Must-Read: Alisdair McKay and Ricardo Reis: Optimal Automatic Stabilizers

Posted on by Brad DeLong

Must-Read: Alisdair McKay and Ricardo Reis: Optimal Automatic Stabilizers:

Should the generosity of unemployment benefits and the progressivity of income taxes depend on the presence of business cycles?… We derive an augmented Baily-Chetty formula showing that the optimal generosity and progressivity depend on a macroeconomic stabilization term. Using a series of analytical examples, we show that this term typically pushes for an increase in generosity and progressivity as long as slack is more responsive to social programs in recessions. A calibration to the U.S. economy shows that taking concerns for macroeconomic stabilization into account raises the optimal unemployment benefits replacement rate by 13 percentage points but has a negligible impact on the optimal progressivity of the income tax…

Must-Read: Giles Wilkes: How I learnt to love the economic blogosphere

Posted on by Brad DeLong

Must-Read: Giles Wilkes: How I learnt to love the economic blogosphere:

Let me introduce you to Interfluidity, the blog of Steve Randy Waldman, a computer programmer now based, I believe, in San Francisco. Waldman epitomises the meritocracy of the medium; without the boost others get from being a professor or an already known personality, his blog has grown from obscurity to significance, purely on its merits. As is often the case, notice by more popular blogs will have helped (notably Cowen and DeLong) but his is a prominence earned entirely on merits. (I also like how he holds back from publishing dozens of posts a day.) Waldman’s posts are long but among the very few I think should be printed out and savoured.

A Brief History of (In)equality: Now Live at Project Syndicate

Posted on by Brad DeLong
Digesting Income Inequality Mind the Post

Over at Project Syndicate: A Brief History of (In)equality: BERKELEY – The Berkeley economist Barry Eichengreen recently gave a talk in Lisbon about inequality that demonstrated one of the virtues of being a scholar of economic history. Eichengreen, like me, glories in the complexities of every situation, avoiding oversimplification in the pursuit of conceptual clarity. This disposition stays the impulse to try to explain more about the world than we can possibly know with one simple model. For his part, with respect to inequality, Eichengreen has identified six first-order processes at work over the past 250 years.

READ MOAR of A Brief History of (In)equality at Project Syndicate

The permanent income hypothesis, wealth inequality, and anti-recessionary stimulus

Posted on by Bridget Ansel
If someone handed you $10 right now, what would you do with it?

I asked before, “If someone handed you $10 right now, what would you do with it? Would you decide to spend it right away? Or would you stash it away? Or some combination of the two?” How you answer that hypothetical would reveal your marginal propensity to consume. But why do people have different marginal propensities to consume? The way economists have long thought about this concept is through the perspective of the “permanent income hypothesis,” an idea advanced by famed University of Chicago economist Milton Friedman. The hypothesis states that an individual’s consumption depends less on their income today (their transitory income) and more on their lifetime income (their permanent income).

Yet as economics columnist Noah Smith writes, some empirical work shows some big flaws in the hypothesis. So it’s worth thinking through the hypothesis and how inequality, specifically wealth inequality, influences consumption.

The permanent income hypothesis posits that if you’re handed $10 right now, whether you spend it today depends less on how much income you took in today (perhaps only $10) and more on how much you’re going to make over the course of your life. Hopefully, $10 is a drop in the bucket compared to your lifetime earnings so you’re unlikely to spend much of that extra money. But as Smith points out, there’s a good amount of research that shows people will spend a decent amount of surprise money when they receive it. So what’s going on here?

The answer lies in who is most likely to spend that additional money. There are well-known variations in the marginal propensities to consume. People with lower net worth tend to have higher marginal propensities to consume, while these propensities decline as a person’s net worth increases. More specifically, research points to the importance of liquid wealth, or wealth that a person can readily access. The research shows that people who consume a decent chunk of new income are likely to be less wealthy.

Perhaps these less wealthy people have less access to credit and can’t borrow funds to finance their consumption. Regardless of the reason, if people with few liquid assets are quick to spend cash they receive, then this has important implications for fiscal policy. If policymakers want to make sure that the money they appropriate to fight a recession gets spent quickly, then they want to get it to the people with few or no liquid assets. These are the ones who will actually spend it, boosting consumption and helping to restart economic growth.

