Brookings: Experts - David H. Romer

Brookings Papers on Economic Activity: Fall 2012

David H. Romer and Justin Wolfers , eds. — Wed, 10 Apr 2013 00:00:00 -0400

Brookings Institution Press 2013 367pp.

Brookings Papers on Economic Activity (BPEA) provides academic and business economists, government officials, and members of the financial and business communities with timely research on current economic issues.

Learn more about the BPEA conference series.Contents:

Political Polarization and the Dynamics of Political Language: Evidence from 130 Years of Partisan Speech
Jacob Jensen (Columbia University), Ethan Kaplan (University of Maryland), Suresh Naidu (Columbia University), and Laurence Wilse-Samson (Columbia University)
The Ins and Outs of Forecasting Unemployment: Using Labor Force Flows to Forecast the Labor Market
Regis Barnichon (Centre de Recerca en Economia Internacional, Barcelona) and Christopher J. Nekarda (Board of Governors of the Federal Reserve System)
Winning the War: Poverty from the Great Society to the Great Recession
Bruce D. Meyer (University of Chicago) and James X. Sullivan (University of Notre Dame)
The Reversal of the Employment-Population Ratio in the 2000s: Facts and Explanations
Robert A. Moffitt (Johns Hopkins University)
What Have They Been Thinking? Homebuyer Behavior in Hot and Cold Markets
Karl E. Case (Wellesley College), Robert J. Shiller (Yale University), and Anne K. Thompson (McGraw-Hill Construction)
Capital Controls: Gates versus Walls
Michael W. Klein (Tufts University)

ABOUT THE EDITORS

David H. Romer

Justin Wolfers

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Brookings Papers on Economic Activity: Spring 2012

David H. Romer and Justin Wolfers , eds. — Fri, 31 Aug 2012 00:00:00 -0400

Brookings Institution Press 2012 350pp.

Contents:

Democratic Change in the Arab World, Past and Present
Eric Chaney (Harvard University)
Disentangling the Channels of the 2007–2009 Recession
James Stock (Harvard University) and Mark Watson (Princeton University)
Macroeconomic Effects of FOMC Forward Guidance
Jeffrey Campbell, Charles Evans, Jonas Fisher, and Alejandro Justiniano (Federal Reserve Bank of Chicago)
Is the Debt Overhang Holding Back Consumption?
Karen Dynan (Brookings Institution)
The Euro’s Three Crises
Jay Shambaugh (Georgetown University)
Fiscal Policy in a Depressed Economy
J. Bradford DeLong (University of California–Berkeley) and Lawrence Summers (Harvard University)

ABOUT THE EDITORS

David H. Romer

Justin Wolfers

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Brookings Papers on Economic Activity: Fall 2011

David H. Romer and Justin Wolfers , eds. — Tue, 27 Mar 2012 00:00:00 -0400

Brookings Institution Press 2012 350pp.

Editors' Summary (Full Text)

Recession and the Costs of Lost Jobs
By Til von Wachter (Columbia University) and Steve Davis (University of Chicago)

What Do Small Businesses Do?
By Benjamin Pugsley and Erik Hurst (University of Chicago)

Unemployment Insurance and Job Search in the Great Recession
By Jesse Rothstein (University of California–Berkeley)

The Effects of Quantitative Easing on Interest Rates: Channels and Implications for Policy
By Annette Vissing-Jorgenson and Arvind Krishnamurthy (Northwestern University)

Practical Monetary Policy: Examples from Sweden and the United States
By Lars Svensson (Sveriges Riksbank)

The Labor Market in the Great Recession-An Update to September 2011
By Aysegul Sahin (Federal Reserve Bank of New York)

The Income- and Expenditure-Side Estimates of U.S. Output Growth-An Update to 2011Q2
By Jeremy Nalewaik (Board of Governors, Federal Reserve System)

ABOUT THE EDITORS

David H. Romer

Justin Wolfers

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Brookings Papers on Economic Activity: Spring 2011

David H. Romer and Justin Wolfers , eds. — Mon, 01 Aug 2011 00:00:00 -0400

Brookings Institution Press 2011 405pp.

Job Search, Emotional Well-Being, and Job Finding in a Period of Mass Unemployment: Evidence from High-Frequency Longitudinal Data (Abstract)
By Alan Krueger (Princeton University) and Andreas Mueller (Stockholm University)

Financially Fragile Households: Evidence and Implications (Abstract)
By Annamaria Lusardi (George Washington University), Daniel Schneider (Princeton University), and Peter Tufano (Harvard University)

Let's Twist Again: A High-Frequency Event-Study Analysis of Operation Twist and Its Implications for QE2 (Abstract)
By Eric Swanson (Federal Reserve Bank of San Francisco)

An Exploration of Optimal Stabilization Policy (Abstract)
By N. Gregory Mankiw and Matthew Weinzierl (Harvard University)

What Explains the German Labor Market Miracle in the Great Recession? (Abstract)
By Michael Burda (Humboldt University) and Jennifer Hunt (McGill University)

Inflation Dynamics and the Great Recession (Abstract)
By Laurence Ball (Johns Hopkins University) and Sandeep Mazumder (Wake Forest University)

ABOUT THE EDITORS

David H. Romer

Justin Wolfers

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Brookings Papers on Economic Activity: Fall 2010

David H. Romer and Justin Wolfers , eds. — Thu, 03 Mar 2011 00:00:00 -0500

Brookings Institution Press 2011 350pp.

Editors' Summary (Full Text)

The Increase in Income Cyclicality of High-Income Households and Its Relation to the Rise in Top Income Shares (Abstract)
By Jonathan A. Parker and Annette Vissing-Jorgensen (Northwestern University)

The State of the Social Safety Net in the Post-Welfare Reform Era (Abstract)
By Marianne P. Bitler (University of California, Irvine) and Hilary W. Hoynes (University of California, Davis)

The Impact of No Child Left Behind on Students, Teachers, and Schools (Abstract)
By Thomas S. Dee (University of Virginia) and Brian A. Jacob (University of Michigan)

How Useful Are Estimated DSGE Model Forecasts for Central Bankers? (Abstract)
By Rochelle M. Edge (Board of Governors of the Federal Reserve System) and Refet S. Gürkaynak (Bilkent University)

Regulating the Shadow Banking Industry (Abstract)
By Gary Gorton and Andrew Metrick (Yale University)

State Fiscal Policies and Transitory Income Fluctuations (Abstract)
By James R. Hines, Jr. (University of Michigan)

ISSN 007-2303

ABOUT THE EDITORS

David H. Romer

Justin Wolfers

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Editors' Summary of the Fall 2010 Brookings Papers on Economic Activity

David H. Romer and Justin Wolfers — Thu, 16 Sep 2010 00:00:00 -0400

The papers discussed below can be found at the Brookings Papers on Economic Activity archive.

The Brookings Panel on Economic Activity held its ninetieth conference in Washington, D.C., on September 16 and 17, 2010, just as the economy was struggling to recover from the Great Recession. The Brookings Papers has always strived to provide timely policy analysis, and ﬁve of the papers in this volume study aspects of the causes and consequences of this slump. These papers examine the effects of the business cycle on the incomes of the very richest Americans; welfare, welfare reform, and poverty during recessions; the failure of modern macroeconomic models to adequately forecast economic conditions; the role of shadow banking in the financial crisis and the appropriate regulatory response; and expenditures by state and local governments over the business cycle. The remaining paper studies the impact of the No Child Left Behind Act, a far-reaching education reform that will shape the skills of the labor force for years to come.

