Understanding the Great Recession

Transcription

1 Understanding the Great Recession Lawrence Christiano Martin Eichenbaum Mathias Trabandt Ortigia June 214.

2 Background

3 Background GDP appears to have suffered a permanent (1%?) fall since 28.

4 Background GDP appears to have suffered a permanent (1%?) fall since 28. Trend decline in labor force participation accelerated after the end of the recession in 29.

5 Background GDP appears to have suffered a permanent (1%?) fall since 28. Trend decline in labor force participation accelerated after the end of the recession in 29. Unemployment rate persistently high recent fall primarily reflects the fall in labor force participation.

6 Background GDP appears to have suffered a permanent (1%?) fall since 28. Trend decline in labor force participation accelerated after the end of the recession in 29. Unemployment rate persistently high recent fall primarily reflects the fall in labor force participation. Employment to population ratio fell sharply with little evidence of recovery.

7 Background GDP appears to have suffered a permanent (1%?) fall since 28. Trend decline in labor force participation accelerated after the end of the recession in 29. Unemployment rate persistently high recent fall primarily reflects the fall in labor force participation. Employment to population ratio fell sharply with little evidence of recovery. Vacancies have risen, but unemployment has fallen relatively little ( shift in Beveridge curve, mismatch ).

8 Background GDP appears to have suffered a permanent (1%?) fall since 28. Trend decline in labor force participation accelerated after the end of the recession in 29. Unemployment rate persistently high recent fall primarily reflects the fall in labor force participation. Employment to population ratio fell sharply with little evidence of recovery. Vacancies have risen, but unemployment has fallen relatively little ( shift in Beveridge curve, mismatch ). Investment and consumption persistently low.

9 Questions What were the key forces driving U.S. economy during the Great Recession?

10 Questions What were the key forces driving U.S. economy during the Great Recession? Mismatch in the labor market?

11 Questions What were the key forces driving U.S. economy during the Great Recession? Mismatch in the labor market? Why was the drop in inflation so moderate?

12 To answer our questions we need a model Model must provide empirically plausible account of key macroeconomic aggregates employment, vacancies, LFPR, job finding rate, unemployment rate, real wages output, consumption, investment,..

13 To answer our questions we need a model Model must provide empirically plausible account of key macroeconomic aggregates employment, vacancies, LFPR, job finding rate, unemployment rate, real wages output, consumption, investment,.. Novel features of labor market Endogenize labor force participation. Derive wage inertia as an equilibrium outcome.

14 To answer our questions we need a model Model must provide empirically plausible account of key macroeconomic aggregates employment, vacancies, LFPR, job finding rate, unemployment rate, real wages output, consumption, investment,.. Novel features of labor market Endogenize labor force participation. Derive wage inertia as an equilibrium outcome. Estimate model using pre-28 data. Use estimated model to analyze post-28 data.

15 Questions and Answers What forces drove real quantities in the Great Recession? Shocks to financial markets were the key drivers, even for variables like labor force participation.

16 Questions and Answers What forces drove real quantities in the Great Recession? Shocks to financial markets were the key drivers, even for variables like labor force participation. Consumption wedge perturbation to agents intertemporal Euler equation that makes them want to accumulate the risk-free asset.

17 Questions and Answers What forces drove real quantities in the Great Recession? Shocks to financial markets were the key drivers, even for variables like labor force participation. Consumption wedge perturbation to agents intertemporal Euler equation that makes them want to accumulate the risk-free asset. Financial wedge motivated by sharp increase in credit spreads observed in post-28 period. perturbation to households first order condition for optimal capital accumulation.

18 Questions and Answers Mismatch in the labor market?

19 Questions and Answers Mismatch in the labor market? Not a first order feature of the Great Recession.

20 Questions and Answers Mismatch in the labor market? Not a first order feature of the Great Recession. We account for shift in the Beveridge curve, without resorting to structural shifts in the labor market.

21 Questions and Answers Mismatch in the labor market? Not a first order feature of the Great Recession. We account for shift in the Beveridge curve, without resorting to structural shifts in the labor market. Rise in government consumption associated with ARRA had peak multiplier effect in excess of 2.

22 Questions and Answers Mismatch in the labor market? Not a first order feature of the Great Recession. We account for shift in the Beveridge curve, without resorting to structural shifts in the labor market. Rise in government consumption associated with ARRA had peak multiplier effect in excess of 2. But overall effect was small because of size and timing of spending.

23 Questions and Answers Why was the drop in inflation so moderate?

24 Questions and Answers Why was the drop in inflation so moderate? Prolonged slowdown in TFP growth during the Great Recession.

25 Questions and Answers Why was the drop in inflation so moderate? Prolonged slowdown in TFP growth during the Great Recession. Rise in cost of firms working capital as measured by spread between corporate-borrowing rate, risk-free interest rate.

26 Labor Market

27 Labor Market Employment* E* Unemployment* U* Non,par/cipa/on* N*

28 Labor Market ~C t = E 1 X t= t U( ~ C t ); h (1!!)(C t ) " +! " C H t # " i 1! Employment E Unemployment U Non- par/cipa/on N - Household labor force decision - Split between U and E determined by job- finding rate.

29 Labor Market E 1 X t= t U( ~ C t ); h ~C t = (1!!)(C t ) " +! " Ct H # " i 1 h " # i!! C H t = (1! L t ) 1!$c (L t! l t ) $c Employment E Unemployment U Non- par/cipa/on N - Household labor force decision - Split between U and E determined by job- finding rate.

30 h " # Labor Market! max fct;lt;c H t ;Bt+1;Kt+1;It;ltg1 t= h " # i E 1 X t= P t C t + P I;t I t + B t+1 t U( ~ C t ); Employment E " R K;t K t +(L t! l t ) P t D t + l t W t + R t!1 B t! T t K t+1 =(1% A K ) K t + [1 % S (I t =I t!1 )] I t : Unemployment U Non- par/cipa/on N - Household labor force decision - Split between U and E determined by job- finding rate.

