Aggregate Shocks Research Articles

Is Keynesianism still increasingly relevant? The importance of the economic multiplier

Cyclically, the debate on Keynes’ economic policies reemerge. The economic impact of the pandemic caused by COVID-19 has relaunched the discussion about the importance of Keynesian policies, the multipliers effects, and their impact on stimulating economies. This paper aims to analyze the importance and relevance of the Keynesian multiplier before the pandemic, in a period without experiencing exceptional aggregate shocks. The main focus of the research is to examine the shortcomings of the public investment multiplier, which plays a central role in Keynesian theory. Despite the undeniable relevance of the concept, the issue is to understand the extent to which the multiplier is still relevant in specific contexts. The research presents empirical evidence which suggests that the effects of public investment depend on structural characteristics of economies specifically trade liberalization, the dimension of internal markets, the question of countries having the freedom to issue their currency, and the issue of currencies being accepted as an international reserve. A sample of 35 OECD countries was used for the period 2010–2018. The Keynesian public investment multiplier was calculated for several countries and the obtained values were related to various correlations carried out to assess the relationship between public investment, national income, and specific characteristics of the economies to which the multipliers are sensitive. The results obtained contrast in terms of short-term and long-term impacts so, is at least dubious, that one can rely on Keynesian public policies to boost economies at least in the absence of substantial shocks to aggregate demand.

Limited Firm Insurance and Aggregate Implications

This paper studies the impacts of financial shocks on firm insurance, firm dynamics, and macroeconomic implications. A key departure from the literature is that firms provide wage insurance contracts to risk-averse workers in a long-term relationship. Such contracts endogenously impose a form of inflexible debt liability to firms, and make firms with limited financial net worth more vulnerable to shocks than others. In our model, firms have heterogenous productivity and financial net worth, and also firms face financial frictions. Search and matching in the labor market endogenously determines the value of wage contract, and thus the level of liability to the firm. We have three new findings: (1) The wage dynamics of the quantitative model are consistent with those in empirical studies, with significant insurance against firm-level idiosyncratic shocks, and also a weak comovement between aggregate wage and GDP when there are aggregate shocks. (2) Firms with limited financial resources are hit by financial shocks significantly more than others, with larger negative impacts on dividends, credit borrowing, firm value, and firm entry; the endogenous wage insurance also becomes more limited, and there are more separations. These impacts on both firms and workers are different from—and cannot be accounted for by—standard models with a representative firm or worker. (3) Quantitative exercises for the Great Recession in the United States suggest that aggregate productivity shocks and financial shocks play different roles; without financial shocks, we cannot account for the dynamics of financial variables, including the reduced credit borrowing, spikes in credit spreads, and large drops in dividend payments. Lastly, we provide microlevel empirical supports for our model implications. This paper was accepted by Lukas Schmid, finance. Funding: Y. Wang acknowledges the financial support from the National Natural Science Foundation of China [Grant 72150003] and the grant from Shenzhen Municipal Government [Grant 1210614103]. Supplemental Material: The data files are available at https://doi.org/10.1287/mnsc.2023.01627 .

Private ownership in monopolistic competition models

Motivated by empirical evidence, I study the properties of a monopolistic competition model with private ownership. Toward that goal, I consider a monopolistic competition model with additive preferences, homogeneous workers and homogeneous firms. I then introduce in such a standard framework a single additional ingredient: private ownership. Private ownership means that each firm is owned and managed by a single household called the entrepreneur, and this entrepreneur receives profits as sole revenues. In turn, private ownership changes the nature of entry. Free entry in the industry is no longer satisfied. Rather, the number of firms is now determined through occupational choice. Armed with this new framework, I provide a full characterization of a market equilibrium, and compare it to the standard model with collective ownership and free entry. Notably, I find new results concerning optimality, the transmission of aggregate shocks and the ability of the new model to replicate well-established empirical facts.

