Knowledge that Transforms

I show that the nature of the Federal Open Market Committee’s (FOMC’s) forward guidance language shapes the private sector’s responses to monetary policy statements. From February 2000 to June 2003, the FOMC only gave forward guidance about economic outlook risks, and a decrease in the expected federal funds rate path caused stock prices to fall, GDP growth forecasts to fall, and the unemployment rate to rise. From August 2003 to May 2006, the FOMC added forward guidance about policy inclinations, and a decrease in the expected federal funds rate path had the opposite effects. These results suggest that forward guidance that emphasizes economic outlook risks causes stronger information effects than forward guidance that emphasizes policy inclinations.

We propose a “dominant currency paradigm” with three key features: dominant currency pricing, pricing complementarities, and imported inputs in production. We test this paradigm using a new dataset of bilateral price and volume indices for more than 2,500 country pairs that covers 91 percent of world trade, as well as detailed firm-product-country data for Colombian exports and imports. In strong support of the paradigm we find that (i) noncommodities terms-of-trade are uncorrelated with exchange rates; (ii) the dollar exchange rate quantitatively dominates the bilateral exchange rate in price pass-through and trade elasticity regressions, and this effect is increasing in the share of imports invoiced in dollars; (iii) US import volumes are significantly less sensitive to bilateral exchange rates, compared to other countries’ imports; (iv) a 1 percent US dollar appreciation against all other currencies predicts a 0.6 percent decline within a year in the volume of total trade between countries in the rest of the world, controlling for the global business cycle. We characterize the transmission of, and spillovers from, monetary policy shocks in this environment.

This paper uses new confidential Census data to revisit the relationship between firm size, cyclicality, and financial frictions. First, we find that large firms (the top 1 percent by size) are less cyclically sensitive than the rest. Second, high and rising concentration implies that the higher cyclicality of the bottom 99 percent of firms only has a modest impact on aggregate fluctuations. Third, differences in cyclicality are not simply explained by financing, and in fact appear largely unrelated to proxies for financial strength. We instead provide evidence for an alternative mechanism based on the industry scope of the very largest firms.

The pace of job reallocation has declined in the United States in recent decades. We draw insight from canonical models of business dynamics in which reallocation can decline due to (i ) lower dis persion of idiosyncratic shocks faced by businesses, or (ii ) weaker marginal responsiveness of businesses to shocks. We show that shock dispersion has actually risen, while the responsiveness of business-level employment to productivity has weakened. Moreover, declining responsiveness can account for a significant fraction of the decline in the pace of job reallocation, and we find suggestive evidence this has been a drag on aggregate productivity.

We examine the role of FM radio in mitigating violent conflict. We collect original data on radio broadcasts encouraging defections during the Lord’s Resistance Army (LRA) insurgency. This constitutes the first quantitative evaluation of an active counterinsurgency policy that encourages defections through radio messages. Exploiting random topography-driven variation in radio coverage along with panel variation at the grid-cell level, we identify the causal effect of messaging on violence. Broadcasting defection messages increases defections and reduces fatalities, violence against civilians, and clashes with security forces. Income shocks have opposing effects on both the conflict and the effectiveness of messaging.

Esther Duflo delivered her Prize Lecture on Sunday 8 December 2019, at the Aula Magna, Stockholm University.

A key question in the literature on motivated reasoning and self-deception is how motivated beliefs are sustained in the presence of feedback. In this paper, we explore dynamic motivated belief patterns after feedback. We establish that positive feedback has a persistent effect on beliefs. Negative feedback, instead, influences beliefs in the short run, but this effect fades over time. We investigate the mechanisms of this dynamic pattern, and provide evidence for an asymmetry in the recall of feedback. Finally, we establish that, in line with theoretical accounts, incentives for belief accuracy mitigate the role of motivated reasoning.

We estimate the price effect of US import restrictions on washers. The 2012 and 2016 antidumping duties against South Korea and China were accompanied by downward or minor price movements along with production relocation to other export platform countries. With the 2018 tariffs, on nearly all source countries, the price of washers increased nearly 12 percent. Interestingly, the price of dryers—not subject to tariffs—increased by an equivalent amount. Factoring in dryer prices and price increases by domestic brands, the 2018 tariffs on washers imply a tariff elasticity of consumer prices of above one.

The Bartik instrument is formed by interacting local industry shares and national industry growth rates. We show that the typical use of a Bartik instrument assumes a pooled exposure research design, where the shares measure differential exposure to common shocks, and identification is based on exogeneity of the shares. Next, we show how the Bartik instrument weights each of the exposure designs. Finally, we discuss how to assess the plausibility of the research design. We illustrate our results through two applications: estimating the elasticity of labor supply, and estimating the elasticity of substitution between immigrants and natives.

This paper analyzes how bounded rationality affects monetary and fiscal policy via an empirically relevant enrichment of the New Keynesian model. It models agents’ partial myopia toward distant atypical events using a new microfounded “cognitive discounting” parameter. Compared to the rational model, (i) there is no forward guidance puzzle; (ii) the Taylor principle changes: with passive monetary policy but enough myopia equilibria are determinate and economies stable; (iii) the zero lower bound is much less costly; (iv) price-level targeting is not optimal; (v) fiscal stimulus is effective; (vi) the model is “ neo-Fisherian” in the long run, Keynesian in the short run.