Economic Fluctuations and Growth
October 25, 2013
Gian Luca Clementi, New York University and NBER, and Berardino Palazzo, Boston University
Do firm entry and exit play a major role in shaping aggregate dynamics? Clementi's and Palazzo's answer is yes. Entry and exit propagate the effects of aggregate shocks. This results in greater persistence and unconditional variation of aggregate time series. These are features of the equilibrium allocation in Hopenhayn's (1992) model of equilibrium industry dynamics, amended to allow for investment in physical capital and aggregate fluctuations. In the aftermath of a positive productivity shock, the number of entrants increases. The new firms are smaller and less productive than the incumbents, as in the data. As the common productivity component reverts to its unconditional mean, the new entrants that survive become more productive over time, keeping aggregate efficiency higher than in a scenario without entry or exit.
Yuriy Gorodnichenko, University of California at Berkeley and NBER, and Michael Weber, University of California at Berkeley
Gorodnichenko and Weber show that after monetary policy announcements, the conditional volatility of stock market returns rises more for firms with stickier prices than for firms with more flexible prices. This differential reaction is economically large as well as strikingly robust to a broad array of checks. These results suggest that menu costs - broadly defined to include physical costs of price adjustment, informational frictions, et cetera - are an important factor for nominal price rigidity. The authors also show that their empirical results are qualitatively and, under plausible calibrations, quantitatively consistent with New Keynesian macroeconomic models where firms have heterogeneous price stickiness. Since their framework is valid for a wide variety of theoretical models and frictions preventing firms from price adjustment, they provide "model-free" evidence that sticky prices are indeed costly.
Andrew Atkeson and Pierre-Olivier Weill, University of California at Los Angeles and NBER, and Andrea Eisfeldt, University of California at Los Angeles
In the large literature modeling and measuring the effects of financial frictions on business cycles, a key aggregate state variable is the distribution of individual firms' financial soundness. This distribution determines how financial frictions amplify and propagate business cycle shocks through their effect on the decisions of financially unsound firms. Atkeson, Eisfeldt, and Weill propose a simple, transparent, and robust method for retracing quantitatively the history of the distribution of firms' financial soundness during U.S. business cycles over most of the last century for a broad cross–section of firms. They highlight three main findings for this key aggregate state variable. First, the three worst recessions between 1926 and 2012 coincided with sharp deteriorations in the financial soundness of all firms, but other recessions did not. Second, fluctuations in total asset volatility, rather than fluctuations in leverage, at the firm level appear to drive most of the variation in the distribution of firms' financial soundness. These fluctuations in firms' total asset volatility are only partly the result of a change in the volatility in the component of returns common across firms - the majority are in fact the result of fluctuations in level of volatility that is idiosyncratic to each firm. Finally, the distribution of financial soundness for large financial firms largely resembles that for large non–financial firms.
Leonid Kogan, MIT and NBER; Dimitris Papanikolaou, Northwestern University and NBER; Amit Seru, University of Chicago and NBER; and Noah Stoffman, Indiana University
Kogan, Papanikolaou, Seru, and Stoffman explore the role of technological innovation as a source of economic growth by constructing direct measures of innovation at the firm level. The authors combine patent data for U.S. firms from 1926 to 2010 with the stock market response to news about patents to assess the economic importance of each innovation. Their innovation measure predicts productivity and output at the firm, industry and aggregate level. Furthermore, capital and labor flow away from non-innovating firms toward innovating firms within an industry. There exists a similar, though weaker, pattern across industries. Cross–industry differences in technological innovation are strongly related to subsequent differences in industry output growth.
Jesus Fernandez-Villaverde, University of Pennsylvania and NBER; Pablo Guerrón-Quintana, Federal Reserve Bank of Philadelphia; Keith Kuester, University of Bonn; and Juan Rubio-Ramírez, Duke University
Fernandez-Villaverde, Guerrón-Quintana, Kuester, and Rubio-Ramírez study the effects of changes in uncertainty about future fiscal policy on aggregate economic activity. First, they estimate tax and spending processes for the United States that allow for time-varying volatility. They uncover strong evidence of the importance of this time-varying volatility in accounting for the dynamics of tax and spending data. The authors then feed these processes into an otherwise standard New Keynesian business cycle model estimated to the U.S. economy. They find that fiscal volatility shocks can have a sizable adverse effect on economic activity and inflation, in particular when the economy is at the zero lower bound of the nominal interest rates. An endogenous increase in markups accounts for about half of the contraction.
Emmanuel Farhi, Harvard University and NBER, and Ivan Werning, MIT and NBER
Farhi and Werning provide explicit solutions for government spending multipliers during a liquidity trap and within a fixed exchange regime using standard closed and open-economy models. They confirm the potential for large multipliers during liquidity traps. For a currency union, the authors show that self-financed multipliers are small, always below unity. However, outside transfers or windfalls can generate larger responses in output, whether or not they are spent by the government. Their solutions are relevant for local and national multipliers, providing insight into the economic mechanisms at work as well as the testable implications of these models.