In the first paper, Jonathan A. Parker and Annette Vissing-Jorgensen study the cyclicality of income at the very top of the income distribution. The conventional wisdom has been that the brunt of recessions falls on less educated, lower-income workers. Parker and Vissing-Jorgensen show, however, that households in the top 1 percent of the income distribution see their income rise steeply in booms and fall sharply in busts, much more so than the average household. This pattern is robust: it appears regardless of the occupation of the high-earning households and is not driven by the timing of exercising stock options. It is not even conﬁned to the United States: the authors present evidence of similar patterns in Canada. Importantly, they find that consumption as well as income moves with the business cycle among those at the top.

These results do not mean that the conventional wisdom was entirely wrong, however. It remains true that less educated households also suffer disproportionately during recessions, largely because of increased unemployment. The impact of recessions on income is therefore U-shaped across the income distribution: many low-income households are adversely affected, the middle of the distribution is less affected, and the very top of the distribution is hit hard.

Parker and Vissing-Jorgensen’s new results are driven in part by their examination of post-1982 data. In earlier years, when top incomes were not so extraordinarily high, they were also less cyclical. Thus, an increase in the cyclicality of high earners corresponded with an increase in their relative incomes. Parker and Vissing-Jorgensen show that this pattern holds across different income groups, across decades, and even across countries: the more unequal the income distribution, the more cyclical is the income of the rich. The authors conclude by developing a theoretical model linking income cyclicality with income inequality. The model suggests that one source of their findings may be progress in information and communications technology, which has enabled very high ability entrepreneurs to leverage their talents, earning them more in good times but exposing them to plummeting demand in bad times.

In the second paper, Marianne P. Bitler and Hilary W. Hoynes take the opposite perspective from Parker and Vissing-Jorgensen, exploring the cyclicality of well-being among the poorest. The United States has historically protected its poorest citizens from economic ﬂuctuations through a patchwork system of welfare and social insurance programs: Aid to Families with Dependent Children provided cash assistance to poor families with children, while the food stamp program and Medicaid, among others, provided in-kind beneﬁts. Welfare reform in the 1990s overhauled the cash assistance system (now called Temporary Assistance for Needy Families), and researchers have found that participation in this and some other welfare programs has declined since the reform. An unexplored— but currently pressing—question is whether welfare reform has weakened the social safety net, so that it no longer insures poor Americans against large income swings.

Bitler and Hoynes marshal an impressive array of evidence to attack this question, analyzing decades of data and studying numerous indicators of adult and child well-being. They ﬁnd some evidence that welfare reform has weakened the safety net: poverty (using the ofﬁcial measure, which excludes noncash transfers) has risen more sharply with the unemployment rate in the years after reform than it did in the years before. On the other hand, the authors also find that welfare reform has had no impact on the cyclicality of food consumption, food insecurity, health insurance coverage, household crowding, or health. Reconciling these results, Bitler and Hoynes report that participation in noncash safety net programs generally, and especially the food stamp program, has become much more responsive to economic conditions in the years since welfare reform. On the other hand, participation in cash assistance programs has, if anything, become less responsive to the business cycle. Overall, therefore, Bitler and Hoynes ﬁnd that cash welfare reform weakened the safety net, but that the food stamp program picked up much of the slack.

In the third paper, Thomas S. Dee and Brian A. Jacob evaluate the signature education legislation of the last several decades, the No Child Left Behind Act of 2001. This policy brought dramatic changes to the education landscape by instituting regular, high-stakes assessments of students in public schools. Proponents of No Child Left Behind hoped that these high-stakes tests would motivate school districts to improve educational outcomes, thereby aligning the interests of schools and teachers with those of voters and parents. Critics, however, worried that high-stakes testing would distort teacher incentives even further, encouraging them to teach to the test, ignore nontested subject matter, inappropriately place low-achieving students in special needs classrooms, and neglect high-achieving students.

In their thorough evaluation, Dee and Jacob find support for both the proponents and the critics. The authors focus on tests that are not part of the high-stakes tests under No Child Left Behind, and thus are unlikely to be substantially distorted by teaching to the test. They find that No Child Left Behind appears to have had a positive impact on math learning, especially at lower grades and for students from traditionally disadvantaged populations. They find no evidence of an adverse impact on math achievement at either the top or the bottom of the ability distribution; indeed, the evidence suggests that No Child Left Behind had a roughly constant impact across the ability distribution. On the other hand, the policy appears not to have improved reading performance.

Several mechanisms contributed to the improvement in math learning. No Child Left Behind induced schools to spend about $600 more per student per year, Dee and Jacob estimate, with much of the extra money coming from state and local rather than federal sources. This money supported additional instruction as well as education support services. The legislation also led to an increase in the share of teachers with master’s degrees. But some of the critics’ fears were justiﬁed: schools reduced instruction in social studies and science—nontested subjects—and increased instruction in tested subjects, especially reading.

In the fourth paper, Rochelle M. Edge and Refet S. Gürkaynak study the forecasting performance of the dynamic stochastic general equilibrium (DSGE) models currently fashionable among macroeconomists. DSGE models’ emphasis on deep structural parameters, such as individuals’ preferences, the available technology, and resource constraints, means that—if the models’ underlying assumptions about economic behavior are correct— they are immune to the Lucas critique (that is, the possibility that forward-looking behavior can cause previous patterns to break down in response to policy changes or other developments). Yet their success in predicting macroeconomic movements remains largely unexplored.

The authors focus on the forecasts of the most prominent of these DSGE models for the United States over the period 1992–2006. Consistent with previous evaluations, they find that DSGE models yield forecasts that tend to be less biased and more accurate than the professional forecasts, the Federal Reserve’s “Greenbook” forecasts, or purely statistical forecasts. But this is a limited success, as Edge and Gürkaynak find that the DSGE forecasts do relatively well only because the performance of all of these forecasts is quite poor. Indeed, the absolute performance of even the DSGE forecasts suggests that, for example, the 95 percent confidence interval around that model’s forecasts of annual inflation is 4 percentage points wide, and that most of the time its forecast of annual GDP growth cannot rule out anything from a near-recession to a boom. The slight edge that DSGE forecasts have over other forecasts is therefore not particularly noteworthy, since it involves comparing one weak forecast with others.

The authors argue that the poor performance of all forecasting techniques reﬂects the time period they study. Because they focus on the Great Moderation period, there is little variation in inﬂation or GDP growth, and therefore little to forecast. A final thought experiment drives this point home. They ask whether a policymaker considering the 1992–2006 period would have done better adopting any of the forecasts they consider, or, assuming that the policymaker knew the actual mean for that period, using that mean as the forecast. It turns out that the simple average predicts better than any of the forecasts, conﬁrming that none of the forecasts is providing much information.

