Under Review Substantially Revised: April 9 2021
This paper characterizes a general class of macroeconomic models with incomplete information, which feature both endogenous signal processes and endogenous state variables. I introduce an algorithm to solve the general model, and demonstrate how to compute it. Then, I prove a global uniqueness theorem for stable equilibria. As an application, I consider a business cycle model with capital where firms must make inferences about aggregate shocks through the movements of endogenous prices. The model is solvable even though the fundamental state of the economy is never revealed. I calibrate using US industry-level panel data, and apply the model to study investment cost shocks. I find that incomplete information amplifies the effects of these shocks, raising the volatility of consumption over the business cycle.
For a thousand years, income growth was associated with a rising military employment share. But this share peaked in the early 20th century, after which military employment shares fell with income growth. I argue that rising military shares were driven by structural change out of agriculture, and the recent declines are driven by substitution from soldiers towards military goods. I document evidence for this substitution effect: as countries' incomes rise, the ratio of their military expenditure share to their military employment share rises too. I introduce a game theoretic model of growth and warfare that reproduces the time series patterns of military expenditure and employment. The model also correctly predicts the cross-sectional pattern, that military employment and expenditure shares are decreasing in income during wars. Finally, I show that faster economic growth can reduce military expenditure in the long run.
Journal of Demographic Economics (2021)
Advanced economies undergo three transitions during their development: 1. They transition from a rural to an urban economy. 2. They transition from low income growth to high income growth. 3. Their demographics transition from initially high fertility and mortality rates to low modern levels. The timings of these transitions are correlated in the historical development of most advanced economies. I unify complementary theories of the transitions into a nonlinear model of endogenous long run economic and demographic change. The model reproduces the timing and magnitude of the transitions. Because the model captures the interactions between all three transitions, it is able to explain three additional empirical patterns: a declining urban-rural wage gap, a declining rural-urban family size ratio, and most surprisingly, that early urbanization slows development. This third prediction distinguishes the model from other theories of long-run growth, so I test and confirm it in cross-country data.
Journal of International Money and Finance (2021)
Most countries hold large gross asset positions, lending in their domestic currency and borrowing in foreign currency. As a result, their balance sheets are exposed to nominal exchange rate movements. We argue that when asset markets are incomplete, nominal exchange rate exposure allows countries to partially insure against shocks that move real exchange rates. We demonstrate that asset market incompleteness which features a meaningful portfolio choice can simultaneously generate realistic gross asset positions and also resolve the Backus-Smith puzzle: that relative consumptions and real exchange rates are negatively correlated. We also show that local perturbation methods that use endogenous discount factors to stabilize models are inaccurate when the average and steady state interest rates differ, even when they correctly characterize the average portfolio holdings. To address this, we develop a novel global solution method to accurately solve the equilibrium portfolio problem.
I study the effects of sentiments in a business cycle model with dispersed information featuring capital and learning from endogenous signals. Business cycle volatility is amplified by the inclusion of sentiment shocks about future productivity, which are propagated through capital accumulation. Excess volatility of investment leads to excess volatility in the capital stock, so I study policy interventions to moderate these "capital bubbles". Policy makers can improve welfare even when using only public information. I consider a policy rule for asset purchases and find that the optimal policy is countercyclical, encouraging investment during recessions and discouraging during booms.
How do terms of trade shocks affect open economies? We use a panel of global commodity prices to estimate the dynamic effects of terms of trade shocks on macroeconomic variables for 205 countries. We find that terms of trade shocks resemble wealth shocks: a terms of trade improvement increases consumption and investment by more than output and decreases net exports, contrary to prior evidence and standard theory. To explain this outcome, we also show that terms of trade improvements increase countries' net foreign asset position, due to valuation effects of nominal net assets. To make sense of these results, we augment a standard business cycle model with realistic international portfolio choice. We estimate the model for a large sample of countries, and show that it can replicate our empirical findings: terms of trade improvements look like wealth shocks, and their importance for business cycles is heterogeneous, depending on the country's international portfolio position.
The share of aggregate income paid as compensation to labor is frequently used as a proxy for income inequality. If capital holdings are very concentrated among high income individuals, increasing their share of GDP, all else equal, widens the gap with poorer workers. Indeed, two striking features over the last three decades of many advanced and developing economies are the declining labor shares in income and the rise in income inequality. The relationship between factor shares and inequality, however, is not so simple in a richer world with realistic features such as endogenous home decisions and capital-skill complementarity. In such a world, total inequality will change with (i) the labor share, (ii) the amount of within-labor and within-capital income inequality, and (iii) the degree to which the highest wage earners are also those earning the highest capital incomes. Macroeconomic trends and shocks that impact any one of these three moments are likely to impact simultaneously all of them. We develop a framework where all these terms are jointly determined and estimate the model to clarify the roles of changing technology, policies, and factor proportions on labor shares and total income inequality around the globe.
Why is growth slowing? Two facts are documented: 1. Richer countries spend a greater share of their income on research and development, and 2. Countries with high spending on research and development grow slower. These facts are evident in both the US time series and in the cross-section of countries. The paper proposes a model that explains these two facts, driven by declining returns to research and development. As technology advances, it costs a greater share of output to increase at the same rate; innovators compensate by spending more in R&D, but cannot compensate fully. In the long run, the R&D share of output asymptotes to 3.0-3.9%, and the per capita GDP growth rate declines to 1.0-1.5%.