31 Labor Market Employment* E* Unemployment* U* Non,par/cipa/on* N* Bargaining* Three*types*of*worker,firm*mee/ngs:* *i)*e*to*e*,*ii)*u*to*e,*iii)*n*to*e**

32 Modified version of Hall-Milgrom

33 Modified version of Hall-Milgrom Firms pay a fixed cost to meet a worker (must post vacancies, but these are costless).

34 Modified version of Hall-Milgrom Firms pay a fixed cost to meet a worker (must post vacancies, but these are costless). Then, workers and firms engage in alternating-offer bargaining. Better off reaching agreement than parting ways. Disagreement leads to continued negotiations.

35 Modified version of Hall-Milgrom Firms pay a fixed cost to meet a worker (must post vacancies, but these are costless). Then, workers and firms engage in alternating-offer bargaining. Better off reaching agreement than parting ways. Disagreement leads to continued negotiations. If bargaining costs don t depend too sensitively on state of economy, neither will wages.

36 Modified version of Hall-Milgrom Firms pay a fixed cost to meet a worker (must post vacancies, but these are costless). Then, workers and firms engage in alternating-offer bargaining. Better off reaching agreement than parting ways. Disagreement leads to continued negotiations. If bargaining costs don t depend too sensitively on state of economy, neither will wages. firms suffer cost, γ, when they reject an offer by the worker and make a counteroffer.

37 Modified version of Hall-Milgrom Firms pay a fixed cost to meet a worker (must post vacancies, but these are costless). Then, workers and firms engage in alternating-offer bargaining. Better off reaching agreement than parting ways. Disagreement leads to continued negotiations. If bargaining costs don t depend too sensitively on state of economy, neither will wages. firms suffer cost, γ, when they reject an offer by the worker and make a counteroffer. costs somewhat sensitive to state of business cycle:

38 Modified version of Hall-Milgrom Firms pay a fixed cost to meet a worker (must post vacancies, but these are costless). Then, workers and firms engage in alternating-offer bargaining. Better off reaching agreement than parting ways. Disagreement leads to continued negotiations. If bargaining costs don t depend too sensitively on state of economy, neither will wages. firms suffer cost, γ, when they reject an offer by the worker and make a counteroffer. costs somewhat sensitive to state of business cycle: protracted negotiations mean lost output/wages.

39 Modified version of Hall-Milgrom Firms pay a fixed cost to meet a worker (must post vacancies, but these are costless). Then, workers and firms engage in alternating-offer bargaining. Better off reaching agreement than parting ways. Disagreement leads to continued negotiations. If bargaining costs don t depend too sensitively on state of economy, neither will wages. firms suffer cost, γ, when they reject an offer by the worker and make a counteroffer. costs somewhat sensitive to state of business cycle: protracted negotiations mean lost output/wages. rejection of an offer risks, with probability δ, that negotiations break down completely.

40 Modified version of Hall-Milgrom Firms pay a fixed cost to meet a worker (must post vacancies, but these are costless). Then, workers and firms engage in alternating-offer bargaining. Better off reaching agreement than parting ways. Disagreement leads to continued negotiations. If bargaining costs don t depend too sensitively on state of economy, neither will wages. firms suffer cost, γ, when they reject an offer by the worker and make a counteroffer. costs somewhat sensitive to state of business cycle: protracted negotiations mean lost output/wages. rejection of an offer risks, with probability δ, that negotiations break down completely. After expansionary shock, rise in wages is relatively small.

41 Value functions for Workers and Firms Worker value functions: V t = w t + E t m t+1 [ρv t+1 + (1 ρ) s (f t+1 V t+1 + (1 f t+1 ) U t+1 ) + (1 ρ) (1 s) N t+1 ].

42 Value functions for Workers and Firms Worker value functions: V t = w t + E t m t+1 [ρv t+1 + (1 ρ) s (f t+1 V t+1 + (1 f t+1 ) U t+1 ) + (1 ρ) (1 s) N t+1 ]. U t = D + E t m t+1 [sf t+1 V t+1 +s (1 f t+1 ) U t+1 + (1 s) N t+1 ]

43 Value functions for Workers and Firms Worker value functions: V t = w t + E t m t+1 [ρv t+1 + (1 ρ) s (f t+1 V t+1 + (1 f t+1 ) U t+1 ) + (1 ρ) (1 s) N t+1 ]. U t = D + E t m t+1 [sf t+1 V t+1 +s (1 f t+1 ) U t+1 + (1 s) N t+1 ] N t = E t m t+1 [e t+1 (f t+1 V t+1 + (1 f t+1 )U t+1 ) + (1 e t+1 ) N t+1 ]

44 Value functions for Workers and Firms Worker value functions: V t = w t + E t m t+1 [ρv t+1 + (1 ρ) s (f t+1 V t+1 + (1 f t+1 ) U t+1 ) + (1 ρ) (1 s) N t+1 ]. U t = D + E t m t+1 [sf t+1 V t+1 +s (1 f t+1 ) U t+1 + (1 s) N t+1 ] N t = E t m t+1 [e t+1 (f t+1 V t+1 + (1 f t+1 )U t+1 ) + (1 e t+1 ) N t+1 ] Value of a match: J t = ϑ t w t + βe t m t+1 J t+1

45 Rest of Model: Medium-Sized DSGE Competitive final goods production: Y t = 1 Y f 1 λ f λ j,t dj.

46 Rest of Model: Medium-Sized DSGE Competitive final goods production: Y t = 1 Y f 1 λ f λ j,t dj.

47 Rest of Model: Medium-Sized DSGE Competitive final goods production: Y t = 1 Y f 1 λ f λ j,t dj.

48 Rest of Model: Medium-Sized DSGE Competitive final goods production: Y t = j th input produced by monopolist: Production: Y j,t = kj,t α ( ) 1 α zt h j,t φ. 1 Y f 1 λ f λ j,t dj.

