Economic Fluctuations and Growth

July 11, 2015
Giovanni Violante of New York University and Ivan Werning of MIT, Organizers

Gary B. Gorton, Yale University and NBER, and Guillermo Ordoñez, University of Pennsylvania and NBER

Good Booms, Bad Booms

Credit booms usually precede financial crises. However, some credit booms end in a crisis (bad booms) and others do not (good booms). Gorton and Ordoñez document that, while all booms start with an increase of Total Factor Productivity (TFP) and Labor Productivity (LP), such growth falls much faster subsequently for bad booms. The researchers then develop a simple framework to explain this. Firms finance investment opportunities with short-term collateralized debt. If agents do not produce information about the collateral quality, a credit boom develops, accommodating firms with lower quality projects and increasing the incentives of lenders to acquire information about the collateral, eventually triggering a crisis. When the average quality of investment opportunities also grows, the credit boom may not end in a crisis because the gradual adoption of low quality projects is not strong enough to induce information about collateral. Finally, the researchers also test the main predictions of the model.

Xavier Giroud, MIT and NBER, and Holger Mueller, New York University and NBER

Firm Leverage and Unemployment during the Great Recession (NBER Working Paper No. 21076)

Giroud and Mueller argue that firms' balance sheets were instrumental in the propagation of shocks during the Great Recession. Using establishment-level data, the researchers show that firms that tightened their debt capacity in the run-up to the Great Recession ("high-leverage firms") exhibit a significantly larger decline in employment in response to household demand shocks than firms that freed up debt capacity ("low-leverage firms"). In fact, all of the job losses associated with falling house prices during the Great Recession are concentrated among establishments of high-leverage firms. At the county level, the researchers show that counties with a larger fraction of establishments belonging to high-leverage firms exhibit a significantly larger decline in employment in response to household demand shocks. Thus, firms' balance sheets also matter for aggregate employment.

Charles I. Jones, Stanford University and NBER, and Jihee Kim, Korea Advanced Institute of Science and Technology

A Schumpeterian Model of Top Income Inequality (NBER Working Paper No. 20637)

Top income inequality rose sharply in the United States over the last 35 years but increased only slightly in economies like France and Japan. Why? In this paper, Jones and Kim explore a model in which heterogeneous entrepreneurs, broadly interpreted, exert effort to generate exponential growth in their incomes. On its own, this force leads to rising inequality. Creative destruction by outside innovators restrains this expansion and induces top incomes to obey a Pareto distribution. The development of the world wide web and a reduction in top tax rates are examples of changes that raise the growth rate of entrepreneurial incomes and therefore increase Pareto inequality. In contrast, policies that stimulate creative destruction reduce top inequality. Examples include research subsidies or a decline in the extent to which incumbent firms can block new innovation. Differences in these considerations across countries and over time, perhaps associated with globalization, may explain the varied patterns of top income inequality seen in the data.

Gita Gopinath, Harvard University and NBER; Sebnem Kalemli-Özcan, University of Maryland and NBER; Loukas Karabarbounis, University of Chicago and NBER; and Carolina Villegas-Sanchez, ESADE-Universitat Ramon Llull

Capital Allocation and Productivity in South Europe

Following the introduction of the euro in 1999, countries in the South experienced large capital inflows and low productivity. Gopinath, Kalemli-Özcan, Karabarbounis, and Villegas-Sanchez use data for manufacturing firms in Spain to document a significant increase in the dispersion of the return to capital across firms, a stable dispersion of the return to labor across firms, and a significant increase in productivity losses from misallocation over time. The researchers develop a model of heterogenous firms facing financial frictions and investment adjustment costs. The model is consistent with cross-sectional and time-series patterns in size, productivity, capital returns, investment, and debt observed in production and balance sheet data. The researchers illustrate how the decline in the real interest rate, often attributed to the euro convergence process, generates a decline in sectoral total factor productivity as capital inflows are misallocated toward firms that are not necessarily the most productive. The authors conclude by showing that similar trends in dispersion and productivity losses are observed in Italy and Portugal but not in Germany, France, and Norway.

Marcus Hagedorn, Institute for Advanced Studies, and Jessie Handbury and Iourii Manovskii, University of Pennsylvania and NBER

Demand Stimulus, Inflation and Marginal Costs: Empirical Evidence

The relationship between government spending, marginal costs and inflation is at the core of New Keynesian theories of price setting. In particular, the impact of a demand stimulus on marginal costs and inflation determines the size of the fiscal multiplier. Yet, despite the fundamental importance of this relationship to theory, documenting it in the data has proved elusive. In this paper, Hagedorn, Handbury, and Manovskii estimate the effect of a fiscal expansion on inflation using the Nielsen Retail Scanner Data. To identify this response of inflation to a demand stimulus (an increase in the generosity of unemployment insurance) authors exploit a policy discontinuity at U.S. state borders. They find that inflation (and also spending) responds with a delay in a hump-shaped manner. To assess the impact on marginal costs authors explore whether this response is consistent with two leading models of price setting, the sticky price model and the sticky information model, which they show to have different implications for the size of the fiscal multiplier. Authors find that the sticky information model is consistent with their empirical findings whereas the sticky price model is not.

Martin Beraja and Juan Ospina, University of Chicago, and Erik Hurst, University of Chicago and NBER

The Aggregate Implications of Regional Business Cycles

Inferences about the determinants of aggregate business cycles from cross-region variation is possible, but should be conducted with caution. In a model of a monetary union Beraja, Hurst, and Ospina make the case that regional economies differ from their aggregate counterparts in two important respects: (i) local and aggregate elasticities to the same shock can differ and (ii) the types of shocks driving the local and aggregate business cycles can differ. The researchers develop a semi-structural methodology that combines regional and aggregate data to jointly identify the shocks determining employment, prices and wages at both the aggregate and local. Using household and scanner data, the researchers document that consumer prices and nominal wages are quite flexible at local levels. The strong cross-region relationship between wage growth and employment growth stands in sharp contrast to the aggregate time series patterns during the Great Recession. Applying their procedure, the authors find that a combination of both "demand" and "supply" shocks are necessary to account for the joint dynamics of aggregate prices, wages and employment during the 2007-2012 period in the U.S. while only "demand" shocks are necessary to explain most of the observed cross state variation. The researchers conclude that the wage stickiness necessary to get demand shocks to be the primary cause of aggregate employment declines during the Great Recession is inconsistent with the flexibility of wages estimated from cross-region variation.