Understanding Noninflationary Demand-Driven Business Cycles
2014; University of Chicago Press; Volume: 28; Linguagem: Inglês
10.1086/674592
ISSN1537-2642
Autores Tópico(s)Economic theories and models
ResumoPrevious articleNext article FreeUnderstanding Noninflationary Demand-Driven Business CyclesPaul Beaudry and Franck PortierPaul BeaudryVancouver School of Economics, University of British Columbia, and NBER Search for more articles by this author and Franck PortierToulouse School of Economics and CEPR Search for more articles by this author PDFPDF PLUSFull Text Add to favoritesDownload CitationTrack CitationsPermissionsReprints Share onFacebookTwitterLinkedInRedditEmailPrint SectionsMoreI. IntroductionIn this paper we first point out a puzzle regarding the nature of US business cycles over the last thirty years. As is well known, over this period the economy experienced three main cycles. In each case, the common narrative behind these cycles has been that they were in large part driven by demand (residential investment demand in the 2000s, "tech" investment demand in the 1990s, and commercial real estate investment demand in the 1980s). The view that these cycles were to a large extent demand-driven is supported by the fact that both TFP (total factor productivity) and measured investment-specific technological progress were either countercyclical or at most acyclical over the period, making a pure supply-side explanation unlikely. While the real economy experienced these cycles, inflation was very stable over the entire period and exhibited only a very small covariance with output. Such demand-driven cycles are not in themselves puzzling, but the associated inflation patterns are if one adopts a simple New Keynesian perspective for interpreting the period. In particular, using a standard calibration of a baseline New Keynesian Phillips curve, we show that actual inflation exhibited a level of volatility two to seven times smaller than that predicted by the model. While it may be possible to explain these facts by relying on very infrequent changes in prices (much larger than that supported by microeconomic studies), or by adding sticky wages, we believe that it is desirable to explore more substantive changes to the New Keynesian paradigm, which may deliver more robust explanations to episodes of noninflationary demand-driven business cycles. This is the goal of the paper.The main claim of the paper is that noninflationary demand-driven business cycles are very easy to explain if one moves away from the representative agent framework on which the New Keynesian model and the RBC (real business cycle) model are based. There are two dimensions on which we believe one needs to move away from the representative agent framework. On the one hand, it is important to recognize that in the short run agents are not perfectly mobile between different sectors of the economy. In particular, an agent that is producing consumption goods may not be able to switch without cost to producing investment goods. On the other hand, it is also the case that financial markets are incomplete such that agents may not perfectly insure themselves against shocks that may affect the sector in which they are specialized. We will show that these two features are sufficient to offer a simple theory of noninflationary demand-driven business cycles. The reason that sectoral specialization is important is that it gives rise to trade between individuals, where the value of that trade—the gains from trade—vary with agents' perceptions about the future. For example, if the demand for the investment good by workers in the consumption sector goes down because they become more pessimistic about the future, so does their desire to trade consumption goods with agents in the investment goods sector. This will cause a reduction in trade and production of both the consumption and investment goods. Hence, an initial drop of the perceived value of investment will trigger a broad-based recession, contrarily of what would happen in a representative agent model, where resources would instead be allocated away from the investment sector toward the consumption sector, leading to an increase in consumption. As this contraction of trade is not the outcome of some imperfect flexibility of prices, it can be accommodated without putting pressures on inflation. Similarly, rosy perceptions regarding the future returns to capital can create a generalized boom without inducing inflation.The paper is structured as follows. In section I we present business cycle patterns that motivate our analysis. In section II we give a preview of our theoretical approach, present our basic framework, and derive the competitive equilibrium of the economy. In section III we show how and when changes in demand induced by changes in perceptions about the future can cause business cycle type fluctuations if agents are not perfectly mobile across sectors and cannot fully insure against changes in perceptions. As we prove our claims in a very simple setup, we also discuss the generality of the results. In section IV we extend the model to allow for sticky prices, which gives rise to a modified New Keynesian model. The main aspect we emphasize is that the concept of a natural rate should not be viewed as only determined by productive capacity, frictions and preferences, and independent of what may appear as demand shocks. Instead we show that in our framework the natural rate is inherently linked to changes in demand-type shocks, and therefore one cannot view changes in demand as inducing movement along a stable Phillips curve. The Phillips curve itself will change with demand shocks. Hence in our setup it is not necessarily the case that a supply shock renders a different type of inflation-output trade-off than