49 Rest of Model: Medium-Sized DSGE Competitive final goods production: Y t = j th input produced by monopolist: Production: Y j,t = kj,t α ( ) 1 α zt h j,t φ. 1 Y f 1 λ f λ j,t dj.

50 Rest of Model: Medium-Sized DSGE Competitive final goods production: Y t = j th input produced by monopolist: Production: Y j,t = kj,t α ( ) 1 α zt h j,t φ. 1 Y f 1 λ f λ j,t dj.

51 Rest of Model: Medium-Sized DSGE Competitive final goods production: Y t = j th input produced by monopolist: Production: Y j,t = k α j,t ( zt h j,t ) 1 α φ. Homogeneous good, h j,t, purchased in competitive markets for real price, ϑ t. 1 Y f 1 λ f λ j,t dj.

52 Rest of Model: Medium-Sized DSGE Competitive final goods production: Y t = j th input produced by monopolist: Production: Y j,t = k α j,t ( zt h j,t ) 1 α φ. Homogeneous good, h j,t, purchased in competitive markets for real price, ϑ t. 1 Y f 1 λ f λ j,t dj.

53 Rest of Model: Medium-Sized DSGE Competitive final goods production: Y t = j th input produced by monopolist: 1 Y f 1 λ f λ j,t dj. Production: Y j,t = k α j,t ( zt h j,t ) 1 α φ. Homogeneous good, h j,t, purchased in competitive markets for real price, ϑ t. Retailers prices subject to Calvo sticky price frictions (no price indexation). Homogeneous input good h t produced by the firms in our labor market model.

54 Rest of Model: Medium-Sized DSGE Competitive final goods production: Y t = j th input produced by monopolist: 1 Y f 1 λ f λ j,t dj. Production: Y j,t = k α j,t ( zt h j,t ) 1 α φ. Homogeneous good, h j,t, purchased in competitive markets for real price, ϑ t. Retailers prices subject to Calvo sticky price frictions (no price indexation). Homogeneous input good h t produced by the firms in our labor market model. Taylor rule.

55 Estimated Parameters, Pre-28 Data

56 Estimated Parameters, Pre-28 Data Estimation by impulse response matching, Bayesian methods.

57 Estimated Parameters, Pre-28 Data Estimation by impulse response matching, Bayesian methods. Prices change on average every 4 quarters.

58 Estimated Parameters, Pre-28 Data Estimation by impulse response matching, Bayesian methods. Prices change on average every 4 quarters. δ : roughly.1% chance of a breakup after rejection.

59 Estimated Parameters, Pre-28 Data Estimation by impulse response matching, Bayesian methods. Prices change on average every 4 quarters. δ : roughly.1% chance of a breakup after rejection. γ : cost to firm of preparing counteroffer roughly 1 day s production.

60 Estimated Parameters, Pre-28 Data Estimation by impulse response matching, Bayesian methods. Prices change on average every 4 quarters. δ : roughly.1% chance of a breakup after rejection. γ : cost to firm of preparing counteroffer roughly 1 day s production. Posterior mode of hiring cost:.49% of GDP; replacement ratio: 17% of wage.

61 Estimated Parameters, Pre-28 Data Estimation by impulse response matching, Bayesian methods. Prices change on average every 4 quarters. δ : roughly.1% chance of a breakup after rejection. γ : cost to firm of preparing counteroffer roughly 1 day s production. Posterior mode of hiring cost:.49% of GDP; replacement ratio: 17% of wage. Elasticity of substitution between home and market goods: 3. set a priori, see Aguiar-Hurst-Karabarbounis (212).

62 Accounting for the Great Recession Use model to assess which shocks account for gap between: What actually happened. What would have happened in absence of the shocks.

63 The Figure U.S. 6: The Great Recession Recession in the U.S. Log Real GDP Inflation (%, y o y) Federal Funds Rate (%) Unemployment Rate (%) Employment/Population (%) Labor Force/Population (%) Log Real Investment Log Real Consumption Log Real Wage Log Vacancies Job Finding Rate (%) G Z Corporate Spread (%) Log TFP Log Gov. Cons.+Invest. Data 28Q Notes: Gray areas indicate NBER recession dates

64 The Figure U.S. 6: The Great Recession Recession in the U.S. Log Real GDP Inflation (%, y o y) Federal Funds Rate (%) Unemployment Rate (%) Employment/Population (%) Labor Force/Population (%) Log Real Investment Log Real Consumption Log Real Wage Log Vacancies Job Finding Rate (%) G Z Corporate Spread (%) Log TFP Log Gov. Cons.+Invest. Data 28Q2 Linear Trend from 21Q1 to 28Q Notes: Gray areas indicate NBER recession dates

65 The Figure U.S. 6: The Great Recession Recession in the U.S. Log Real GDP Inflation (%, y o y) Federal Funds Rate (%) Unemployment Rate (%) Employment/Population (%) Labor Force/Population (%) Log Real Investment Log Real Consumption Log Real Wage Log Vacancies Job Finding Rate (%) G Z Corporate Spread (%) Log TFP Log Gov. Cons.+Invest. Data 28Q2 Linear Trend from 21Q1 to 28Q2 Forecast 28Q3 and beyond Notes: Gray areas indicate NBER recession dates

66 The U.S. Great Recession: Data Targets Figure 7: The U.S. Great Recession: Data vs. Model 5 GDP (%) Data Employment (p.p.) Real Wage (%) Inflation (p.p., y o y) Labor Force (p.p.) Vacancies (%) Federal Funds Rate (ann. p.p.) Investment (%) Job Finding Rate (p.p.) Unemployment Rate (p.p.) Consumption (%) G Z Corp. Bond Spread (ann. p.p.) TFP Level (%) Gov. Cons. & Invest. (%, exog.)

