http://www.minneapolisfed.org/publications_papers/wp/ <em>Working Papers</em> are early drafts of academic research papers written by economists affiliated with the Minneapolis Fed. Not all of these are available to the public. Many <em>Working Papers</em> later become Staff Reports. Many <em>Working Papers</em> are available in electronic form as PDF and/or PostScript files. <br><br> Those not available electronically should be available at your local library. 2013-04-30T00:00:00-06:00 http://www.minneapolisfed.org/disclaimer.cfm en Federal Reserve Bank of Minneapolis http://www.minneapolisfed.org/publications_papers/pub_display.cfm?id=5097 2013-04-30T00:00:00-06:00 The rise in within-group consumption inequality in response to the increase in within-group income inequality over the last three decades in the U.S. is puzzling to expected-utility-based incomplete market models. The two-sided lack of commitment models exhibit too little consumption inequality while the standard incomplete markets models tend to predict too much consumption inequality. We show that a model with two-sided lack of commitment and chance attitudes, as emphasized by prospect theory, can explain the relationship and can avoid the systematic bias of the expected utility models. The chance attitudes, such as optimism and pessimism, imply that the households attribute a higher weight to high and low outcomes compared to their objective probabilities. For realistic values of risk aversion and of chance attitudes, the incentives for households to share the idiosyncratic risk decrease. The latter effect endogenously amplifies the increase in consumption inequality relative to the expected utility model, thereby improving the fit to the data. Reconciling Consumption Inequality with Income Inequality 2013-04-30T00:00:00-06:00 Vadym Lepetyuk Vadym Lepetyuk Christian A. Stoltenberg Christian A. Stoltenberg 2013-04 Working Paper April 2013 http://www.minneapolisfed.org/publications_papers/pub_display.cfm?id=5088 2013-04-15T00:00:00-06:00 In this paper, we study the role of education as insurance against a bad marriage. Historically, due to disparities in earning power and education across genders, married women often found themselves in an economically vulnerable position, and had to suffer one of two fates in a bad marriage: either they get divorced (assuming it is available) and struggle as low-income single mothers, or they remain trapped in the marriage. In both cases, education can provide a route to emancipation for women. To investigate this idea, we build and estimate an equilibrium search model with education, marriage/divorce/remarriage, and household labor supply decisions. A key feature of the model is that women bear a larger share of the divorce burden, mainly because they are more closely tied to their children relative to men. Our focus on education is motivated by the fact that divorce laws typically allow spouses to keep the future returns from their human capital upon divorce (unlike their physical assets), making education a good insurance against divorce risk. However, as women further their education, the earnings gap between spouses shrinks, leading to more unstable marriages and, in turn, further increasing demand for education. The framework generates powerful amplification mechanisms, which lead to a large rise in divorce rates and a decline in marriage rates (similar to those observed in the US data) from relatively modest exogenous driving forces. Further, in the model, women overtake men in college attainment during the 1990s, a feature of the data that has proved challenging to explain. Our counterfactual experiments indicate that the divorce law reform of the 1970s played an important role in all of these trends, explaining more than one-quarter of college attainment rate of women post-1970s and one-half of the rise in labor supply for married women. Women’s Emancipation through Education: A Macroeconomic Analysis 2013-04-15T00:00:00-06:00 Fatih Guvenen Fatih Guvenen Michelle Rendall Michelle Rendall 2013-04 Working Paper April 2013 http://www.minneapolisfed.org/publications_papers/pub_display.cfm?id=5051 2013-02-20T00:00:00-06:00 Consider an economy in which various types of labor are used to produce consumption, but not all types of labor are useful for upgrading the stock of organization capital–that is, for replacing old projects with more productive new projects. When news induces consumers to want to save more, low-quality projects are destroyed across all sectors of the economy, even though the economy is set to increase its stock of new