A more telling evaluation of DSGE models’ usefulness must therefore await assessments of their performance in less stable environments. As a step in this direction, Edge and Gürkaynak take a preliminary look at the Great Recession. They present suggestive evidence that the DSGE forecasts were remarkably slow to provide any information concerning the fall in output as the recession unfolded, and that they were outperformed by the other available forecasts in this episode.

In the fifth paper, Gary Gorton and Andrew Metrick examine the “shadow” banking system and consider how it should be regulated. The shadow banking system refers to arrangements or institutions that are economically similar to traditional banking but that operate outside traditional banking arrangements—and, crucially, outside traditional regulation.

Gorton and Metrick begin by documenting the magnitude and sources of the rise in shadow banking and its role in the ﬁnancial crisis. They describe how a combination of regulatory restrictions on traditional banks, implicit government subsidies of shadow banking (notably through free implicit insurance of money market mutual funds), and ﬁnancial innovation led to an explosion of shadow banking over the past three decades. They emphasize that one key force behind the growth of shadow banking is special bankruptcy provisions for repurchase agreements (“repos”), which give ﬁnancial institutions access to a highly liquid source of short-term funding. They also describe how the conjunction of short-term liquid liabilities and long-term illiquid assets left shadow banking vulnerable to panics similar to traditional bank runs, and how such panics were critical in the ﬁnancial crisis that erupted in the fall of 2008.

The authors then offer both some general principles for regulating shadow banking and a speciﬁc proposal to implement those principles. They point out that the critical role of the special bankruptcy provisions for repos gives regulators a powerful lever: by restricting the circumstances under which the bankruptcy safe harbor applies, regulators can shape the system. They argue that much of shadow banking involves sensible arrangements for handling large ﬁnancial transactions, and thus that regulators should not try to use their powers to force a return to the traditional system. Instead, drawing on lessons from history, they argue that regulation should involve explicit insurance of money market mutual funds that guarantee stable asset values, and stronger collateral requirements for repos and securitization. The speciﬁc set of proposals they put forth involve creating new classes of narrow ﬁnancial institutions for money market mutual funds and for the holding of securitized assets.

In the final paper, James R. Hines, Jr. studies expenditure by state and local government over the business cycle. As Hines observes, more than 40 percent of total government expenditure comes from state and local rather than federal government. Since fiscal policy is a key tool for managing aggregate demand, how states and local governments respond to recessions is a key component of the ﬁscal policy response to the business cycle.

Whereas federal expenditure is clearly countercyclical, rising during recessions and falling (relative to GDP) during booms, Hines shows that aggregate state and local government expenditure hardly responds when GDP falls below its potential. Unlike the federal government, most states have balanced budget requirements that limit their ability to borrow during recessions. Countercyclical state ﬁscal policy therefore requires strong discipline; states need to save during the good times so they can spend in the bad.

Hines suggests, however, that poor governance in some states contributes to making their expenditure actually procyclical. States that rank higher in corruption, a proxy for more general incompetence, tend to have especially procyclical expenditure. Corroborating this story, Hines ﬁnds further evidence that states in general lack strong discipline in the fact that they have a high propensity (perhaps 80 percent) to spend out of federal grants. Whereas a rational state government would save the federal money, states apparently cannot help but spend the cash they have on hand. But this policy vice suggests a policy remedy: federal grants to state governments may be an effective way to stimulate aggregate demand during recessions.

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Brookings Papers on Economic Activity: Spring 2010

David H. Romer and Justin Wolfers , eds. — Fri, 03 Sep 2010 00:00:00 -0400

Brookings Institution Press 2010 361pp.

Brookings Papers on Economic Activity (BPEA) provides academic and business economists, government officials, and members of the financial and business communities with timely research on current economic issues.

Learn more about the BPEA conference series.

Contents:

Editors' Summary (Full Text)

The Labor Market in the Great Recession (Abstract)
By Michael W. L. Elsby (University of Michigan), Bart Hobijn (Federal Reserve Bank of San Francisco), and Ayşegül Şahin (Federal Reserve Bank of New York)

The Income- and Expenditure- Side Estimates of U.S. Output Growth (Abstract)
By Jeremy J. Nalewaik (Board of Governors of the Federal Reserve System)

The Rug Rat Race (Abstract)
By Garey Ramey and Valerie A. Ramey (University of California, San Diego)

The Crisis (Abstract)
By Alan Greenspan (Greenspan Associates LLC)

The Initial Impact of the Crisis on Emerging Market Countries (Abstract)
By Olivier J. Blanchard (International Monetary Fund and MIT), Mitali Das (International Monetary Fund), and Hamid Faruqee (International Monetary Fund)

Geographic Variation in Health Care: The Role of Private Markets (Abstract)
By Tomas J. Philipson (University of Chicago), Seth A. Seabury (RAND Corporation), Lee M. Lockwood (University of Chicago), Dana P. Goldman (University of Southern California), and Darius Lakdawalla (Univeresity of Southern California)

ISSN 007-2303

ABOUT THE EDITORS

David H. Romer

Justin Wolfers

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Editors' Summary of the Spring 2011 Brookings Papers on Economic Activity

David H. Romer and Justin Wolfers — Thu, 18 Mar 2010 00:00:00 -0400

The papers discussed below are available as free downloads at the Brookings Papers on Economic Activity archive.

The Brookings Panel on Economic Activity held its eighty-ninth conference in Washington, D.C., on March 18 and 19, 2010. The recent ﬁnancial crisis and ensuing recession continue to dominate the minds of leading economists, and this conference was no exception. Three of the papers in this volume assess macroeconomic developments in light of these remarkable events, examining the downturn in the U.S. labor market, the vulnerability of the ﬁnancial system, and the spread of the crisis to emerging market countries. In each case the authors illustrate how economic institutions mediated the consequences of the macroeconomic shocks. A fourth paper, which addresses how best to measure GDP, is also highly relevant, showing that an alternative to the most commonly used measure would have yielded a clearer early warning of the size and scope of the U.S. downturn. The two remaining papers compile interesting new data that speak to ongoing longer-term debates about the balance between work and family and about health care reform.

In the first paper in this issue, Michael Elsby, Bart Hobijn, and Ayşegül Şahin provide a heroic real-time analysis of recent labor market outcomes, comparing the recession that began in late 2007 with earlier downturns. All major measures of labor market conditions—including changes in unemployment, employment, participation, and hours—indicate that this most recent recession has been more severe than any since the Great Depression. The impact of the recession has been widespread, as unemployment rates among most major socioeconomic groups have exceeded previous postwar peaks.

Yet this recession also mirrors previous downturns in many respects. As in those recessions, the total decline in labor input is about one-third due to a shorter workweek and two-thirds due to fewer people working. Labor force participation has fallen, muting the impact of this decline on the unemployment rate. And the sharpest impacts of this recession also follow the pattern observed in earlier downturns, with men suffering more than women, the young more than the old, and the less educated and racial minorities bearing disproportionate impacts.