67 Two Financial Market Shocks 1 Consumption wedge, b t : Shock to demand for safe assets ( Flight to Quality Shock, see e.g. Fisher 214): 1 = (1 + b t )E t m t+1 R t /π t+1

68 Two Financial Market Shocks 1 Consumption wedge, b t : Shock to demand for safe assets ( Flight to Quality Shock, see e.g. Fisher 214): 1 = (1 + b t )E t m t+1 R t /π t+1 2 Financial wedge, k t : Reduced form of risk shock, Christiano-Davis (26), Christiano-Motto-Rostagno (214): 1 = (1 k t )E t m t+1 R k t+1 /π t+1

69 Two Financial Market Shocks 1 Consumption wedge, b t : Shock to demand for safe assets ( Flight to Quality Shock, see e.g. Fisher 214): 1 = (1 + b t )E t m t+1 R t /π t+1 2 Financial wedge, k t : Reduced form of risk shock, Christiano-Davis (26), Christiano-Motto-Rostagno (214): 1 = (1 k t )E t m t+1 R k t+1 /π t+1

70 Two Financial Market Shocks 1 Consumption wedge, b t : Shock to demand for safe assets ( Flight to Quality Shock, see e.g. Fisher 214): 1 = (1 + b t )E t m t+1 R t /π t+1 2 Financial wedge, k t : Reduced form of risk shock, Christiano-Davis (26), Christiano-Motto-Rostagno (214): 1 = (1 k t )E t m t+1 R k t+1 /π t+1 Financial wedge also applies to working capital loans: Interest charge on working capital: R t ( 1 + k t ) Assume 1/2 of labor inputs financed with loans. Higher financial wedge directly increases cost to firms.

71 Measurement of Shocks 1 Financial wedge, 1 k t, measured using GZ spread data.

72 Measurement of Shocks 1 Financial wedge, 1 k t, measured using GZ spread data. 2 Government shock measured using G data.

73 Measurement of Shocks 1 Financial wedge, 1 k t, measured using GZ spread data. 2 Government shock measured using G data. 3 Neutral technology shock based on TFP data.

74 Measurement of Shocks 1 Financial wedge, 1 k t, measured using GZ spread data. 2 Government shock measured using G data. 3 Neutral technology shock based on TFP data. 4 We don t have data on the consumption wedge, b t. - In 28Q3, agents expect b t to jump from to.33% until 213Q2. - In 212Q3 agents revise expectation and expect b t to remain up until 214Q3 (stand-in for fiscal cliff, sequester).

75 Measurement of Shocks 1 Financial wedge, 1 k t, measured using GZ spread data. 2 Government shock measured using G data. 3 Neutral technology shock based on TFP data. 4 We don t have data on the consumption wedge, b t. - In 28Q3, agents expect b t to jump from to.33% until 213Q2. - In 212Q3 agents revise expectation and expect b t to remain up until 214Q3 (stand-in for fiscal cliff, sequester). Stochastic simulation starting 28q3 (nonlinear model, no perfect foresight).

76 Exogenous Processes Figure 7: The U.S. Great Recession: Exogenous Variables G Z Corporate Bond Spread (annualized p.p.) Gov. Consumption & Investment (%) 5 4 Data Model 2 2 Data Model Neutral Technology Level (%) 1.5 Consumption Wedge (annualized p.p.) Initial path from 28Q3 Revised path from 212Q

77 Assessing model s implication for TFP

78 Monetary Policy in the Great Recession From 28Q3 to 211Q2: Taylor-type feedback rule subject to the ZLB.

79 Monetary Policy in the Great Recession From 28Q3 to 211Q2: Taylor-type feedback rule subject to the ZLB. Policy from 211Q3-212Q4: Date-based forward guidance Keep funds rate at zero for next 8 quarters.

80 Monetary Policy in the Great Recession From 28Q3 to 211Q2: Taylor-type feedback rule subject to the ZLB. Policy from 211Q3-212Q4: Date-based forward guidance Keep funds rate at zero for next 8 quarters. Policy from 213Q1: keep funds rate at zero until either unemployment falls below 6.5% or inflation rises above 2.5%.

81 The U.S. Great Recession: Data vs. Model Figure 7: The U.S. Great Recession: Data vs. Model 5 GDP (%) Data Employment (p.p.) Real Wage (%) Inflation (p.p., y o y) Labor Force (p.p.) Vacancies (%) Federal Funds Rate (ann. p.p.) Investment (%) Job Finding Rate (p.p.) Unemployment Rate (p.p.) Consumption (%) G Z Corp. Bond Spread (ann. p.p.) TFP Level (%) Gov. Cons. & Invest. (%, exog.)

82 The U.S. Great Recession: Data vs. Model Figure 7: The U.S. Great Recession: Data vs. Model 5 GDP (%) Data Model Employment (p.p.) Real Wage (%) Inflation (p.p., y o y) Labor Force (p.p.) Vacancies (%) Federal Funds Rate (ann. p.p.) Investment (%) Job Finding Rate (p.p.) Unemployment Rate (p.p.) Consumption (%) G Z Corp. Bond Spread (ann. p.p.) TFP Level (%) Gov. Cons. & Invest. (%, exog.)

83 Decomposing What Happened into Shocks Our shocks roughly reproduce the actual data.

84 Decomposing What Happened into Shocks Our shocks roughly reproduce the actual data. We investigate the effect of a shock by shutting it off. Resulting decomposition is not additive because of nonlinearity.

85 Decomposing What Happened into Shocks Our shocks roughly reproduce the actual data. We investigate the effect of a shock by shutting it off. Resulting decomposition is not additive because of nonlinearity. Results: Financial wedge shock - accounts for the biggest effect on real quantitites.

86 Decomposing What Happened into Shocks Our shocks roughly reproduce the actual data. We investigate the effect of a shock by shutting it off. Resulting decomposition is not additive because of nonlinearity. Results: Financial wedge shock - accounts for the biggest effect on real quantitites. Flight to quality shock - drives economy into lower bound, pushes down inflation.

