Economic Fluctuations and Growth

Members of the NBER's Economic Fluctuations and Growth Program met March 1 in San Francisco. Research Associates David Lagakos of University of California, San Diego and Martin Schneider of Stanford University organized the meeting. These researchers' papers were presented and discussed:

Paolo Martellini, University of Pennsylvania, and Guido Menzio, New York University and NBER

Declining Search Frictions, Unemployment and Growth (NBER Working Paper No. 24518)

The Diamond-Mortensen-Pissarides theory argues that unemployment and vacancies emerge because of search frictions in the labor market. Yet, over the last century, U.S. unemployment and vacancy rates show no trend, even though search efficiency in the labor market must have improved thanks to the diffusion of telephones, computers and the Internet. Martellini and Menzio resolve this puzzle using a search model where firm-worker matches are inspection goods. They show that if the distribution of idiosyncratic productivity for new matches is Pareto, then unemployment, vacancy, job-finding and job-loss rates remain constant while the efficiency of search grows over time. Improvements in search technology show up in productivity growth. A corollary of the theory is that population growth does not affect unemployment and vacancy rates even under non-constant returns to scale in the search process. The researchers develop and implement a strategy to measure the growth rate of the search technology, the returns to scale of the search process, and their contribution to productivity growth.

Tarek Alexander Hassan, Boston University and NBER; Stephan Hollander, Tilburg University; Laurence van Lent, Frankfurt School of Finance and Management; and Ahmed Tahoun, London Business School

Firm-Level Political Risk: Measurement and Effects (NBER Working Paper No. 24029)

Hassan, Hollander, van Lent, and Tahoun adapt simple tools from computational linguistics to construct a new measure of political risk faced by individual U.S. firms: the share of their quarterly earnings conference calls that they devote to political risks. The researchers validate their measure by showing it correctly identifies calls containing extensive conversations on risks that are political in nature, that it varies intuitively over time and across sectors, and that it correlates with the firm's actions and stock market volatility in a manner that is highly indicative of political risk. Firms exposed to political risk retrench hiring and investment and actively lobby and donate to politicians. Interestingly, the vast majority of the variation in the measure is at the firm level rather than at the aggregate or sector level, in the sense that it is neither captured by time fixed effects and the interaction of sector and time fixed effects, nor by heterogeneous exposure of individual firms to aggregate political risk. The dispersion of this firm-level political risk increases significantly at times with high aggregate political risk. Decomposing the measure of political risk by topic, the researchers find that firms that devote more time to discussing risks associated with a given political topic tend to increase lobbying on that topic, but not on other topics, in the following quarter.

Fernando E. Alvarez, University of Chicago and NBER, and Francesco Lippi, Luiss Guido Carli University and Einaudi Institute for Economics and Finance

The Analytic Theory of a Monetary Shock

Alvarez and Lippi propose a new method to analyze the propagation of a once and for all shock in a large class of sticky price models. The method is based on the eigenvalue-eigenfunction representation of the cross-sectional process for price adjustments and provides a thorough characterization of the entire impulse response function for any moment of interest. The researchers use the method to discuss several substantive applications, such as (i) a general analytic characterization of "selection effects", (ii) parsimonious representation of the impulse response function and (iii) volatility shocks in monetary models. The researchers conclude by showing the method can also be applied to models featuring asymmetric return functions and asymmetric law of motion for the state.

Pedro Bordalo, University of Oxford; Nicola Gennaioli, Bocconi University; Yueran Ma, University of Chicago ; and Andrei Shleifer, Harvard University and NBER

Over-Reaction in Macroeconomic Expectations (NBER Working Paper No. 24932)

Bordalo, Gennaioli, Ma, and Shleifer study the rationality of individual and consensus professional forecasts of macroeconomic and financial variables using the methodology of Coibion and Gorodnichenko (2015), which examines predictability of forecast errors from forecast revisions. They report two key findings: forecasters typically over-react to their individual news, while consensus forecasts under-react to average forecaster news. To reconcile these findings, the researchers combine the diagnostic expectations model of belief formation from Bordalo, Gennaioli, and Shleifer (2018) with Woodford's (2003) noisy information model of belief dispersion. The forward looking nature of diagnostic expectations yields additional implications, which the researchers also test and confirm. A structural estimation exercise indicates that the model captures important variation in the data, yielding a value for the belief distortion parameter similar to estimates obtained in other settings.

Joel David, University of Southern California, and Venky Venkateswaran, New York University and NBER

The Sources of Capital Misallocation (NBER Working Paper No. 23129)

David and Venkateswaran develop a methodology to disentangle sources of capital 'misallocation', i.e. dispersion in value-added/capital. It measures the contributions of technological/informational frictions and a rich class of firm-specific factors. An application to Chinese manufacturing firms reveals that adjustment costs and uncertainty, while significant, explain only a modest fraction of the dispersion, which stems largely from other factors: a component correlated with productivity and a fixed effect. Adjustment costs are more salient for large U.S. firms, though other factors still account for bulk of the dispersion. Technological/markup heterogeneity explains a limited fraction in China, but a potentially large share in the U.S.

Juan Morelli and Diego Perez, New York University, and Pablo Ottonello, University of Michigan

Global Banks and Systemic Debt Crises

Morelli, Ottonello, and Perez studies the role of financial intermediaries in the global market of risky external debt. They first provide empirical evidence measuring the effect of global banks' net worth on bond prices of emerging-market economies. The researchers exploit within-borrower bond variation and show that, around the collapse of Lehman Brothers, bonds held by more distressed global banks saw larger price contractions. They then construct a model of global banks' lending to emerging economies and quantify their role using the empirical estimates and other key data. In the model, banks' net worths affect bond prices by the combination of a form of market segmentation and banks' financial frictions. The researchers show that these banks' exposure to emerging economies is the key to determine their role in propagating shocks. With the current observed exposure, global banks generally play an important role transmitting shocks originating in developed economies, accounting for the bulk of the variation of spreads in emerging economies during the recent global financial crisis. Global banks help explain key patterns of debt prices observed in the data, and the evolution of their exposure over the last decades can explain the changing nature of systemic debt crises in emerging economies.

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