projects. Labor that can be used to create new projects becomes more expensive and labor that cannot becomes cheap. Average wages may not change at all, and the employment of workers who cannot invest in new projects will decline. If physical capital complements the inputs of these workers, investment in physical capital tends to move together with their employment. These results are derived analytically for a prototype economy that has the essential ingredients of empirically relevant equilibrium models of firm heterogeneity. The Stolper-Samuelson Effects of a Decline in Aggregate Consumption 2013-02-20T00:00:00-06:00 Erzo G.J. Luttmer Erzo G.J. Luttmer 2013-02 Working Paper February 2013 http://www.minneapolisfed.org/publications_papers/pub_display.cfm?id=5048 2013-02-07T00:00:00-06:00 We analyze optimal policy in a simple small open economy model with price setting frictions. In particular, we study the optimal response of the nominal exchange rate following a terms of trade shock. We depart from the New Keynesian literature in that we explicitly model interna-tionally traded commodities as intermediate inputs in the production of local final goods and assume that the small open economy takes this price as given. This modification not only is in line with the long-standing tradition of small open economy models, but also changes the optimal movements in the exchange rate. In contrast with the recent small open economy New Keynesian literature, our model is able to reproduce the comovement between the nominal exchange rate and the price of exports, as it has been documented in the commodity currencies literature. Although we show there are preferences for which price stability is optimal even without flexible fiscal instruments, our model suggests that more attention should be given to the coordination between monetary and fiscal policy (taxes) in small open economies that are heavily dependent on exports of commodities. The model we propose is a useful framework in which to study fear of floating. Optimal Devaluations 2013-02-07T00:00:00-06:00 Juan Pablo Nicolini Juan Pablo Nicolini Constantino Hevia Constantino Hevia 2013-02 Working Paper February 2013 http://www.minneapolisfed.org/publications_papers/pub_display.cfm?id=4858 2013-02-01T00:00:00-06:00 We analyze the secular decline in interstate migration in the United States between 1991 and 2011. Gross flows of people across states are about 10 times larger than net flows, yet have declined by around 50 percent over the past 20 years. We argue that the fall in migration is due to a decline in the geographic specificity of returns to occupations, together with an increase in workers’ ability to learn about other locations before moving there, through information technology and inexpensive travel. These explanations find support in micro data on the distribution of earnings and occupations across space and on rates of repeat migration. Other explanations, including compositional changes, regional changes, and the rise in real incomes, do not fit the data. We develop a model to formalize the geographic-specificity and information mechanisms and show that a calibrated version is consistent with cross-sectional and time-series patterns of migration, occupations, and incomes. Our mechanisms can explain at least one-third and possibly all of the decline in gross migration since 1991. Understanding the Long-Run Decline in Interstate Migration 2013-02-01T00:00:00-06:00 Greg Kaplan Greg Kaplan Sam Schulhofer-Wohl Sam Schulhofer-Wohl 2013-02 Working Paper Revised February 2013 http://www.minneapolisfed.org/publications_papers/pub_display.cfm?id=4797 2012-11-27T00:00:00-06:00 In 1950 Mexico entered an economic takeoff and grew rapidly for more than 30 years. Growth stopped during the crises of 1982–1995, despite major reforms, including liberalization of foreign trade and investment. Since then growth has been modest. We analyze the economic history of Mexico 1877–2010. We conclude that the growth 1950–1981 was driven by urbanization, industrialization, and education and that Mexico would have grown even more rapidly if trade and investment had been liberalized sooner. If Mexico is to resume rapid growth — so that it can approach U.S. levels of income — it needs further reforms. Catch-up Growth Followed by Stagnation: Mexico, 1950–2010 2012-11-27T00:00:00-06:00 Timothy J. Kehoe Timothy J. Kehoe Felipe Meza Felipe Meza 2012-11 Working Paper Revised November 2012 http://www.minneapolisfed.org/publications_papers/pub_display.cfm?id=4942 2012-09-04T00:00:00-06:00 This paper develops a vector autoregression (VAR) for macroeconomic time series which are observed at mixed frequencies – quarterly and monthly. The mixed-frequency VAR is cast in state-space form and estimated with Bayesian methods under a Minnesota-style prior. Using a real-time data set, we generate and evaluate forecasts from the mixed-frequency VAR and compare them to forecasts from a VAR that is estimated based on data time-aggregated to quarterly frequency. We document how information that becomes available within the quarter improves the forecasts in real time. Real-Time Forecasting with a Mixed-Frequency VAR 2012-09-04T00:00:00-06:00 Frank Schorfheide Frank Schorfheide Dongho Song Dongho Song 2012-09 Working Paper August 2012 http://www.minneapolisfed.org/publications_papers/pub_display.cfm?id=4941 2012-08-31T00:00:00-06:00 Evaluations of new infrastructure in developing countries typically focus on direct effects, such as the impact of an electrification program on household energy use. But if new infrastructure induces people to move into an area, other local publicly provided goods may become congested, offsetting the benefit of the infrastructure. We use a simple model to show how to measure the net benefit of a place-based program without data on land prices—an indicator that is commonly used to measure congestion in developed countries but that often cannot be used in poor countries because land markets are missing or land prices are badly measured. Our model shows that congestion externalities are especially large when land markets are missing. To illustrate, we estimate the welfare impact of a recent household electrification program in South Africa. Congestion externalities from migration reduced local welfare gains by half. Migration, Congestion Externalities, and the Evaluation of Spatial Investments 2012-08-31T00:00:00-06:00 Sam Schulhofer-Wohl Sam Schulhofer-Wohl Taryn Dinkelman Taryn Dinkelman 2012-08 Working Paper August 2012 http://www.minneapolisfed.org/publications_papers/pub_display.cfm?id=4940 2012-08-30T00:00:00-06:00 This paper adds imitation by incumbent firms, and not just by new entrants, to the model of selection and growth developed in Luttmer [2007]. Noisy firm-level innovation and imitation give rise to a long-run growth rate that exceeds the average rate at which individual firms innovate. It can be shown, in simple examples, that the economy converges to a long-run balanced growth path from compactly supported initial productivity distributions. The right tail of the stationary distribution of de-trended productivity is approximately Pareto. The tail index of this distribution depends on the rate at which incumbents are able to imitate only indirectly, through general equilibrium effects of this parameter on the equilibrium growth rate. Eventually, Noise and Imitation Implies Balanced Growth 2012-08-30T00:00:00-06:00 Erzo G.J. Luttmer Erzo G.J. Luttmer 2012-08 Working Paper August 2012 http://www.minneapolisfed.org/publications_papers/pub_display.cfm?id=4933 2012-08-08T00:00:00-06:00 When the zero lower bound on nominal interest rates binds, monetary policy cannot provide appropriate stimulus. We show that, in the standard New Keynesian model, tax policy can deliver such stimulus at no cost and in a time-consistent manner. There is no need to use inefficient policies such as wasteful public spending or future commitments to low interest rates. Unconventional Fiscal Policy at the Zero Bound 2012-08-08T00:00:00-06:00 Isabel Correia Isabel Correia Juan Pablo Nicolini Juan Pablo Nicolini Pedro Teles Pedro Teles Emmanuel Farhi Emmanuel Farhi 2012-08 Working Paper August 2012 http://www.minneapolisfed.org/publications_papers/pub_display.cfm?id=4599 2012-07-09T00:00:00-06:00 We show how to use panel data on household consumption to directly estimate households’ risk preferences. Specifically, we measure heterogeneity in risk aversion among households in Thai villages using a full risk-sharing model, which we then test allowing for this heterogeneity. There is substantial, statistically significant heterogeneity in estimated risk preferences. Full insurance cannot be rejected. As the risk sharing, as-if-complete-markets theory might predict, estimated risk preferences are unrelated to wealth or other characteristics. The heterogeneity matters for policy: Although the average household would benefit from eliminating village-level risk, less-risk-averse households who are paid to absorb that risk would be worse off by several percent of household consumption. Heterogeneity and Risk Sharing in Village Economies 2012-07-09T00:00:00-06:00 Robert Townsend