Economic Fluctuations and Growth
Members and guests of the NBER's Program on Economic Fluctuations and Growth met at the Federal Reserve Bank of San Francisco on February 5. Nobel Prize-winning economist Milton Friedman of Stanford University was the group's luncheon speaker. Organizers George A. Akerlof, University of California, Berkeley, and Martin S. Eichenbaum, NBER and Northwestern University, put together this program:
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Davis and Willen characterize the covariance of asset returns and shocks to labor income for a hypothetical group of individuals defined in terms of gender, education, and age. They find that the correlation between income shocks and equity returns increases with educational attainment and surprisingly is negative for several gender/education groups. Davis and Willen then develop a life-cycle model with incomplete markets and use it to evaluate the portfolio choice and welfare implications of hedging with financial assets. They find that there are large gains from trading a "full menu" of assets, exceeding $15,000 in present value for many persons. Even a single asset can generate sizable gains for certain demographic groups. Thus, the hedging motive has significant consequences for the structure of the optimal portfolio.
Lusardi shows that there are vast differences in wealth holdings among U.S. households, even in similar age groups. Further, a large percentage of U.S. households near retirement have little or no wealth. Approximately 30 percent of such households do little or no planning for retirement. Lusardi notes that planning is shaped by the experience of other individuals: older siblings or elderly parents, for example. Financial difficulties and declining health later in life also provide strong incentives for planning. Individuals who do plan are more likely to hold large amounts of wealth and to invest their wealth in high return assets, such as stocks. Thus, planning plays an important role in explaining the saving behavior of many households.
Alvarez and Jermann measure the "marginal cost of consumption fluctuations," that is the benefit of a small reduction in consumption fluctuations. They show that this measure is an upper bound to the benefits of reducing all consumption fluctuations. To measure the marginal cost of fluctuations, they fit a variety of nonstationary pricing kernels that reproduce key asset pricing statistics. They find that consumers would be willing to pay a very high price for reducing overall uncertainty about consumption. However, for consumption volatility corresponding to the business cycle frequencies, the marginal cost is about one-third of a percent of consumption, an estimate of the same order of magnitude as the one found by Lucas (1987). Alvarez and Jermann also clarify the link between the cost of consumption uncertainty, the equity premium, and the slope of the real term structure.
Kremer and Chen note that developing countries with highly unequal income distributions, such as Brazil or South Africa, face an uphill battle in reducing inequality. Educated workers in these countries have a much lower birthrate than that of uneducated workers. Assuming that children of educated workers are more likely to become educated, the discrepancy in birthrates tends to increase the proportion of unskilled workers. This reduces their wages, and thus their opportunity cost of having children, creating a vicious cycle. The authors' model incorporating this effect generates multiple steady-state levels of inequality, suggesting that in some circumstances temporarily increasing access to educational opportunities could permanently reduce inequality. The empirical evidence suggests that the fertility differential between the educated and uneducated is greater in less equal (income) countries, which is consistent with the model.
Two key facts about European unemployment must be explained: the rise in unemployment since the 1960s and the diversity of experiences in the individual countries. While adverse shocks potentially explain much of the rise in unemployment, there are not enough differences among these shocks to explain the differences across countries. Alternatively, explanations focusing on labor market institutions explain the current diversity of experiences well, but many of these institutions predate the rise in unemployment. Based on a panel of institutions and shocks for 20 OECD nations since 1960, Blanchard and Wolfers find that the interaction between shocks and institutions is crucial to explaining both stylized facts. They test two specifications and their results suggest that institutions determine the relevance of the unemployed to wage setting, thereby determining the evolution of equilibrium unemployment rates following a shock.
Gilchrist and Williams consider a neoclassical interpretation of postwar growth in Germany and Japan that relies on a catch-up mechanism through capital accumulation in which technology is embodied in new capital goods. They emphasize that the "economic miracle" in Germany and Japan reflected a gap in "machines" rather than a gap in "ideas." Using a putty-clay model of production and capital accumulation, Gilchrist and Williams capture many of the key empirical properties of Germany's and Japan's postwar experience, including persistently high but declining growth rates of labor and total factor productivity, the U-shaped response of the capital-output ratio, relatively stable investment-output ratios, and reasonable rates of return to capital during the transition path.