Monetary Economics

November 7, 2014
Atif Mian, Princeton University, and Jón Steinsson, Columbia University, Organizers

Gauti Eggertsson, Brown University and NBER, and Pierpaolo Benigno and Federica Romei, Luiss Guido Carli

Dynamic Debt Deleveraging and Optimal Monetary Policy (NBER Working Paper 20556)

In this paper, Benigno, Eggertsson, and Romei study optimal monetary policy under dynamic debt deleveraging once the zero bound is binding. Unlike the existing literature, the natural rate of interest is endogenous and depends on macroeconomic policy. Optimal monetary policy successfully raises the natural rate of interest by creating an environment that speeds up deleveraging, thus endogenously shortening the duration of the crisis and a binding zero bound. Inflation should be front loaded. Fiscal-policy multipliers can be even higher than in existing models, but depend on the way in which public spending is financed.

Neil Mehrotra, Brown University, and Dmitriy Sergeyev, Bocconi University

Financial Shocks and Job Flows

The labor market recovery since the end of the Great Recession has been characterized by a marked decline in labor market turnover. In this paper, Mehrotra and Sergeyev provide evidence that the housing crisis and financial nature of the Great Recession account for this decline in job flows. The researchers exploit MSA-level variation in job flows and housing prices to show that a decline in housing prices diminishes job creation and lagged job destruction. Moreover, they document differences across firm size and age categories, with middle-sized firms (20-99 employees) and new and young firms (firms less than 5 years of age) most sensitive to a decline in house prices. They propose a quantitative model of firm dynamics with collateral constraints, calibrating the model to match the distribution of employment by firm size and age. Financial shocks in the authors' firm dynamics model depresses job creation and job destruction and replicates the empirical pattern of the sensitivity of job flows across firm age and size categories.

Antonio Falato and Nellie Liang, Federal Reserve Board

Do Creditor Rights Increase Employment Risk? Evidence from Loan Covenants

Financial contracts that mitigate incentive conflicts between firms and their creditors have a large impact on employees. Using a regression discontinuity design, Falato and Liang provide evidence that there are sharp and substantial employment cuts following loan covenant violations, when creditors gain control rights to accelerate, restructure, or terminate a loan. The employment cuts following violations are larger at firms with higher financing frictions and agency costs and when employees have weaker bargaining power. The cuts are also much larger in industry and macroeconomic downturns, when employees have fewer alternative job opportunities. In addition, union elections that create new labor bargaining units lead to higher spreads on new loans, consistent with creditors requiring greater compensation when employees have more bargaining power. The researchers' analysis establishes a specific link between financing frictions and employment, and offers direct evidence that binding financial contracts are an important amplification mechanism of economic downturns.

Mark Bils, University of Rochester and NBER; Peter Klenow, Stanford University and NBER; and Benjamin Malin, Federal Reserve Bank of Minneapolis

Resurrecting the Role of the Product Market Wedge in Recessions (NBER Working Paper 20555)

Employment and hours appear far more cyclical than dictated by the behavior of productivity and consumption. This puzzle has been labeled "the labor wedge" -- a cyclical wedge between the marginal product of labor and the marginal rate of substitution of consumption for leisure. The wedge can be broken into a product market wedge (price markup) and a labor market wedge (wage markup). Based on the wages of employees, the literature has attributed the wedge almost entirely to labor market distortions. Because employee wages may be smoothed versions of the true cyclical price of labor, Bils, Klenow, and Malin instead examine the self-employed, intermediate inputs, and work-in-process inventories. Looking at the past quarter century in the U.S., the researchers find that price markup movements are at least as important as wage markup movements -- including in the Great Recession and its aftermath. Thus sticky prices and other forms of countercyclical markups deserve a central place in business cycle research, alongside sticky wages and matching frictions.

Marco Di Maggio, Columbia University; Amir Kermani, University of California, Berkeley; and Rodney Ramcharan, Federal Reserve Board

Monetary Policy Pass-Through: Household Consumption and Voluntary Deleveraging

Do households benefit from expansionary monetary policy? Di Maggio, Kermani, and Ramcharan investigate how indebted households' consumption and saving decisions are affected by anticipated changes in monthly interest payments. The researchers focus on borrowers with adjustable rate mortgages that originated between 2005 and 2007 featuring an automatic reset of the interest rate after five years. The monthly payment due from the average borrower falls by 52 percent ($900) upon reset, resulting in an increase in disposable income totaling tens of thousands of dollars over the remaining life of the mortgage. They uncover three patterns. First, the average household increases monthly car purchases by 40 percent ($150) upon reset. Second, this expansionary effect is attenuated by the borrowers' voluntary deleveraging, as a significant fraction of the increased income is deployed to accelerate debt repayment. Third, the marginal propensity to consume is significantly higher for low income borrowers and for those that had experienced a larger decline in housing wealth. To complement these household-level findings, they employ county-level data to provide evidence that consumption responded more to a reduction in short-term interest rates in counties with a larger fraction of adjustable rate mortgage debt. Their results shed light on the income channel of monetary policy as well as the role of debt rigidity in reducing the effectiveness of monetary policy.

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