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Series:Staff Report  Bank:Federal Reserve Bank of Minneapolis 

Asset Prices and Unemployment Fluctuations
Recent critiques have demonstrated that existing attempts to account for the unemployment volatility puzzle of search models are inconsistent with the procylicality of the opportunity cost of employment, the cyclicality of wages, and the volatility of risk-free rates. We propose a model that is immune to these critiques and solves this puzzle by allowing for preferences that generate time-varying risk over the cycle, and so account for observed asset pricing fluctuations, and for human capital accumulation on the job, consistent with existing estimates of returns to labor market experience. Our model reproduces the observed fluctuations in unemployment because hiring a worker is a risky investment with long-duration surplus flows. Intuitively, since the price of risk in our model sharply increases in recessions as observed in the data, the benefit from creating new matches greatly drops, leading to a large decline in job vacancies and an increase in unemployment of the same magnitude as in the data.
AUTHORS: Kehoe, Patrick J.; Lopez, Pierlauro; Midrigan, Virgiliu; Pastorino, Elena
DATE: 2020-01-08

Monetary Policy and Sovereign Risk in Emerging Economies (NK-Default)
This paper develops a New Keynesian model with sovereign default risk (NK-Default). We focus on the interaction between monetary policy, conducted according to an interest rate rule that targets inflation, and external defaultable debt issued by the government. Monetary policy and default risk interact since both affect domestic consumption, production, and inflation. We find that default risk amplifies monetary frictions and generates a tension for monetary policy, which increases the volatility of inflation and nominal rates. These monetary frictions in turn discipline sovereign borrowing, slowing down debt accumulation and lowering sovereign spreads. Our framework replicates the positive comovements of spreads with nominal domestic rates and inflation, a salient feature of emerging markets data, and can rationalize the experience of Brazil during the 2015 downturn, with high inflation, nominal rates, and spreads.
AUTHORS: Arellano, Cristina; Bai, Yan; Mihalache, Gabriel
DATE: 2020-01-10

Housing Wealth Effects: The Long View
We provide new time-varying estimates of the housing wealth effect back to the 1980s. We use three identification strategies: OLS with a rich set of controls, the Saiz housing supply elasticity instrument, and a new instrument that exploits systematic differences in city-level exposure to regional house price cycles. All three identification strategies indicate that housing wealth elasticities were if anything slightly smaller in the 2000s than in earlier time periods. This implies that the important role housing played in the boom and bust of the 2000s was due to larger price movements rather than an increase in the sensitivity of consumption to house prices. Full-sample estimates based on our new instrument are smaller than recent estimates, though they remain economically important. We find no significant evidence of a boom-bust asymmetry in the housing wealth elasticity. We show that these empirical results are consistent with the behavior of the housing wealth elasticity in a standard life-cycle model with borrowing constraints, uninsurable income risk, illiquid housing, and long-term mortgages. In our model, the housing wealth elasticity is relatively insensitive to changes in the distribution of LTV for two reasons: First, low-leverage homeowners account for a substantial and stable part of the aggregate housing wealth elasticity; Second, a rightward shift in the LTV distribution increases not only the number of highly sensitive constrained agents but also the number of underwater agents whose consumption is insensitive to house prices.
AUTHORS: Guren, Adam M.; McKay, Alisdair; Nakamura, Emi; Steinsson, Jon
DATE: 2020-01-31

A Welfare Analysis of Occupational Licensing in U.S. States
We assess the welfare consequences of occupational licensing for workers and consumers. We estimate a model of labor market equilibrium in which licensing restricts labor supply but also affects labor demand via worker quality and selection. On the margin of occupations licensed differently between U.S. states, we find that licensing raises wages and hours but reduces employment. We estimate an average welfare loss of 12 percent of occupational surplus. Workers and consumers respectively bear 70 and 30 percent of the incidence. Higher willingness to pay offsets 80 percent of higher prices for consumers, and higher wages compensate workers for 60 percent of the cost of mandated investment in occupation-specific human capital.
AUTHORS: Kleiner, Morris M.; Soltas, Evan J.
DATE: 2019-10-15

Rising Bank Concentration
Concentration of insured deposit funding among the top four commercial banks in the U.S. has risen from 15% in 1984 to 44% in 2018, a roughly three-fold increase. Regulation has often been attributed as a factor in that increase. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 removed many of the restrictions on opening bank branches across state lines. We interpret the Riegle-Neal act as lowering the cost of expanding a bank's funding base. In this paper, we build an industry equilibrium model in which banks endogenously climb a funding base ladder. Rising concentration occurs along a transition path between two steady states after branching costs decline.
AUTHORS: Corbae, Dean; D'Erasmo, Pablo
DATE: 2020-03-02