87 Decomposing What Happened into Shocks Our shocks roughly reproduce the actual data. We investigate the effect of a shock by shutting it off. Resulting decomposition is not additive because of nonlinearity. Results: Financial wedge shock - accounts for the biggest effect on real quantitites. Flight to quality shock - drives economy into lower bound, pushes down inflation. Government spending shock - relatively small role.

88 Decomposing What Happened into Shocks Our shocks roughly reproduce the actual data. We investigate the effect of a shock by shutting it off. Resulting decomposition is not additive because of nonlinearity. Results: Financial wedge shock - accounts for the biggest effect on real quantitites. Flight to quality shock - drives economy into lower bound, pushes down inflation. Government spending shock - relatively small role. TFP shock - plays an important role in preventing drop in inflation.

89 Decomposing What Happened into Shocks Our shocks roughly reproduce the actual data. We investigate the effect of a shock by shutting it off. Resulting decomposition is not additive because of nonlinearity. Results: Financial wedge shock - accounts for the biggest effect on real quantitites. Flight to quality shock - drives economy into lower bound, pushes down inflation. Government spending shock - relatively small role. TFP shock - plays an important role in preventing drop in inflation.

90 Phillips Curve Widespread skepticism that NK model can account for modest decline in inflation during the Great Recession.

91 Phillips Curve Widespread skepticism that NK model can account for modest decline in inflation during the Great Recession. One response: Phillips curve got flat or always was very flat (e.g. Christiano, Eichenbaum and Rebelo, 211).

92 Phillips Curve Widespread skepticism that NK model can account for modest decline in inflation during the Great Recession. One response: Phillips curve got flat or always was very flat (e.g. Christiano, Eichenbaum and Rebelo, 211). Alternative: standard Phillips curve misses sharp rise in costs Unusually high cost of credit to finance working capital. Fall in TFP. Both raise countervailing pressure on inflation.

93 Decomposition for Inflation

94 Beveridge Curve Much attention focused on sharp rise in vacancies and relatively small fall in unemployment Claim that fish hook shape is evidence of shift in matching function. This claim is based on assumption (a really bad one now!) that unemployment is at steady state.

95 Beveridge Curve Much attention focused on sharp rise in vacancies and relatively small fall in unemployment Claim that fish hook shape is evidence of shift in matching function. This claim is based on assumption (a really bad one now!) that unemployment is at steady state. In our model, no shift occurs in the matching technology. if anything, our model predicts an even bigger shift than occured.

96 The Beveridge Curve: Data vs. Model Vacancies (log dev. from data trend or model steady state) Q3 Figure 15: Beveridge Curve: Data vs. Model 213Q2 211Q4 29Q1 21Q3 29Q4 Data Model Unemployment Rate (p.p. dev. from 28Q2 data or model steady state)

97 Model Predicts Fish Hook, Why? Simplest DMP style model U t+1 U t = (1 ρ)(1 U t ) f t U t

98 Model Predicts Fish Hook, Why? Simplest DMP style model solving for f t : U t+1 U t = (1 ρ)(1 U t ) f t U t f t = (1 ρ) (1 U t) U t U t+1 U t U t

99 Model Predicts Fish Hook, Why? Simplest DMP style model solving for f t : U t+1 U t = (1 ρ)(1 U t ) f t U t f t = (1 ρ) (1 U t) U t U matching function t+1 U t {}}{ = σ t ( V t ) α U t U t

100 Model Predicts Fish Hook, Why? Simplest DMP style model solving for f t : U t+1 U t = (1 ρ)(1 U t ) f t U t f t = (1 ρ) (1 U t) U t solving for V t : V t = (1 ρ)(1 U t) σ t U 1 α t U matching function t+1 U t {}}{ = σ t ( V t ) α U t U t standard approximation sets this to zero {}}{ U t+1 U t σ t U 1 α t 1/α Naturally implies a fish hook pattern.

101 Magnitude of Fish Hook in DMP Model U.S. Beveridge Curve 4 Jan 21 JOLTS Data (Dec 2 Jan 214) Stylized Model, Steady State Condition U= Imposed Stylized Model, Steady State Condition Not Imposed 3.5 Vacancy Rate, V, (%) Jan 214 Sept Unemployment Rate, U, (%) (ρ =.97, α =.6, σ =.84, monthly)

102 Conclusion Bulk of movements in economic activity during the Great Recession due to financial frictions interacting with the ZLB. ZLB has caused negative spending shocks to push the economy into a prolonged recession.

103 Conclusion Bulk of movements in economic activity during the Great Recession due to financial frictions interacting with the ZLB. ZLB has caused negative spending shocks to push the economy into a prolonged recession. Findings based on looking through lens of a NK model: firms face moderate degrees of price rigidities, no sticky wages.

104 Conclusion Bulk of movements in economic activity during the Great Recession due to financial frictions interacting with the ZLB. ZLB has caused negative spending shocks to push the economy into a prolonged recession. Findings based on looking through lens of a NK model: firms face moderate degrees of price rigidities, no sticky wages. No (or little) evidence for mismatch in labor market.

105 Conclusion Bulk of movements in economic activity during the Great Recession due to financial frictions interacting with the ZLB. ZLB has caused negative spending shocks to push the economy into a prolonged recession. Findings based on looking through lens of a NK model: firms face moderate degrees of price rigidities, no sticky wages. No (or little) evidence for mismatch in labor market. Modest fall in inflation is not a puzzle once fall in TFP and risky working capital channel are taken into account.

106

107 Background

108 Background GDP appears to have suffered a permanent fall since 28.

109 Background GDP appears to have suffered a permanent fall since 28. Trend decline in labor force participation accelerated after the end of the recession in 29.

110 Background GDP appears to have suffered a permanent fall since 28. Trend decline in labor force participation accelerated after the end of the recession in 29. Unemployment rate persistently high recent fall primarily reflects the fall in labor force participation.

111 Background GDP appears to have suffered a permanent fall since 28. Trend decline in labor force participation accelerated after the end of the recession in 29. Unemployment rate persistently high recent fall primarily reflects the fall in labor force participation. Employment rate fell sharply with little evidence of recovery.