Robert Townsend Sam Schulhofer-Wohl Sam Schulhofer-Wohl Pierre-Andre Chiappori Pierre-Andre Chiappori Krislert Samphantharak Krislert Samphantharak 2012-07 Working Paper Revised May 2012 http://www.minneapolisfed.org/publications_papers/pub_display.cfm?id=4823 2012-05-21T00:00:00-06:00 Prior to the mid-1980s, labor productivity growth was a useful barometer of the U.S. economy’s performance: it was low when the economy was depressed and high when it was booming. Since then, labor productivity has become significantly less procyclical. In the recent downturn of 2008–2009, labor productivity actually rose as GDP plummeted. These facts have motivated the development of new business cycle theories because the conventional view is that they are inconsistent with existing business cycle theory. In this paper, we analyze recent events with existing theory and find that the labor productivity puzzle is much less of a puzzle than previously thought. In light of these findings, we argue that policy agendas arising from new untested theories should be disregarded. The Labor Productivity Puzzle 2012-05-21T00:00:00-06:00 Edward C. Prescott Edward C. Prescott Ellen R. McGrattan Ellen R. McGrattan 2012-05 Working Paper Revised May 2012 http://www.minneapolisfed.org/publications_papers/pub_display.cfm?id=4829 2012-03-19T00:00:00-06:00 This paper presents a simple formula that relates the tail index of the firm size distribution to the aggregate speed with which an economy converges to its balanced growth path. The fact that there are so many firms in the right tail implies that aggregate shocks that permanently destroy employment among incumbent firms, rather than cause these firms to scale back temporarily, are followed by slow recoveries. This is true despite the presence of many rapidly growing firms. Aggregate convergence rates are non-linear: they can be very high for economies far below the balanced growth path and very low for advanced economies. Slow Convergence in Economies with Firm Heterogeneity 2012-03-19T00:00:00-06:00 Erzo G.J. Luttmer Erzo G.J. Luttmer 2012-03 Working Paper Revised March 2012 http://www.minneapolisfed.org/publications_papers/pub_display.cfm?id=4824 2012-02-16T00:00:00-06:00 This paper examines two different clearing arrangements for bank liabilities. One was a profit-maximizing private entity, the Suffolk Banking System. It cleared notes for New England banks between 1827 and 1858. The other was a nonprofit collective, the clearinghouses organized in many cities beginning in 1853. The paper examines how well these arrangements prevented bank failures and acted as lenders of last resort. It finds the Suffolk system had fewer failures but acted less like a lender of last resort. It argues that these differences can be explained by the different incentives facing the Suffolk Bank and the members of clearinghouses. Clearing Arrangements in the United States before the Federal Reserve System 2012-02-16T00:00:00-06:00 Warren E. Weber Warren E. Weber 2012-02 Working Paper February 2012 http://www.minneapolisfed.org/publications_papers/pub_display.cfm?id=4422 2011-12-02T00:00:00-06:00 Prior to 1861, several U.S. states established bank liability insurance schemes. One type was an insurance fund. Member banks paid into a state-run fund that paid bank creditors’ losses. A second scheme was a mutual guarantee system. Member banks were legally responsible for the liabilities of any insolvent bank. This paper’s hypothesis is that the moral hazard problem was controlled under a scheme to the degree that member banks had the power and incentive to control or modify others’ risk-taking behavior. Schemes that gave member banks both strong incentives and power were able to control the moral hazard problem better than schemes in which one or both features were weak. Empirical evidence on bank failures and losses on banks’ asset portfolios is consistent with this hypothesis. Bank Liability Insurance Schemes Before 1865 2011-12-02T00:00:00-06:00 Warren E. Weber Warren E. Weber 2011-12 Working Paper Revised December 2011 http://www.minneapolisfed.org/publications_papers/pub_display.cfm?id=4778 2011-11-30T00:00:00-06:00 A problem facing the United States and many other countries is how to finance retirement consumption as the number of their workers per retiree falls. The problem with a savings for retirement systems is that there is a shortage of good savings opportunities given the nature of most current tax systems and governments’ limited ability to honor the debt it issues. We find that eliminating capital income taxes will greatly increase saving