Matching with Phantoms

April 27, 2010

By Bruno Decreuse

Searching for partners involves informational persistence that reduces future traders’ matching probability. In this paper, traders that are no longer available but who left tracks on the market are called phantoms. I examine a discrete-time matching market in which phantom traders are a by-product of search activity, no coordination frictions are assumed, and non-phantom traders may lose time trying to match with phantom traders. The resulting aggregate matching technology features increasing returns to scale in the short run, but has constant returns to scale in the long run. I discuss the labor market evidence and argue that there is observational equivalence between phantom unemployed and on-the-job seekers.

Those involved in faculty searches can very well relate with this paper. The fact that it takes time to process candidate files leads to obsolete information about the availability of candidates, with potentially high costs of deal with a file of someone who has already found a job. Similarly, candidates may put effort in an application for a position that has already been filled. While the academic job search may dramatize such effects, they may still apply and be macroeconomically relevant for other labor markets.


News Shocks and the Slope of the Term Structure of Interest Rates

April 18, 2010

By André Kurmann and Christopher Otrok

We provide a new structural interpretation of the relationship between the slope of the term structure of interest rates and macroeconomic fundamentals. We first adopt an agnostic identification approach that allows us to identify the shocks that explain most of the movements in the slope. We find that two shocks are sufficient to explain virtually all movements in the slope. Impulse response functions for the first shock, which explains the majority of the movements in the slope, lead us to interpret this main shock as a news shock about future productivity. We confirm this interpretation by formally identifying such a news shock as in Barsky and Sims (2009) and Sims (2009). We then assess to what extent a New Keynesian DSGE model is capable of generating the observed slope responses to a news shock. We find that augmenting DSGE models with a term structure provides valuable information to discipline the description of monetary policy and the model’s response to news shocks in general.

As this week’s NEP-DGE report was particularly long, I chose to highlight a second paper. This one feeds on the recent interest with the impact of news on business cycle. In this case, the focus is on the term structure of interest rates, an often neglected feature of economic fluctuations.

Tapping the Supercomputer Under Your Desk: Solving Dynamic Equilibrium Models with Graphics Processors

April 18, 2010

By Eric M. Aldrich, Jesús Fernández-Villaverde, Ronald Gallant and Juan F. Rubio-Ramírez

This paper shows how to build algorithms that use graphics processing units (GPUs) installed in most modern computers to solve dynamic equilibrium models in economics. In particular, we rely on the compute uni.ed device architecture (CUDA) of NVIDIA GPUs. We illustrate the power of the approach by solving a simple real business cycle model with value function iteration. We document improvements in speed of around 200 times and suggest that even further gains are likely.

There are fewer and fewer excuses for someone claiming a problem is too complex to solve. Computers have gained a lot of power, and this paper shows how to tap the unused part of your computer. Next up, the supposedly 90% of our brain we do not use.

Investment-specific technology shocks and international business cycles: an empirical assessment

April 12, 2010

By Federico S. Mandelman, Pau Rabanal, Juan F. Rubio-Ramírez and Diego Vilán

In this paper, we first introduce investment-specific technology (IST) shocks into an otherwise standard international real business cycle model and show that a thoughtful calibration of them along the lines of Raffo (2009) successfully addresses several of the existing puzzles in the literature. In particular, we obtain a negative correlation of relative consumption and the terms of trade (Backus-Smith puzzle), as well as a more volatile real exchange rate, and cross-country output correlations that are higher than consumption correlations (price and quantity puzzles). Then we use data from the Organisation for Economic Co-operation and Development for the relative price of investment to build and estimate these IST processes across the United States and a “rest of the world” aggregate, showing that they are cointegrated and well represented by a vector error–correction model. Finally, we demonstrate that, when we fit such estimated IST processes into the model, the shocks are actually powerless to explain any of the existing puzzles.

International real business cycle models have created more puzzles than explained things, and these puzzles have been very resilient despite years of research. Here, the authors stack all the cards towards explaining the puzzles: the puzzles are mostly due to productivity differentials across countries, which they perturb with investment-technology specific shocks. Unfortunately, empirically plausible shocks do not deliver, again.

Bank Liquidity, Interbank Markets and Monetary Policy

April 7, 2010

By Xavier Freixas, Antoine Martin and David Skeie

A major lesson of the recent financial crisis is that the interbank lending market is crucial for banks facing large uncertainty regarding their liquidity needs. This paper studies the efficiency of the interbank lending market in allocating funds. We consider two different types of liquidity shocks leading to different implications for optimal policy by the central bank. We show that, when confronted with a distributional liquidity-shock crisis that causes a large disparity in the liquidity held among banks, the central bank should lower the interbank rate. This view implies that the traditional tenet prescribing the separation between prudential regulation and monetary policy should be abandoned. In addition, we show that, during an aggregate liquidity crisis, central banks should manage the aggregate volume of liquidity. Two different instruments, interest rates and liquidity injection, are therefore required to cope with the two different types of liquidity shocks. Finally, we show that failure to cut interest rates during a crisis erodes financial stability by increasing the risk of bank runs.

This paper is an example of an often forgotten literature on payment systems and interbank markets that is particularly useful in understanding policy during the recent crisis. It also shows that policies need to be known to be effective.