Periodic Reporting for period 2 - BUCCAC (Business Cycle Causes and Consequences)
Okres sprawozdawczy: 2022-07-01 do 2023-12-31
Modern economies fluctuate over time. Fluctuations that are persistent – but not permanent – are usually referred to as business cycles. Such business cycles come in many different shapes and sizes: consider the Great Recession and the Covid-19 Recession, both very large contractions, but very different in nature and sources. However, one thing that is common to them is that they impact on a large fraction of society and thus matter for national welfare. Such fluctuations are also typically what policy makers have in mind when they design and implement stabilization policies.
The BUCCAC project sets out to contribute knowledge to the sources and consequences of such business cycle fluctuations.
The work is divided into the following topics:
• Aim 1: Developing methods for estimating the consequences of particular impulses (known as structural shocks) to the aggregate economy.
• Aim 2: Applications of dynamic causal methods for the estimation of the impact of consumer sentiment shocks and of changes in market power
• Aim 3: Develop theories of business cycles and develop insights about stabilization policy.
At this point, major progress have been made on Aims 2 and 3. We will discuss this below. We do not envisage any issues in delivering on all fronts of the proposal.
The BUCCAC project sets out to contribute knowledge to the sources and consequences of such business cycle fluctuations.
The work is divided into the following topics:
• Aim 1: Developing methods for estimating the consequences of particular impulses (known as structural shocks) to the aggregate economy.
• Aim 2: Applications of dynamic causal methods for the estimation of the impact of consumer sentiment shocks and of changes in market power
• Aim 3: Develop theories of business cycles and develop insights about stabilization policy.
At this point, major progress have been made on Aims 2 and 3. We will discuss this below. We do not envisage any issues in delivering on all fronts of the proposal.
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.
“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.
- The paper "Sentimental Business Cycles" suggest a way to measure "non-fundamental" shocks and estimate their impact on the economy. We think that this could have quite some impact on the academic literature and on policy, and lead researchers to look deeper for the candidates for impulses to the business cycle beyond those typically considered.
- In "Financial Frictions: Micro vs. Macro Volatility" we (i) provide the first empirical evidence on countercyclicality of the marginal propensity to consume and the importance of credit spreads for this, (ii) show how the existence and countercyclical movements in consumer credit spreads induce heterogeneous effects of common (macro shocks), (iii) argue that financial regulation aimed at delivering macroeconomic stability could induce microeconomic volatility. We think each three of these contributions will have important impact on academic research and on policy design.
- “Shocks, Frictions and Inequality in Korean Business Cycles,” we have provided one of the first fully estimated open economy HANK models, a literature that we think will become a very important tool for both research and policy going forwards.
Over the last year we have worked hard on a major sub-project on antitrust and market power. We provide researchers with a narrative of more than 50 years of antitrust investigations in the United States. Secondly, it will provide insights into how market power impacts on firm behavior and firm valuations. Third, we will use the results to estimate how changes in market power impacts on the economy and we believe that this will deliver valuable new insights and how market power impacts the economy. It will also deliver an instrument for estimation of markups that we think could have significant impact both on academia and on policy.
- In "Financial Frictions: Micro vs. Macro Volatility" we (i) provide the first empirical evidence on countercyclicality of the marginal propensity to consume and the importance of credit spreads for this, (ii) show how the existence and countercyclical movements in consumer credit spreads induce heterogeneous effects of common (macro shocks), (iii) argue that financial regulation aimed at delivering macroeconomic stability could induce microeconomic volatility. We think each three of these contributions will have important impact on academic research and on policy design.
- “Shocks, Frictions and Inequality in Korean Business Cycles,” we have provided one of the first fully estimated open economy HANK models, a literature that we think will become a very important tool for both research and policy going forwards.
Over the last year we have worked hard on a major sub-project on antitrust and market power. We provide researchers with a narrative of more than 50 years of antitrust investigations in the United States. Secondly, it will provide insights into how market power impacts on firm behavior and firm valuations. Third, we will use the results to estimate how changes in market power impacts on the economy and we believe that this will deliver valuable new insights and how market power impacts the economy. It will also deliver an instrument for estimation of markups that we think could have significant impact both on academia and on policy.