Is Something Really Wrong with Macroeconomics?

November 29, 2017

By Ricardo Reis

While there is much that is wrong with macroeconomics today, most critiques of the state of macroeconomics are off target. Current macroeconomic research is not mindless DSGE modelling filled with ridiculous assumptions and oblivious of data. Rather, young macroeconomists are doing vibrant, varied, and exciting work, getting jobs, and being published. Macroeconomics informs economic policy only moderately and not more nor all that differently than other fields in economics. Monetary policy has benefitted significantly from this advice in keeping inflation under control and preventing a new Great Depression. Macroeconomic forecasts perform poorly in absolute terms and given the size of the challenge probably always will. But relative to the level of aggregation, the time horizon, and the amount of funding, they are not so obviously worse than those in other fields. What is most wrong with macroeconomics today is perhaps that there is too little discussion of which models to teach and too little investment in graduate-level textbooks.

What he says. To which I would add that more investment in undergraduate education and some vulgarization would be most welcome, too, given the common misconceptions about macroeconomics.


Capital Specificity, the Distribution of Marginal Products and Aggregate Productivity

November 22, 2017

By Andrea Lanteri and Pamela Medina

This paper studies the role of capital specificity and investment irreversibility on the distribution of marginal products of capital and aggregate TFP. We use a methodology new to the misallocation literature, based on the study of “mobility” across quantiles of a distribution. In a panel of Peruvian firms, we show that persistent dispersion in marginal products is explained to an important extent by the persistence of low marginal products. That is, by unproductive firms that take a long time to downsize. Using a quantitative general-equilibrium model of firm dynamics with idiosyncratic shocks, calibrated to match key features of our data, we argue that the persistence of low marginal products suggests that irreversibility frictions are large. Moreover, it is inconsistent with theories of misallocation based only on financing constraints.

Misallocation is a big topic these days, but little is known about the underlying frictions. This paper makes progress on this front with what looks to me a case of the sunk cost fallacy. Attachment to capital that “still works” prevents significant productivity improvements.

The Lifetime Costs of Bad Health

November 17, 2017

By Mariacristina De Nardi, Svetlana Pashchenko and Ponpoje Porapakkarm

Health shocks are an important source of risk. People in bad health work less, earn less, face higher medical expenses, die earlier, and accumulate much less wealth compared to those in good health. Importantly, the dynamics of health are much richer than those implied by a low-order Markov process. We first show that these dynamics can be parsimoniously captured by a combination of some lag-dependence and ex-ante heterogeneity, or health types. We then study the effects of health shocks in a structural life-cycle model with incomplete markets. Our estimated model reproduces the observed inequality in economic outcomes by health status, including the income-health and wealth-health gradients. Our model has several implications concerning the pecuniary and non-pecuniary effects of health shocks over the life-cycle. The (monetary) lifetime costs of bad health are very concentrated and highly unequally distributed across health types, with the largest component of these costs being the loss in labor earnings. The non-pecuniary effects of health are very important along two dimensions. First, individuals value good health mostly because it extends life expectancy. Second, health uncertainty substantially increases lifetime inequality by affecting the variation in lifespans.

This paper has already received quite a bit of attention, but I still want to highlight it this week. Indeed, imagine a new type of insurance that would insure you against being born with bad genes. There is nothing you can do about bad genes (yet), and you carry that weight your whole life (which may be shorter). This paper allows you to quantify the payout in the gene lottery. Presumably, the lucky ones would have to pay in.

Labor Market Liquidity

November 10, 2017

By Korie Amberger and Jan Eeckhout

Labor market liquidity (flows to and from employment) have decreased sharply in the US in the last decades while the unemployment rate has remained constant; and across developed economies, there are also huge differences in flows. This poses very different risk profiles for workers: low labor market liquidity makes employment more attractive (higher job security) and unemployment less so (lower reemployment security). In this paper we ask which regime offers better insurance and higher welfare: job security or reemployment security? Except for very high levels of labor market liquidity, we find that welfare for a given asset level is increasing in liquidity for both the unemployed and employed. To avoid being borrowing constrained in an illiquid labor market, unemployed workers dissave more slowly, and the employed increase their savings, whose value is affected by equilibrium prices (wages and the interest rate). However, allowing capital markets to readjust generates higher aggregate welfare as flows decrease, completely through improved job security and asset accumulation for the low-skilled employed. The aggregate welfare gains from lower liquidity are sizable, 1.4% of consumption when comparing across countries. Optimal Unemployment Insurance (UI) is around 40% in the benchmark US economy and is increasing with lower labor market liquidity. A skill-specific optimal policy heavily favors the less wealthy low skilled but less so in a more illiquid labor market. Finally, we find lower flows decrease wealth inequality.

What is the better labor market? A US-like one with high turnover and no job security, or a European-style with life-long jobs and long-term unemployment? This paper shows the former seems to dominate, as the high turnover acts like an insurance mechanism that requires less unemployment insurance and pushes people to save more, both of of which contribute to positive general equilibrium effects. The model could have added more incentive effects and they would have reinforced the result, like the fact that in a fluid labor market workers need more to stay productive to survive or that job maching will end up better if more matches are tried.

Occupational Hazards and Social Disability Insurance

November 3, 2017

By Amanda Michaud and Davic Wiczer

Using retrospective data, we introduce evidence that occupational exposure significantly affects disability risk. Incorporating this into a general equilibrium model, social disability insurance (SDI) affects welfare through (i) the classic, risk-sharing channel and (ii) a new channel of occupational reallocation. Both channels can increase welfare, but at the optimal SDI they are at odds. Welfare gains from additional risk-sharing are reduced by overly incentivizing workers to choose risky occupations. In a calibration, optimal SDI increases welfare by 2.3% relative to actuarially fair insurance, mostly due to risk sharing.

This is the classic insurance conundrum: it enhances welfare through risk-sharing, but also reduces it through encouraging risk-taking. Here it is with disability insurance that influences occupational choice. In the paper, the disability is expressed as not being able to general labor income. I wonder if accounting for the physical hurt of a disability would significantly affect the outcome. I can understand that this is difficult to model and calibrate, though.

[a previous version of this post had the wrong paper title]