112 Background GDP appears to have suffered a permanent fall since 28. Trend decline in labor force participation accelerated after the end of the recession in 29. Unemployment rate persistently high recent fall primarily reflects the fall in labor force participation. Employment rate fell sharply with little evidence of recovery. Vacancies have risen, but unemployment has fallen relatively little ( shift in Beveridge curve, mismatch ).

113 Background GDP appears to have suffered a permanent fall since 28. Trend decline in labor force participation accelerated after the end of the recession in 29. Unemployment rate persistently high recent fall primarily reflects the fall in labor force participation. Employment rate fell sharply with little evidence of recovery. Vacancies have risen, but unemployment has fallen relatively little ( shift in Beveridge curve, mismatch ). Investment and consumption persistently low.

114 What Sort of Model do we Need?

115 What Sort of Model do we Need? The labor market is a big part of the puzzle.

116 What Sort of Model do we Need? The labor market is a big part of the puzzle. need a model with endogenous labor force participation, unemployment, vacancies, etc.

117 What Sort of Model do we Need? The labor market is a big part of the puzzle. need a model with endogenous labor force participation, unemployment, vacancies, etc. Need investment and capital.

118 What Sort of Model do we Need? The labor market is a big part of the puzzle. need a model with endogenous labor force participation, unemployment, vacancies, etc. Need investment and capital. Incorporate price-setting frictions. Hard to get a big recession out of deleveraging and financial market frictions if market prices move effi ciently.

119 What Sort of Model do we Need? The labor market is a big part of the puzzle. need a model with endogenous labor force participation, unemployment, vacancies, etc. Need investment and capital. Incorporate price-setting frictions. Hard to get a big recession out of deleveraging and financial market frictions if market prices move effi ciently. We stress interaction of shocks with zero lower bound (ZLB). Hard to get ZLB to matter in a model with flexible prices.

120 What Sort of Model do we Need? The labor market is a big part of the puzzle. need a model with endogenous labor force participation, unemployment, vacancies, etc. Need investment and capital. Incorporate price-setting frictions. Hard to get a big recession out of deleveraging and financial market frictions if market prices move effi ciently. We stress interaction of shocks with zero lower bound (ZLB). Hard to get ZLB to matter in a model with flexible prices. Work with a modified New Keynesian DSGE model. Forces are captured in the form of wedges. That is, we avoid microfounding the shocks.

121 Outline

122 Outline Mostly, a standard medium-sized DSGE model

123 Outline Mostly, a standard medium-sized DSGE model Must adapt the labor market side of the model:

124 Outline Mostly, a standard medium-sized DSGE model Must adapt the labor market side of the model: adopt DMP-style matching and bargaining.

125 Outline Mostly, a standard medium-sized DSGE model Must adapt the labor market side of the model: adopt DMP-style matching and bargaining. to account for observed labor market volatility,

126 Outline Mostly, a standard medium-sized DSGE model Must adapt the labor market side of the model: adopt DMP-style matching and bargaining. to account for observed labor market volatility, environment must be characterized by wage inertia.

127 Outline Mostly, a standard medium-sized DSGE model Must adapt the labor market side of the model: adopt DMP-style matching and bargaining. to account for observed labor market volatility, environment must be characterized by wage inertia. adopt alternating offer bargaining as described in Christiano-Eichenbaum-Trabandt 213 (build on Hall-Milgrom).

128 Outline Mostly, a standard medium-sized DSGE model Must adapt the labor market side of the model: adopt DMP-style matching and bargaining. to account for observed labor market volatility, environment must be characterized by wage inertia. adopt alternating offer bargaining as described in Christiano-Eichenbaum-Trabandt 213 (build on Hall-Milgrom). no need to make wages exogenously sticky.

129 Outline Mostly, a standard medium-sized DSGE model Must adapt the labor market side of the model: adopt DMP-style matching and bargaining. to account for observed labor market volatility, environment must be characterized by wage inertia. adopt alternating offer bargaining as described in Christiano-Eichenbaum-Trabandt 213 (build on Hall-Milgrom). no need to make wages exogenously sticky. Estimate model using pre-28 data.

130 Outline Mostly, a standard medium-sized DSGE model Must adapt the labor market side of the model: adopt DMP-style matching and bargaining. to account for observed labor market volatility, environment must be characterized by wage inertia. adopt alternating offer bargaining as described in Christiano-Eichenbaum-Trabandt 213 (build on Hall-Milgrom). no need to make wages exogenously sticky. Estimate model using pre-28 data. Use estimated model to analyze post-28 data.

131 The Effect of Neutral Technology Figure 8: The U.S. Great Recession: Effects of Neutral Technology GDP (%) Baseline Model No Neutral Tech Employment (p.p.) Inflation (p.p., y o y) Labor Force (p.p.) Federal Funds Rate (ann. p.p.) Investment (%) Unemployment Rate (p.p.) Consumption (%) Real Wage (%) Vacancies (%) Job Finding Rate (p.p.) G Z Corp. Bond Spread (ann. p.p.) TFP Level (%) Gov. Cons. & Invest. (%, exog.) Fin. Wedge (quart. p.p., exog.) Cons. Wedge (quart. p.p., exog.)

132 The Effect of Consumption Wedge Figure 11: The U.S. Great Recession: Effects of Consumption Wedge 5 GDP (%) Baseline Model No Cons. Wedge Employment (p.p.) Inflation (p.p., y o y) Labor Force (p.p.) 4 2 Federal Funds Rate (ann. p.p.) Investment (%) Unemployment Rate (p.p.) Consumption (%) Real Wage (%) Vacancies (%) Job Finding Rate (p.p.) G Z Corp. Bond Spread (ann. p.p.) TFP Level (%) Gov. Cons. & Invest. (%, exog.) Fin. Wedge (quart. p.p., exog.) Cons. Wedge (quart. p.p., exog.)