that associated with a demand shock. Finally, in section V, we explore the relevance of our main assumptions regarding labor market segmentation and incomplete insurance using PSID (Panel Study of Income Dynamics) data over the period 1968 to 2007.Note that throughout our analysis, our aim is to present the main ideas in the most possible transparent setting. The results presented here are therefore all of a qualitative nature, and we present examples that can be solved analytically as much as possible. Given our focus on clarifying qualitative implications, we leave for further exploration the quantitative implications of our framework.A. Motivating PatternsFigure 1 plots the US series for total hours worked, real GDP, and inflation over the period 1960:Q1 to 2012:Q3. The hours worked series and the GDP series are in per capita terms and HP filtered.1 The inflation series corresponds to the log change in the core CPI (Consumer Price Index). Table 1 reports the standard deviations of these series for the same period and for the post-Volcker subperiod (1987:Q4–2012:Q3). The table also reports standard deviations for other prices series and for HP (Hodrick-Prescott) filtering, showing the robustness of the patterns. What can be seen on the figure and from the table is that the volatility of hours worked has remained almost unchanged over the period, and we can see three clear cycles since the 1982 recession. In this respect the business cycle remains fully alive in the second part of the sample. In contrast to hours, the volatility of inflation is about half as volatile over the post-Volcker period when compared with the full sample. In fact, in the post-Volcker period, as seen in figure 1, the inflation series appears remarkably flat. For GDP, there is a modest decrease in volatility that is well known from the Great Moderation literature.Fig. 1. Hours, GDP, and inflationNote: Hours and GDP are per capita and HP filtered. Inflation is not filtered, and in annual terms. Shaded areas represent episodes identified as recessions by the NBER.View Large ImageDownload PowerPointTable 1. Standard deviation of hours, GDP, and various measures of inflationVariable1960:Q1–2012:Q3Post-VolckerHours1.911.96GDP1.551.22Core CPI inflation0.670.28Core PCE inflation0.540.25GDP deflator inflation0.590.25HP core CPI inflation0.340.14HP core PCE inflation0.230.13GDP Deflator inflation0.270.18Notes: Hours and GDP are per capita and HP filtered. Inflation measures are either in levels or HP filtered. CPI is Consumer Price Index, PCE is Personal Consumption Expenditures, "Core" means excluding food and energy.View Table ImageThis is the first question we want to address: Is the joint movement of output and inflation over the post-Volcker period approximately consistent with a standard New Keynesian model where HP filtered movements in output primarily reflect changes in demand (i.e., the output gap) as opposed to changes in the natural level of output that reflect changes in supply? To explore this issue, let us consider the basic New Keynesian Phillips Curve (where we follow the notation from Galí's 2008 textbook):πt=βEtπt+1+κy˜t+μt,where κ = λ[σ + (ϕ + α)/(1 − α)], λ = [(1 − θ)(1 − βθ)]/θ]Θ, and Θ = [(1 − α)/(1 − α + α∈)], ỹt is the output gap (defined as actual minus natural output), and μt is a supply cost push shock assumed to be i.i.d. with mean zero. If, for example, the output gap is an AR(1) process with persistence ρ:y˜t=ρy˜t−1+∊t,where ∈t is a mean zero i.i.d. process, then solving forward we obtain:πt=κ1−βρy˜t+μt.The term [κ/(1 − βρ]ỹt, therefore, provides a measure of predicted inflation based on movements in the output gap. We use Galí's baseline calibration (Galí 2008, chapter 3) for the Phillips curve. Those parameters are displayed in Table 2. Note that θ = 2/3 corresponds to a mean price duration of three quarters.Table 2. Galí's baseline calibration of the New Phillips curveβσϕαθε0.99111/32/36View Table ImageThe remaining element needed to calculate our predicted inflation series is the autoregressive parameter for the output gap, which we estimate to be 0.85 from our HP filtered GDP series over the period 1947 to 2012. In Table 3 we report the volatility of the resulting predicted inflation as well as its ratio relative to four measures of actual inflation. These measures are the level core CPI core inflation, HP filtered core CPI inflation, level GDP deflator inflation, and HP filtered GDP deflator inflation. As can be seen from the table, the volatility of predicted inflation is roughly 3.5 to 7 times larger than that of actual inflation for the post-Volcker period.2 The predicted inflation series and actual core CPI inflation (HP filtered) are plotted together in figure 2 for the post-Volcker period. This figure gives a clear visual representation of how far the predicted series deviates from actual inflation over the period.Table 3. Predicted (by the NPC) and actual standard deviations of inflation, for different measures of inflation and different samples, using HP filtered per capita GDP as a measure of the output gap 1960–2012Post-Volcker Actual s.d. of ygap1.551.22(a)Actual s.d. of level CPI core inflation0.670.28(b)Actual s.d. of HP CPI core inflation0.340.14(c)Actual s.d. of level GDP deflator inflation0.590.25(d)Actual s.d. of HP GDP deflator inflation0.270.18(e)Predicted s.d. of inflation1.220.96 Ratio (e)/(a)1.833.45 Ratio (e)/(c)2.073.83 Ratio (e)/(b)3.546.91 Ratio (e)/(d)4.455.26View Table ImageFig. 