Economic Fluctuations and Growth

Members of the NBER's Economic Fluctuations and Growth Research Program met in San Francisco on February 23. Research Associate Andrew Atkeson, University of California at Los Angeles and Asset Pricing Program Director Monika Piazzesi of Stanford University. These researchers' papers were presented and discussed:

Matteo Maggiori, Harvard University and NBER; Brent Neiman, University of Chicago and NBER; and Jesse Schreger, Columbia University and NBER

International Currencies and Capital Allocation

Maggiori, Neiman, and Schreger establish that global portfolios are driven by an often neglected aspect: the currency of denomination of assets. Using a dataset of $27 trillion in security-level investment positions, they demonstrate that investor holdings are biased toward their own currencies to such an extent that each country holds the bulk of all securities denominated in their own currency, even those issued by foreign borrowers in developed countries. In fact, this home-currency bias almost entirely explains home-country bias in these data. While large firms can issue in foreign currency and borrow from foreigners, the vast majority of firms issue only in local currency and do not access foreign capital. These patterns hold broadly across countries with the exception of international currency issuers such as the U.S. The global willingness to hold the U.S. dollar, or international currency bias, means that even small U.S. firms that borrow exclusively in dollars have little difficulty borrowing from abroad. Global portfolios shifted sharply away from the euro and toward the dollar starting with the 2008 financial crisis, further cementing the dollar's international role and amplifying the benefit that its status brings to the U.S. The researchers rationalize these findings in a framework with downward-sloping demand for bonds in each currency in which firms pay a fixed cost to borrow in foreign currency.

John Kennan, University of Wisconsin at Madison and NBER

Spatial Variation in Higher Education Financing and the Supply of College Graduates (NBER Working Paper No. 21065)

In the U.S. there are large differences across States in the extent to which college education is subsidized, and there are also large differences across States in the proportion of college graduates in the labor force. State subsidies are apparently motivated in part by the perceived benefits of having a more educated workforce. Kennan extends the migration model of Kennan and Walker (2011) to analyze how geographical variation in college education subsidies affects the migration decisions of college graduates. The model is estimated using NLSY data, and used to quantify the sensitivity of migration and college enrollment decisions to differences in expected net lifetime income, focusing on how cross-State differences in public college financing affect the educational composition of the labor force. The main finding is that these differences have substantial effects on college enrollment, and that these effects are not dissipated through migration.

Katarína Borovičková, New York University, and Robert Shimer, University of Chicago and NBER

High Wage Workers Work for High Wage Firms (NBER Working Paper No. 24074)

Borovičková and Shimer develop a new approach to measuring the correlation between the types of matched workers and firms. Their approach accurately measures the correlation in data sets with many workers and firms, but a small number of independent observations for each. Using administrative data from Austria, the researchers find that the correlation between worker and firm types lies between 0.4 and 0.6. They use artificial data sets with correlated worker and firm types to show that our estimator is accurate. In contrast, the Abowd, Kramarz and Margolis (1999) fixed effects estimator suggests no correlation between types in our data set. The researchers show both theoretically and empirically that this reflects an incidental parameter problem.

Marcus Hagedorn, University of Oslo; Iourii Manovskii, University of Pennsylvania and NBER; and Kurt Mitman, Institute for International Economic Studies

The Fiscal Multiplier

Hagedorn, Manovskii, and Mitman measure the size of the fiscal multiplier using a heterogeneous agents model with incomplete markets, capital and rigid prices and wages. This environment captures all elements that are considered essential for a quantitative analysis. First, output is (partially) demand determined due to pricing frictions in product and labor markets, so that a fiscal stimulus increases aggregate demand. Second, incomplete markets deliver a realistic distribution of the marginal propensity to consume across the population, whereas all households counterfactually behave according to the permanent income hypothesis if markets are complete. Here, poor households feature high MPCs and thus tend to spend a large fraction of the additional income that arises as a result of a fiscal stimulus, assigning a quantitatively important role to the standard textbook Keynesian cross logic. Interestingly, and unlike conventional wisdom would suggest, the researchers dynamic forward looking model reinforces this channel significantly. Third, the model features a realistic wealth to income ratio since the researchers allow two assets, government bonds and capital. They find that market incompleteness plays the key role in determining the size of the fiscal multiplier, which is about 1.5 if deficit financed and about 0.6 if tax financed. Surprisingly, the size of fiscal multiplier remains similar in the Great recession where the economy was in a liquidity trap. Finally, Hagedorn, Manovskii, and Mitman elucidate the differences between their heterogeneous-agent incomplete-markets model to those featuring complete markets or hand-to-mouth consumers.

Fatih Guvenen, University of Minnesota and NBER; Gueorgui Kambourov and Burhanettin Kuruscu, University of Toronto; Sergio Ocampo-Diaz, University of Minnesota; and Daphne Chen, Florida State University

Use It Or Lose It: Efficiency Gains from Wealth Taxation Use It Or Lose It: Efficiency Gains from Wealth Taxation

Guvenen, Kambourov, Kuruscu, Ocampo-Diaz, and Chen study the quantitative implications of wealth taxation (tax on the stock of wealth) as opposed to capital income taxation (tax on the income flow from capital) in an overlapping-generations incomplete-markets model with rate of return heterogeneity across individuals. With such heterogeneity, capital income and wealth taxes have opposite implications for efficiency and some key distributional outcomes. Under capital income taxation, entrepreneurs who are more productive, and therefore generate more income, pay higher taxes. Under wealth taxation, on the other hand, entrepreneurs who have similar wealth levels pay similar taxes regardless of their productivity, which expands the base and shifts the tax burden toward unproductive entrepreneurs. This reallocation increases aggregate productivity and output. In the simulated model calibrated to the U.S. data, a revenue-neutral tax reform that replaces capital income tax with a wealth tax raises welfare by about 8% in consumption-equivalent terms. Moving on to optimal taxation, the optimal wealth tax is positive, yields even larger welfare gains than the tax reform, and is preferable to optimal capital income taxes. Interestingly, optimal wealth taxes result in more even consumption and leisure distributions (despite the wealth distribution becoming more dispersed), which is the opposite of what optimal capital income taxes imply. Consequently, wealth taxes can yield both efficiency and distributional gains.

Carlos Garriga, Federal Reserve Bank of St. Louis, and Aaron Hedlund, University of Missouri

Housing Finance, Boom-Bust Episodes, and Macroeconomic Fragility

Garriga and Hedlund analyze how arrangements in the in the mortgage market impact the dynamics of housing (boom-bust episodes) and the economy using a structural equilibrium model with incomplete markets and endogenous adjustment costs. In response to mortgage rates and credit conditions, the model can generate movements in house prices, residential investment, and homeownership consistent with the U.S. housing boom-bust. The propagation to the macroeconomy is asymmetric with much higher consumption sensitivity during the bust than the boom due to the endogenous fragility caused by mortgage debt. Mortgages with adjustable-rates increase the sensitivity of house prices to credit conditions relative to an economy with fixed-rate loans without refinancing. Macro prudential policies can mitigate fragility by reducing the magnitude of house price movements without curtailing homeownership.

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