133 The Effect of Forward Guidance Figure 13: The U.S. Great Recession: Effects of Forward Guidance 5 1 GDP (%) Baseline Model No Forward Guidance Employment (p.p.) Inflation (p.p., y o y) Labor Force (p.p.) Federal Funds Rate (ann. p.p.) Investment (%) Unemployment Rate (p.p.) Consumption (%) Real Wage (%) Vacancies (%) Job Finding Rate (p.p.) G Z Corp. Bond Spread (ann. p.p.) TFP Level (%) Gov. Cons. & Invest. (%, exog.) Fin. Wedge (quart. p.p., exog.) Cons. Wedge (quart. p.p., exog.)

134 The Effect of 212Q3 Consumption Wedge Figure 14: The U.S. Great Recession: Effects of 212Q3 Consumption Wedge Shock 5 GDP (%) Baseline Model No 212Q3 Cons. Wedge Employment (p.p.) Inflation (p.p., y o y) Labor Force (p.p.) Federal Funds Rate (ann. p.p.) Investment (%) Unemployment Rate (p.p.) Consumption (%) Real Wage (%) Vacancies (%) Job Finding Rate (p.p.) G Z Corp. Bond Spread (ann. p.p.) TFP Level (%) Gov. Cons. & Invest. (%, exog.) Fin. Wedge (quart. p.p., exog.) Cons. Wedge (quart. p.p., exog.)

135 The Government Consumption Multiplier Figure 16: Fiscal Multiplier in a 3 Year Zero Lower Bound Episode Government Consumption (% of steady state GDP) Year Fiscal Stimulus 6 Year Fiscal Stimulus Years 2.5 GDP (% dev. from steady state) Multiplier Year Fiscal Stimulus 6 Year Fiscal Stimulus Years Notes: Stimulus lasts for 3 or 6 years with AR(1)=.6 thereafter. 3 years constant nominal interest rate. Perfect foresight.

136 Gilchrist-Zakrajšek Corporate Spread Percent

137 The Effect of Government Consumption Figure 12: The U.S. Great Recession: Effects of Government Consumption and Investment 5 1 GDP (%) Baseline Model No Gov. Cons Employment (p.p.) Inflation (p.p., y o y) Labor Force (p.p.) Federal Funds Rate (ann. p.p.) Investment (%) 4 2 Unemployment Rate (p.p.) Consumption (%) Real Wage (%) Vacancies (%) Job Finding Rate (p.p.) G Z Corp. Bond Spread (ann. p.p.) TFP Level (%) Gov. Cons. & Invest. (%, exog.) Fin. Wedge (quart. p.p., exog.) Cons. Wedge (quart. p.p., exog.)

138 Government Consumption Played only a Small Role

139 Government Consumption Played only a Small Role Estimated multiplier around 2 during early period (American Recovery and Reinvestment Act of 29) But, rise in G then too small to have a substantial effect.

140 Government Consumption Played only a Small Role Estimated multiplier around 2 during early period (American Recovery and Reinvestment Act of 29) But, rise in G then too small to have a substantial effect. Recent decline in G is large, but has small multiplier effect. consistent with ZLB analysis of Christiano-Eichenbaum-Rebelo (JPE212).

141 Government Consumption Played only a Small Role Estimated multiplier around 2 during early period (American Recovery and Reinvestment Act of 29) But, rise in G then too small to have a substantial effect. Recent decline in G is large, but has small multiplier effect. consistent with ZLB analysis of Christiano-Eichenbaum-Rebelo (JPE212). G movements expected to last beyond ZLB have very small multiplier effects. G beyond ZLB has negative impact on ZLB, because of depressive wealth effects on consumption.

142 Other Labor Market Variables: Vacancies. Empirical measure of vacancies (JOLTS): position posted by an establishment, which it would fill if it met a suitable candidate.

143 Other Labor Market Variables: Vacancies. Empirical measure of vacancies (JOLTS): position posted by an establishment, which it would fill if it met a suitable candidate. compare vacancies in model with JOLTS.

144 Other Labor Market Variables: Vacancies. Empirical measure of vacancies (JOLTS): position posted by an establishment, which it would fill if it met a suitable candidate. compare vacancies in model with JOLTS. Vacancies in our model. vacancies costless, but firm must post them to hire.

145 Other Labor Market Variables: Vacancies. Empirical measure of vacancies (JOLTS): position posted by an establishment, which it would fill if it met a suitable candidate. compare vacancies in model with JOLTS. Vacancies in our model. vacancies costless, but firm must post them to hire. if firm wants to hire h workers it must post v = h Q vacancies (it takes Q as given).

146 Other Labor Market Variables: Vacancies. Empirical measure of vacancies (JOLTS): position posted by an establishment, which it would fill if it met a suitable candidate. compare vacancies in model with JOLTS. Vacancies in our model. vacancies costless, but firm must post them to hire. if firm wants to hire h workers it must post v = h Q vacancies (it takes Q as given). vacancies posted at the level of the establishment (firm has many establishments). if a vacancy produces a suitable candidate, he/she is hired.

147 Other Labor Market Variables: Vacancies. Empirical measure of vacancies (JOLTS): position posted by an establishment, which it would fill if it met a suitable candidate. compare vacancies in model with JOLTS. Vacancies in our model. vacancies costless, but firm must post them to hire. if firm wants to hire h workers it must post v = h Q vacancies (it takes Q as given). vacancies posted at the level of the establishment (firm has many establishments). if a vacancy produces a suitable candidate, he/she is hired. Q determined in the normal way : Q = agg hires agg vacancies

148 Other Labor Market Variables: Vacancies. Empirical measure of vacancies (JOLTS): position posted by an establishment, which it would fill if it met a suitable candidate. compare vacancies in model with JOLTS. Vacancies in our model. vacancies costless, but firm must post them to hire. if firm wants to hire h workers it must post v = h Q vacancies (it takes Q as given). vacancies posted at the level of the establishment (firm has many establishments). if a vacancy produces a suitable candidate, he/she is hired. Q determined in the normal way : Q = agg hires agg vacancies = constant ( ) agg job searchers σ agg vacancies

