NBER Reporter: Fall 2000

Economic Fluctuations and Growth

The summer research meeting of the NBER's Program on Economic Fluctuations and Growth took place in Cambridge on July 22. Kenneth D. West, NBER and University of Wisconsin, Madison, and Michael Woodford, NBER and Princeton University, organized the program and chose the following papers for discussion:

Pierre-Olivier Gourinchas, NBER and Princeton University, "Precautionary Savings, Life Cycle, and Macroeconomics"

Discussants: Christopher D. Carroll, NBER and Johns Hopkins University, and Jose-Victor Rios-Rull, NBER and University of Pennsylvania

Marvin J. Barth III, Federal Reserve Board of Governors, and Valerie A. Ramey, NBER and University of California, San Diego, "The Cost Channel of Monetary Transmission" (NBER Working Paper No. 7675)

Discussants: Christopher A. Sims, NBER and Princeton University, and Mark Gertler, New York University

Paul Beaudry, NBER and University of British Columbia, and Franck Portier, Université de Toulouse, "An Exploration into Pigou's Theory of Cycles"

Discussants: Nobuhiro Kiyotaki, London School of Economics, and James D. Hamilton, NBER and University of California, San Diego

Craig Burnside, World Bank, and Martin Eichenbaum and Sergio Rebelo, NBER and Northwestern University, "On the Fundamentals of Self-Fulfilling Speculative Attacks"

Discussants: Olivier Jeanne, International Monetary Fund, and Paolo Pesenti, Federal Reserve Bank of New York

Stefania Albanesi, Northwestern University; V. V. Chari, University of Minnesota; and Lawrence J. Christiano, NBER and Northwestern University, "Expectation Traps and Monetary Policy"

Discussants: Peter N. Ireland, NBER and Boston College, and Lars E. O. Svensson, NBER and Institute for International Economic Studies

Stephen Bond, Oxford University, and Jason G. Cummins, New York University, "The Stock Market and Investment in the New Economy: Some Tangible Facts and Intangible Fictions"

Discussants: Robert E. Hall, NBER and Stanford University, and Janice C. Eberly, NBER and Northwestern University

Gourinchas explores the implications of precautionary saving and life-cycle behavior for aggregate macroeconomic fluctuations and individual dynamics. Existing heterogeneous agent models of the business cycle, with uncertainty of labor income and incomplete markets, yield aggregate quantitative predictions that are almost identical to those of representative agent models. This quasi-aggregation theorem arises when idiosyncratic shocks are largely transitory. The author revisits these results in the context of an overlapping generations model with two sources of heterogeneity: age and idiosyncratic shocks to labor income. The results indicate that quasi-aggregation still obtains. However, the nature of the equilibrium and of aggregate fluctuations is influenced by the existence of idiosyncratic risk.

Barth and Ramey show that the "cost channel" may be an important part of the monetary transmission mechanism. They argue that if working capital is an essential component of production and distribution, then monetary contractions can affect output through a supply channel as well as through the traditional demand-type channels. The authors specify an industry equilibrium model and use it to interpret the results of a vector autoregression analysis. They find that after a monetary contraction, many industries have periods of falling output and rising price-wage ratios, consistent with a supply shock. These effects are found to be noticeably more pronounced during the period before 1979.

Beaudry and Portier propose a model of business cycles in which recessions and booms arise as the result of difficulties encountered by agents in properly forecasting the economy's future capital needs. The idea has a long history in macroeconomic literature, as reflected by the work of Pigou (1927). The authors first illustrate the type of general equilibrium structure that can give rise to such phenomena. Then they examine the extent to which such a model can explain the observed pattern of U.S. recessions -- frequency and depth -- without relying on technological regress. Beaudry and Portier argue that this type of model may help to explain elements of the recent downturns in Asia as well as why recessions appear to be driven by declines in aggregate demand, even in the absence of any significant price rigidities.

Burnside, Eichenbaum, and Rebelo propose a theory of twin banking-currency crises in which both fundamentals and self-fulfilling beliefs play crucial roles. Fundamentals determine whether crises will occur. Self-fulfilling beliefs determine when they occur. The fundamental that causes twin crises is government guarantees to domestic banks' foreign creditors. When these guarantees are in place, twin crises inevitably occur but their timing is a multiple equilibrium phenomenon that depends on agents' beliefs. So, while self-fulfilling beliefs have an important role to play, twin crises do not happen just anywhere. They happen in countries where there are fundamental problems such as guarantees to the financial sector.

Albanesi, Chari, and Christiano examine whether standard monetary general equilibrium models with benevolent monetary authorities acting under discretion can explain the persistent episodes of high and low inflation observed in many countries. Specifically, they ask whether private agents' expectations of high or low inflation can lead them to take actions, which then make it optimal for monetary authorities to validate these expectations. Following Chari, Christiano, and Eichenbaum (1998), the authors label such an outcome an expectation trap. They find that expectation traps can occur, even in the absence of trigger strategies. Moreover, they demonstrate this possibility in a model that has some hope of being able to account for key features of inflation dynamics.

Bond and Cummins consider whether the increase in the stock market reflects the growing role of intangible capital in generating profits (that is, the birth of the New Economy) or a persistent and broadly based increase in the market valuation of companies relative to their fundamental value. The authors introduce a new approach based on the Q model of investment that is rich enough to encompass both these possibilities. They then study investment behavior, in both tangible and intangible capital, and assess whether it is consistent with one or both explanations. Although Bond and Cummins can identify a limited role for intangible investment, they find no evidence that it accounts for the spectacular rise in the stock market valuation of firms. Their results suggest that persistent deviations of equity values from firms' fundamental valuations are an important feature of U.S. stock markets over the past 17 years, and that this can account for the weak observed relationship between share prices and investment.

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