The authors then turn to examining inﬂows and outﬂows from unemployment. They ﬁnd that inﬂows into unemployment rose sharply, particularly in the early stages of the recession, and that the subsequent rise in unemployment largely reﬂects a rise in the duration of unemployment spells. Yet the rate at which workers separate from jobs has not risen—a fact that suggests a change in the composition of separations toward fewer quits (which often involve job-to-job ﬂows) and more layoffs. The important role of layoffs early in this recession represents a departure from recent downturns, but it parallels earlier severe recessions. Outﬂows from unemployment (the ﬂip side of the rise in duration of the typical unemployment spell) have been strikingly similar across demographic groups, and hence demographic differences in the impact of this recession—as in previous downturns—are largely driven by the different rates at which members of each group typically enter unemployment.

Looking forward, Elsby, Hobijn, and Şahin note that the rise in inﬂows to unemployment has abated, and that the rate at which workers are exiting unemployment has fallen further than in previous recessions. Consequently, the key to subsequent recovery will be further rises in the unemployment exit rate. Indeed, perhaps the most distinctive feature of this recession is the recent record low in the exit rate, which is also reﬂected in current record rates of long-term unemployment. Unfortunately, recent job vacancy data suggest that the Beveridge curve, which relates unemployment and vacancies, has shifted outward, perhaps because of a decline in the efﬁciency with which job seekers are being matched with available jobs. In turn, outﬂows from unemployment are lower than might be expected on the basis of the vacancy-unemployment ratio, which, the authors argue, may be partly (but only partly) due to the temporary extension of unemployment insurance for the long-term unemployed. Because the long-term unemployed tend to exit unemployment only very slowly, outﬂows from unemployment may remain depressed for some time, dampening the recovery. Even so, the authors note that the emerging long-term unemployment problem in the United States remains small relative to the stagnation that virtually halted the recovery of European labor markets in the 1970s and 1980s.

In the second paper, Jeremy Nalewaik turns to a critically important issue in economic measurement. GDP, a country’s overall economic output, can be measured either as the sum of all ﬁnal expenditures or as the sum of all incomes earned. Yet despite the conceptual equivalence, the measure based on expenditure—which Nalewaik calls GDP(E)—has often differed substantially over recent decades from the measure based on income, or GDP(I). Currently, the Bureau of Economic Analysis, the ofﬁcial source of data for both measures, emphasizes the expenditure-based measure as its “top line” measure, and the income-based measure (which the bureau calls gross domestic income, or GDI) rarely receives much mention in public discussion.

Nalewaik compellingly demonstrates that this emphasis is misplaced. Real-time estimates of the income-based measure of GDP growth have yielded a much more reliable picture of the contours of the business cycle than the expenditure-based measure. He makes his case in three steps. First, he runs an array of horserace regressions, assessing the relative weight that one should put on real-time GDP(I) and GDP(E) data in predicting each of a wide range of measures of business cycle conditions, including changes in the unemployment rate, employment growth, the slope of the yield curve, growth in stock prices, and periods of recession. In each case he ﬁnds that GDP(I) vastly outperforms GDP(E). Likewise, GDP(I) does a better job of predicting the future path of many of these business cycle indicators, as well as the GDP predictions of professional forecasters and next quarter’s growth in both GDP(E) and GDP(I) themselves. In fact, the only variable that GDP(E) signiﬁcantly helps predict is the ﬁnal revised value of growth in this quarter’s GDP(E). And even on this score, the regressions using data since the mid-1990s suggest putting about equal weight on GDP(E) and GDP(I).

Second, Nalewaik turns to evaluating the estimates after they have been thoroughly revised. Since the 1980s, the gap between the revised measures has been highly cyclical, with GDP(E) recording a shallower and less distinct business cycle. Digging into the construction of the estimates, he concludes that GDP(E) is constructed from data sources that appear to miss important parts of the business cycle. And indeed, he shows that the ﬁnal GDP(I) data are much more highly correlated with numerous other indicators of business conditions than are the ﬁnal GDP(E) data.

Finally, Nalewaik shows that GDP(I) has identiﬁed the beginning of each of the last four recessions more quickly than GDP(E). Indeed, one reason that there was some debate as to whether the economy had entered a recession in late 2007 is that the expenditure-based measure continued to show economic growth throughout 2008.

The paper concludes with a modest proposal: that the Bureau of Economic Analysis emphasize as its top-line estimate of GDP growth a weighted average of GDP(E) and GDP(I), placing at least as much weight on GDP(I) as on GDP(E). We believe that Nalewaik has presented an overwhelming case and hope that the bureau will be responsive; until then, macroeconomists would do well to make themselves more familiar with income-based measures of GDP.

In the third paper, Garey Ramey and Valerie Ramey bring to light a rather extraordinary recent trend in Americans’ use of time: parents—and in particular highly educated parents—have greatly increased the amount of time they spend on childcare activities. In time-use surveys from 1965 to 1995, mothers recorded an average of about 12 hours per week looking after their children, and the gap between college-educated mothers and those with less education was about 1 hour. Yet by 2007 this time commitment had risen to 21 hours per week for college-educated mothers, and to 16 hours per week for non-college-educated mothers. Similar changes were observed among fathers: the rise in their childcare time was smaller in absolute terms, but larger proportionally. These are macroeconomically important shifts, representing around $300 billion in forgone wages, and the change in time use is roughly comparable to the effect of a typical recession on work hours.

The authors present a novel hypothesis for these observations. The child population has grown with the baby-boom “echo,” but ever-more-valuable spots in elite colleges have not increased commensurately. In response, parents, and especially college-educated parents, are engaged in a “rug rat race,” making ever-increasing investments of their time in activities that they believe will help build a compelling college application for their children. Just as in an arms race, or as in the original “rat race” among urban white-collar workers, this rivalry can lead to overinvestment in some activities relative to the social optimum.

The authors document several facts consistent with their explanation: the rise in time spent with children paralleled the rise in the number of graduating high school seniors; much of this rise reﬂects time spent caring for older children, and in particular transporting them to extracurricular activities; and the trend toward increasing childcare time is less evident in Canada, where college admissions are less rivalrous. The authors also assess—and reject—a number of competing explanations, including changes in who becomes a parent (the rise in average childcare hours remains even when averaging across all adults); rising incomes (an insufﬁcient explanation given the moderate income elasticity of childcare time); increasing safety concerns (survey data suggest that such concerns actually fell over the relevant period); greater enjoyment of childcare (which predicts, counterfactually, that fertility would also rise); and more ﬂexible work schedules (which cannot explain why the rise is even greater among nonworking mothers). The facts so carefully catalogued by the authors will surely generate further research, and with it, even more hypotheses about just what factors are driving these enormous and important changes in family and work life.

In the fourth paper, Alan Greenspan offers his diagnosis of the recent ﬁnancial crisis and his proposals for reducing the chances of future crises. The seeds of the crisis, in his view, were sown by a period of historically low real interest rates, unprecedented macroeconomic stability, and low inﬂation. These developments led to large increases in investors’ willingness to take on risk and, partly as a result, to the rapid growth of home prices in the mid-2000s. This price growth in turn fueled (and was reinforced by) an explosion of securitization of mortgage loans into assets whose risk characteristics were often poorly understood and that were often held by highly leveraged institutions. When home prices began to fall in 2006, the result was a cascade of ﬁnancial failures and contagion. Greenspan assigns some of the blame for the crisis to failures of regulatory oversight, but he ﬁnds no evidence that the conduct of monetary policy played a role: economic theory, time-series evidence from the United States, and cross-country evidence all suggest that the central bank’s decisions about its interest rate target over a period of a few years are not a major driver of home prices.

