Economic Fluctuations and Growth

Greg Kaplan and Benjamin Moll, Princeton University and NBER, and Giovanni L. Violante, New York University and NBER

Monetary Policy According to HANK (NBER Working Paper No. 21897)

Kaplan, Moll, and Violante revisit the transmission mechanism of monetary policy for household consumption in a Heterogeneous Agent New Keynesian (HANK) model. The model yields empirically realistic distributions of household wealth and marginal propensities to consume because of two key features: multiple assets with different degrees of liquidity and an idiosyncratic income process with leptokurtic income changes. In this environment, the indirect effects of an unexpected cut in interest rates, which operate through a general equilibrium increase in labor demand, far outweigh direct effects such as intertemporal substitution. This finding is in stark contrast to small- and medium-scale Representative Agent New Keynesian (RANK) economies, where intertemporal substitution drives virtually all of the transmission from interest rates to consumption.

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Pedro Bordalo, University of London; Nicola Gennaioli, Università Bocconi; and Andrei Shleifer, Harvard University and NBER

Diagnostic Expectations and Credit Cycles

Bordalo, Gennaioli, and Shleifer present a model of credit cycles arising from diagnostic expectations — a belief formation mechanism based on Kahneman and Tversky's (1972) representativeness heuristic. In this formulation, when revising their beliefs agents overweight future outcomes that have become more likely in light of incoming data. Diagnostic expectations are forward looking, and as such are immune to the Lucas critique and nest rational expectations as a special case. Diagnostic expectations exhibit excess volatility, over-reaction to news, and systematic reversals. These dynamics can account for several features of credit cycles and macroeconomic volatility.

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Dongya Koh, University of Arkansas; Raul Santaeulàlia-Llopis, Washington University in St. Louis; and Yu Zheng, City University of Hong Kong

Labor Share Decline and Intellectual Property Products Capital

Koh, Santaeulàlia-Llopis, and Zheng study the behavior of the U.S. labor share over the past 65 years. They find that intellectual property products (IPP) capital accounts entirely for the observed decline of the U.S. labor share, which is otherwise secularly constant for traditional capital (i.e., structures and equipment). The decline of the labor share reflects the fact that the U.S. is undergoing a transition to a more IPP capital-intensive economy. This result has essential implications for the U.S. macroeconomic model.

Marcelo Veracierto, Federal Reserve Bank of Chicago

Adverse Selection, Risk Sharing and Business Cycles

Veracierto considers a real business cycle model in which agents have private information about the stochastic realization to their value of leisure. For the case of logarithmic preferences, Veracierto provides an analytical characterization of the solution to the mechanism design problem of this economy. Moreover, he shows a striking irrelevance result: That the stationary behavior of all aggregate variables are exactly the same in the private information economy as in the full information case. Thus, the private information has no effects on aggregate fluctuations. For more general preferences, the researcher introduce a new computational method to solve it. This is an important contribution of the paper since the method could be used to solve a wide class of models with heterogeneous agents and aggregate uncertainty. Calibrating the model to U.S. data, Veracierto finds a similar irrelevance result for other CRRA preferences: The aggregate allocations of the private information and full information economies are numerically indistinguishable.

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Sumit Agarwal, National University of Singapore; Souphala Chomsisengphet, Office of the Comptroller of the Currency; Neale Mahoney, University of Chicago and NBER; and Johannes Stroebel, New York University and NBER

Do Banks Pass Through Credit Expansions to Consumers Who Want to Borrow? (NBER Working Paper No. 21567)

Agarwal, Chomsisengphet, Mahoney, and Stroebel examine the ability of policymakers to stimulate household spending during the Great Recession by reducing banks' cost of funds. Using panel data on 8.5 million credit cards and 743 credit limit regression discontinuities, the researchers find that the one-year marginal propensity to borrow (MPB) is declining in credit score, falling from 59% for consumers with FICO scores below 660 to essentially zero for consumers with FICO scores above 740. The researchers use the same credit limit discontinuities, combined with a model of lending, to estimate banks' marginal propensity to lend (MPL) out of a decrease in their cost of funds. For the lowest FICO score consumers, higher credit limits sharply reduce profits from lending. This limits banks' incentives to pass-through credit expansions to these consumers, relative to consumers with higher FICO scores. The authors conclude that banks' MPL is lowest for consumers with the highest MPB and discuss the implications for policies that aim to stimulate the economy through banks.

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Timo Boppart, IIES, Stockholm University, and Per Krusell, Stockholm University and NBER

Labor Supply in the Past, Present, and Future: A Balanced-Growth Perspective

Boppart and Krusell argue that a stable utility function of consumption and hours worked for which income effects are slightly stronger than substitution effects can rationalize the long-run data for the main macroeconomic quantities. In these long-run data, in the U.S. as well as in other countries, as productivity grows at a steady rate, hours worked fall slowly and at an approximately constant rate. The researchers narrow down the set of preferences consistent with balanced growth under constant (negative) hours growth. The resulting class amounts to a slight enlargement of the well-known "balanced-growth preferences" that dominate the macro literature and are based on requiring constant hours worked. Thus, hours falling at a constant rate is not inconsistent with the remaining balanced-growth facts but merely requires a slight broadening of the preference class considered. The broadening of the preference class introduces some well-known cases not previously thought to be consistent with balanced growth. From the researchers' perspective, they interpret the recent decades of stationary hours worked in the U.S. as a temporary departure from a long-run pattern, and to the extent productivity will keep growing, they predict that hours will fall further.