Economic Fluctuations and Growth

October 24, 2014
Veronica Guerrieri, University of Chicago, and Richard Rogerson, Princeton University, Organizers

Patrick Kehoe, University of Minnesota and NBER; Virgiliu Midrigan, New York University and NBER; and Elena Pastorino, University of Minnesota

Debt Constraints and Employment

In the Great Contraction, the regions of the United States that experienced the largest declines in household debt to income also experienced the largest drops in consumption and employment. Kehoe, Midrigan, and Pastorino develop a search and matching model that reproduces such patterns. Tighter debt constraints raise workers' and firms' discount rates, thus reducing match surplus, vacancy creation and employment. Two ingredients of the researchersÂ’ model, on-the-job human capital accumulation and worker debt constraints, greatly amplify the drop in employment. On-the-job human capital accumulation implies that the returns to posting a vacancy are backloaded: the surplus from a match is thus more sensitive to changes in firm discount rates. Worker debt constraints amplify these effects further by preventing wages from falling too much. The authors show that the model reproduces the salient cross-sectional features of the U.S. data, including the co-movement between consumption, house prices, debt-to-income as well as tradable and non-tradable employment.

Atif Mian, Princeton University and NBER, and Amir Sufi, University of Chicago and NBER

House Price Gains and U.S. Household Spending from 2002 to 2006 (NBER Working Paper 20152)

Mian and Sufi examine the effect of rising U.S. house prices on borrowing and spending from 2002 to 2006. There is strong heterogeneity in the marginal propensity to borrow and spend. Households in low income zip codes aggressively liquefy home equity when house prices rise, and they increase spending substantially. In contrast, for the same rise in house prices, households living in high income zip codes are unresponsive, both in their borrowing and spending behavior. The entire effect of housing wealth on spending is through borrowing, and, under certain assumptions, this spending represents 0.8% of GDP in 2004 and 1.3% of GDP in 2005 and 2006. Households that borrow and spend out of housing gains between 2002 and 2006 experience significantly lower income and spending growth after 2006.

Xavier Gabaix, New York University and NBER, and Matteo Maggiori, Harvard University and NBER

International Liquidity and Exchange Rate Dynamics (NBER Working Paper 19854)

Gabaix and Maggiori provide a theory of the determination of exchange rates based on capital flows in imperfect financial markets. Capital flows drive exchange rates by altering the balance sheets of financiers that bear the risks resulting from international imbalances in the demand for financial assets. Such alterations to their balance sheets cause financiers to change their required compensation for holding currency risk, thus impacting both the level and volatility of exchange rates. The researchers' theory of exchange rate determination in imperfect financial markets not only rationalizes the empirical disconnect between exchange rates and traditional macroeconomic fundamentals, but also has real consequences for output and risk sharing. Exchange rates are sensitive to imbalances in financial markets and seldom perform the shock absorption role that is central to traditional theoretical macroeconomic analysis. The authors' derive conditions under which heterodox government financial policies, such as currency interventions and taxation of capital flows, can be welfare improving. The researchers' framework is flexible; it accommodates a number of important modeling features within an imperfect financial market model, such as non-tradables, production, money, sticky prices or wages, various forms of international pricing-to-market, and unemployment.

Ufuk Akcigit, University of Pennsylvania and NBER; Harun Alp, University of Pennsylvania; and Michael Peters, Yale University

Lack of Selection and Limits to Delegation: Firm Dynamics in Developing Countries

Firm dynamics in poor countries show striking differences to those of rich countries. While some firms indeed experience growth as they age, many firms are simply stagnant in that they neither exit nor expand. Akcigit, Alp, and Peters interpret this fact as a lack of selection, whereby producers with little growth potential survive because innovating firms do not expand enough to force them out of the market. To explain these differences the researchers develop a theory, whereby contractual frictions limit firms' acquisition of managerial time. If managerial effort provision is non-contractible, entrepreneurs will benefit little from delegating decision power to outside managers, as they spend most of their time monitoring their managerial personnel. As the return to managerial time is higher in big firms, improvements in the degree of contract enforcement will raise the returns of growing large and thereby increase the degree of creative destruction. To discipline the quantitative importance of this mechanism, the authors incorporate such incomplete managerial contracts into an endogenous growth model and calibrate it to firm level data from India. Improvements in the efficacy of managerial delegation can explain a sizable fraction of the difference between plants' life-cycle in the U.S. and India.

Christina Romer and David Romer, University of California, Berkeley and NBER

New Evidence on the Impact of Financial Crises in Advanced Countries

This paper revisits the aftermath of financial crises in advanced countries in the decades before the Great Recession. Romer and Romer construct a new series on financial distress in 24 OECD countries for the period 1967-2007. The series is based on narrative assessments of the health of countries' financial systems that were made in real time; and it classifies financial distress on a relatively fine scale, rather than treating it as a 0-1 variable. The researchers find little support for the conventional wisdom that the output declines following financial crises are uniformly large and long-lasting. Rather, the declines are highly variable, on average only moderate, and often temporary. One important driver of the variation in outcomes across crises appears to be the severity and persistence of the financial distress itself: when distress is particularly extreme or continues for an extended period, the aftermath of a crisis is worse.

George-Marios Angeletos, MIT and NBER, and Fabrice Collard and Harris Dellas, University of Bern

Quantifying Confidence

Angeletos, Collard, and Dellas augment DSGE models with a tractable type of strategic uncertainty which they interpret as variation in "confidence" about the state of the economy. The researchers next quantify the role of this mechanism for U.S. business cycles. They find that it helps account for many salient features of the data, including moments and wedges; it drives a significant fraction of the business cycle in estimated models that allow for multiple structural shocks; and it captures the notion of "aggregate demand" without nominal rigidities. The authors complement these findings with evidence that the business-cycle volatility in the data is captured by an empirical factor which is unlike the structural forces that are popular in the literature but similar to the one they formalize.

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