opportunities and make a savings-for-retirement system feasible with only modest amount of government debt. The switch from a system close to the current U.S. retirement system, which relies heavily on taxing workers’ incomes and making lump-sum transfers to retirees, to one without income taxes will increase the welfare of all birth-year cohorts alive today and particularly the welfare of the yet unborn cohorts. The equilibrium paths for the current and alternative policies are computed. On Efficiently Financing Retirement 2011-11-30T00:00:00-06:00 Edward C. Prescott Edward C. Prescott Ellen R. McGrattan Ellen R. McGrattan 2011-11 Working Paper November 2011 http://www.minneapolisfed.org/publications_papers/pub_display.cfm?id=4657 2011-11-03T00:00:00-06:00 It is widely believed that an important factor underlying the rapid growth in China is increased foreign direct investment (FDI) and the transfer of foreign technology capital, which is accumulated know-how from investment in research and development (R&D), brands, and organizations that is not specific to a plant. In this paper, we study two channels through which FDI can contribute to upgrading of the stock of technology capital: knowledge spillovers and appropriation. Knowledge spillovers lead to new ideas that do not directly compete or devalue the foreign affiliate's stock. Appropriation, on the other hand, implies a redistribution of property rights over patents and trademarks; the gain to domestic companies comes at a loss to the multinational company (MNC). In this paper we build these sources of technology capital transfer into the framework developed by McGrattan and Prescott (2009, 2010) and introduce an endogenously-chosen intensity margin for operating technology capital in order to capture the trade-offs MNCs face when expanding their markets internationally. We first demonstrate that abstracting from technology capital transfers results in predicted bilateral FDI inflows to China that are grossly at odds with the data. We then use the bilateral inflows to parameterize the model with technology capital transfers and compute the global economic impact of Chinese policies that encouraged greater inflows of FDI and technology capital transfers. Microevidence on automobile patents is used to support our parameter choices and main findings. Technology Capital Transfer 2011-11-03T00:00:00-06:00 Edward C. Prescott Edward C. Prescott Ellen R. McGrattan Ellen R. McGrattan Thomas J. Holmes Thomas J. Holmes 2011-11 Working Paper Revised November 2011 http://www.minneapolisfed.org/publications_papers/pub_display.cfm?id=4765 2011-10-11T00:00:00-06:00 We study bilateral exchange, both direct trade and indirect trade that happens through chains of intermediaries or middlemen. We develop a model of this activity and present applications. This illustrates how, and how many, intermediaries get involved, and how the terms of trade are determined. Bargaining with intermediaries depends on how they bargain with downstream intermediaries, leading to interesting holdup problems. We discuss the roles of buyers and sellers in bilateral exchange, and how to interpret prices. We develop a particular bargaining solution and relate it to other solutions. We also illustrate how bubbles can emerge in the value of inventories. Buyers, Sellers and Middlemen: Variations in Search Theory 2011-10-11T00:00:00-06:00 Randall Wright Randall Wright Yuet-Yee Wong Yuet-Yee Wong 2011-10 Working Paper October 2011 http://www.minneapolisfed.org/publications_papers/pub_display.cfm?id=4762 2011-10-11T00:00:00-06:00 We study models of credit with limited commitment, which implies endogenous borrowing constraints. We show that there are multiple stationary equilibria, as well as nonstationary equilibria, including some that display deterministic cyclic and chaotic dynamics. There are also stochastic (sunspot) equilibria, in which credit conditions change randomly over time, even though fundamentals are deterministic and stationary. We show this can occur when the terms of trade are determined by Walrasian pricing or by Nash bargaining. The results illustrate how it is possible to generate equilibria with credit cycles (crunches, freezes, crises) in theory, and as recently observed in actual economies. Endogenous Credit Cycles 2011-10-11T00:00:00-06:00 Randall Wright Randall Wright Chao Gu Chao Gu 2011-10 Working Paper October 2011 http://www.minneapolisfed.org/publications_papers/pub_display.cfm?id=4761 2011-10-11T00:00:00-06:00 The generation and implementation of ideas, or knowledge, is crucial for economic performance. We