Optimal banking with delegated monitoring

We propose a model of financial intermediation based on delegated monitoring, where firms' returns are private information that lenders can ascertain through costly state verification. Our model has two key features: lenders cannot commit to their verification strategies and there are aggregate shocks. Simple debt contracts are Pareto optimal with or without intermediation. We show that the benefits of intermediation can be limited by financial instability in the presence of aggregate shocks. However, a well-designed resolution mechanism ensures the Pareto optimality of financial intermediation, and a bail-out policy can restore financial stability.

Aggregate Shocks and the Formation of Preferences and Beliefs

Aggregate Shocks and the Formation of Preferences and Beliefs

Monetary non-neutrality in a multisector economy: The role of risk-sharing

We show that the degree of risk-sharing among heterogeneous workers is a key determinant of monetary non-neutrality in a multisector sticky-price model. In this framework, workers are employed across different sectors, earning distinct wages. The limited ability of workers to fully insure against labor income risks results in strategic complementarity in firms' price-setting decisions with respect to aggregate shocks and strategic substitutability with respect to idiosyncratic shocks. These pricing interactions lead to sluggish adjustments of the price level in response to monetary and other aggregate shocks, causing significant fluctuations in the output gap while maintaining large responses of individual prices to idiosyncratic shocks. We illustrate these results across three stylized asset market scenarios: complete markets, non-contingent bond-only markets, and financial autarky.

The nonlinear impacts of macroeconomic shocks on the US regional housing markets

ABSTRACT This paper examines the asymmetrical impacts of aggregate macroeconomic shocks on the US regional housing markets by estimating nonlinear Vector Autoregressive models. We show how aggregate output, monetary, inflation, and credit shocks result in heterogenous impulse responses of the housing market volatilities across growing and declining housing market regimes in nine census divisions and 19 metropolitan cities. We find that output and inflation shocks cause qualitatively asymmetrical responses across regimes in majority of regions. A positive output shock and a negative inflation shock reduce (increase) housing price uncertainties when housing markets are in a declining (booming) regime in most regions. The responses of regional housing price volatilities to monetary and credit shocks are quantitatively asymmetrical across regimes in most regions. We also find that aggregate shocks have larger contributions on changing the probabilities of regime switching when a regional housing market is initially expanding than declining. Among aggregate shocks, inflation shock has the most prominent contributions across most regions. It also presents the strongest asymmetrical effects across positive and negative shocks. Our results can help regional decision makers utilize fiscal policies, regulatory measures, and regional planning to mitigate the destabilizing effects of macroeconomic shocks on regional housing markets.

The paradox of search intensity

In standard labor search and matching models, the search intensity (SI) of unemployed workers is procyclical and complements job creation. Both predictions are at odds with the US labor market following the Great Recession. To address these inconsistencies, this paper extends the standard model to incorporate multi-market simultaneous search (MMSS). Adverse aggregate shocks can raise SI as workers simultaneously search in more markets because the incentives are decreasing in the local job-finding rate. This broader search effort leads to higher offer rejection, which in turn discourages firm entry. The offer-rejection externality can result in multiple equilibria. In the calibrated model, a temporary financial crisis can cause a persistent increase in both SI and unemployment.

The macroeconomics of hedging income shares

The debate about the falling labor share has brought attention to the income-shares trends, but less attention has been devoted to their variability. We analyze how their fluctuations can be insured between workers and capitalists, and the corresponding implications for financial markets. We study a neoclassical growth model with aggregate shocks that affect income shares and financial frictions that prevent firms from fully insuring idiosyncratic risk. We examine theoretically how aggregate risk sharing is shaped by the combination of idiosyncratic risk and moving shares. In this setting, accumulation of safe assets by capitalists and risky assets by workers emerges naturally as a tool to insure income shares' risk. Then, in a quantitative exploration we show that low interest rates, rising capital shares, and accumulation of safe assets by firms and risky assets by households can be rationalized by persistent shocks to the labor share.