2. Actual inflation and the one predicted by the New Phillips curveNote: Actual inflation is demeaned core CPI inflation and output gap is measured by HP filtered GDP. Shaded areas represent episodes identified as recessions by the NBER.View Large ImageDownload PowerPointThere are at least three inferences one can take away from the observed discrepancy between our simple New Keynesian model–based predicted inflation series and actual inflation. First, it may be that the parameters or specification that we are using for the simple Phillips curve are wrong. Second, it may be that cyclical movements in output mainly reflect changes in the supply capacity of the economy as opposed to changes in demand, making HP filtered output a very improper measure of the output gap over this period. Or third, it may be that the simple New Keynesian model may be misleading by emphasizing that demand-driven changes in output should be inflationary. As for the first inference, it is obviously possible to find parameters that will allow the volatility of inflation built from (1) to be similar to that observed in the data. However, this requires a very large degree of price stickiness, which seems implausible to us. As an example, a mean price duration of seven quarters is needed for predicted inflation to match actual one, when actual inflation is measured by HP filtered core CPI inflation over the post-Volcker period. Using a more sophisticated model that includes wages rigidities and backward-looking Phillips curve might be a way to solve this quantitative issue. This is generally the approach favored by the literature, but it is not the path we follow here. Instead we want to propose an alternative real mechanism. However, before exploring this alternative path, we want to briefly discuss the second possibility that cyclical changes in output over the post-Volcker period may have been primarily driven by changes in the supply capacity of the economy as opposed to changes in demand.Following the RBC literature, we begin by exploring the plausibility of a supply-based story by examining the behavior of total factor productivity over the period as this could be the driver of noninflationary output movements. To this end, we use the measure of TFP built by John Fernald (2012), which is corrected for capacity utilization. In figure 3 we plot together both hours worked and TFP as well as GDP and TFP (all series are HP filtered). Visual inspection suggested that these series are not comoving positively together over the period. In fact, the correlations are quite negative. Post-Volcker, the actual correlation between hours worked and TFP is –.64, while the correlation between GDP and TFP is –.23. This suggests to us that interpreting output movements over the post-Volcker as reflecting mainly change in the supply capacity of the economy driven by TFP is not a very plausible avenue.Fig. 3. Joint movements of hours, GDP, and TFPNote: Hours and GDP are per capita and TFP is the corrected Fernald (2012) measure. All variables are HP filtered. Shaded areas represent episodes identified as recessions by the NBER.View Large ImageDownload PowerPointWhile a TFP based supply story does not seem promising as a way to help reconcile the inflation predicted by the simple New Keynesian model and actual observed inflation, an explanation based on investment-specific technological change may offer another channel. In particular, following the logic presented in Greenwood, Hercowitz, and Huffman (1988)—and more recently in Fisher (2006) and in Justiniano, Primiceri, and Tambalotti (2010)—an increase in productivity of investment can act as an expansionary supply shock if the induced change in the relative price of investment leads firms to depreciated their capital stock more quickly. To explore the plausibility of this channel over the period, we examine the movement of the relative price of investment in terms of consumption goods. In Table 4 we report the correlation between various measures of the price of investment goods and hours worked or output. The table reports correlations for eight different measures of the relative price of investment goods, where the price of the consumption good is associated with the core CPI series.3 We report correlations for the whole sample as well as for the post-Volcker sample to help clarify relationship with the literature.Table 4. Various measures of the relative price of investment, deflating with core CPI, correlations with hours, and GDP With HWith GDPVariable1960:Q1–2012:Q3Post-Volcker1960:Q1–2012:Q3Post-VolckerQual. adj. I–0.070.56–0.070.38Fixed I0.420.760.230.56Non res. I0.090.63–0.080.35Struct.I0.440.750.180.53Equip.I–0.250.17–0.26–0.04PPI equip.–0.240.11–0.29–0.06Resid. I0.700.800.560.74SP5000.310.560.400.66Note: All variables are HP filtered. See appendix for sources.View Table ImageThe eight investment prices we consider are: the quality-adjusted investment price built by Liu,Waggoner, and Zha (2011); the BEA (Bureau of Economic Analysis) measure for fixed investment, and separately, the BEA measures for nonresidential investment, structures, equipment, and residential investment; and finally the PPI (Producer Price Index) for equipment from the BLS (Bureau of Labor Statistics). We also report results using the SP500 as a measure of the price of investment as suggested by Q-Theory. If we first focus on Table 4, which reports correlations with HP filter hours worked, we see that over the entire sample there is a mix of correlations. The relative price of structures and residential investment are procyclical, while the relative price of equipment is countercyclical. If we take a weighted sum of these different components, as done by Liu, Waggoner, and Zha (2011), we get an overall picture where the relative price of investment is approximately acyclical. However, once we focus on the post-Volcker period we get a much clearer picture with the relative of investment appearing procyclical for all our measure, albeit only mildly so for equipment. Interestingly, over the post-Volcker period, the correlation based on the encompassing price of