Economic Fluctuations and Growth

Members of the NBER's Economic Fluctuations and Growth Program met October 19 in New York City. Research Associates Raquel Fernández of New York University and Stephanie Schmitt-Grohé of Columbia University organized the meeting. These researchers' papers were presented and discussed:

Chris Edmond, University of Melbourne; Virgiliu Midrigan, New York University and NBER; and Daniel Xu, Duke University and NBER

How Costly Are Markups? (NBER Working Paper No. 24800)

Edmond, Midrigan, and Xu study the welfare costs of markups in a dynamic model with heterogeneous firms and endogenously variable markups. They find that the welfare costs of markups are large. They decompose the costs of markups into three channels: (i) an aggregate markup that acts like a uniform output tax, (ii) misallocation of factors of production, and (iii) an inefficiently low rate of entry. The researchers find that the aggregate markup accounts for about two-thirds of the costs, misallocation accounts for about one-third, and the costs due to inefficient entry are negligible. The researchers evaluate simple policies aimed at reducing the costs of markups. Subsidizing entry is not an effective tool in the model: while more competition reduces individual firms' markups it also reallocates market shares towards larger firms and the net effect is that the aggregate markup hardly changes. Size-dependent policies aimed at reducing concentration can reduce the aggregate markup but have the side effect of greatly increasing misallocation and reducing aggregate productivity.

David Baqaee, London School of Economics, and Emmanuel Farhi, Harvard University and NBER

Productivity and Misallocation in General Equilibrium (NBER Working Paper No. 24007)

Baqaee and Farhi provide a general non-parametric formula for aggregating microeconomic shocks in general equilibrium economies with distortions such as taxes, markups, frictions to resource reallocation, and nominal rigidities. They show that the macroeconomic impact of a shock can be boiled down into two components: its "pure" technology effect, and its effect on allocative efficiency arising from the reallocation of resources, which can be measured via changes in factor income shares. The researchers derive a formula showing how these two components are determined by structural microeconomic parameters such as elasticities of substitution, returns to scale, factor mobility, and network linkages. Overall, the results generalize those of Solow (1957) and Hulten (1978) to economies with distortions. As examples, the researchers pursue some applications focusing on markup distortions. They operationalize the non-parametric results and show that improvements in allocative efficiency account for about 50% of measured TFP growth over the period 1997-2015. Baqaee and Farhi implement their structural results and conclude that eliminating markups would raise TFP by about 20%, increasing the economy wide cost of monopoly distortions by two orders of magnitude compared to the famous 0.1% estimate by Harberger (1954).

Bill Dupor, Federal Reserve Bank of St. Louis; M. Saif Mehkari, University of Richmond; Rong Li, Renmin University of China; and Yi-Chan Tsai, National Taiwan University

The 2008 U.S. Auto Market Collapse

New vehicle sales in the U.S. fell nearly 40 percent during the last recession, causing significant job losses and unprecedented government interventions in the auto industry. Dupor, Mehkari, Li, and Tsai explore two potential explanations for this decline: falling home values and falling households' income expectations. First, they establish that declining home values explain only a small portion of the observed reduction in household new vehicle sales. Using a county-level panel from the episode, the researchers find: (1) A one-dollar fall in home values reduced household new vehicle spending by 0.5 to 0.7 cents and overall new vehicle spending by 0.9 to 1.2 cents, and (2) Falling home values explain between 16 and 19 percent of the overall new vehicle spending decline. Next, examining state-level data from 1997-2016, the researchers find: (3) The short-run responses of new vehicle consumption to home value changes are larger in the 2005-2011 period relative to other years, but at longer horizons (e.g. 5 years), the responses are similar across the two sub-periods, and (4) The service flow from vehicles, as measured by miles traveled, responds very little to house price shocks. The researchers also detail the sources of the differences between their findings (1) and (2) from existing research. Second, they establish that declining current and expected future income expectations potentially played an important role in the auto market's collapse. Dupor, Mehkari, Li, and Tsai build a permanent income model augmented to include infrequent, repeated car buying. Their calibrated model matches the pre-recession distribution of auto vintages and the liquid-wealth-to-income ratio, and exhibits a large vehicle sales decline in response to a mild decline in expected permanent income due to a transitory slowdown in income growth. In response to the shock, households delay replacing existing vehicles, allowing them to smooth the effects of the income shock without significantly adjusting the service flow from their vehicles. Combining the negative results regarding housing wealth with the positive model-based findings, the researchers interpret the auto market collapse as consistent with existing permanent income based approaches to durable goods purchases (e.g., Leahy and Zeira (2005)).

Martin S. Eichenbaum and Sergio Rebelo, Northwestern University and NBER; and Arlene Wong, Princeton University and NBER

State Dependent Effects of Monetary Policy: The Refinancing Channel (NBER Working Papers No. 25152)

Eichenbaum, Rebelo, and Wong study how the impact of monetary policy depends on the distribution of savings from refinancing mortgages. They show that the efficacy of monetary policy is state dependent, varying in a systematic way with the pool of potential savings from refinancing. The researchers construct a quantitative dynamic lifecycle model that accounts for the findings. Motivated by the rapid expansion of Fintech, they study the impact of a fall in refinancing costs on the efficacy of monetary policy. The model implies that as refinancing costs decline, the effects of monetary policy become less state dependent and more powerful.

Ernest Liu, Princeton University; Atif R. Mian, Princeton University and NBER; and Amir Sufi, University of Chicago and NBER

Low Interest Rates, Market Power, and Productivity Growth

Liu, Mian, and Sufi build an endogenous growth model to show how low interest rates can increase market power and lower aggregate productivity growth. The model delivers both a traditional expansion in productivity growth in response to lower interest rates, and a slowdown in productivity growth from an increase in market power. When interest rates fall to low levels, the strategic competition effect dominates: the distance between a market leader and a follower increases which reduces investments in productivity by both. The model predicts that very low interest rates lead to an increase in market concentration and mark-ups, a decline in creative destruction and firm entry, a widening productivity-gap between the leader and followers within an industry, and ultimately a decline in productivity growth. The researchers provide empirical evidence in support of these predictions.

Simon Jäger, MIT and NBER; Benjamin Schoefer, University of California, Berkeley; Samuel G. Young, MIT; and Josef Zweimüller, University of Zurich

Wages and the Value of Nonemployment (NBER Working Paper No. 25230)

Nonemployment is often posited as the outside option in macroeconomic models with wage bargaining and in models of labor market monopsony. The value of this state is therefore a fundamental determinant of wages, and in turn labor supply and job creation. Jaeger, Schoefer, Young, and Zweimüller measure the effect of the value of the nonemployment option on employed workers' wages. Their variation in nonemployment values arises from four large reforms of UI benefit levels in Austria, which they study quasi-experimentally by measuring wage responses in existing and new jobs using administrative data. The researchers analysis reveals a precisely estimated, low sensitivity of wages to UI benefit levels ranging between 0 and 4 cents on the dollar. This insensitivity holds even among workers with a priori low bargaining power and for workers with low labor force attachment, in areas of high unemployment, with high predicted unemployment duration, and among recently unemployed workers, and despite high take-up and eligibility - factors that either eliminate confounders or ought to render wages even more sensitive to nonemployment values. The insensitivity holds for job stayers and job switchers and persists when zoomed out to the firm or industry as the bargaining unit. This insensitivity of wages to the nonemployment option presents a puzzle to widely used wage setting protocols in macroeconomics and implies that nonemployment scenarios may not constitute a relevant threat point in bargaining. The evidence supports wage setting mechanisms that largely insulate wages from the value of nonemployment.

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