Quantifying the Forces Leading to the Collapse of GDP after the
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Quantifying the Forces Leading to the Collapse of GDP after the Financial Crisis Robert E. Hall Hoover Institution and Department of Economics Stanford University Structural and Cyclical Elements in Macroeconomics Federal Reserve Bank of San Francisco 16 March 2012 · 1
Transcript of Quantifying the Forces Leading to the Collapse of GDP after the
Quantifying the Forces Leading
to the Collapse of GDP after
the Financial Crisis
Robert E. HallHoover Institution and Department of Economics
Stanford University
Structural and Cyclical Elements in Macroeconomics
Federal Reserve Bank of San Francisco16 March 2012
·1
A key question today
Why does a decline in product demand raiseunemployment?
Moot in normal times because under a wide class ofobjective functions, the central bank will fully offset shiftsin product demand, leaving unemployment constant.
The exception occurs when the interest rate is pinned atthe zero lower bound.
In this setting, the real interest rate is minus the rate ofinflation.
·
2
A key question today
Why does a decline in product demand raiseunemployment?
Moot in normal times because under a wide class ofobjective functions, the central bank will fully offset shiftsin product demand, leaving unemployment constant.
The exception occurs when the interest rate is pinned atthe zero lower bound.
In this setting, the real interest rate is minus the rate ofinflation.
·
2
A key question today
Why does a decline in product demand raiseunemployment?
Moot in normal times because under a wide class ofobjective functions, the central bank will fully offset shiftsin product demand, leaving unemployment constant.
The exception occurs when the interest rate is pinned atthe zero lower bound.
In this setting, the real interest rate is minus the rate ofinflation.
·
2
A key question today
Why does a decline in product demand raiseunemployment?
Moot in normal times because under a wide class ofobjective functions, the central bank will fully offset shiftsin product demand, leaving unemployment constant.
The exception occurs when the interest rate is pinned atthe zero lower bound.
In this setting, the real interest rate is minus the rate ofinflation.
·
2
Response to shock with standard
DMP labor market
0 010
‐0.005
0.000
0.005
0.010
0.015
0.020Infla
tion
rate
‐0.025
‐0.020
‐0.015
‐0.010
0.00 0.02 0.04 0.06 0.08 0.10 0.12 0.14
Unemployment rate
Labor market Product market
3
Extended DMP model
Unemployment depends negatively on the rate of inflation.
Higher inflation raises employers’ incentives to recruit newworkers.
The rest of the talk is about the mechanism underlying thenegative dependence.
·
4
Extended DMP model
Unemployment depends negatively on the rate of inflation.
Higher inflation raises employers’ incentives to recruit newworkers.
The rest of the talk is about the mechanism underlying thenegative dependence.
·
4
Extended DMP model
Unemployment depends negatively on the rate of inflation.
Higher inflation raises employers’ incentives to recruit newworkers.
The rest of the talk is about the mechanism underlying thenegative dependence.
·
4
Equilibration with a Negative
Dependence of DMP
Unemployment on Inflation
2
3
4
5
6Infla
tion
rate
Product market
0
1
2
0 5 10 15
Unemployment rate
Labor market
5
Basic conclusion
If the DMP curve is steeper than the product-market curve,a drop in product demand raises inflation.
Evidence is reasonably conclusive that a drop in productdemand lowers inflation.
Thus, to explain the observation that inflation falls whenunemployment rises by introducing a dependence of DMPunemployment on the inflation rate, the DMP labor-marketcurve must be flatter than the product-market curve.
·
6
Basic conclusion
If the DMP curve is steeper than the product-market curve,a drop in product demand raises inflation.
Evidence is reasonably conclusive that a drop in productdemand lowers inflation.
Thus, to explain the observation that inflation falls whenunemployment rises by introducing a dependence of DMPunemployment on the inflation rate, the DMP labor-marketcurve must be flatter than the product-market curve.
·
6
Basic conclusion
If the DMP curve is steeper than the product-market curve,a drop in product demand raises inflation.
Evidence is reasonably conclusive that a drop in productdemand lowers inflation.
Thus, to explain the observation that inflation falls whenunemployment rises by introducing a dependence of DMPunemployment on the inflation rate, the DMP labor-marketcurve must be flatter than the product-market curve.
·
6
Getting inflation into the
wage-determination function
Walsh (2003): Sticky prices result in variations in marketpower, which enters the DMP model because higher marketpower lowers the revenue contribution of a worker.
This mechanism seems be falling out of favor in NewKeynesian thinking.
V. Ramey (2010) questions empirical evidence ofcountercyclical variations in markups.
·
7
Getting inflation into the
wage-determination function
Walsh (2003): Sticky prices result in variations in marketpower, which enters the DMP model because higher marketpower lowers the revenue contribution of a worker.
This mechanism seems be falling out of favor in NewKeynesian thinking.
V. Ramey (2010) questions empirical evidence ofcountercyclical variations in markups.
·
7
Getting inflation into the
wage-determination function
Walsh (2003): Sticky prices result in variations in marketpower, which enters the DMP model because higher marketpower lowers the revenue contribution of a worker.
This mechanism seems be falling out of favor in NewKeynesian thinking.
V. Ramey (2010) questions empirical evidence ofcountercyclical variations in markups.
·
7
Gertler-Sala-Trigari (2008)
based on Gertler-Trigari (2009)
Newly-hired workers inherit a nominal wage from mostrecent nominal bargain.
Inflation erodes the real wage and raises J , loweringunemployment.
Equilibrium sticky wage as in Hall (2005): J needs toremain in bargaining set between bargains, but this is not ahard condition to satisfy.
No departure from strict rationality.