study this process in a model of endogenous growth with frictions. Productivity increases with knowledge, which advances via innovation, and with the exchange of ideas from those who generate them to those best able to implement them (technology transfer). But frictions in this market, including search, bargaining, and commitment problems, impede exchange and thus slow growth. We characterize optimal policies to subsidize research and trade in ideas, given both knowledge and search externalities. We discuss the roles of liquidity and financial institutions, and show two ways in which intermediation can enhance efficiency and innovation. First, intermediation allows us to finance more transactions with fewer assets. Second, it ameliorates certain bargaining problems, by allowing entrepreneurs to undo otherwise sunk investments in liquidity. We also discuss some evidence, suggesting that technology transfer is a significant source of innovation and showing how it is affected by credit considerations. Innovation and Growth with Financial, and other, Frictions 2011-10-11T00:00:00-06:00 Randall Wright Randall Wright Jonathan Chiu Jonathan Chiu Cesaire Meh Cesaire Meh 2011-10 Working Paper October 2011 http://www.minneapolisfed.org/publications_papers/pub_display.cfm?id=4763 2011-10-11T00:00:00-06:00 Why do some sellers set nominal prices that apparently do not respond to changes in the aggregate price level? In many models, prices are sticky by assumption; here it is a result. We use search theory, with two consequences: prices are set in dollars, since money is the medium of exchange; and equilibrium implies a nondegenerate price distribution. When the money supply increases, some sellers may keep prices constant, earning less per unit but making it up on volume, so profit stays constant. The calibrated model matches price-change data well. But, in contrast with other sticky-price models, money is neutral. Sticky Prices: A New Monetarist Approach 2011-10-11T00:00:00-06:00 Randall Wright Randall Wright Allen Head Allen Head Lucy Qian Liu Lucy Qian Liu Guido Menzio Guido Menzio 2011-10 Working Paper October 2011 http://www.minneapolisfed.org/publications_papers/pub_display.cfm?id=4649 2011-04-07T00:00:00-06:00 <i>The Cincinnati Post</i> published its last edition on New Year’s Eve 2007, leaving the <i>Cincinnati Enquirer</i> as the only daily newspaper in the market. The next year, fewer candidates ran for municipal office in the Kentucky suburbs most reliant on the <i>Post,</i> incumbents became more likely to win reelection, and voter turnout and campaign spending fell. These changes happened even though the <i>Enquirer</i> at least temporarily increased its coverage of the <i>Post</i>’s former strongholds. Voter turnout remained depressed through 2010, nearly three years after the <i>Post</i> closed, but the other effects diminished with time. We exploit a difference-in-differences strategy and the fact that the <i>Post</i>’s closing date was fixed 30 years in advance to rule out some non-causal explanations for our results. Although our findings are statistically imprecise, they demonstrate that newspapers—even underdogs such as the <i>Post</i>, which had a circulation of just 27,000 when it closed—can have a substantial and measurable impact on public life. Do Newspapers Matter? Short-Run and Long-Run Evidence from the Closure of <i>The Cincinnati Post</i> 2011-04-07T00:00:00-06:00 Sam Schulhofer-Wohl Sam Schulhofer-Wohl Miguel Garrido Miguel Garrido 2011-04 Working Paper April 2011 http://www.minneapolisfed.org/publications_papers/pub_display.cfm?id=4643 2011-04-04T00:00:00-06:00 The neoclassical growth model is extended to include costly intermediated borrowing and lending between households. This is an important extension as substantial resources are used in intermediating the large amount of borrowing and lending between households. In 2007, in the United States, the amount intermediated was 1.7 times GNP, and the resources used in this intermediation amounted to at least 3.4 percent of GNP. The theory implies that financial intermediation services are an intermediate good and that the spread between borrowing and lending rates measures the efficiency of the financial sector. <br><br> This paper was previously published as Working Paper 655 and Staff Report 405 under the title "Intermediated Quantities and Returns." Costly Financial Intermediation in Neoclassical Growth Theory 2011-04-04T00:00:00-06:00 Edward C. Prescott Edward C. Prescott Rajnish Mehra Rajnish Mehra Facundo Piguillem Facundo Piguillem 2011-04 Working Paper April 2011