149 Other Labor Market Variables: Job Finding Rate. Job finding rate: f = agg hires agg job searchers

150 Monetary Policy in the Great Recession From 28Q3 to 211Q2:

151 Monetary Policy in the Great Recession From 28Q3 to 211Q2: Taylor-type rule 1.7 {}}{ ( ln(z t ) = ln(r) + r π ln π A t /π A).15 {}}{ +.25 r y ln (Y t /Yt ) The actual policy rate, R t :.231 {}}{ ( ) +.25 r y ln Y t /(Y t 4 µ A Y ) + σ R ε R,t. ln (R t ) = max {ln (1), ρ R ln(z t 1 ) + (1 ρ R ) ln(z t )}

152 Monetary Policy in the Great Recession From 28Q3 to 211Q2: Taylor-type rule 1.7 {}}{ ( ln(z t ) = ln(r) + r π ln π A t /π A).15 {}}{ +.25 r y ln (Y t /Yt ) The actual policy rate, R t :.231 {}}{ ( ) +.25 r y ln Y t /(Y t 4 µ A Y ) + σ R ε R,t. ln (R t ) = max {ln (1), ρ R ln(z t 1 ) + (1 ρ R ) ln(z t )} Policy from 211Q3-212Q4: date-based forward guidance (8 quarters) Policy from 213Q1: keep funds rate at zero until either unemployment falls below 6.5% or inflation rises above 2.5%.

153 Stochastic Simulation of the Model Feed the four shocks to the model and simulate the post 28Q2 data.

154 Stochastic Simulation of the Model Feed the four shocks to the model and simulate the post 28Q2 data. Observed GZ, TFP and G data are treated as realizations of a stochastic process.

155 Stochastic Simulation of the Model Feed the four shocks to the model and simulate the post 28Q2 data. Observed GZ, TFP and G data are treated as realizations of a stochastic process. At each date t, agents observe period t and earlier obs. only.

156 Stochastic Simulation of the Model Feed the four shocks to the model and simulate the post 28Q2 data. Observed GZ, TFP and G data are treated as realizations of a stochastic process. At each date t, agents observe period t and earlier obs. only. At t they must forecast future values of the shocks. They compute forecasts using time series models for the shocks.

157 Stochastic Simulation of the Model Feed the four shocks to the model and simulate the post 28Q2 data. Observed GZ, TFP and G data are treated as realizations of a stochastic process. At each date t, agents observe period t and earlier obs. only. At t they must forecast future values of the shocks. They compute forecasts using time series models for the shocks. Solve nonlinear model, imposing certainty equivalence. Go back

158 Fish Hooks in Other Recessions 4.5 U.S. Beveridge Curve Vacancy Rate, V, (%) Unemployment Rate, U, (%)

159 Fish Hooks in Other Recessions 4.5 U.S. Beveridge Curve Vacancy Rate, V, (%) Unemployment Rate, U, (%)

160 Fish Hooks in Other Recessions 4.5 U.S. Beveridge Curve Vacancy Rate, V, (%) Unemployment Rate, U, (%)

161 Fish Hooks in Other Recessions 4.5 U.S. Beveridge Curve Vacancy Rate, V, (%) Unemployment Rate, U, (%)

162 Fish Hooks in Other Recessions 4.5 U.S. Beveridge Curve Vacancy Rate, V, (%) Unemployment Rate, U, (%)

163 Fish Hooks in Other Recessions 4.5 U.S. Beveridge Curve Vacancy Rate, V, (%) Unemployment Rate, U, (%)

164 Fish Hooks in Other Recessions 4.5 U.S. Beveridge Curve Vacancy Rate, V, (%) Unemployment Rate, U, (%)

165 Fish Hooks in Other Recessions 4.5 U.S. Beveridge Curve Vacancy Rate, V, (%) Unemployment Rate, U, (%)

166 Fish Hooks in Other Recessions 4.5 U.S. Beveridge Curve Vacancy Rate, V, (%) Unemployment Rate, U, (%)

167 End of Period Labor Market Flows

168 End of Period Labor Market Flows Unemployed and just-separated workers at end of t 1 : separated workers at end of t 1 {}}{ (1 ρ) employed in t 1 {}}{ l t 1 + unemployed in t 1 {}}{ labor force in t 1 {}}{ L t 1 l t 1

169 End of Period Labor Market Flows Unemployed and just-separated workers at end of t 1 : separated workers at end of t 1 {}}{ (1 ρ) employed in t 1 {}}{ l t 1 + unemployed in t 1 {}}{ labor force in t 1 {}}{ L t 1 l t 1 = (1 ρ) l t 1 + L t 1 l t 1

170 End of Period Labor Market Flows Unemployed and just-separated workers at end of t 1 : separated workers at end of t 1 {}}{ (1 ρ) employed in t 1 {}}{ l t 1 + unemployed in t 1 {}}{ labor force in t 1 {}}{ L t 1 l t 1 = (1 ρ) l t 1 + L t 1 l t 1 = L t 1 ρl t 1.

171 End of Period Labor Market Flows Unemployed and just-separated workers at end of t 1 : separated workers at end of t 1 {}}{ (1 ρ) employed in t 1 {}}{ l t 1 + unemployed in t 1 {}}{ labor force in t 1 {}}{ L t 1 l t 1 = (1 ρ) l t 1 + L t 1 l t 1 = L t 1 ρl t 1. Some thrown exogenously into non-employment: stay and search for jobs {}}{ s (L t 1 ρl t 1 ), go into non-employment {}}{ (1 s) (L t 1 ρl t 1 )

172 Beginning of Period Job Search Labor force at start of time t : L t = period t 1 unemployed and separated who stay in labor force {}}{ s (L t 1 ρl t 1 ) + people that were employed in previous period and remain attached {}}{ ρl t 1 + people sent to labor force from non-employment {}}{ r t