28th Annual Conference on Macroeconomics 2013

Lettau and Ludvigson identify three shocks, distinguished by whether their effects are permanent or transitory, to characterize the post-war dynamics of aggregate consumer spending, labor earnings,and household wealth. The first shock accounts for virtually all of the variation in consumption; they argue that it can be plausibly interpreted as a permanent total factor productivity shock . The second shock, which underlies the vast bulk of quarterly fluctuations in labor income growth, permanently reallocates rewards between shareholders and workers but leaves consumption unaffected. Over the last 25 years, the cumulative effect of this shock has persistently boosted stock market wealth and persistently lowered labor earnings. They call this a factors-share shock . The third shock is a persistent but transitory innovation that accounts for the vast majority of quarterly fluctuations in asset values but has a negligible impact on consumption and labor earnings at all horizons. They call this an exogenous risk aversion shock. They show that the 2000-2 asset market crash and recession surrounding it was characterized by a negative transitory wealth (positive risk aversion) shock, predominantly affecting stock market wealth. By contrast, the 2007-9 crash and recession was characterized by a string of large negative productivity shocks, as well as positive risk aversion shocks.

Bianchi and Melosi develop a theoretical framework to account for the observed instability of the link between inflation and fiscal imbalances across time and countries. Current policymakers' behavior influences agents' beliefs about the way that debt will be stabilized. The standard policy mix consists of a virtuous fiscal authority that moves taxes in response to debt and a central bank that has full control over inflation. When policymakers deviate from this Virtuous regime, agents conduct Bayesian learning to infer the likely duration of the deviation. As agents observe more and more deviations, they become increasingly pessimistic about a prompt return to the Virtuous regime and inflation starts drifting in response to a fiscal imbalance. Shocks that were dormant under the Virtuous regime now start manifesting themselves. These changes initially are imperceptible, they can unfold over decades, and they accelerate as agents' beliefs deteriorate. Dormant shocks explain the run-up of US inflation and uncertainty in the 1970s. The currently low long-term interest rates and inflation expectations might hide the true risk of inflation faced by the U.S. economy.

Eliaz and Spiegler incorporate reference-dependent worker behavior into a search-matching model of the labor market, in which firms have all the bargaining power and productivity follows a log-linear AR(1) process. Motivated by Akerlof (1982) and Bewley (1999), they assume that existing workers' output falls stochastically from its normal level when their wages fall below a "reference point" which is equal to their lagged-expected wage. They formulate the model game-theoretically and show that it has a unique sub-game perfect equilibrium with the following properties: existing workers experience downward wage rigidity, as well as destruction of output following negative shocks due to layoffs or loss of morale; newly hired workers earn relatively ‡flexible wages, but not as much as in the benchmark without reference dependence; and market tightness is more volatile than under this benchmark.

During the last thirty years, U.S. business cycles have been characterized by counterc-yclical technology shocks and very low inflation variability. While the first fact runs counter to an RBC view of fluctuation, and calls for demand shocks as a source of fluctuations, the second fact is difficult to reconcile with a New Keynesian model in which demand shocks are accommodated. Beaudry and Portier show that non-inflationary demand driven business cycles can be explained easily if one moves away from the representative agent framework on which the New Keynesian model and the RBC model are based. They show how changes in demand, induced by changes in perceptions about the future, can cause business cycle type fluctuations when agents are not perfectly mobile across sectors. Because they use an extremely simple framework, they discuss the generality of the results and develop a modified New Keynesian model with non-inflationary demand driven fluctuations. They also document the relevance of their main assumptions regarding labor market segmentation and incomplete insurance using PSID data over the period 1968-2007.