Aggregate implications of innovation policy
In this paper we present a tractable model of innovating firms and the aggregate economy that we use to assess quantitatively the link between the responses of firms to changes in innovation policy and the impact of those policy changes on aggregate output and welfare. We show that, to a first-order approximation, a wide range of policy changes have a long-run impact in direct proportion to the fiscal expenditures on those policies, and that to evaluate the aggregate impact of a policy change, there is no need to calculate changes in firms' decisions in response to these policy changes. ; We use these results to compare the relative magnitudes of the impact on aggregates in the long run of three innovation policies in the United States: the Research and Experimentation Tax Credit, federal expenditure on R&D, and the corporate profits tax. We argue that the corporate profits tax is a relatively important policy through its negative effects on innovation and physical capital accumulation. We also use a calibrated version of our model to examine the absolute magnitude of the impact of these policies on aggregates. We show that, depending on the magnitude of spillovers, it is possible for changes in innovation policies to have very large impact on aggregates in the long run. However, over a 15-year horizon, the impact of changes in innovation policies on aggregate output is not very sensitive to the magnitude of spillovers. ; On the basis of these results we conclude that, while it is possible to make comparisons about the relative importance of different policies and sharp predictions about their aggregate impact in the medium term, it is very difficult to shed much light on the implications of innovation policies for long-run aggregate outcomes and welfare in the absence of direct quantitative evidence on the magnitude of spillovers.
AUTHORS: Atkeson, Andrew; Burstein, Ariel
DATE: 2011

Gambling for redemption and self-fulfilling debt crises
We develop a model for analyzing the sovereign debt crises of 2010?2012 in the Eurozone. The government sets its expenditure-debt policy optimally. The need to sell large quantities of bonds every period leaves the government vulnerable to self-fulfilling crises in which investors, anticipating a crisis, are unwilling to buy the bonds, thereby provoking the crisis. In this situation, the optimal policy of the government is to reduce its debt to a level where crises are not possible. If, however, the economy is in a recession where there is a positive probability of recovery in fiscal revenues, the government may optimally choose to ?gamble for redemption,? running deficits and increasing its debt, thereby increasing its vulnerability to crises.
AUTHORS: Kehoe, Timothy J.; Conesa, Juan Carlos
DATE: 2012

Perfectly competitive innovation
We construct a competitive model of innovation and growth under constant returns to scale. Previous models of growth under constant returns cannot model technological innovation. Current models of endogenous innovation rely on the interplay between increasing returns and monopolistic markets. In fact, established wisdom claims monopoly power to be instrumental for innovation and sees the nonrivalrous nature of ideas as a natural conduit to increasing returns. The results here challenge the positive description of previous models and the normative conclusion that monopoly through copyright and patent is socially beneficial.
AUTHORS: Levine, David K.; Boldrin, Michele
DATE: 2002

Why are married women working so much?
We study the large observed changes in labor supply by married women in the United States over 1950-1990, a period when labor supply by single women has hardly changed at all. We investigate the effects of changes in the gender wage gap, technological improvements in the production of nonmarket goods and potential inferiority of these goods on understanding this change. We find that small decreases in the gender wage gap can explain simultaneously the significant increases in the average hours worked by married women and the relative constancy in the hours worked by single women, and single and married men. We also find that technological improvements in the household have-for realistic values-too small an impact on married female hours and the relative wage of females to males. Some specifications of the inferiority of home goods match the hours patterns, but have counterfactual predictions for wages and expenditure patterns.
AUTHORS: Manuelli, Rodolfo E.; McGrattan, Ellen R.; Jones, Larry E.
DATE: 2003

Heterogeneity in expected longevities
We develop a new methodology to compute differences in the expected longevity of individuals who are in different socioeconomic groups at age 50. We deal with two main problems associated with the standard use of life expectancy: that people?s socioeconomic characteristics evolve over time and that there is a time trend that reduces mortality over time. Using HRS data for individuals from different cohorts, we estimate a hazard model for survival with time-varying stochastic endogenous covariates that yields the desired expected durations. We uncover an enormous amount of heterogeneity in expected longevities between individuals in different socioeconomic groups, albeit less than implied by a naive (static) use of socioeconomic characteristics. Our analysis allows us to decompose the longevity differentials into differences in health at age 50, differences in mortality conditional on health, and differences in the evolution of health with age. Remarkably, it is the latter that is the most important for most socioeconomic characteristics. For instance, education and wealth are health protecting but have little impact on two-year mortality rates conditional on health. Finally, we document an increasing time trend of all these differentials in the period 1992?2008, and a likely increase in the socioeconomic gradient in mortality rates in the near future. The mortality differences that we find have huge welfare implications that dwarf the differences in consumption accruing to people in different socioeconomic groups.
AUTHORS: Pijoan-Mas, Josep; Rios-Rull, Jose-Victor
DATE: 2012




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