Dollar invoicing, global value chains, and the business cycle dynamics of international trade

May 6, 2020

By David Cook and Nikhil Patel

Recent literature has highlighted that international trade is mostly priced in a few key vehicle currencies, and is increasingly dominated by intermediate goods and global value chains (GVCs). Taking these features into account, this paper reexamines the business cycle dynamics of international trade and its relationship with monetary policy and exchange rates. Using a three country dynamic stochastic general equilibrium (DSGE) framework, it finds key differences between the response of final goods and GVC trade to both internal and external shocks. In particular, the model shows that in response to a dollar appreciation triggered by a US interest rate increase, direct bilateral trade between non-US countries contracts more than global value chain oriented trade which feeds US final demand. We use granular data on GVC at the sector level to document empirical evidence in favor of this prediction.

Few people may appreciate that, but this papers brings back memories from my dissertation and shortly thereafter. Back then, I was working on international real business cycles and wrote separate papers on asymmetries (with a three-country model), exchange rate fluctuations, and the importance of intermediate goods. How things have evolved since, now papers integrate all three without difficulty! Nice!

Health versus Wealth: On the Distributional Effects of Controlling a Pandemic

April 27, 2020

By Andrew Glover, Jonathan Heathcote, Dirk Krueger and José-Víctor Ríos-Rull

To slow the spread of COVID-19, many countries are shutting down non-essential sectors of the economy. Older individuals have the most to gain from slowing virus diffusion. Younger workers in sectors that are shuttered have the most to lose. In this paper, we build a model in which economic activity and disease progression are jointly determined. Individuals differ by age (young and retired), by sector (basic and luxury), and by health status. Disease transmission occurs in the workplace, in consumption activities, at home, and in hospitals. We study the optimal economic mitigation policy of a utilitarian government that can redistribute across individuals, but where such redistribution is costly. We show that optimal redistribution and mitigation policies interact, and reflect a compromise between the strongly diverging preferred policy paths of different subgroups of the population. We find that the shutdown in place on April 12 is too extensive, but that a partial shutdown should remain in place through July.

Among the hundreds of papers already written on COvid-19, a few stand out, and this is one of the select few. Proper confinement design is an important question, especially as it has very strong distributional consequences. Here, the best tools of trade are applied to understand the consequences of the current confinement policies. Of course, the paper was produced in record time and you could argue about some choices, but this draft shows clearly that a more nuanced approach is warranted. History will tells us whether this is right.

The Murder-Suicide of the Rentier: Population Aging and the Risk Premium

April 20, 2020

By Joseph Kopecky and Alan Taylor

Population aging has been linked to global declines in interest rates. A similar trend shows that equity risk premia are on the rise. An existing literature can explain part of the decline in the trend in safe rates using demographics, but has no mechanism to speak to trends in relative asset prices. We calibrate a heterogeneous agent life-cycle model with equity markets, showing that this demographic channel can simultaneously account for both the majority of a downward trend in the risk free rate, while also increasing premium attached to risky assets. This is because the life cycle savings dynamics that have been well documented exert less pressure on risky assets as older households shift away from risk. Under reasonable calibrations we find declines in the safe rate that are considerably larger than most existing estimates between the years 1990 and 2017. We are also able to account for most of the rise in the equity risk premium. Projecting forward to 2050 we show that persistent demographic forces will continue push the risk free rate further into negative territory, while the equity risk premium remains elevated.

To continue on the theme mentioned here two weeks ago, population aging is crucial for some many economic outcomes. This paper adds to it. However, I am starting to wonder whether the current pandemic is going to make those changes less drastic as it will lead to less pronounced aging of the population.

Should Germany Have Built a New Wall? Macroeconomic Lessons from the 2015-18 Refugee Wave

April 13, 2020

BY Christopher Busch, Dirk Krueger, Alexander Ludwig, Irina Popova and Zainab Iftikhar

In 2015-2016 Germany experienced a wave of predominantly low-skilled refugee immigration. We evaluate its macroeconomic and distributional effects using a quantitative overlapping generations model calibrated using German micro data to replicate education and productivity differentials between foreign born and native workers. Workers are modelled as imperfect substitutes in aggregate production leading to endogenous wage differentials. We simulate the dynamic effects of this refugee wave, with specific focus on the welfare impact on low skilled natives. Our results indicate that the small losses this group suffers can be compensated by welfare gains of other parts of the native population.

This paper addresses a question that is delicate yet needs to be answered: What are the consequences of an influx of refugees. And once more, it shows that the outcome is generally positive on the economic side. And as long losers are compensated and socio-ethnographic concerns are addressed, a wave of refugees should be fine.

Demographics and the decline in firm entry: Lessons from a life-cycle model

April 8, 2020

By Oke Röhe and Nikolai Stähler

Since the mid-1970s, firm entry rates in the United States have declined significantly. This also holds for other OECD countries over the past years. At the same time, these economies experienced a gradual process of population aging. Applying a tractable life-cycle model with endogenous firm dynamics, we show that falling US firm entry rates can be explained by demographic transition. Specifically, our model simulations suggest that aging can account for up to one third of the observed decrease in US firm entry rates. In addition to the negative effects of a slowdown in working-age population growth on firm entry, our analysis points out that an increase in longevity may also be an important factor contributing to the decline in business dynamism, weighing on both firm entry and exit rates.

