Economic Fluctuations and Growth Research Meeting

July 11, 2009
Mark Bils and Julio Rotemberg, Organizers

James Kahn, University of Pennsylvania
What Drives Housing Prices?

Kahn develops a growth model with land and housing services that explains much of the amplitude and timing of medium frequency house price fluctuations over the last 40 years. House prices are predicted to have a "bubbly" appearance, with housing wealth rising faster than income for an extended period before collapsing and experiencing an extended decline. The analysis suggests that the current downturn in the housing sector was triggered by a productivity slowdown that began in 2004. One implication of this finding is that policies aimed at affecting house prices through credit market interventions are likely to have only a modest impact.

Olivier J. Blanchard, International Monetary Fund and NBER; Jean-Paul L'Huillier, MIT; and Guido Lorenzoni, MIT and NBER
News, Noise, and Fluctuations: An Empirical Exploration

Blanchard and his co-authors explore models of aggregate fluctuations with two basic ingredients: agents form anticipations about the future based on noisy sources of information; and, these anticipations affect spending and output in the short run. The objective is to separate fluctuations attributable to actual changes in fundamentals (news) from those caused by temporary errors in the private sector's estimates of these fundamentals (noise). Using a simple model where the consumption random walk hypothesis holds exactly, the authors address some basic methodological issues and take a first pass at the data. First, they show that if the econometrician has no informational advantage over the agents in the model, structural VARs cannot be used to identify news and noise shocks. Next, they develop a structural Maximum Likelihood approach that allows them to identify the model's parameters and to evaluate the role of news and noise shocks. Applied to postwar U.S. data, this approach suggests that noise shocks play an important role in short-run fluctuations.

Fatih Guvenen, University of Minnesota and NBER
Inferring Labor Income Risk from Economic Choices: An Indirect Inference Approach

Guvenen and Smith use the information contained in the joint dynamics of households' labor earnings and consumption-choice decisions to quantify the nature and amount of income risk that households face. They accomplish this by estimating a structural consumption-savings model using panel data from the Panel Study of Income Dynamics and the Consumer Expenditure Survey. Specifically, they estimate the persistence of labor income shocks, the extent of systematic differences in income growth rates, the fraction of these systematic differences that households know when they begin their working lives, and the amount of measurement error in the data. Income processes that differ along these dimensions can have vastly different implications for economic behavior as well as for a variety of policy questions. Although data on labor earnings alone can shed light on some of these dimensions, to assess what households know about their income processes requires using the information contained in their economic choices (here, consumption-savings decisions). In addition, consumption data increases the precision of the parameter estimates. To estimate the consumption-savings model, the authors use indirect inference, a simulation method that puts virtually no restrictions on the structural model and allows the estimation of income processes from economic decisions with general specifications of utility, frequently binding borrowing constraints, and missing observations. The main substantive findings are that income shocks are not very persistent; systematic differences in income growth rates are large; and individuals have substantial amounts of information about their future income prospects. Consequently, the amount of uninsurable lifetime income risk that households perceive is smaller than what is typically assumed in calibrated macroeconomic models with incomplete markets.

Roland Benabou, Princeton University and NBER
Groupthink: Collective Delusions in Organizations and Markets

Benabou develops a model of (individually rational) collective reality denial in groups, organizations, and markets. Whether participants' tendencies toward wishful thinking reinforce or dampen each other hinges upon a simple and novel mechanism. When an agent can expect to benefit from other's delusions, this makes him more of a realist; when he is more likely to suffer losses from them, this pushes him toward denial, which becomes contagious. This general "Mutually Assured Delusion" principle can give rise to multiple social cognitions of reality, irrespective of any strategic payoff interactions or private signals. It also implies that in hierachical organizations, realism or denial will trickle down, causing subordinates to take their mindsets and beliefs from the leaders. Contagious "exuberance" can also seize asset markets, leading to evidence-resistant investment frenzies and subsequent deep crashes. In addition to collective illusions of control, the model accounts for the mirror case of fatalism and collective resignation. The welfare analysis differentiates valuable group morale from harmful groupthink and identifies a fundamental tension in organizations' attitudes toward free speech and dissent.

Robert J. Barro, Harvard University and NBER; Emi Nakamura, Columbia University and NBER; Jon Steinsson, Columbia University and NBER; and Jose Ursua, Harvard University
Crises and Recoveries in an Empirical Model of Consumption Disasters

Barro and his co-authors estimate an empirical model of consumption disasters using a new panel data set on consumption for 24 countries and more than 100 years. The model allows for permanent and transitory effects of disasters that unfold over multiple years. It also allows the timing of disasters to be correlated across countries. The authors estimate the model using Bayesian methods. Their estimates imply that the average length of disasters is roughly six years and that more than half of the short run impact of disasters on consumption are reversed in the long run on average. The researchers investigate the asset pricing implications of these rare disasters. In a model with power utility and standard values for risk aversion, stocks surge at the onset of a disaster because of agents' strong desire to save. This counterfactual predition causes a low equity premium, especially in normal times. In contrast, a model with Epstein-Zin-Weil preferences and an intertemporal elasticity of substitution equal to 2 yields a sizeable equity premium in normal times for modest values of risk aversion.

Melissa Dell, MIT;Benjamin Jones, Northwestern University and NBER ; and Benjamin Olken, MIT and NBER
Climate Shocks and Economic Growth: Evidence from the Last Half Century

Dell, Jones, and Olken use annual variation in temperature and precipitation over the past 50 years to examine the impact of climatic changes on economic activity throughout the world. They find first that higher temperatures substantially reduce economic growth in poor countries but have little effect in rich countries. Second, higher temperatures appear to reduce growth rates, rather than just the level of output, in poor countries. Third, higher temperatures have wide-ranging effects in poor nations, reducing agricultural output, industrial output, and aggregate investment, and increasing political instability. Analysis of decade or longer climate shifts also shows substantial negative effects on growth in poor countries. Should future impacts of climate change mirror these historical effects, the negative impact on poor countries may be substantial.

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