Must-Reads: July 27, 2016

Posted on by Brad DeLong

Should Reads:

Must-Read: Diego Anzoategui et al.: Endogenous Technology Adoption and R&D as Sources of Business Cycle Persistence

Posted on by Brad DeLong

Must-Read: Diego Anzoategui et al.: Endogenous Technology Adoption and R&D as Sources of Business Cycle Persistence:

We… augment a workhorse New Keynesian DSGE model with an endogenous TFP mechanism that allows for both costly development and adoption of new technologies. We estimate the model and use it to assess the sources of the productivity slowdown. We find that a significant fraction of the post-Great Recession fall in productivity was an endogenous phenomenon. The endogenous productivity mechanism also helps account for the slowdown in productivity prior to the Great Recession, though for this period shocks to the effectiveness of R&D expenditures are critical. Overall, the results are consistent with the view that demand factors have played a role in the slowdown of capacity growth since the onset of the recent crisis. More generally, they provide insight into why recoveries from financial crises may be so slow.

Must-Read: Josh Hausman: What Was Bad for General Motors Was Bad for America: The Automobile Industry and the 1937/38 Recession

Posted on by Brad DeLong

Must-Read: Josh Hausman: What Was Bad for General Motors Was Bad for America: The Automobile Industry and the 1937/38 Recession:

In the 1937/38 recession… an auto industry supply shock contributed both to the recession’s anomalies and to its severity. Labor-strife-induced wage increases and an increase in raw material costs led auto manufacturers to raise prices in fall 1937. Expectations of these price increases brought auto sales forward. When auto prices finally rose, sales plummeted. This shock likely reduced 1938 auto sales by roughly 600,000 units and 1938 GDP growth by 0.5–1 percentage point.

Expenditure Shares, Price Measurement, and True Relative Labor Productivity Growth in Post-WWII Manufacturing: What the Aggregate Deta Suggest

Posted on by Brad DeLong
Distraction Google Search

Tuesday Morning Distraction: Well, I was supposed to be sitting three tables down from Aaron Edlin at the Claremont Peets this morning doing research. But I got myself distracted–convinced myself that I ought to right something about the sharp Matthew Yglesias’s (and why, Harvard Economics Department, was he not an economics major?) piece on premature deindustrialization. And then I got myself redistracted…

Let’s start with one of the standard graphs: the American share of (nonfarm) employment that is in manufacturing:

At the start of the 1930s manufacturing employment was 30% of nonfarm employment. It is now 9% of nonfarm employment. In the absence of our trade deficit in manufacturing, it would be 12% of nonfarm employment. Thus only one-sixth of the reduction in the manufacturing share of nonfarm employment can be traced to the emergence of our manufacturing trade deficit–six-sevenths of the share decline is due to extra-fast improvements in manufacturing labor productivity and to shifts in the types of goods and services that we demand.

How much of the 18%-point ex-manufacturing trade deficit decline in the manufacturing employment share can be traced to demand shifts? Answering that question requires taking a view on what an unshifted demand would look like. Another standard graph is the nominal share of manufacturing production in GDP:

On the same axes as the nominal share of manufacturing production, I have plotted a series called “real” obtained from the nominal share by (a) multiplying it by the chain price index for GDP and (b) dividing it by the chain price index for manufacturing. This is not the real share of real GDP that is real manufacturing production. It is the “real” share. “Real” shares calculated this way do not add up to totals. This is a ratio of two flawed aggregative index numbers scaled so that in 2000 the ratio matches the nominal share of manufacturing in GDP.

At the start of the 1950s manufacturing production was 27% of GDP (manufacturing labor productivity was in value terms some 5/4 of average labor productivity, including the farm sector), and it has since fallen to 11% of GDP (manufacturing labor productivity is still in value terms 5/4 of average labor productivity). But over the course of the last 70 years the measured price of manufactures has fallen relative to the measured price of GDP by 1.4%/year, so that all of the declining share of manufactures in nominal GDP can be, in some sense, accounted for as an extra-fast improvement in manufacturing productivity and thus a relative reduction in market prices.

If there were a single commodity called “GDP” and a single commodity called “manufactured goods”, then we would say that:

  • The relative price of “manufactured goods” today is only 40% of its level 70 years ago…
  • If the income and price elasticities of demand for “manufactured goods” were one, then we would have expected the decline in relative price to 40% of its initial value to be associated with a 2.5-fold multiplication in relative quantities, and for the nominal share of manufactures in GDP to remain the same. Thus if the “unshifted demand” has associated with it a manufactured-goods demand curve of unit price elasticity, all of the 18%-point fall could be traced to changes in our market preferences away from manufactures. But I see nothing in the world or in our culture to generate such a shift in tastes and thus in market demand away from manufactured stuff. Manufactured stuff is useful, really useful…
  • If the income elasticity of demand for “manufactured goods” were one and the price elasticity of demand were zero, then we would have expected the decline in relative price to 40% of its initial value to be associated with stability in relative quantities, and for the nominal share of manufactures in GDP to fall on the same track as the price–as it has. Thus if the “unshifted demand” has associated with it a manufactured-goods demand curve of zero price elasticity, none of the 18%-point fall could be traced to changes in our market preferences away from manufactures.