Greenspan then turns to the issue of how to reduce the risk of future crises. He argues that policymakers face daunting empirical difﬁculties in fully understanding risks and in identifying asset bubbles and potential incipient crises in real time. This implies that policies that require regulators to forecast ﬁnancial instability are unlikely to succeed, especially considering the political and practical difﬁculties in continually adjusting regulation in response to economic developments.

Instead, he argues, the system needs to be designed so that it is broadly robust to shocks. One key feature of such a system would be increased capital requirements for ﬁnancial institutions. Based on historical relationships, he estimates that these could be as high as 10 to 15 percent without impairing the functioning of the banking system. Such requirements would need to apply both to existing regulated banks and to the “shadow” banking system and be accompanied by ample collateral and liquidity requirements. Finally, Greenspan argues that it is essential to address the problem of ﬁnancial institutions that are “too big to fail,” either by breaking them up or by putting in place mechanisms that subject their equity holders and creditors to the possibility of large losses without threatening the stability of the ﬁnancial system.

In the fifth paper, Olivier Blanchard, Mitali Das, and Hamid Faruqee investigate the short-run impact of the global financial crisis on emerging market countries. They begin with a simple reduced-form model to identify possible channels of transmission. Some channels involve trade, through reduced demand for a country’s exports when its trading partners enter a crisis. Others involve ﬁnancial markets, through reduced demand for a country’s assets and increases in risk premia. The authors argue that it is crucial to recognize the adverse effects of depreciation of the home currency on real debt burdens, and the possibility that depreciation may reduce net exports in the short run. Once these complications are introduced, even a comparatively barebones model allows for a potentially rich set of effects of the initial shocks and for complex interactions with the policy responses.

Blanchard, Das, and Faruqee then turn to the cross-country data. They ﬁnd evidence of effects working in the expected directions. In late 2008 and early 2009, countries whose trading partners suffered larger shortfalls in growth relative to precrisis forecasts suffered substantially larger growth shortfalls themselves, suggesting an important impact through trade. And countries that had more debt coming due during the crisis also suffered much larger growth shortfalls, suggesting an important impact through ﬁnancial markets.

At the same time, no simple story explains the different effects of the crisis across countries. Although both trade and ﬁnancial variables typically are signiﬁcant when both are included in the regressions, a substantial portion of the variation in growth remains unexplained. The results also imply that a hypothetical country with no trade or ﬁnancial exposure to the rest of the world would nonetheless have suffered a signiﬁcant growth shortfall from the precrisis prediction, suggesting that more was at work than the channels the authors focus on. The authors are unable to detect any large role of reserve holdings, the exchange rate regime, or the ﬁscal response in determining the short-run impact of the crisis.

The paper concludes by looking at three countries in detail: Latvia, Russia, and Chile. The contrast between Russia and Chile is particularly striking. Much about the two countries before the crisis was similar: both are ﬁnancially open economies whose exports are dominated by commodities. Yet Russia had one of the largest growth shortfalls, while Chile’s shortfall was below the average. The different outcomes are not entirely mysterious, however: Chile’s stronger institutions and longer track record of sound policies seem to have prevented a net capital outﬂow, whereas Russia’s attempt to use its reserves to stem what proved to be overwhelming pressure for depreciation led to very large capital outﬂows.

In the final paper, Tomas Philipson, Seth Seabury, Lee Lockwood, Dana Goldman, and Darius Lakdawalla examine geographic variation in health care utilization and spending. An important line of inquiry—most prominently associated with the Dartmouth Atlas project—has documented large disparities in health care use and spending across regions of the country. These disparities cannot be explained by differences in observed patient demographics or disease prevalence, and regions using more health care do not exhibit substantially better outcomes. But the authors note that these ﬁndings are largely based on data from Medicare, which is a public program. By contrast, private payers may have stronger incentives to restrain costs and utilization, and hence greater incentives to eliminate wasteful procedures. On the ﬂip side, government-run insurers have greater bargaining power, which they may use to restrain costs.

In their empirical analysis, the authors compare health care use and spending records of employees and retirees of 35 Fortune 500 ﬁrms with patient records from a survey of Medicare beneﬁciaries. In order to analyze samples with roughly comparable health status, they focus only on patients with a diagnosis of heart disease. The authors ﬁnd that the variance of health care utilization across 99 metropolitan areas tends to be lower in the private than in the public sector, although this ﬁnding is sensitive to controlling appropriately for differences in the demographic and health status of the two samples. The geographic variation in health care spending (as opposed to utilization), on the other hand, is generally lower in the public sector. The authors highlight the need for further research on the determinants and beneﬁts of health care utilization and spending in the private sector.

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Brookings Papers on Economic Activity: Fall 2009

David H. Romer and Justin Wolfers , eds. — Fri, 26 Feb 2010 00:00:00 -0500

Brookings Institution Press 2010 276pp.

Editors' Summary (Full Text)

Heeding Daedalus: Optimal Inflation and the Zero Lower Bound (Abstract)
By John C. Williams (Federal Reserve Bank of San Francisco)

The Age of Reason: Financial Decisions over the Life Cycle and Implications for Regulation (Abstract)
By Sumit Agarwal (Federal Reserve Bank of Chicago), John C. Driscoll (Board of Governors of the Federal Reserve System), Xavier Gabaix (New York University), and David Laibson (Harvard University)

Interpreting the Unconventional U.S. Monetary Policy of 2007-09 (Abstract)
By Ricardo Reis (Columbia University)

By How Much Does GDP Rise If the Government Buys More Output? (Abstract)
By Robert E. Hall (Stanford University)

When the North Last Headed South: Revisting the 1930s (Abstract)
By Carmen M. Reinhart (University of Maryland) and Vincent R. Reinhart (American Enterprise Institute)

ISSN 007-2303

ABOUT THE EDITORS

David H. Romer

Justin Wolfers

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Brookings Papers on Economic Activity: Spring 2009

David H. Romer and Justin Wolfers , eds. — Thu, 01 Oct 2009 00:00:00 -0400

Brookings Institution Press 2009 332pp.

The Brookings Papers on Economic Activity, long one of Brookings’s signature publications, has new leadership. The two incoming editors have both made outstanding contributions to economic research and the communication of economic ideas to a broad audience. They will ensure that BPEA continues to be a central meeting place for leading scholars analyzing important economic problems.

The new editorial team will retain BPEA’s focus on empirical research of current issues in macroeconomics and economic policy, emphasizing real-world events and institutions. The journal will uphold its tradition of excellence in areas such as fiscal and monetary policy, labor markets, wages and prices, the distribution of income and wealth, international capital flow, and international trade and development.

Learn more about the BPEA conference series.