·
8
Gertler-Sala-Trigari (2008)
based on Gertler-Trigari (2009)
Newly-hired workers inherit a nominal wage from mostrecent nominal bargain.
Inflation erodes the real wage and raises J , loweringunemployment.
Equilibrium sticky wage as in Hall (2005): J needs toremain in bargaining set between bargains, but this is not ahard condition to satisfy.
No departure from strict rationality.
·
8
Gertler-Sala-Trigari (2008)
based on Gertler-Trigari (2009)
Newly-hired workers inherit a nominal wage from mostrecent nominal bargain.
Inflation erodes the real wage and raises J , loweringunemployment.
Equilibrium sticky wage as in Hall (2005): J needs toremain in bargaining set between bargains, but this is not ahard condition to satisfy.
No departure from strict rationality.
·
8
Gertler-Sala-Trigari (2008)
based on Gertler-Trigari (2009)
Newly-hired workers inherit a nominal wage from mostrecent nominal bargain.
Inflation erodes the real wage and raises J , loweringunemployment.
Equilibrium sticky wage as in Hall (2005): J needs toremain in bargaining set between bargains, but this is not ahard condition to satisfy.
No departure from strict rationality.
·
8
The U.S. economy in October 2008
and October 2009, while at the
zero lower bound
1.8
2.0
2.2
2.4
2.6
2.8
3.0Infla
tion
rate
Product market
October 2008:
October 2009: Inflation 1.5%, Unemployment 10.1%
3.5 percentage point shift
1.0
1.2
1.4
1.6
0 5 10 15
Unemployment rate
Labor market
Inflation 1.9%, Unemployment 6.6%
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Inflation and Unemployment
after the Crisis
0.0
0.5
1.0
1.5
2.0
2.5
3.0
0 2 4 6 8 10 12
Infla
tion rate, p
ercent per year
Unemployment rate, percent
2008:4through 2011:4
2007:1through 2008:3
4.2 percentage point increase
0.63 percentage point decrease
10
The U.S. Economy in December
2007 and December 2009
1.8
2.0
2.2
2.4
2.6
2.8
3.0Infla
tion
rate
Product market
October 2008:
October 2009: Inflation 1.5%, Unemployment 10.1%
3.5 percentage point shift
1.0
1.2
1.4
1.6
0 5 10 15
Unemployment rate
Labor market
Inflation 1.9%, Unemployment 6.6%
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Two types of households
βP
(cP,t+1
cP,t
)−1/σ
(1 + rt) = 1
βI
(cI,t+1
cI,t
)−1/σ
(1 + rI,t) = 1
rI,t = rt + ρ[vt − bt]+
cI,t = wt−1nt−1 − (1 + rt−1)vt−1 −ρ
2
([vt−1 − bt−1]
+)2
+ vt.
·
12
Two types of households
βP
(cP,t+1
cP,t
)−1/σ
(1 + rt) = 1
βI
(cI,t+1
cI,t
)−1/σ
(1 + rI,t) = 1
rI,t = rt + ρ[vt − bt]+
cI,t = wt−1nt−1 − (1 + rt−1)vt−1 −ρ
2
([vt−1 − bt−1]
+)2
+ vt.
·
12
Two types of households
βP
(cP,t+1
cP,t
)−1/σ
(1 + rt) = 1
βI
(cI,t+1
cI,t
)−1/σ
(1 + rI,t) = 1
rI,t = rt + ρ[vt − bt]+
cI,t = wt−1nt−1 − (1 + rt−1)vt−1 −ρ
2
([vt−1 − bt−1]
+)2
+ vt.
·
12
Two types of households
βP
(cP,t+1
cP,t
)−1/σ
(1 + rt) = 1
βI
(cI,t+1
cI,t
)−1/σ
(1 + rI,t) = 1
rI,t = rt + ρ[vt − bt]+
cI,t = wt−1nt−1 − (1 + rt−1)vt−1 −ρ
2
([vt−1 − bt−1]
+)2
+ vt.
·
12
Financial friction
ft =1
qt
[αytkt
+ (1 − δ)qt+1
]− 1 − rt.
·
13
Borrowing by impatient
households
vt = (1 + rt−1)vt−1 +ρ
2
([vt − bt]
+)2 − wt−1nt−1 + cI,t.
bt = vt − xt
·
14
Borrowing by impatient
households
vt = (1 + rt−1)vt−1 +ρ
2
([vt − bt]
+)2 − wt−1nt−1 + cI,t.
bt = vt − xt
·
14
Taylor rule
rN,t = [τ0 + τππt − τuut]+
·
15
Investment/GDP Ratio and
Comprehensive Unemployment
Rate, 2005 to 2022
5
10
15
20
25
30
35
40
0
5
10
15
20
25
30
2005 2007 2009 2011 2013 2015 2017 2019 2021
Percen
t
Percen
t
Investment/GDP, left scale
Comprehensive unemployment rate, right scale
16
The Implied Values of the
Financial Friction
0
2
4
6
8
10
12
14
16
2009 2012 2015 2018 2021
Percen
t per year
17
Implied Values of the Tightening
of the Borrowing Constraint as
a Percent of Total Consumption
‐6
‐4
‐2
0
2
4
6
2009 2012 2015 2018 2021
Percen
t of p
er‐cap
ita con
sumption
18
Model Solution with Financial
Friction Only
0.00
0.05
0.10
0.15
0.20
0.25
2009 2011 2013 2015 2017 2019
Compreh
ensive une
mploymen
t rate
Actual and projected
Model solution with financial friction only
19
Burden of Deleveraging as a
Percent of Consumption
‐5
0
5
10nt of con
sumption
‐15
‐10
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Perce
20