Yet another paper highlighting that population aging is critical in understanding some deep changes in the economy. At this point, one has to ask what is not influenced by population aging. Or, one needs to justify why a model does not include population aging if it tries to explain some trend.

Fiscal Policy during a Pandemic

March 31, 2020

By Miguel Faria-e-Castro

I use a dynamic stochastic general equilibrium model to study the effects of the 2019-20 coronavirus pandemic in the United States. The pandemic is modeled as a large negative shock to the utility of consumption of contact-intensive services. General equilibrium forces propagate this negative shock to the non-services and financial sectors, triggering a deep recession. I use a calibrated version of the model to analyze different types of fiscal policies: (i) government purchases, (ii) income tax cuts, (iii) unemployment insurance benefits, (iv) unconditional transfers, and (v) liquidity assistance to services firms. I find that UI benefits are the most effective tool to stabilize income for borrowers, who are the hardest hit, while savers favor unconditional transfers. Liquidity assistance programs are effective if the policy objective is to stabilize employment in the affected sector.

I usually do not promote the papers of my colleagues on this blog, but this time I have to. This is a very timely paper looking at the policy options in the current context of the Covid-19 pandemic and its very high expected unemployment. It also shows that DGE models can be used to analyze economic phenomena for which we have no empirical history to draw from: theory is the only tool we have. And it can deliver its results very fast (the paper took one week to make it to NEP-DGE, in this context even to slow…).

Supply Chain Disruptions, Time to Build, and the Business Cycle

March 23, 2020

Bt Matthias Meier

We provide new evidence that (i) time to build is volatile and countercyclical, and that (ii) supply chain disruptions lengthen time to build. Motivated by these findings, we develop a general equilibrium model in which heterogeneous firms face non-convex adjustment costs and multi-period time to build. In the model, supply chain disruptions lengthen time to build. Calibrating the model to US micro data, we show that disruptions, which lengthen time to build by 1 month, depress GDP by 1% and aggregate TFP by 0.2%. Structural vector autoregressions corroborate the quantitative importance of supply chain disruptions.

A timely study of supply chain disruptions, within business cycles, though. I doubt that if the current disruption due to Covid-19 last a couple of months, the impact on output will be just a couple of percents. Business cycle models approximated around their steady-state show their limitations in that case. But I wonder what lessons for today we could still draw form this model.

Endogenous Preferences for Parenting and Macroeconomic Outcomes

March 16, 2020

By Nigar Hashimzade

This paper investigates the effects of parenting time on macroeconomic outcomes and welfare when parenting choices are determined by own childhood experience and social norms in an overlapping generations framework. Parenting time and material expenditures on children generate children’s human capital. When the share of parenting time is relatively low and parenting and leisure are complements or weak substitutes the model has two steady-state equilibria with different welfare levels. In the high-welfare equilibrium parents have stronger endogenous taste for parenting and spend more time with children and less in paid work. Higher productivity due to the higher human capital more than compensates for the reduction in working hours, leading to a higher output level, in comparison to the low-welfare equilibrium.

I find the concept of endogenous preferences a bit unsettling, as I was taught that tastes are exogenously given. The idea here, though, is that preferences regarding parenting choices are driven by parents, peers, and own experiences. This can lead to interesting dynamics. But fundamentally, preferences are still exogenous, they simply follow a more complex “algorithm.” Little by little, we are getting closer to the chemical processes that drive our decisions.

The global macroeconomic impacts of COVID-19: Seven scenarios

March 9, 2020

By Warwick McKibbin and Roshen Fernando

The outbreak of coronavirus named COVID-19 has disrupted the Chinese economy and is spreading globally. The evolution of the disease and its economic impact is highly uncertain which makes it difficult for policymakers to formulate an appropriate macroeconomic policy response. In order to better understand possible economic outcomes, this paper explores seven different scenarios of how COVID-19 might evolve in the coming year using a modelling technique developed by Lee and McKibbin (2003) and extended by McKibbin and Sidorenko (2006). It examines the impacts of different scenarios on macroeconomic outcomes and financial markets in a global hybrid DSGE/CGE general equilibrium model.The scenarios in this paper demonstrate that even a contained outbreak could significantly impact the global economy in the short run. These scenarios demonstrate the scale of costs that might be avoided by greater investment in public health systems in all economies but particularly in less developed economies where health care systems are less developed and population density is high.

It did not take long to find an extensive analysis of the economics consequences of the current health crisis.

Micro Jumps, Macro Humps: Monetary Policy and Business Cycles in an Estimated HANK Model

March 2, 2020

By Adrien Auclert, Matthew Rognlie and Ludwig Straub

We estimate a Heterogeneous-Agent New Keynesian model with sticky household expectations that matches existing microeconomic evidence on marginal propensities to consume and macroeconomic evidence on the impulse response to a monetary policy shock. Our estimated model uncovers a central role for investment in the transmission mechanism of monetary policy, as high MPCs amplify the investment response in the data. This force also generates a procyclical response of consumption to investment shocks, leading our model to infer a central role for these shocks as a source of business cycles.

I have reported here about quite a few exciting heterogeneous agent papers that deepen our understanding of economic fluctuations. I have not gone back though all of them, but it is likely true that none of them is able to match the hump-shape response to monetary impulses. Indeed, the marginal propensity to consume of the less fortunate ones is very high and they react immediately to changes in economic conditions. This paper manages to get the hump in one particular way. One cannot exclude that there are other ways to get it, but know we know there is at least one plausible reconciliation of macro and micro facts.