Contents:

Editors' Summary (Full Text)

The Financial Crisis: An Inside View (Abstract)
By Phillip Swagel (Georgetown University)

Understanding Inflation-Indexed Bond Markets (Abstract)
By John Y. Campbell (Harvard University), Robert J. Schiller (Yale University), and Luis M. Viceira (Harvard University)

Do Tax Cuts Starve the Beast? The Effect of Tax Changes on Government Spending (Abstract)
By Christina D. Romer and David Romer (University of California, Berkeley)

Causes and Consequences of the Oil Shock of 2007-08 (Abstract)
By James D. Hamilton (University of California, San Diego)

Why Doesn't Capitalism Flow to Poor Countries (Abstract)
By Rafael Di Tella (Harvard University) and Robert MacCulloch (Imperial College, London)

ISSN 007-2303

ABOUT THE EDITORS

David H. Romer

Justin Wolfers

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{9ABF977A-E4A6-41C8-B030-0FD655E07DBF}, 978-0-8157-0337-2, 35 Order

Editors' Summary of the Fall 2009 Brookings Papers on Economic Activity

David H. Romer and Justin Wolfers — Thu, 10 Sep 2009 00:00:00 -0400

The papers discussed below are available as free downloads at the Brookings Papers on Economic Activity archive.

The Brookings Panel on Economic Activity held its eighty-eighth conference in Washington, D.C., on September 10 and 11, 2009. All of the papers were related in some way to the remarkable macroeconomic developments of the past two years: the papers considered the zero lower bound on nominal interest rates, consumer ﬁnancial regulation, unconventional monetary policy, the macroeconomic consequences of ﬁscal stimulus, and monetary and ﬁscal policy in the Great Depression. This issue of the Brookings Papers on Economic Activity presents the papers from the conference, comments by the formal discussants, and summaries of the discussions of the papers by conference participants.

In the first paper, John Williams investigates the implications of the fact that monetary policy cannot push nominal interest rates below zero. An earlier literature studied this issue in light of the Bank of Japan’s experience with near-zero rates beginning in the mid-1990s and the Federal Reserve’s experience with very low rates in 2003 and 2004. That literature concluded that although the zero lower bound was likely to be a binding constraint relatively frequently, its average economic cost was likely to be small. Williams reexamines this conclusion in light of the recent crisis, during which most major central banks pushed interest rates close to zero.

Williams’s ﬁrst ﬁnding is that the zero lower bound is imposing very large costs in the current episode. He reports that although the downturn would have been almost as severe in the absence of the zero bound, the recovery would have been much faster. He estimates that an unconstrained Federal Reserve would have cut its federal funds rate target by about an additional 400 basis points, and that those cuts would have raised output over the next four years by a cumulative $1.8 trillion. Moreover, this increased output would have come with little or no cost in terms of the Federal Reserve’s inﬂation objective.

Looking forward, Williams considers the possibility that the recent sharp recession might signal a return to the greater macroeconomic volatility experienced in the 1960s and 1970s. Such a change would greatly increase the probability that the zero bound would become a binding constraint with a low target rate of inﬂation, fundamentally altering the case for a low target. For instance, Williams ﬁnds that a 1 percent annual inﬂation target would very likely be associated with frequent and costly encounters with the zero bound. A 2 percent target would also likely involve large costs if policy-makers follow a conventional interest rate rule; however, these costs could be mitigated substantially if policymakers followed alternative monetary policy rules or used countercyclical ﬁscal policy more aggressively. Only when the inﬂation target is set as high as 4 percent can policymakers be conﬁdent that the zero lower bound will not prevent them from forcefully countering recessions. This is an important and provocative ﬁnding in light of the current debate around the optimal inﬂation target for the United States.

In the second paper, Sumit Agarwal, John Driscoll, Xavier Gabaix, and David Laibson mount a compelling case that many individuals, particularly older ones, often make poor ﬁnancial choices. The authors investigate patterns of errors in personal ﬁnancial decisionmaking across several large-scale databases. A particular strength of these datasets is that they allow the authors to demonstrate quite convincingly that errors in ﬁnancial decisionmaking are both widespread and quite costly. The ﬁnancial mistakes they consider include suboptimal use of offers of low interest rates on transfers of credit card balances, misestimation of housing values, and tolerance of excessive interest rates and fee payments. Across a wide range of ﬁnancial decisions, the authors ﬁnd that the tendency to make these errors initially declines with age, then ﬂattens during the middle years, and ﬁnally rises increasingly steeply during old age. The “age of reason”—the trough of this U-shaped pattern—occurs when people are in their early ﬁfties. This nonlinear pattern likely reﬂects the offsetting inﬂuences of ﬁnancial experience (which rises with age) and cognitive ability (which generally declines with age). Financial errors by older persons are a particular source of concern because the stakes are often large—personal net worth is typically highest in old age—and the horizon to recover from errors is often limited.

The authors then turn to an assessment of the regulatory implications of these ﬁndings, structured around a taxonomy of alternative regulatory regimes. Although their focus is on the particular challenges faced by older adults, much of the discussion is relevant for all vulnerable populations. In rough order from least to most interventionist, the regimes are laissezfaire, disclosure requirements, “nudges” (through choices of defaults, for example), expanded use of advance directives (instructions set out today against a future loss of competency), requirements for ﬁnancial “driver’s licenses” (where individuals must establish competency to be allowed to make certain ﬁnancial decisions), enhanced requirements for ﬁduciaries, protection of assets through sequestration in safe investments, ex post prohibition of ﬁnancial products found to be deleterious, and mandatory preapproval of ﬁnancial products by regulators. This taxonomy provides a useful framework to guide regulatory change, although the authors conclude that a clear roadmap for appropriate regulation awaits further empirical evidence on how consumers actually make ﬁnancial decisions. Given the importance of the issues, much more research on household ﬁnance is clearly needed.

Standard textbook accounts of monetary policy describe the role of the central bank primarily in terms of its control of short-term interest rates (in the United States, the federal funds rate). Yet over the past two years the Federal Reserve and other central banks have deployed a whole host of alternative policy instruments, broadly described as “unconventional monetary policy.” In the third paper, Ricardo Reis examines the Federal Reserve’s use of these instruments.

Reis’s focus is on the most novel of the new instruments: direct interventions in credit markets. To analyze these, Reis builds a theoretical model describing the interactions among four types of ﬁnancial actors in addition to the central bank: investors, who have funds to lend but no specialized ﬁnancial knowledge or skills; traders, who have a specialized ability to evaluate ﬁnancial instruments; lenders, who have a specialized ability to evaluate investment projects; and entrepreneurs, who seek to borrow to undertake investment projects. This approach gives a central role to imperfect and incomplete information in explaining ﬁnancial market transactions. These market imperfections not only result in departures from ﬁrst-best outcomes, but in some circumstances can even lead to a collapse of normal ﬁnancial ﬂows.

Reis then examines the Federal Reserve’s recent interventions through the lens of his model. He ﬁnds that their impacts often depend on the details of the interventions, on market conditions, and on the skills or authority the central bank has that other market participants do not. He also ﬁnds that in many circumstances loans to traders are a particularly effective form of intervention.

The paper then turns to the Federal Reserve’s other instruments. Reis explains why standard concerns about the possibility of insolvency that apply to ﬁrms or governments do not apply to the central bank when it increases its liabilities by expanding the quantity of reserves. He also argues that the expansion of reserves will lead to inﬂation only if the Federal Reserve becomes unduly concerned about the state of its balance sheet, or if deterioration of the balance sheet results in the Federal Reserve losing its independence. Turning to the question of appropriate interest rate policy in the vicinity of the zero lower bound, Reis concludes that the Federal Reserve has followed the precrisis recommendations of many economists—committing to a spell of low interest rates and raising expected inﬂation—only to a very small extent.

