De-leveraging and the financial accelerator: how Wall Street can shock main street

The severity of the recent economic downturn raises questions about the role of financial markets in modern market economies. Why did rising defaults in a relatively small portion of the U.S. housing market cause a financial crisis? Why do financial crises have outsized adverse effects on the rest of the economy? As a general rule, a decline in economic activity in the nonfinancial sector, such as occurs during a typical recession, induces greater restraint on the part of the financial sector and that restraint - manifested usually in a pullback of credit and funding - in turn causes further setbacks to the nonfinancial sector. In the academic literature, this feedback effect is called the financial accelerator. In "De-Leveraging and the Financial Accelerator: How Wall Street Can Shock Main Street," Satyajit Chatterjee looks at what underlay the financial shock that emanated from Wall Street in the fall of 2007. Then he focuses on the channels through which the financial accelerator works and how the accelerator can turn a financial market disruption into a deep recession.Financial crises ; Recessions

Inflation, financial markets and capital formation - commentary

Capital ; Financial markets ; Inflation (Finance)

The long-run effects of the bankruptcy reform bill

Bankruptcy

On the Contribution of Agglomeration Economies to the Spatial Concentration of U.S. Employment

Why does the level of economic activity vary so much across space? One reason given is "agglomeration economies," meaning that a firm's or household's production costs (of market and home goods, respectively) are lower when production is carried out in close proximity to other firms and households. In this paper I explore, via a quantitative spatial macroeconomic model, the contribution of agglomeration economies to the observed spatial concentration of US employment. The approach is analogous to "business-cycle accounting" or "growth accounting." As in these accounting exercises, the results of the "spatial accounting" performed in this study depend on the details of the model used. The critical detail pertains to how the model rationalizes the stability of low-density localities. If it is rationalized via an appeal to restrictions on labor mobility, the accounting implies that the bulk of spatial concentration results from an unequal distribution of natural advantages. In contrast, if it is rationalized via an agglomeration threshold (an employment level below which agglomeration economies are absent) the accounting implies that the bulk of the spatial concentration results from increasing returnsAgglomeration Economies, Natural Advantage, Density, Congestion

The Taylor curve and the unemployment-inflation tradeoff.

The subject of our next article, "The Taylor Curve and the Unemployment-Inflation Tradeoff," by Satyajit Chatterjee, is finding an optimal monetary policy menu. In the past, monetary policy options were described in terms of a tradeoff between the unemployment rate and the inflation rate, the so-called Phillips curve. Macroeconomists no longer view the Phillips curve as a viable “policy menu” because its use as such is inconsistent with mainstream macroeconomic theory. In the late 1970s, John Taylor suggested an alternative set of options for policymakers to consider, one that is consistent with macroeconomic theory. These alternative options involve a tradeoff between the variability of output and the variability of inflationUnemployment ; Inflation (Finance) ; Monetary policy

From cycles to shocks: progress in business-cycle theory

Boom leads to recession, recession to boom, and the economy is caught in a self-sustaining cycle. Or is it? More recent economic theory states that cyclical fluctuations in the economy are caused by shocks and other disturbances that continually buffet the economy. In this article, Satyajit Chatterjee examines the historical process by which the explanation of fluctuations in the economy has evolved from a theory of cycles to one of shocks.Business cycles

A theory of asset price booms and busts and the uncertain return to innovation

Many observers believe that turbulence in asset prices results from bouts of optimism and pessimism among investors that have little to do with economic reality. While psychology and emotions are no doubt important motivators of human actions, an explanation for asset price booms and busts that ignores the fact that humans are also thinking animals does not seem entirely satisfactory or plausible. In this article, Satyajit Chatterjee presents a counterpoint to the view that “it’s all psychology.” He reports on a theory of asset price booms and busts that is based entirely on rational decision-making and devoid of psychological elements. The explanation suggests that asset price booms and crashes are most likely to occur when the value of the asset in question depends on an innovation whose full profit potential is initially unknown to investors.Asset pricing

The economic logic of a fresh start

A debtor’s right to have his or her debts dismissed or discharged via a bankruptcy proceeding is referred to as the law’s “fresh start” provision. Fresh start has been — and continues to be — a controversial feature of the U.S. bankruptcy law. Lately, the law has come under scrutiny because of the dramatic rise in personal bankruptcy filings over the past 25 years. In “The Economic Logic of a Fresh Start,” Satyajit Chatterjee explains the economic logic underlying the fresh start concept. He also argues that this logic can explain why opposition to a discharge policy has waxed and waned over time. ; Also issued as Payment Cards Center Discussion Paper No. 08-04Bankruptcy

A quantitative assessment of the role of agglomeration economies in the spatial concentration of U.S. employment

This paper seeks to quantify the contribution of agglomeration economies to the spatial concentration of U.S. employment. A spatial macroeconomic model with heterogeneous localities and agglomeration economies is developed and calibrated to U.S. data on the spatial distribution of employment. The model is used to answer the question: By how much would the spatial concentration of employment decline if agglomeration economies were counterfactually suppressed? For the most plausible calibration, the answer is about 48 percent. More generally, the general equilibrium contribution of agglomeration economies appears to be substantial, with empirically defensible calibrations yielding estimates between 40 and 60 percent.Employment

The peopling of macroeconomics: Microeconomics of aggregate consumer expenditures

Since the 1950s economists have been building a theory of aggregate consumer spending, seeking to understand how individual households choose to spend and how their choices change when interest rates, the unemployment rate, and other economic indicators change. Before that time, economists looked for "economic laws" that would explain the connection between one set of economic aggregates and another, without considering the decisions of individual households. Although the process of connecting macroeconomic aggregates to individuals' behavior is far from complete, predictions of aggregate consumer spending are now rooted in predictions of individual behavior. In "The Peopling of Macroeconomics: Microeconomics of Aggregate Consumer Expenditures," Satyajit Chatterjee takes readers through a brief historical survey from the early work on the consumption function to the theory of aggregate consumer spending in modern macroeconomic models.Consumer behavior ; Microeconomics