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Entry, Exit of Firms Amplify the Business Cycle
When new businesses are created, they generate new jobs. When unprofitable businesses close, employees lose their jobs. Given the connection between firm entry and exit and changes in employment, it is natural to ask how this entry and exit affects the broader business cycle.
Working Paper
Entry and Exit, Unemployment, and Macroeconomic Tail Risk
This paper builds a nonlinear business cycle model with endogenous firm entry and exit and equilibrium unemployment. The entry and exit mechanism generates asymmetry and amplifies the transmission of productivity shocks, exposing the economy to significant tail risk. When calibrating the rates of entry and exit to match their shares of job creation and destruction, our quantitative model generates higher-order moments consistent with U.S. data. Firm exit particularly amplifies the severity and persistence of deep recessions such as the COVID-19 crisis. In the absence of entry and exit, the ...
Working Paper
COVID-19: A View from the Labor Market
This paper examines the response of the U.S. labor market to a large and persistent job separation rate shock, motivated by the ongoing economic effects of the COVID-19 pandemic. We use nonlinear methods to analytically and numerically characterize the responses of vacancy creation and unemployment. Vacancies decline in response to the shock when firms expect persistent job destruction and the number of unemployed searching for work is low. Quantitatively, under our baseline forecast the unemployment rate peaks at 19.7%, 2 months after the shock, and takes 1 year to return to 5%. Relative to ...
Working Paper
Valuation Risk Revalued
The recent asset pricing literature finds valuation risk is an important determinant of key asset pricing moments. Valuation risk is modelled as a time preference shock within Epstein-Zin recursive utility preferences. While this form of valuation risk appears to fit the data extremely well, we show the preference specification violates an economically meaningful restriction on the weights in the Epstein-Zin time-aggregator. The same model with the corrected preference specification performs nearly as well at matching asset pricing moments, but only if the risk aversion parameter is well ...
Working Paper
Global dynamics at the zero lower bound
This article presents global solutions to standard New Keynesian models to show how economic dynamics change when the nominal interest rate is constrained at its zero lower bound (ZLB). We focus on the canonical New Keynesian model without capital, but we also study the model with capital, with and without investment adjustment costs. Our solution method emphasizes accuracy to capture the expectational effects of hitting the ZLB and returning to a positive interest rate. We find that the response to a technology shock has perverse consequences when the ZLB binds, even when a discount factor ...
Working Paper
Forward guidance and the state of the economy
This paper examines forward guidance using a nonlinear New Keynesian model with a zero lower bound (ZLB) constraint on the nominal interest rate. Forward guidance is modeled with news shocks to the monetary policy rule. The effectiveness of forward guidance depends on the state of the economy, the speed of the recovery, the ZLB constraint, the degree of uncertainty, the monetary response to inflation, the size of the news shocks, and the forward guidance horizon. Specifically, the stimulus from forward guidance falls as the economy deteriorates or as households expect a slower recovery. When ...
Working Paper
Uncertainty Shocks in a Model of Effective Demand: Comment
Basu and Bundick (2017) show a second moment intertemporal preference shock creates meaningful declines in output in a sticky price model with Epstein and Zin (1991) preferences. The result, however, rests on the way they model the shock. If a preference shock is included in Epstein-Zin preferences, the distributional weights on current and future utility must sum to 1, otherwise it creates an asymptote in the response to the shock with unit intertemporal elasticity of substitution. When we change the preferences so the weights sum to 1, the asymptote disappears as well as their main ...
Journal Article
Fed’s Effective Lower Bound Constraint on Monetary Policy Created Uncertainty
Uncertainty about the economy increased when the Fed reduced the federal funds rate to its effective lower bound because the constraint restricted the Fed?s ability to stabilize the economy. As a result, a much stronger negative relationship between uncertainty and economic activity emerged during and shortly after the Great Recession.
Working Paper
The Zero Lower Bound and Estimation Accuracy
During the Great Recession, many central banks lowered their policy rate to its zero lower bound (ZLB), creating a kink in the policy rule and calling into question linear estimation methods. There are two promising alternatives: estimate a fully nonlinear model that accounts for precautionary savings effects of the ZLB or a piecewise linear model that is much faster but ignores the precautionary savings effects. Repeated estimation with artificial datasets reveals some advantages of the nonlinear model, but they are not large enough to justify the longer estimation time, regardless of the ...
Working Paper
Nonlinear Search and Matching Explained
Competing explanations for the sources of nonlinearity in search and matching modelsindicate that they are not fully understood. This paper derives an analytical solution to atextbook model that highlights the mechanisms that generate nonlinearity and quantifiestheir contributions. Procyclical variation in the matching elasticity creates nonlinearity inthe job finding rate, which interacts with the law of motion for unemployment. These resultsshow the matching function choice is not innocuous. Quantitatively, the Den Haan et al.(2000) matching function more than doubles the skewness of ...