Saturday, January 4, 2014

More from AEA

John Haltiwanger presented work with Foster and Grim on "cleansing" recessions. In past recessions, job destruction (i.e., shrinking or closing establishments) drove net employment declines, and total reallocation of jobs (job creation + destruction) rose in a productivity-enhancing way. In the Great Recession, the main driver of the net employment decline was a collapse in job creation; additionally, reallocation fell and the relationship between firm productivity and exit was relatively flat compared to the past. A big part of the job creation story was the lack of new firms and the beating taken by existing young firms relative to older ones. Relatively speaking, in this recession productive firms failed and unproductive ones survived. Normally, productive firms get a growth bump during recessions, but this time they didn't. All of this indicates that significant distortions were at work. We need stories to explain this; maybe financial issues are the key.

My main takeaway from this and related work is that (a) this recession was different from previous postwar recessions, and (b) there are enough strange things going on with firm dynamics that the story seems unlikely to be amenable to the simple AD/AS framework.

"Liquidity constraints, risk premia, and the macroeconomic effects of liquidity shocks" is a paper by Ivan Jaccard. This is an RBC model with a shock to collateral (he describes it as a liquidity shock). A draft is here, and slides are here.

One possible explanation for the severity of the Great Recession is that the effects of the financial crisis were amplified by the shortage of pledgeable assets created by the initial subprime shock.

I found the paper interesting because it highlighted a couple of big concepts in modern macro:

In the model economy that matches the equity premium, our main finding is that a small negative liquidity shock can generate a deep recession and a stock market crash. In the version of the model that is unable to generate plausible risk premia, in contrast, the effects of liquidity shocks are considerably smaller.

That pesky equity premium! But the model can generate large, persistent output effects of a small shock--without nominal rigidities.

For some time I've been keeping an eye on this paper by Guerrieri and Lorenzoni. Here we get a reasonably comprehensive model of credit crunch, including both heterogeneity and the ZLB. A common characteristic of representative agent ZLB models is some ploy to get the economy to the ZLB, such as a shock to discount rates. These don't seem implausible to me, but in models like Guerrieri & Lorenzoni you get the solid decline in interest rates that arises naturally in models with precautionary savings and financial shocks. The model gets a severe contraction following a financial shock. It's amplified by nominal rigidities and the presence of durable goods (houses are durable...).

Simon Gilchrist and coauthors have a paper on uncertainty shocks (paper, slides). This is a garden variety mean-preserving spread in the shock distribution; under imperfect financial markets, credit spreads rise. The model incorporates both investment adjustment costs and financial frictions. A credit spread arises from modeled agency problems, and this is the key channel through which uncertainty hits the economy.

Go look at their empirical measure of uncertainty; the discussant didn't buy it.

Here I'm going to plug my work with coauthors on endogenous uncertainty, where uncertainty is of the TFP/sales volatility variety. In our model, firms choose how many markets to operate (where "market" can mean product, geography, etc.).  More markets means diversification means lower volatility, and a firm's market exposure varies over the business cycle, so countercyclical volatility arises naturally. We need to be more careful about treating the second moment as exogenous.

I saw this paper presented (housing collateral and entrepreneurship), which I've already reviewed here. The discussant was David Sraer, and he noted that we have yet to determine the relative quantitative significance of the two proposed channels through which housing hit the economy: the Mian & Sufi consumption channel and the alternative collateral channel. This is one of the things I'm trying to do with my dissertation work.

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