Economic Fluctuations and Growth Research Meeting

February 3, 2012
Nir Jaimovich of Duke University and Guido Lorenzoni of MIT, Organizers

Gary B. Gorton, Yale University and NBER, and Guillermo Ordonez, Yale University

Collateral Crises (NBER Working Paper No. 17771)

Gorton and Ordonez note that short-term collateralized debt -- private money -- is efficient if agents are willing to lend without producing costly information about the collateral that is backing the debt. When the economy relies on such informationally-insensitive debt, firms with low quality collateral can borrow, generating a credit boom and an increase in output. Financial fragility builds up over time as information about counterparties decays. A crisis occurs when a small shock causes agents to suddenly have incentives to produce information, leading to a decline in output. A social planner would produce more information than private agents, but would not always want to eliminate fragility.

Elias Albagli, University of Southern California; Christian Hellwig, Toulouse School of Economics; and Aleh Tsyvinski, Yale University and NBER

A Theory of Asset Prices based on Heterogeneous Information (NBER Working Paper No. 17548)

Albagli, Hellwig, and Tsyvinski propose a theory of asset prices that emphasizes heterogeneous information as the main element determining prices of different securities. With only minimal restrictions on security payoffs and trader preferences, noisy aggregation of heterogeneous information drives a systematic wedge between the impact of fundamentals on an asset price, and the corresponding impact on cash flow expectations. From an ex ante perspective, this information aggregation wedge leads to a systematic gap between an asset's expected price and its expected dividend, whose sign and magnitude depend on the asymmetry between upside and downside payoff risks, and on the importance of information heterogeneity. Moreover, when information frictions are sufficiently severe, the model is consistent with arbitrarily high levels of excess price variability as well as low return predictability. Importantly, these results do not rely on traders' risk aversion and thus offer an alternative theory of expected asset returns and price volatility. As applications of their theory, the authors first highlight how heterogeneous information leads to systematic departures from the Modigliani-Miller theorem and provide a new theory of debt versus equity. Then, in a dynamic extension, they provide conditions under which price bubbles are sustainable.

Francisco Buera, Federal Reserve Bank of Minneapolis and NBER; Joseph Kaboski, University of Notre Dame and NBER; and Yongseok Shin, Washington University in St. Louis

The Macroeconomics of Microfinance

Buera, Kaboski, and Shin quantitatively evaluate the aggregate and distributional effects of economy-wide microfinance or credit programs targeted toward small businesses. They find that the redistributive impacts of microfinance are stronger in general equilibrium (GE) than in partial equilibrium, but the aggregate impacts on output, capital, and consumption are smaller. Aggregate total factor productivity (TFP) decreases with microfinance in partial equilibrium but increases in general equilibrium. The GE results show that making the typical microfinance program more widely available will have only a small impact on per-capita income, because the increase in TFP is offset by lower capital accumulation resulting from the redistribution of income from high-savers to low-savers. Nevertheless, the vast majority of the population will be positively affected by microfinance through the equilibrium increase in wages.

Cosmin Ilut, Duke University, and Martin Schneider, Stanford University and NBER
Ambiguous Business Cycles

Ilut and Schneider consider business cycle models with agents who dislike both risk and ambiguity (Knightian uncertainty). Ambiguity aversion is described by recursive multiple priors preferences that capture agents' lack of confidence in probability assessments. While modeling changes in risk typically requires higher-order approximations, changes in ambiguity in these models work like changes in conditional means. The models thus allow for uncertainty shocks but still can be solved and estimated using first-order approximations. In their estimated medium-scale DSGE model, a loss of confidence about productivity works like "unrealized" bad news. Time-varying confidence emerges as a major source of business cycle fluctuations.

Ulrike Malmendier, University of California at Berkeley and NBER,and Stefan Nagel, Stanford University and NBER
Learning from Inflation Experiences

How do individuals form expectations about future inflation? The answer to this question is of central importance for both macroeconomic policies and individual investment and consumption decisions, but the question remains unresolved. Malmendier and Nagel propose that personal life-time experiences play a significant role in the formation of inflation expectations. Unlike in existing models of adaptive learning, individuals overweight inflation rates experienced during their life times so far relative to other "available" historical data. The experience-based model implies that young individuals place more weight on recently experienced inflation than older individuals, because recent experiences make up a larger part of their lifetimes so far. Averaged across cohorts, expectations resemble those obtained from constant-gain learning algorithms common in macroeconomics, but the speed of learning differs between cohorts based on cross-sectional heterogeneity between cohorts. Using 54 years of microdata on inflation expectations from the Reuters/Michigan Survey of Consumers, the authors show that differences in life-time experiences strongly predict differences in subjective expectations. As implied by their model, young individuals place more weight on recently experienced inflation than older individuals. There is substantial disagreement between young and old individuals about future inflation rates in periods of high surprise inflation, such as the 1970s. The experience effect also helps to predict the time-series of forecast errors in the Reuters/Michigan survey and the Survey of Professional Forecasters, and the excess returns on nominal long-term bonds.

Greg Kaplan, University of Pennsylvania, and Giovanni L. Violante, New York University and NBER

A Model of the Consumption Response to Fiscal Stimulus Payments (NBER Working Paper No. 17338)

A wide body of empirical evidence, based on randomized experiments, finds that 20-40 percent of fiscal stimulus payments (for example, tax rebates) are spent on nondurable household consumption in the quarter when they are received. Kaplan and Violante develop a structural economic model to interpret this evidence. They integrate the classical Baumol-Tobin model of money demand into the workhorse incomplete-markets life-cycle economy. In this framework, households can hold two assets: a low-return liquid asset (such as cash, checking account) and a high-return illiquid asset (for example, housing, retirement account) that carries a transaction cost. The optimal life-cycle pattern of wealth accumulation implies that many households are "wealthy hand-to-mouth": they hold little or no liquid wealth despite owning sizeable quantities of illiquid assets. They therefore display large propensities to consume out of additional transitory income, and small propensities to consume out of news about future income. The authors document the existence of such households in data from the Survey of Consumer Finances. A version of the model parameterized to the 2001 tax rebate episode generates consumption responses to fiscal stimulus payments that are in line with the data.

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