The paper investigates the common dynamic properties of business-cycle fluctuations across countries, regions, and the world. We employ a Bayesian dynamic latent factor model to estimate common components in macroeconomic aggregates (output, consumption, and investment) in a 60-country sample covering seven regions of the world. The results indicate that a common world factor is an important source of volatility for aggregates in most countries, providing evidence for a world business cycle. We find that region-specific factors play only a minor role in explaining fluctuations in economic activity. We also document similarities and differences across regions, countries, and aggregates.
Macroeconomics was born as a distinct field in the 1940s, as a part of the intellectual response to the Great Depression. The term then referred to the body of knowledge and expertise that we hoped would prevent the recurrence of that economic disaster. My thesis in this lecture is that macroeconomics in this original sense has succeeded: Its central problem of depression-prevention has been solved, for all practical purposes, and has in fact been solved for many decades. There remain important gains in welfare from better fiscal policies, but I argue that these are gains from providing people with better incentives to work and to save, not from better fine tuning of spending flows. Taking U.S. performance over the past 50 years as a benchmark, the potential for welfare gains from better long-run, supply side policies exceeds by far the potential from further improvements in short-run demand management. My plan is to review the theory and evidence leading to this conclusion. Section I outlines the general logic of quantitative welfare analysis, in which policy comparisons
We show how a Schumpeterian process of creative destruction can induce rational, herd behavior by entrepreneurs across diverse sectors as if fueled by “animal spirits.” Consequently, a multisector economy, in which productivity improvements are made by independent, profit-seeking entrepreneurs, exhibits regular booms, slowdowns, and downturns as part of the long-run growth process. Our cyclical equilibrium has higher average growth, but lower welfare than the corresponding acyclical one. We show how a negative relationship can emerge between volatility and growth across cycling economies, and assess the extent to which our model matches several features of actual business cycles.
The current financial crisis in the commercial airline industry has engendered an active debate over appropriate governmental policies. Proponents of government support, instrumental in legislating a $5 billion cash transfer and $10 billion loan guarantee fund for U.S. carriers following September 11, 2001, point to the critical role that airlines play in the U.S. economy and the devastating effects airline failures could have on air service. Opponents argue that most airlines continue to operate through bankruptcy resolution and that even a complete shutdown of a major carrier, which rarely occurs, would stimulate expansion by other airlines to replace its abandoned flights. This debate highlights the need to understand the causal effect of airline financial distress on airline operations, distinct from correlations that may exist as a result of adverse demand or cost shocks that lead to both service declines and financial distress. We focus on airline Chapter 11 bankruptcy filings, an extreme measure of financial distress. We use data from 1984 through 2001 to evaluate the impact of major bankruptcies on the level of flights and destinations served at U.S. airports. Our results suggest that bankruptcy induces modest declines in service levels, particularly at midsize airports. This raises the question of whether such declines are socially inefficient. Restrictions imposed by the bankruptcy court judge or the creditors of an airline operating under Chapter 11 may affect total industry output or capacity offered if other carriers cannot rapidly replace the production of the constrained firm (i.e., if firms are not homogeneous and entry is not costless). With heterogeneous firms, one firm may be uniquely positioned to supply a flight, and its decision not to do so may lead to a reduction in total service. This is particularly likely in network industries, such as airlines, where there are strong production complementarities across routes. It is also possible, however, that pre-bankruptcy service levels were inefficiently high. The bankrupt carrier may have overprovided service, perhaps in an attempt to build market share, or flight-frequency competition among carriers may have led to excessive flights. In these cases, the flight reduction associated with bankruptcy may cause a movement toward the socially optimal level of service. Our work takes a first step toward resolving this issue, by determining the magnitude of bankruptcy effects on aggregate air service. The results suggest the need for further research to assess its possible welfare implications.
Since the early 1980's, patterns of emergingmarket finance have changed significantly. Greater integration of capital markets and a trend toward a greater use of direct lending through bonds has led to relatively decreased use of indirect finance through syndicated bank loans. These changes have produced benefits to investors through opportunities for risk diversification and to emerging-market sovereign borrowers by increasing the investor base. The broadened investor base in bond financing, however, raises problems of coordination and collective action in the event of a sovereign borrower's default and restructuring. Now, three parties are involved in determining the debt markdown required to produce solvency: the debtor, creditors, and the global taxpayer through international financial institutions (IFI's). The complex relationships among the borrowers, creditors, and the global taxpayer have made restructuring obligations a costly and time-consuming exercise, especially with the possibility of holdouts. Both the sovereign borrower and its creditors have an incentive to avoid a restructuring in the hope of financial assistance from the global taxpayer. Sovereign governments may not undertake the politically painful steps involved in beginning a restructuring when there is always the hope that official assistance will be forthcoming. Creditors may not accept a reduction in the value of their claims, also in the hope that official assistance will be forthcoming. Costs of postponed and disorderly restructurings are real and substantial. Delays in restructuring can drain a country's resources and increase the ultimate costs of restoring financial sustainability. Creditors bear a burden as well, because the losses associated with the restructuring are reflected in values of
Gravity equations have been widely used to infer trade flow effects of various institutional arrangements. We show that estimated gravity equations do not have a theoretical foundation. This implies both that estimation suffers from omitted variables bias and that comparative statics analysis is unfounded. We develop a method that (i) consistently and efficiently estimates a theoretical gravity equation and (ii) correctly calculates the comparative statics of trade frictions. We apply the method to solve the famous McCallum border puzzle. Applying our method, we find that national borders reduce trade between industrialized countries by moderate amounts of 20–50 percent.
Segerstrom (1998) demonstrates that the social optimum requires “radical” technological breakthroughs to be treated less favorably than “incremental” innovations in a growing economy. The aim of this note is to assess the robustness of this welfare result on the basis of two levels of generalization: (i) the elasticity of substitution between any two goods is allowed to be larger than one, and (ii) inter-industry spillovers are introduced. We show that Segerstrom’s results can be reversed. It is also shown that in contrast to Segerstrom, R&D subsidies can be globally optimal, irrespective of the size of innovation, when inter-industry spillovers are large.
In many of the decisions we make we rely on the advice of others who have preceded us. For example, before we buy a car, choose a dentist, choose a spouse, find a school for our children, sign on to a retirement plan, etc. we usually ask the advice of others who have experience with such decisions. The same is true when we make major financial decisions. Here people easily take advice from their fellow workers or relatives as to how to choose stock, balance a portfolio, or save for their child’s education. Although some advice we get is from experts, most of the time we make our decisions relying only on the rather uninformed word-of-mouth advice we get from our friends or neighbors. We call this ?aive advice? In this paper I will outline a set of experimental results that indicate that word-of-mouth advice is a very powerful force in shaping the decisions that people make and tends to push those decisions in the direction of the predictions of the rational theory.
Inference methods that recognize the clustering of individual observations have been available for more than 25 years. Brent Moulton (1990) caught the attention of economists when he demonstrated the serious biases that can result in estimating the effects of aggregate explanatory variables on individual-specific response variables. The source of the downward bias in the usual ordinary least-squares (OLS) standard errors is the presence of an unobserved, state-level effect in the error term. More recently, John Pepper (2002) showed how accounting for multi-level clustering can have dramatic effects on t statistics. While adjusting for clustering is much more common than it was 10 years ago, inference methods robust to cluster correlation are not used routinely across all relevant settings. In this paper, I provide an overview of applications of cluster-sample methods, both to cluster samples and to panel data sets.