Another dramatic change in the policy regime that has resulted from the crisis concerns the role of ﬁscal policy. Before the crisis, there was broad consensus that monetary policy should be the prime tool of stabilization policy. But with conventional interest rate policy constrained by the zero lower bound, many countries have turned to ﬁscal policy to stimulate their economies.

In the fourth paper, Robert Hall examines one such ﬁscal tool: increases in government purchases. The title of his paper poses his central question: By how much does GDP rise if the government buys more output? Hall begins with an empirical exploration, focusing on aggregate U.S. data since 1930. His ﬁrst conclusion is that government purchases have varied so little in the period since the Korean War that any test based on data from that period is almost certain to be uninformative. It is only the sharp shocks to government spending resulting from the Korean War and, especially, World War II that allow the correlation between increases in government purchases and increases in GDP to be estimated with any precision. Over his full sample, Hall ﬁnds that each dollar of increased government purchases is associated with an increase in real GDP of about 50 cents. Unfortunately for econometricians, government spending during those wars was not increased in isolation: both also featured major tax increases and (especially World War II) the use of command-and-control measures. Thus, no ﬁrm conclusions can be drawn from these episodes, although one can make a case that they provide likely lower bounds on the effects of increases in government purchases.

Hall then turns to theory. Again, his ﬁrst result is negative: he establishes that a baseline real business cycle model cannot deliver any substantial positive effect of increases in government purchases on output. He ﬁnds that two ingredients are critical to generating such an effect. The ﬁrst is some force causing ﬁrms’ markups of price over marginal cost to fall when output expands, leading to the possibility of a procyclical real wage. The second is a force causing modest increases in the real wage to bring forth substantial increases in the quantity of labor. Hall argues that such a response cannot plausibly occur if households are on their labor supply curves, but can arise if there are labor market and search frictions. He also argues that a third ingredient, complementarity between hours and consumption, is needed for consumption to rise. Adding these features to a calibrated model leads him to conclude that output rises slightly less than one for one with government purchases under normal economic circumstances. Importantly, he also ﬁnds that the impact is likely to be considerably larger when the nominal interest rate is at the zero lower bound.

In the final paper, Carmen Reinhart and Vincent Reinhart reexamine the macroeconomic policy lessons from the last previous episode of a large, synchronized global downturn: the Great Depression. That economic slump, like the current one, led policymakers to implement unconventional monetary policy, which for many countries took the form of abandoning the gold standard. The favored interpretation among economic historians has been that this step, by changing expectations and permitting monetary expansion and currency depreciation, was critical to recovery. The key piece of evidence for this interpretation is the ﬁnding among a small group of industrialized countries of a quantitatively large and highly statistically signiﬁcant correlation between how quickly countries left the gold standard and the severity of their depressions: countries that left sooner tended to fare better. Reinhart and Reinhart challenge this ﬁnding by showing that it is not robust. In particular, expanding the sample to include developing countries and a few others reduces the estimated effect and renders it insigniﬁcantly different from zero. The relationship is even weaker when alternative measures of output behavior are considered. This provocative ﬁnding raises the question as to why the strong relationship between exit and recovery disappears in the broader sample. The authors argue that one would not expect leaving gold to be enough to blunt a severe downturn, and they point out that many countries—including some that left gold early—did not experience substantial depreciations of their currencies against the U.S. dollar.

Turning to ﬁscal policy, Reinhart and Reinhart present two main ﬁndings. First, ﬁscal policy during the Depression was procyclical or acyclical in many countries. Second, even in those where ﬁscal policy was countercyclical, the stimulus was erratic, so that any potential beneﬁts might have been negated by uncertainty on the part of private agents about future policy. This uneven history makes the Great Depression a poor laboratory for testing the potential value of strong, steady ﬁscal stimulus in the face of a major worldwide downturn.

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Editors' Summary of the Spring 2009 Brookings Papers on Economic Activity

David H. Romer and Justin Wolfers — Thu, 02 Apr 2009 00:00:00 -0400

The papers discussed below are available as free downloads at the Brookings Papers on Economic Activity archive.

The Brookings Panel on Economic Activity held its eighty-seventh conference in Washington, D.C., on April 2 and 3, 2009. The conference occurred barely six months after the collapse of the investment bank Lehman Brothers, an event often used to date the transition from a largely conventional cyclical downturn, characterized by a strained ﬁnancial system and mild recession, to a full-blown ﬁnancial and economic crisis. In keeping with the Brookings Papers’ tradition of providing timely analysis of current economic events, three of the papers in this volume address the role of various factors in the initial downturn and the ensuing crisis, including the response of policymakers, the behavior of bond markets, and the role played by the oil market. The two remaining papers examine the impact of tax cuts on government spending, and the role of corruption in undermining popular support for market-oriented policies.

In the ﬁrst paper in this issue, Phillip Swagel provides an insider’s account of the policy debates as they unfolded in real time during his tenure as assistant secretary of the Treasury for economic policy in the last two years of the Bush administration. Swagel’s account is both a blow-byblow history of the policy response to the crisis and a lesson in economic realpolitik. He documents that the Treasury under Secretary Henry Paul-son was quite aware of the fragility of the ﬁnancial system as early as 2006, and indeed, interagency work was well under way to develop a strategy for dealing with a crisis should one occur.

Swagel’s narrative provides insight into the constraints on the policy process that were not immediately apparent to many commentators. In particular, policymakers at the Treasury and at the Federal Reserve were unable to pursue a number of useful policy proposals simply because they and other government agencies lacked appropriate legal authority. Although Congress could have granted that authority, this raised the even larger concern of political constraints, which were particularly important in the context of a profound lack of trust between the executive and legislative branches. A recurrent theme of the paper is the sheer difﬁculty of getting Congress to respond under anything less than crisis conditions— and possibly even then—which delayed and diluted the eventual policy response. Swagel also highlights a third, more practical constraint: time. Policymakers had to make decisions rapidly, often with too little information, as ﬁnancial markets collapsed around them. He reserves some constructive criticism for the role played by many academic macroeconomists throughout the ensuing public debate: their editorializing, in his view, appeared largely uninformed by the various constraints, rendering their advocacy often unhelpful and occasionally even counterproductive. At the same time, however, he faults the Treasury for doing a poor job of making its case to a skeptical public.

In the second paper, John Campbell, Robert Shiller, and Luis Viceira present a thorough accounting of what has been learned from the ﬁrst quarter-century of experience with inﬂation-indexed bonds in the United Kingdom and the ﬁrst decade of experience in the United States. Yields on these bonds indicate a substantial and puzzling decline in long-term real interest rates from the 1990s through 2008. The volatility of these real rates was likewise unexpected, given that a key determinant, the marginal product of capital, can reasonably be presumed to be stable over time. Over the same period, movements in the prices of inﬂation-indexed bonds have come to be negatively correlated with movements in stock prices. The authors also ﬁnd that seemingly very similar bonds can bear surprisingly different yields, with real U.S. and U.K. yields diverging at times by over 2 percentage points.

