zubairy, Texas A&M University

Government Spending Multipliers in Good Times and in Bad: Evidence from U.S. Historical Data

Ramey and Zubairy investigate whether U.S. government spending multipliers differ according to two potentially important features of the economy: 1, the amount of slack; and 2, whether interest rates are near the zero lower bound. They shed light on these questions by analyzing new quarterly historical U.S. data covering multiple large wars and deep recessions. They estimate a state-dependent model in which impulse responses and multipliers depend on the average dynamics of the economy in each state. The authors find no evidence that multipliers differ by the amount of slack in the economy. These results are robust to many alternative specifications. Most specifications also suggest that multipliers are not significantly higher when interest rates are near the zero lower bound. The authors' results imply that, contrary to recent conjecture, government spending multipliers were not necessarily higher than average during the Great Recession.

Paul Beaudry, University of British Columbia and NBER; Dana Galizia, Vancouver School of Economics; and Franck Portier, Toulouse School of Economics

Reconciling Hayek's and Keynes' Views of Recessions (NBER Working Paper 20101)

Recessions often happen after periods of rapid accumulation of houses, consumer durables, and business capital. This observation has led some economists, most notably Friedrich Hayek, to conclude that recessions mainly reflect periods of needed liquidation resulting from past over-investment. According to the main proponents of this view, government spending should not be used to mitigate such a liquidation process because doing so would simply result in the postponement of a needed adjustment. In contrast, since the work of Keynes, many economists have viewed recessions as periods of deficient demand that should be countered by activist fiscal policy. Beaudry, Galizia, and Portier reexamine the liquidation perspective of recessions in a setup where prices are flexible but not all trades are coordinated by centralized markets. They show why and how liquidations can produce periods when the economy functions particularly inefficiently, with many socially desirable trades between individuals remaining unexploited when the economy inherits too many capital goods. In this sense, the model illustrates how liquidations can cause recessions characterized by deficient aggregate demand and accordingly suggests that Keynes' and Hayek's views of recessions may be much more closely linked than previously recognized. In the authors' framework, interventions aimed at stimulating aggregate demand face the tradeoff emphasized by Hayek whereby the current stimulus mainly postpones the adjustment process and therefore prolongs the recession. However, when examining this tradeoff, the authors find that an argument can be made for implementing some stimulative policies even if they postpone a recovery.

Daron Acemoglu, MIT and NBER; Ufuk Akcigit, University of Pennsylvania and NBER; and Murat Alp Celik, University of Pennsylvania

Young, Restless, and Creative: Openness to Disruption and Creative Innovations

Acemoglu, Akcigit, and Celik argue that openness to new, unconventional, and disruptive ideas has a first-order impact on creative innovations - innovations that break new ground in terms of knowledge creation. After presenting a motivating model focusing on the choice between incremental and radical innovation, and on how managers of different ages and human capital are sorted across different types of firms, the authors provide cross-country, firm-level, and patent-level evidence consistent with this pattern. Their measures of creative innovations proxy for innovation quality (the average number of citations per patent), and creativity (the fraction of superstar innovators, the likelihood of a very high number of citations, and the generality of patents). The authors' main proxy for openness to disruption is manager age. This variable is based on the idea that only companies or societies open to such disruption will allow the young to rise up within the hierarchy. Using this proxy at the country, firm, and patent level, the authors present robust evidence that openness to disruption is associated with more creative innovations.