For our demand for manufactured goods to have a price elasticity of zero seems to me to make little sense: Manufactured stuff is useful. When the price of manufactures drops relative to the price of other stuff, we ought to buy more manufactures–not, to be sure, enough to keep the share of our incomes we spend on manufactures constant, but somewhat.

My view is that our measurements have gone substantially awry, and that the price elasticity of demand is about 1/2. The speed with which the share of manufactures in nominal GDP has declined is, in my view, much more consistent with a manufacturing price and labor productivity growth rate differential of not 1.4%/year but more like 3%/year. That would suggest that the relative price of manufactures properly measured today is not 40% but 12% of its immediate post-World War II level, and that the right “real” share graph sees not a constant “real” share of manufactured goods in output, but rather a tripling of the share.

This has implications for the “true” rate of economic growth–an aggregate-scale underestimate of 0.3%/year from this channel alone…

Protecting against risk can help boost U.S. entrepreneurship

Posted on by Bridget Ansel
A new paper looks at the effect of a Canadian maternity-leave reform on entrepreneurship.

Entrepreneurship is a risky endeavor and one that not many people embrace. In an era of declining start-up rates, economists and analysts are thinking about what might spur more people to start their own companies. As Equitable Growth’s Elisabeth Jacobs argues, there are a number of ways that inequality interacts with decisions related to entrepreneurship and innovation. One of the key factors is risk aversion. Simply put, many Americans may be less willing to take risks and therefore are less likely to start new businesses. Perhaps if the cost of failure were reduced then more businesses would be started.

There’s some evidence that public policies can help boost start-up rates by capping the pain of new businesses that fail. A reform to the French unemployment insurance system, for example, allowed workers to remain eligible for benefits if they started a business. One study found that the reform allowed more entrepreneurs to take a gamble and start their own companies. A series of papers by Harvard Business School economist Gareth Olds argues that access to social insurance programs such as the Supplemental Nutrition Assistance Program (more commonly referred to as food stamps) can increase the number of new businesses.

A new paper released this week offers further evidence for this view. The new National Bureau of Economic Research working paper is by economists Joshua D. Gottlieb of the University of British Columbia, Richard Townsend of the University of California-San Diego, and Ting Xu, also of the University of British Columbia. The three economists look at the effect of a maternity-leave reform in Canada enacted during 2000. The reform guaranteed that women can return to their jobs after a year of maternity leave. The economists hypothesize that a year leave with the guarantee of a job at the end would induce some women into taking a chance on starting a new business.

Using a discontinuity based on the cutoff of the birthday of the mother’s new child, Gottlieb, Townsend, and Xu look at the causal effect of the program. They find that entrepreneurship rates go up by a significant amount, around 35 percent. But perhaps these new businesses are just the result of “subsistence” entrepreneurship, meaning that aren’t adding new jobs in the overall economy. The authors find, in fact, that the entrepreneurship spurred by the reform in Canada actually increases entrepreneurship that results in paid employment.

Of course, these results aren’t directly applicable to the United States. But it’s another research paper that shows the perceived risk of starting a business may be an important determinant of entrepreneurship. Sure, some people start companies with dreams of striking it rich. Yet it looks like many more would jump in the ring if they knew they wouldn’t lose everything if they fail.

Must-Read: Stephen J. Terry: The Macro Impact of Short-Termism

Posted on by Brad DeLong

Must-Read: Stephen J. Terry: The Macro Impact of Short-Termism:

Managerial short-termism… I examine through the lens of analyst earnings targets.

Managers face a tradeoff between short-run profits and long-run investment…. Firms that just meet earnings targets lower their investment in R&D and intangibles. Firms that just miss their earnings targets cut CEO pay and face drops in stock-market valuation…. A quantitative general equilibrium endogenous growth model with heterogeneous firms, R&D and accounting manipulation choices, and endogenous earnings forecasts. In the model, the short-run pressure to meet earnings forecasts cuts growth because R&D is misallocated across firms…. This effect cuts growth rates by almost 0.1%, costing the US economy around 6% of output each century. Extending the model to include managerial shirking and empire-building reveals that earnings targets can improve firm value but may still reduce long-run growth and consumer welfare.