Really Uncertain Business Cycles

July 31, 2012

By Nicholas Bloom, Max Floetotto, Nir Jaimovich, Itay Saporta-Eksten and Stephen J. Terry

We propose uncertainty shocks as a new shock that drives business cycles. First, we demonstrate that microeconomic uncertainty is robustly countercyclical, rising sharply during recessions, particularly during the Great Recession of 2007-2009. Second, we quantify the impact of time-varying uncertainty on the economy in a dynamic stochastic general equilibrium model with heterogeneous firms. We find that reasonably calibrated uncertainty shocks can explain drops and rebounds in GDP of around 3%. Moreover, we show that increased uncertainty alters the relative impact of government policies, making them initially less effective and then subsequently more effective.

I am not sure I would qualify uncertainty shocks as new shocks. I have mentioned before the paper by Basu and Bundick that also features time varying variance for TFP shocks (plus similar shocks to intertemporal substitution). This paper is still a significant step forward as it uses plant level data to calibrate the shock process and does not need price rigidity to obtain significant results. It is particularly interesting to see how policy response effectiveness changes through time.

See also a previous post on policy uncertainty.


Fairness, Search Frictions, and Offshoring

July 24, 2012

By Devashish Mitra and Priya Ranjan

Fairness considerations within the firm are introduced into the determination of wages in a two factor Pissarides-style model of search unemployment to study its implications for the unemployment rates of unskilled and skilled workers in both the closed economy case and when the economy can offshore some inputs. While the effect of a fair-wage constraint on unskilled workers takes the form of an increase in their wage and unemployment, we also Önd interesting effects on skilled workers in a closed economy. The skilled wage and skilled unemployment move in directions opposite to each other, with the actual direction of their movement depending on the elasticity of substitution between skilled and unskilled labor. The impact of offshoring of the services of unskilled labor on the unemployment of unskilled workers is stronger in the presence of fairness considerations than in the case when search frictions are the only source of unemployment. Finally, offshoring insulates the skilled labor market outcomes from fairness concerns that are present in a closed economy.

Our models typically assume cut-throat competition, yet there is some evidence that employers are willing to pay beyond the marginal productivity of labor, and not only for efficiency wage considerations. This paper introduces fair wages into a standard labor search environment and yields some interesting outcomes. It will be interesting to see whether the data corroborates the predictions of the model.

A theory of search with deadlines and uncertain recall

July 15, 2012

By Nuray Akin and Brennan Platt

We analyze an equilibrium search model where buyers seek to purchase a good before a deadline and face uncertainty regarding the availability of past price quotes in the future. Sellers cannot observe a potential buyer’s remaining time until deadline nor his quote history, and hence post prices that weigh the probability of sale versus the profit once sold. The model’s equilibrium can take one of three forms. In a late equilibrium, buyers initially forgo purchases, preferring to wait until the deadline. In an early equilibrium, any equilibrium offer is accepted as soon as it is received. In a full equilibrium, higher prices are turned down until near the deadline, while lower prices are immediately accepted. Equilibrium price and sales dynamics are determined by the time remaining until the deadline and the quote history of the consumer.

Interesting theory that provides a new rationale for price dispersion. I wonder how it could explain stock market crashes and house price dynamics, the first because it involves fire sales, the second because deadlines are inherent in moving.

More calls for papers

July 12, 2012

Workshop on Macroeconomic Dynamics

27-28 September 2012, at the University of Sydney

Midwest Macro Meetings

Now also in the Fall. 9-11 November 2012, at the University of Colorado, Boulder.

Debt, Growth and Macroeconomic Policies

6-7 December 2012, at the European Central Bank, Frankfurt.

Trade Wedges, Inventories, and International Business Cycles

July 10, 2012

By George Alessandria, Joseph Kaboski and Virgiliu Midrigan

The large, persistent fluctuations in international trade that can not be explained in standard models by changes in expenditures and relative prices are often attributed to trade wedges. We show that these trade wedges can reflect the decisions of importers to change their inventory holdings. We find that a two-country model of international business cycles with an inventory management decision can generate trade flows and wedges consistent with the data. Moreover, matching trade flows alters the international transmission of business cycles. Specifically, real net exports become countercyclical and consumption is less correlated across countries than in standard models. We also show that ignoring inventories as a source of trade wedges substantially overstates the role of trade wedges in business cycle fluctuations.

Interesting how including inventory management can fix things in international business cycle models. Inventories are held by domestic retailers, who must hold stock before selling (obviously) but also before learning about shocks. Excess inventory can only be returned after one period. This means there are only stocks of imports and domestic goods, but never inventories of export goods. I wonder whether the data yields this, and whether it matters. It should at least for the cyclicality of net exports, because if exporters also have to play the game of expectations about future demand, import inventories become less important in the model.

Durable goods, borrowing constraints and consumption insurance

July 1, 2012

By Enzo A. Cerletti and Josep Pijoan-Mas (In case of doubt, working link here)

In this paper we study the transmission of income shocks into nondurable consumption in the presence of durable goods. We use a standard a life-cycle model with two goods to characterize the interaction of durability of goods, durability of shocks, and borrowing constraints as determinants of shock transmission. We show that borrowing constraints lead to a substitution between durable and non-durable goods upon arrival of an unexpected income change. This substitution biases the conventional measures of insurance based on the response of non-durable consumption to income changes. The sign of this bias depends critically on the persistence of the shock. We show that households have less insurance against transitory shocks and more insurance against permanent shocks than commonly measured. We calibrate the model economy to the US in order to measure the size of this bias.

This is a nice illustration on how ommitting durable goods can seriously mess up the estimation of the response of non-durable goods to income shocks. This is an example of why it is so important to think in terms of theory when estimating elasticities, and of general equilibrum in particular.