Household leveraging and deleveraging

March 24, 2013

By Alejandro Justiniano, Giorgio Primiceri and Andrea Tambalotti

U.S. households’ debt skyrocketed between 2000 and 2007, but has since been falling. This leveraging and deleveraging cycle cannot be accounted for by the liberalization and subsequent tightening of mortgage credit standards that occurred during the period. We base this conclusion on a quantitative dynamic general equilibrium model calibrated using macroeconomic aggregates and microeconomic data from the Survey of Consumer Finances. From the perspective of the model, the credit cycle is more likely due to factors that impacted house prices more directly, thus affecting the availability of credit through a collateral channel. In either case, the macroeconomic consequences of leveraging and deleveraging are relatively minor because the responses of borrowers and lenders roughly wash out in the aggregate.

What I take from this paper is that changes in credit standards and thus lenders cannot be blamed. Anything that would have increased house prices “excessively” is still a potential culprit, including herd behavior, too low interest rates, excessive expectations, or a bubble.


The Impact of Cartelization, Money, and Productivity Shocks on the International Great Depression

March 18, 2013

By Harold Cole and Lee Ohanian

This study exploits panel data from 18 countries to assess the contributions of cartelization policies, monetary shocks, and productivity shocks on macroeconomic activity during the Great Depression. To construct a parsimonious and common model framework, we use the fact that many cartel policies are observationally equivalent to a country-specific labor tax wedge. We estimate a monetary DSGE model with cartel wedges along with productivity and monetary shocks. Our main finding is that cartel policy shocks account for the bulk of the Depression in the countries that adopted significant cartel policies, including the large depressions in the U.S., Germany, Italy, and Australia, and that the estimated cartel policy shocks plausibly coincide with the actual evolution of policies in these countries. In contrast, cartel policy shocks in the countries that did not significantly change policies were small and account for little of their Depressions.

An important follow-up of the Cole-Ohanian research agenda about understanding the Great Depression. And once more, they find that cartelization practices were harmful. The fact that a cartel is harmful is hardly a surprise, but in the context of the Great Depression, this has been met with a lot of resistance for the case of the US. It turns out the international evidence is consistent as well. Will this be convincing?

The Inefficient Markets Hypothesis: Why Financial Markets Do Not Work Well in the Real World

March 15, 2013

By Roger Farmer, Carine Nourry and Alain Venditti

Existing literature continues to be unable to offer a convincing explanation for the volatility of the stochastic discount factor in real world data. Our work provides such an explanation. We do not rely on frictions, market incompleteness or transactions costs of any kind. Instead, we modify a simple stochastic representative agent model by allowing for birth and death and by allowing for heterogeneity in agents’ discount factors. We show that these two minor and realistic changes to the timeless Arrow-Debreu paradigm are sufficient to invalidate the implication that competitive financial markets efficiently allocate risk. Our work demonstrates that financial markets, by their very nature, cannot be Pareto efficient, except by chance. Although individuals in our model are rational; markets are not.

That birth and death matters should be no surprise. As in overlapping generation models, the fact that the yet-to-be-born cannot trade with current generations leads to inefficiencies. That discount factor heterogeneity matters here is more of a surprise, at least to me. I would have expected this to simply to two classes of agents, one borrowing to the limit, the other accumulating to the other limit and that each category would otherwise enjoy efficient allocations, just with a higher discount rate due to the risk pf death. Apparently this is more complex than I thought.

March 2013 conference calls for papers

March 14, 2013

Here is another batch of relevant conference calls for papers, some with very tight submission deadlines. Please send suggestions a little bit earlier!

Workshop in International Economics and Finance, Santo Domingo (Dominican Republic), 6-7 June 2013.

Shanghai Macroeconomics Workshop, Shanghai, 22-24 June 2013.

Liquidity and Financial Crises, Philadelphia, 11-12 October 2013.

Macroeconomics in Perspective Workshop, Laouvain-la-Neuve (Belgium), 23-24 January 2014.

The Economic and Demographic Transition, Mortality, and Comparative Development

March 6, 2013

By Matteo Cervellati and Uwe Sunde

We propose a unified growth theory to investigate the mechanics generating the economic and demographic transition, and the role of mortality differences for comparative development. The framework can replicate the quantitative patterns in historical time series data and in contemporaneous cross-country panel data, including the bi-modal distribution of the endogenous variables across countries. The results suggest that differences in extrinsic mortality might explain a substantial part of the observed differences in the timing of the take-off across countries and the worldwide density distribution of the main variables of interest.

And now something completely different. By and large, unified growth theory is about understand the vary long-term growth trends, especially their changes around the various agricultural revolutions and the Industrial Revolution. I believe this literature is making big strides with papers like this one that does not simply obtain revolutions, but also explains why their timing is different across the world and obtains interesting quantitative results.

Rare shocks, Great Recessions

March 3, 2013

By Vasco Cúrdia, Marco Del Negro and Daniel Greenwald

We estimate a DSGE model where rare large shocks can occur, by replacing the commonly used Gaussian assumption with a Student-t distribution. Results from the Smets and Wouters (2007) model estimated on the usual set of macroeconomic time series over the 1964-2011 period indicate that the Student-t specification is strongly favored by the data even when we allow for low-frequency variation in the volatility of the shocks, and that the estimated degrees of freedom are quite low for several shocks that drive U.S. business cycles, implying an important role for rare large shocks. This result holds even if we exclude the Great Recession period from the sample. We also show that inference about low-frequency changes in volatility and in particular, inference about the magnitude of the Great Moderation is different once we allow for fat tails.

This paper shows that rare events matter, and so even if they do not appear in the data. This means a rejection of the common assumption that shocks are normally distributed. That, we knew already, one has simply to observe that recessions are shorter and steeper than booms. The merit of the paper is to show that the simplifying assumption of normally distributed shocks matters in modelling. What this means in terms of policy remains to be seen.