Productivity Shocks of Dominant Companies and Local Housing Markets

We extend the literature on the influence of firm-level characteristics on housing markets by exploring the association between the labor productivity shocks of dominant firms and local housing prices. Using a sample of all U.S. firms from COMPUSTAT during 1980-2017, we find that the aggregate shocks of labor productivity of dominant firms at the metropolitan statistical area (MSA)-level explain for a significant portion of the local housing price changes in MSAs while controlling for other housing price determinants. About a year or more is required for the shocks to propagate through the local housing markets, which make them a viable predictor of future housing price. The productivity shock – housing price relation is stronger in areas that have more concentrated high-tech dominant firms or where dominant firms have closer links to their local non-dominant industry peers. Shocks are also more influential during economic expansion than economic contraction. Furthermore, the relation also exists at the zipcode level but the shocks propagate faster than at the MSA-level. The findings provide helpful insights for real estate practitioners and policymakers, especially in areas with a higher concentration of large companies.

On natural interest rate volatility

Episodes of low natural interest rates, even transitory, pose a challenge to monetary policy, by possibly causing the effective lower bound (ELB) on the policy rate to bind. Those episodes are more likely to occur not only when the natural rate is low on average but also when fluctuations around its average level are large. We study the responsiveness of the natural interest rate to structural aggregate shocks affecting the aggregate supply of and demand for savings. Using a quantitative overlapping-generations model, we trace back this responsiveness to the slopes of aggregate savings supply and demand curves and argue that both curves have likely flattened over the past four decades in the US This implies a greater sensitivity of the natural interest rate to structural shocks affecting the supply of and demand for aggregate savings — making it more likely, all else equal, that it fall into negative territory.

How do households cope during aggregate shocks? Evidence from the 2009–2015 oil crisis in Nigeria

The effect of global oil price fluctuations on households' costs of living in Nigeria is examined. We extend the Aggregate Demand/Supply (AD/AS) model by incorporating aggregate shock and idiosyncratic risk with cross-sectional heterogeneity in households' distributions and consumption substitution dynamics. Results from our model show that while positive oil prices reflect higher output, whether growth results from inflation or income-level growth remains unclear ―demand-side inflation will raise price levels, amplify budget constraints and ultimately lower welfare. For the empirical analysis, we use oil prices between 2009 and 2015 and micro-level data from the Nigerian General Household Survey (GHS) collected between 2010 and 2016 in Nigeria. In support, we show that increasing oil prices leads to greater consumption. However, the effect varies heterogeneously ―reflecting households' location and consumption substitution dynamics, adjustments in household size, and labor supply are some coping responses to oil price changes.

Ignorant experts and financial fragility

We examine expertise acquisition incentives in a model of debt funding markets in which expertise reduces the cost of acquiring information about underlying collateral. Lenders acquiring expertise gain advantages in financial contracts with borrowers and extract rents from them by creating fear of information acquisition that gives rise to illiquidity. As information about collateral decays over time, there is growth in credit and expertise acquisition, making the economy more vulnerable to an aggregate shock. This result suggests that expertise acquisition is an endogenous amplification mechanism of an aggregate shock.

Sequential trading with coarse contingencies

We consider a dynamic pure exchange economy in which agents have a coarse perception of the future, and awareness emerges gradually over time. We make the key assumption that awareness of a shock to agents' endowments emerges before the shock hits, so agents can adapt by purchasing (or selling) insurance. We provide an irrelevance theorem showing that, under suitable conditions, unawareness matters if and only if it concerns aggregate shocks. In particular, if the unforeseen endowment shocks are purely idiosyncratic, there is no loss of efficiency with respect to the economy with perfect foresight. Building on this result, we show three key implications of unforeseen aggregate shocks: the possibility of non-comonotonic consumption allocations, a systematic bias in asset prices that gives rise to opportunities for intertemporal arbitrage, and the potential of unexpected default due to the agents' inability to repay (roll over) prior debt.

Economic Shocks and Populism

Abstract We study how voters’ preferences between a safe incumbent and a risky opponent change in the aftermath of a negative aggregate shock. With reference-dependent preferences, economically disappointed voters become risk lovers, and are hence attracted by the more risky candidate. Survey data from the German Socio-Economic Panel are consistent with our assumptions and theoretical predictions on voters’ behaviour.

