Understanding booms and busts in housing markets
Some booms in housing prices are followed by busts. Others are not. In either case it is difficult to find observable fundamentals that are correlated with price movements. We develop a model consistent with these observations. Real estate agents have heterogeneous expectations about long-run fundamentals but change their views because of "social dynamics." Agents meet randomly with one another. Those with tighter priors are more likely to convert others to their beliefs. The model generates a "fad": The fraction of the population with a particular view rises and then falls. Depending on ...
When is the government spending multiplier large?
We argue that the government spending multiplier can be very large when the nominal interest rate is constant. We focus on a natural case in which the interest rate is constant, which is when the zero lower bound on nominal interest rates binds. For the economies that we consider it is optimal to increase government spending in response to shocks that make the zero bound binding.
Introducing financial frictions and unemployment into a small open economy model
The current financial crisis has made it abundantly clear that business cycle modeling can no longer abstract from financial factors. It is also clear that the current standard approach of modeling labor markets without explicit unemployment has its limitations. We extend what is becoming the standard new Keynesian model in three dimensions. First, we incorporate financial frictions in the accumulation and management of capital. Second, we model the labor market using a search and matching framework. Third, we extend the model into a small open economy setting. Finally, we estimate the model ...
Trading down and the business cycle
The authors document two facts: First, during recessions consumers trade down in the quality of the goods and services they consume. Second, the production of low-quality goods is less labor intensive than that of high-quality goods. Therefore, when households trade down, labor demand falls, increasing the severity of recessions. The authors find that the trading-down phenomenon accounts for a substantial fraction of the fall in U.S. employment in the recent recession. They study two business cycle models that embed quality choice and find that the presence of quality choice magnifies the ...
Comment on Eggertsson, \"What fiscal policy is effective at zero interest rates?\"
Gauti B. Eggertsson's paper (published in NBER Macroeconomics Annual 2010) represents an important contribution to the analysis of fiscal policy in the New Keynesian model when the zero lower bound on the nominal interest rate is binding. The paper accomplishes a great deal. It analyzes two types of taxes on capital and labor, the investment tax credit, a sales tax, and two types of government spending. It deserves to be an important reference on fiscal policy in a binding zero lower bound. In my discussion, I focus on the subset of Eggertsson's results that initially surprised me and that I ...
Causes and consequences of the oil shock of 2007–08
This paper explores similarities and differences between the run-up of oil prices in 2007??08 and earlier oil price shocks, looking at what caused the price increase and what effects it had on the economy. Whereas historical oil price shocks were primarily caused by physical disruptions of supply, the price run-up of 2007??08 was caused by strong demand confronting stagnating world production. Although the causes were different, the consequences for the economy appear to have been very similar to those observed in earlier episodes, with significant effects on overall consumption spending and ...
Non-linear effects of taxation on growth
We study a model in which the effects of taxation on growth are highly non-linear. Marginal increases in tax rates have a small growth impact when tax rates are low or moderate. When tax rates are high, further tax hikes have a large, negative impact on growth performance. We argue that this non-linearity is consistent with the empirical evidence on the effect of taxation and other disincentives to investment and innovation on economic growth.
Involuntary unemployment and the business cycle
We propose a monetary model in which the unemployed satisfy the official U.S. definition of unemployment: people without jobs who are (1) currently making concrete efforts to find work and (2) willing and able to work. In addition, our model has the property that people searching for jobs are better off if they find a job than if they do not (that is, unemployment is involuntary). We integrate our model of involuntary unemployment into the simple new Keynesian framework with no capital and use the resulting model to discuss the concept of the nonaccelerating inflation rate of unemployment. We ...
Fiscal stimulus and distortionary taxation
We quantify the fiscal multipliers in response to the American Recovery and Reinvestment Act of 2009. We extend the benchmark Smets-Wouters New Keynesian model (Smets and Wouters, 2007), allowing for credit-constrained households, the zero lower bound, government capital, and distortionary taxation. The posterior yields modestly positive short-run multipliers around 0.52 and modestly negative long-run multipliers around -0.42. The multiplier is sensitive to the fraction of transfers given to credit-constrained households, the duration of the zero lower bound, and the capital. The stimulus ...
Liquidity needs in economies with interconnected financial obligations
A model is developed in which firms in a financial system have to settle their debts to each other by using a liquid asset (or money). The question studied is how many firms must have access to this asset from outside the financial system to make sure that all debts within the system are settled. The main result is that these liquidity needs are larger when these firms are more interconnected through their debts, that is, when they borrow from and lend to more firms. Two pecuniary externalities are discussed. One is the result of paying one creditor first rather than another. The second ...