Charles Manski, Northwestern University and NBER
Survey Measurement of Probabilistic Macroeconomic Expectations: Progress and Promise
Economists commonly suppose that persons have probabilistic expectations for uncertain events, yet empirical research measuring expectations was long rare. The inhibition against collection of expectations data has gradually lessened, generating a substantial body of recent evidence on the expectations of broad populations. This paper first summarizes the history leading to development of the modern literature and overviews its main concerns. Manski then describes research on three subjects that should be of direct concern to macroeconomists: expectations of equity returns, inflation expectations, and professional macroeconomic forecasters. He also describes work that questions the assumption that persons have well-defined probabilistic expectations and communicate them accurately in surveys. Finally, Manski considers the evolution of thinking about expectations formation in macroeconomic policy analysis. He favorably observes the increasing willingness of theorists to study alternatives to rational expectations assumptions, but expresses concern that models of expectations formation will proliferate in the absence of empirical research to discipline thinking. To make progress, Manski urges measurement and analysis of the revisions to expectations that agents make following occurrence of unanticipated shocks.
John H. Cochrane, Stanford University and NBER
Michelson-Morley, Occam, and the Zero Lower Bound
The long period of quiet inflation at near-zero interest rates, with large quantitative easing, suggests that core monetary doctrines are wrong. It suggests that inflation can be stable and determinate under a nominal interest rate peg, and that arbitrary amounts of interest-paying reserves are not inflationary. Of the known alternatives, only the new-Keynesian model merged with the fiscal theory of the price level is consistent with this simple interpretation of the facts. Cochrane explores two implications of this conclusion. First, what happens if central banks raise interest rates? Inflation stability suggests that higher nominal interest rates will result in higher long-run inflation. But can higher interest rates temporarily reduce inflation? Yes, but only by a novel mechanism that depends crucially on fiscal policy. Second, what are the implications for the stance of monetary policy and the urgency to “normalize?” Inflation stability implies that low-interest rate monetary policy is, perhaps unintentionally, benign, producing a stable Friedman-optimal quantity of money, that a large interest-paying balance sheet can be maintained indefinitely, and that it might not be wise for central bankers to exploit a temporary negative inflation effect. The fiscal anchoring required by this interpretation of the data responds to discount rates, however, and may not be as strong as it appears.
Steven N. Durlauf, the University of Wisconsin at Madison and NBER; and Ananth Seshadri, the University of Wisconsin at Madison
Understanding the Great Gatsby Curve
The Great Gatsby Curve, the observation that for OECD countries, greater cross-sectional income inequality is associated with lower mobility, has become a prominent part of scholarly and policy discussions because of its implications for the relationship between inequality of outcomes and inequality of opportunities. Durlauf and Seshadri explore this relationship by focusing on evidence and interpretation of an intertemporal Gatsby Curve for the United States. They consider inequality/mobility relationships that are derived from nonlinearities in the transmission process of income from parents to children and the relationship that is derived from the effects of inequality of socioeconomic segregation, which then affects children. Empirical evidence for the mechanisms they identify is strong. The researchers find modest reduced form evidence and structural evidence of an intertemporal Gatsby Curve for the U.S. as mediated by social influences.
Manuel Adelino, Duke University; Antoinette Schoar, MIT and NBER; and Felipe Severino, Dartmouth College
Dynamics of Housing Debt in the Recent Boom and Bust
This paper studies the evolution of home purchase debt, homeownership, and measures of debt burden during the recent housing boom and Great Recession. Adelino, Schoar, and Severino show that the housing boom was shared across the entire income distribution, with small cross-sectional differences in the flow and stock of debt. Homeownership increased for all households except for those with the lowest incomes, and house prices were the main driver of the rise in debt-to-income at origination. There are also no significant changes in loan-to-value ratios at origination during the boom. The results are most consistent with the view that the main drivers of mortgage debt during this period were rising home values and expectations of increasing prices.
Efraim Benmelech, Northwestern University and NBER, and Nittai Bergman, MIT and NBER
Credit Market Freezes
Credit market freezes in which debt issuance declines dramatically and market liquidity evaporates are typically observed during financial crises. In the financial crisis of 2008-09, the structured credit market froze, issuance of corporate bonds declined, and secondary credit markets became highly illiquid. In this paper Benmelech and Bergman analyze liquidity in bond markets during financial crises and compare two main theories of liquidity in markets: (1) asymmetric information and adverse selection, and (2) heterogenous beliefs. Analyzing the 1873 financial crisis as well as the 2008-09 crisis, they find that when bond value deteriorates, bond illiquidity increases, consistent with an adverse selection model of the information sensitivity of debt contracts. While they show that the adverse-selection model of debt liquidity explains a large portion of the rise in illiquidity, the researchers find little support for the hypothesis that opinion dispersion explains illiquidity in financial crises.
Greg Kaplan, the University of Chicago and NBER; Benjamin Moll, Princeton University and NBER; Thomas Winberry, the University of Chicago; and SeHyoun Ahn, Princeton University
When Inequality Matters for Macro and Macro Matters for Inequality
Kaplan, Moll, Winberry, and Ahn develop an efficient and easy-to-use computational method for solving a wide class of general equilibrium heterogeneous agent models with aggregate shocks. Their method extends standard linearization techniques and is designed to work in cases when inequality matters for the dynamics of macroeconomic aggregates. The researchers present two applications that analyze a two-asset incomplete markets model parameterized to match the distribution of income, wealth, and marginal propensities to consume. First, they show that their model is consistent with two key features of aggregate consumption dynamics that are difficult to match with representative agent models: (i) the sensitivity of aggregate consumption to predictable changes in aggregate income and (ii) the relative smoothness of aggregate consumption. Second, the researchers extend the model to feature capital-skill complementarity and show how factor-specific productivity shocks shape dynamics of income and consumption inequality.