Having documented these facts, the authors set out to explain them. They begin with the expectations theory of the term structure—the view that long-term real yields reﬂect current and expected future short-term real interest rates. As expected short-term real rates vary, so too does this long-run expectation. Using a simple econometric model to proxy for expectations about current and future short-term rates, the authors succeed in replicating some of the observed changes in long-term inﬂation-indexed bond yields. Even so, the actual yields are higher and more volatile than suggested by these expectations. This leads the authors to explore whether the yields include a positive risk premium, and if so, how it has varied through time. However, the fact that inﬂation-indexed bond prices are negatively correlated with equity prices suggests that the risk premium should be negative, reﬂecting the value of these bonds in portfolio diversiﬁcation. Moreover, changes over time in this correlation can explain very little of the changes over time in real bond yields.

Finally, the authors pay special attention both to the high yields on inﬂation-indexed bonds in the years following their introduction, and to the extraordinary volatility in these yields during the ﬁnancial crisis in 2008. They conclude that institutional factors played an important role in both phenomena. Such “technical” factors are typically invoked as a euphemism for changes that cannot be otherwise explained, but the authors probe more deeply, ﬁnding that the current episode is “highly abnormal” and likely due to illiquidity, as ﬁnancial institutions were forced to unwind large positions quickly and few of the usual buyers were able to absorb these large shifts. Despite the apparent pricing anomalies that they document, however, the authors conclude that inﬂation-indexed bonds provide both a useful investment instrument for many investors and a valuable ﬁnancing tool for governments.

In the third paper, Christina Romer and David Romer examine the “starve the beast” hypothesis. (In the interest of full disclosure, we note that this paper was commissioned before David Romer accepted the editorship of this journal, and that the editorial duties were handled by his coeditor.) This hypothesis, most closely identiﬁed with President Ronald Reagan and his advisers, holds that tax cuts today impel future reductions in government spending, and hence in the size of government. Some previous studies have found evidence tending to support the hypothesis, but Romer and Romer point to two inherent problems in testing it. One is that the observed correlation between tax cuts and changes in spending might reﬂect reverse causality, with changes (typically increases) in government spending priorities causing changes in taxation. The other is that some third factor, such as a slowing economy, might affect both taxes and spending, producing a spurious association between the two.

To try to isolate the effect of tax changes on government spending, the authors rely on a narrative approach, poring over presidential speeches, congressional reports, and other documents to identify those legislated tax changes not tied to either spending changes or the state of the economy. This yields a set of tax changes that, they argue, can appropriately be used to test the starve-the-beast hypothesis. The most important of these are the 1948 tax cut that passed despite President Harry Truman’s veto, the Kennedy-Johnson tax cut in the mid-1960s, the Reagan tax cut in the early 1980s, and two tax cuts passed during President George W. Bush’s ﬁrst term.

In an exhaustive analysis of this more restricted set of tax changes, Romer and Romer ﬁnd remarkably little evidence in favor of the starve the-beast hypothesis. The tax cuts they identify are not followed by any systematic decrease in government spending relative to its previously expected path; indeed, there is some evidence of a tendency for spending to increase. Moreover, based on the documentary evidence, policymakers in the major episodes appeared largely unconcerned about the sufﬁciency of revenue when making their spending decisions. Instead, the subsequent budgetary adjustments in these episodes generally consisted of a combination of legislated tax increases and nonlegislated increases in revenue. The popular view that tax cuts are “sticky” and not easily undone, and thus, that they create strong pressures for reductions in spending, appears false.

The fourth paper, by James Hamilton, returns to a theme to which he has already made major contributions: the macroeconomic consequences of oil price shocks. The price of oil has recently been spectacularly volatile, rising from $60 a barrel in mid-2007 to a high of $145 a barrel in mid-2008 before collapsing to $30 a barrel by the end of 2008. Hamilton notes that this oil shock differed sharply from previous disruptions. Whereas those could typically be traced to geopolitical developments, this time the rise in oil prices reﬂected the working of the price mechanism to reconcile stagnating worldwide production with rising demand, particularly from China. Because the price elasticity of demand for oil is low, it took a large price rise to bring the quantity demanded back into line with the quantity supplied. In Hamilton’s account, perhaps the most important “shock” during this period was to the received ideas of market participants, who learned that short-run demand is even more price inelastic than they had thought. This shock helps explain both why oil production did not rise in response to the growing demand and why oil inventories declined. The popular competing story—that speculators bid up the price of oil futures, driving up the spot price—faces the key difﬁculty that it suggests, counter-factually, that inventories should have been accumulating. Hamilton argues further that the subsequent collapse in oil prices in 2008 was too large to be explained by the global recession. Instead, it likely reﬂects forces similar to those that accounted for its rise, but in the opposite direction, as market players underestimated the medium-run price elasticity of oil demand.

Hamilton shows that the oil price rise had quantitatively important effects in reducing both consumption spending—particularly on motor vehicles, and especially on domestically produced SUVs—and consumer sentiment in the United States. Marshalling an array of macroeconometric models, he shows that the oil shock explains a large part of the weak macroeconomic performance in late 2007 and much of 2008, and indeed that in the absence of the shock, this period would have been one of slow growth rather than outright recession.

The ﬁnal paper of this issue, by Rafael Di Tella and Robert MacCulloch, begins by documenting an important and previously overlooked stylized fact, namely, that capitalism is surprisingly uncommon around the world. Outside the major industrialized nations, heavy business regulation, leftist rhetoric, and pro-intervention beliefs are the norm. As the authors stress, this pattern is puzzling, given the strong evidence of the positive effects of market-oriented policies on economic growth and the enormous potential gains for poor countries, in particular, from adopting such policies.

The authors propose an intriguing explanation of this seemingly perverse bias against capitalism in poor countries: that it reﬂects the response of their citizens to a corrupt business sector. Corruption, the authors argue, is seen in these countries as disproportionately the fault of business leaders who seek favors from government rather than the bureaucrats who grant them. Hence corruption undermines the legitimacy of business, leading voters to favor interventionist and anticapitalist policies as “punishment” against the business owners, who are broadly seen as having beneﬁted unfairly from their favored position in society. The authors document that within a country, those individuals who perceive corruption to be more widespread tend to have more-interventionist beliefs. They also show that sharp increases in corruption within a country lead to a rise in left-wing voting. Anger is also found to be a more prevalent emotion in corrupt countries than elsewhere, and it is lessened by stricter regulation of business.

We conclude this summary by noting the recent changes in the editorship of the Brookings Papers. Although this is the ﬁrst volume with our names on the cover, the papers were selected by the previous editorial team of Douglas W. Elmendorf, N. Gregory Mankiw, and Lawrence H. Summers; William G. Gale handled much of the work during the transition to the new team. All four have our thanks for their work on this volume and throughout their tenures. We hope to build upon the outstanding foundation built not only by these editors but also by their predecessors, William C. Brainard, Arthur M. Okun, and George L. Perry. We will strive to ensure that the Brookings Papers continues to be a key source for original, timely, and substantive analysis of a wide array of pressing economic issues.

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