Work has been carried out on four major projects, and initial steps has been taking to start on the remaining projects.
“Sentimental Business Cycles,” (Aim 2) published in the Review of Economic Studies, 2023, joint with Lagerborg and Pappa, examines the impact of an impulse to the business cycle often not considered in the literature: Waves of optimism and pessimism amongst households unrelated to economic fundamentals – consumer sentiments. We apply dynamic causal analysis to address this question. The key idea is that changes in consumer sentiments can be estimated by extracting an autonomous component from survey-based estimates of consumer confidence data by means of an instrumental variables approach. To do this, we use an instrument relating to “non-economic news” which impacts consumer confidence, but has no direct economic consequences. We measure consumer confidence from the University of Michigan’s index of consumer expectations (ICE), and the candidate news shock consist of fatalities in U.S. mass shootings. We show that mass-shootings impact on the ICE and, in a second step, that when consumer sentiments deteriorate for autonomous reasons, it induces a slump in aggregate activity and private sector consumption, and a significant weakening of the labour market as reflected by fewer job vacancies and higher unemployment. We show that such consumer sentiment shocks account for a substantial fraction of the impulses to the business cycle. We map mass shootings and consumer confidence to US counties and show that households living in the vicinity of these terrible events display significantly larger declines in consumer confidence than those in other counties.
In “Financial Frictions: Micro vs. Macro Volatility,” joint with Lee, Luetticke, Faccini and Renkin, (Aims 2 and 3) we study how frictions in financial intermediation impacts on the economy. We argue that aggregate shocks have disparate effects on households across the wealth distribution and that this is due to frictions in financial intermediation which introduce a spread in the cost of consumer credit over the return on liquid savings. We study unique Danish administrative data held at Statistics Denmark and provide evidence that the marginal propensity to consume of poor households relative to richer ones rises in recessions and that this derives from countercyclical consumer credit spreads. We analyze a rich heterogeneous agents New Keynesian (HANK) model where banks intermediate between households and firms, and between borrowers and savers. We show that this model induces heterogeneous impact of aggregate shocks across the wealth distribution, and that this derives from the movements in consumer credit spreads. We show that stricter leverage constraints on banks reduce the volatility of the aggregate economy, but induce micro volatility by reducing poorer households’ ability to insure against idiosyncratic risk. This paper is in Revise and resubmit status at the American Economic Review.
In “Shocks, Frictions and Inequality in Korean Business Cycles,” (Aim 3) with Lee and Luetticke, we formulate and estimate a small open economy model in which there is incomplete markets and heterogeneity. This allows us to evaluate the extent to which domestic and foreign shocks impact on inequality and whether inequality materially matters for the sensitivity of the economy to shocks and their impact on welfare. A key finding in the paper is that ``globalization’’ in the sense of foreign trade has had a moderating impact on inequality in Korea. We are currently further developing this paper to consider in more detail the structure of the foreign assets and liabilities portfolios.
In ongoing work, we are working on projects relating to the impact of antitrust and changes in market power (Aims 2 and 3), stabilization policy design in the face of financial sector frictions (Aim 3), and methods for causal analysis in the face of micro economic aggregate shocks (Aim 1). The first of these is already in an advanced stage and results will be ready soon.
