Collateral Shocks

We estimate a macroeconomic model on US data where banks lend to households and businesses and simultaneously adjust lending requirements on the two types of loans. We find that the collateral shock, a change in the ability of the financial sector to redeploy collateral, is the most important force driving the business cycle. Hit by this unique disturbance, our model quantitatively replicates the joint dynamics of output, consumption, investment, employment, and both household and business credit quantities and spreads. The estimated collateral shock generates accurate movements in lending standards and tracks measures of market sentiment. (JEL E21, E23, E24, E32, E44, G21)

Endogenous Separations, Wage Rigidities, and Unemployment Volatility

We show that in microdata, as well as in a search and matching model with flexible wages for new hires, wage rigidities of incumbent workers have substantial effects on separations and unemployment volatility. Allowing for an empirically relevant degree of wage rigidities for incumbent workers drives unemployment volatility as well as the volatility of vacancies and tightness to that in the data. Thus, the degree of wage rigidity for newly hired workers is not a sufficient statistic for determining the effect of wage rigidities on macroeconomic outcomes. This finding affects the interpretation of a large empirical literature on wage rigidities. (JEL E24, J23, J31, J41, J63)

The Rise and Fall of India’s Relative Investment Price: A Tale of Policy Error and Reform

India’s relative price of investment rose 44 percent from 1981 to 1991 and fell 26 percent from 1991 to 2006. We build a simple DGE model, calibrated to Indian data, in order to explore the impact of capital import substitution policies and their reform post-1991 in accounting for this rise and fall. Our model delivers a 23 percent rise before reform and a 31 percent fall thereafter. GDP per effective labor was 3 percent lower in 1991 compared to 1981 due to import restrictions on capital goods. Their removal, and a 71 percentage point reduction in tariff rates, raised GDP per effective labor permanently by 20 percent. (JEL E22, E23, F13, O11, O16, O19)

The Cyclical Behavior of Unemployment and Wages under Information Frictions

I propose a new mechanism for sluggish wages based on workers’ noisy information about the state of the economy. Wages do not respond immediately to a positive aggregate shock because workers do not (yet) have enough information to demand higher wages. The model is robust to two major criticisms of existing theories of sluggish wages and volatile unemployment, namely, that wages are flexible for new hires and the flow opportunity cost of employment (FOCE) is pro-cyclicality. The model generates volatility in the labor market as well as wage and FOCE elasticities with respect to productivity, consistent with the data. (JEL E24, E32, J24, J31, J63)

Offshoring, Automation, Low-Skilled Immigration, and Labor Market Polarization

We show that the observed polarization of employment toward the high- and low-skill occupations disappears when only native workers are considered. Instead, low-skilled immigration explains employment growth at the low tail of the skill distribution. Moreover, while employment rose, wages remained subdued in low-skill occupations. A data-disciplined structural model accounts for this evidence: Offshoring and automation negatively affect middle-skill occupations but enhance employment and wages for the high-skilled. Low-skill employment is sheltered from offshoring and automation, as it consists of manual, non-tradable services. However, low-skilled immigration depresses low-skill wages and encourages native workers to move into skilled occupations through training. (JEL F16, J24, J31, J61, M53)

On the Macroeconomic Consequences of Over-Optimism

Analyzing International Monetary Fund (IMF) data, we find that overly optimistic growth expectations for a country induce economic contractions a few years later. To isolate the causal effect, we take an instrumental variable approach—exploiting randomness in the country allocation of IMF mission chiefs. We first document that IMF mission chiefs differ in their individual degrees of forecast optimism, yielding quasi-experimental variation in the degree of forecast optimism at the country level. The mechanism appears to run through excessive accumulation of debt (public and private). Our findings illustrate the potency of unjustified optimism and underline the importance of basing economic forecasts upon realistic medium-term prospects. (JEL C53, E23, E27, E32, F33, H63)

How Sticky Wages in Existing Jobs Can Affect Hiring

We consider a matching model of employment with flexible wages for new hires but sticky wages within matches. Unlike most models of sticky wages, we allow effort to respond if wages are too high or too low. In the Mortensen-Pissarides model, employment is not affected by wage stickiness in existing matches. But it is in our model. If wages of matched workers are stuck too high, firms require more effort, lowering the value of additional labor and reducing hiring. We find that effort’s response can greatly increase wage inertia. (JEL E24, J23, J31, J41, M51)

Slow Debt, Deep Recessions

Business credit lags GDP growth by about one year. This contributes to high leverage during recessions and slow deleveraging. We show that a model in which firms use risky long-term debt replicates this slow adjustment of firm debt. In the model, slow-moving debt has important effects for real activity. High levels of firm debt issued during expansions are only gradually reduced during recessions. This generates an adverse feedback loop between high default rates and low investment and thereby amplifies the downturn. Sluggish deleveraging slows down the recovery. (JEL E23, E32, E44, G31, G32)

Declining Worker Turnover: The Role of Short-Duration Employment Spells

Using the Quarterly Workforce Indicators database, we document that a significant amount of the decline in labor market turnover during the last two decades is accounted for by the decline in employment spells that last just one or two quarters. This phenomenon is pervasive: short-term employment spells have declined across industries, firm size categories, demographic groups, and geographic regions. Using a search-and-matching model in the Diamond-Mortensen-Pissarides tradition that incorporates noisy signals about the quality of a worker-firm match, we argue that improved screening by workers and firms can account for much of the decline in short-lived employment spells. (JEL E24, J23, J41, J63, M51)

Capital Controls for Crisis Management Policy in a Global Economy

Capital controls may be justified as a policy to combat a financial crisis. But for large economies, capital controls may have substantial spillovers to the rest of the world. We investigate the case for capital controls in a large open economy, when domestic financial constraints may bind during a crisis. When the crisis country is indebted, it must trade off the desire to tax inflows to improve the terms of trade and tax outflows to ease financial constraints. This trade-off renders noncooperative use of capital controls ineffective as crisis management policy. Effective use of capital controls for crisis management requires international cooperation. (JEL F23, F38, F41, G01, H21, H25)