Economists, Incentives, Judgment, and the European CVAR Approach to Macroeconometrics

October 26, 2009

by David Colander

This paper argues that the DSGE approach to macroeconometrics is the dominant approach because it meets the institutional needs of the replicator dynamics of the profession, not because it is necessarily the best way to do macroeconometrics. It further argues that this “DSGE-theory first” approach is inconsistent with the historical approach that economists have advocated in the past and that the alternative European CVAR approach is much more consistent with economist’s historically used methodology, correctly understood. However, because the European CVAR approach requires explicit researcher judgment, it does not do well in the replicator dynamics of the profession. The paper concludes with the suggestion that there should be an increase in dialog between the two approaches.

Is Colander correct in calling for approaches that are consistent with historic approaches to be privileged? Scientific progress is made by trying new approaches, and if they allow old ones to be rejected, then be it. But can we reject these old approaches?


How important is human capital? A quantitative theory assessment of world income inequality

October 18, 2009

by Andrés Erosa, Tatyana Koreshkova and Diego Restuccia

We develop a quantitative theory of human capital investments in order to evaluate the magnitude of cross-country differences in total factor productivity (TFP) that explains the variation in per-capita incomes across countries. We build a heterogeneous-agent economy with cross-sectional variation in ability, schooling, and expenditures on schooling quality. By embedding our analysis in a growth model with tradable and non-tradable sectors, we model sectorial productivity differences across countries, as documented in Hsieh and Klenow (2007). The parameters governing human capital production and random ability and taste processes are restricted by a set of cross-sectional data moments such as variances and intergenerational correlations of earnings and schooling, as well as slope coefficient and R2 in a Mincer regression. Our main finding is that human capital accumulation strongly amplifies TFP differences across countries: To explain a 20-fold difference in the output per worker the model requires a 5-fold difference in the TFP of the tradable sector, versus an 18-fold difference if human capital is fixed across countries. Moreover, we find that sectorial productivity differences play a prominent role in quantitative implications of the theory.

There is plenty of empirical literature trying to establish the importance of human capital in cross-country income differences, usually neglecting that human capital may be endogenous. Clearly, a more structural approach is warranted and this paper delivers this, along with a very rich model. Will this paper convince the cross-country regression enthousiasts?

Liquidity, Innovation and Growth

October 11, 2009

by Aleksander Berentsen, Mariana Rojas Breu and Shouyong Shi

Many countries simultaneously suffer from high rates of inflation, low growth rates of per capita income and poorly developed financial sectors. In this paper, we integrate a microfounded model of money and finance into a model of endogenous growth to examine the effects of inflation and financial development. A novel feature of the model is that the market for innovation goods is decentralized. Financial intermediaries arise endogenously to provide liquid funds to the innovation sector. We calibrate the model to address two quantitative issues. One is the effects of an exogenous improvement in the productivity of the financial sector on welfare and per capita growth. The other is the effects of inflation on welfare and growth. Consistent with the data but in contrast to previous work, reducing inflation generates large gains in the growth rate of per capita income as well as in welfare. Relative to reducing inflation, improving the efficiency of the financial market increases growth and welfare by much smaller amounts.

It is difficult to find theory that give a large welfare gain from reducing inflation. This paper seems to achieve it by combining endogenous financial intermediation with endogenous growth. While empirics confirm its results by comparing high, medium and low-inflation countries, one can also ask whether welfare effects are significant within low-inflation regimes, say from 5% to 2%, instead of the traditional 10% to 0% (or Friedman Rule).

The Quantitative Importance of News Shocks in Estimated DSGE Models

October 6, 2009

by Hashmat Khan and John Tsoukalas

We estimate a dynamic stochastic general equilibrium (DSGE) model with several frictions and shocks, including news shocks to total factor productivity (TFP) and investment-specic (IS) technology, using quarterly US data from 1954-2004 and Bayesian methods. When all types of shocks are considered, TFP news and IS news compete with other atemporal and intertemporal shocks and account for less than 1.5% and 0.15% of the unconditional variance of output growth, respectively. In the fleexible price-wage environment, the contributions of the two shocks are 2.4% and 0%, respectively. When we exclude an atemporal (price markup) shock, the role for TFP news rises but the t of that model is substantially poorer relative to the benchmark model. Based on the variance decompositions and impulse responses, our findings suggest that news shocks are likely to be less important in estimated sticky price-wage DSGE models relative to perfectly competitive models.

News shocks have recently become a popular avenue to study business cycles, following Beaudry and Portier (2004, 2006). But this paper seems to indicate that they are quantitatively of no importance. Should we still consider them?