Learning about labor markets

We study a general equilibrium model of the labor market in which agents slowly learn about their suitability for jobs. Our model reproduces desirable features of the data, many of which standard models fail to replicate. We explore how, in such an environment, asymmetric information can lead to substantial misallocation. We calibrate our model to US data and quantify the welfare loss arising from misallocation due to informational frictions. The tractability of the model allows us to explore the responsiveness of wages and employment to an aggregate shock. We find that wage rigidity arises endogenously because of protracted learning, and in line with the data, the model is able to generate a larger and more persistent employment response.

Asset prices in a production network

The relative importance of sectoral and aggregate productivity shocks in asset pricing is examined using a nonlinear dynamic equilibrium model where heterogeneous sectors interact in a production network. The model accounts for the heterogeneity in sectoral stock returns and endogenously generates conditional heteroskedasticity and fat tails. The equity risk premium is shown to be driven by sectoral shocks – specially to investment good producers and mining – with a limited contribution from the aggregate shock. SMM estimates of the elasticities of substitution between material inputs and between investment goods support the assumption of gross complementarity employed by previous network literature.

Sectoral Heterogeneity in Nominal Price Rigidity and the Origin of Aggregate Fluctuations

We study the role of heterogeneity in nominal price rigidity for aggregate fluctuations in a model with sectoral productivity shocks. Theoretically, sectoral heterogeneity in the pricing friction has an ambiguous effect on GDP and aggregate price volatility. Quantitatively, (i) GDP volatility is amplified when the friction is heterogeneous rather than homogeneous; (ii) sectoral shocks can jointly rationalize the volatility of sectoral prices, aggregate prices, and GDP, unlike aggregate shocks; and (iii) shocks to the largest or most central sectors may not matter in the aggregate as heterogeneous pricing frictions may alter the identity of the most important sectors for aggregate fluctuations. (JEL E12, E23, E31, E32)

Digital Labour Platforms as Shock Absorbers: Evidence from the COVID-19 Pandemic in Mozambique

Abstract Digital labour platforms have grown five-fold over the past decade, enabling significant expansion of gig work worldwide. We interrogate the critique that these platforms tend to amplify aggregate shocks for registered workers. Based on the universe of records from a matching platform for manual freelancers in Mozambique, we analyse how task supply and demand altered with the onset of COVID-19. Treating the pandemic as a structural break, which extends to an event study analysis, we find it was associated with a net increase in tasks demanded per worker, but no clear change in supply growth (new registrations). While these general trends are evident across multiple market segments, there is also evidence of relatively higher demand for female as compared to male workers during the pandemic. This suggests digital labour markets can help some workers adjust to economic shocks in low-income contexts.

A Non‐parametric Estimation of Productivity with Idiosyncratic and Aggregate Shocks: The Role of Research and Development (R&D) and Corporate Tax

We develop a non‐parametric technique framework for estimating firm‐level Total Factor Productivity (TFP). Our paper has two major novelties: first, we propose a modelling of productivity with both firm‐idiosyncratic factors and aggregate shocks. Second, we apply the Bayesian Markov Chain Monte Carlo (MCMC) technique that offers a numerical integration of productivity outside the posterior overcoming the restrictive assumptions about the relationship between productivity and variable production inputs. We implement our methodology in a group of 4,286 manufacturing firms from France, Germany, Italy, and the UK (2001–14). The results show that: (i) aggregate shocks matter for firm TFP evolution. The global financial crisis of 2008 caused severe, albeit short, adverse effects on TFP; (ii) there is substantial heterogeneity across countries in the way firms react to changes in R&D and taxation. German and UK firms are more sensitive to fiscal changes than R&D, while the opposite is true for Italian firms. R&D and taxation effects are symmetrical for French firms; (iii) the UK productivity handicap continues for years after the financial crisis; and (iv) there are substantial knowledge spillovers among German and Italian firms.