investment built by Liu, Waggoner, and Zha (2011) is almost identical to that reported with the SP500. In panel (a) of figure 4 we plot together hours worked and relative price of investment based on the encompassing Liu, Waggoner, and Zha (2011) index as to illustrate its cyclical pattern. If we move to the correlations with output, the patterns are quite similar, although now the equipment price is mildly countercyclical even over the later period.4Fig. 4. Joint movements of hours and the quality-adjusted relative price of investment and of GDP, consumption, and investmentNote: Consumption is total consumption, investment is fixed investment. The quality-adjusted price of investment is taken from Liu, Waggoner, and Zha (2011) and is deflated by core CPI. All variables are HP filtered. Shaded areas represent episodes identified as recessions by the NBER.View Large ImageDownload PowerPointIn summary, the data presented in this section suggest that over the 1980s, 1990s, and 2000s (a) there have been standard size business cycles movement in terms of hours and slightly reduced size in terms of output; (b) based on movements in TFP and the relative price of investment, these cyclical variations do not seem primarily driven by changes in the supply capacity of the economy,5 which supports a mainly demand-driven narrative for the period; and (c) if the fluctuations are viewed as mainly demand-driven, then the volatility of inflation is surprisingly low. Note that, as shown in panel (b) of figure 4, post-Volcker fluctuations have been "typical" in the sense that consumption and investment were highly procyclical over the period; correlations with HP filtered output are, respectively, .92 and .91. Such positive comovement between consumption, investment, and hours worked will be a key feature we will want our demand-driven model of fluctuations to replicate.In light of these observations, it appears of interest to us to search for a business cycle framework where increases (decreases) in demand can simultaneously create increases (decreases) in hours worked, output and the relative price of investment goods, while not putting any upward (downward) pressure on inflation. The object of the following section is to present such a framework.II. Heterogenous Agents and Demand-Driven Macro FluctuationsA. Demand-Driven Macro FluctuationsAs our goal is to provide a framework for understanding noninflationary demand-driven business cycles, the first issue we need to address is, what do we mean by demand-driven fluctuations? There are several notions of demand shocks in the literature: unexpected changes in exogenous components of output demand such as military spending or other government purchases, or changes in perception about the future state of the economy.6 Our goal is to provide a framework where any of these types of changes could be consistent with noninflationary fluctuations. However, for presentation we will initially focus on demand changes that are associated with changes in perceptions. In a web appendix available from the authors, we show how the same framework can also rationalize noninflationary fluctuations induced by government purchases.The question we will ask is, therefore, under what conditions can a change in perception about the future cause a business cycle (meaning that aggregate output, consumption, investment, hours, as well as sectoral output and hours all co-move) and create fluctuations that do not put pressure on prices. This question can actually be addressed in two steps. In the first step, we can ask under what conditions can changes in perceptions cause a business cycle in a flexible price environment without money, and then in a second step extend the structure to a sticky price environment to show how the resulting model departs from the standard New Keynesian model in a way that allows for noninflationary demand-driven fluctuations.Our first step, therefore, will be to focus on a real (flexible price) model to derive novel insight on when changes in perception can cause business cycle type comovements, that is, positive comovements between investment, consumption, and hours worked. It should be noted that there exist a substantial literature that explore this issue.7 However, in our view most of the proposed explanations in the literature are not very compelling, as either they rely on quite questionable or unintuitive mechanisms or they have what we view as counterfactual predictions.8 Accordingly, our goal will be to highlight a mechanism that is both intuitive and simple and for which we can provide micro-evidence in support of its assumptions.Before going into the formal analysis, it is helpful to begin by providing a simple overview of the mechanisms that we will advance for understanding noninflationary demand-driven fluctuations, and especially clarifying why departing from a representative agent setup may be central to explaining such pattern. Consider an economy where agents' perception about the future changes in a direction that favors increased investment demand now: this could be due, for example, to a perception that future risk has diminished, that future economic policy will favor capital holders, or that future technological change will increase the return to capital. At fixed prices, this will also tend to favor increased consumption, and possibly reduced labor supply, as agents will feel richer. So with increase in demand for both consumption and investment and no increase in labor supply (and even possibly a decrease), some prices will have to adjust. In the standard one-sector representative agent model with sticky prices, two types of outcomes are possible. The first one is that monetary authorities will want to control inflation and will therefore need to increase interest rates to a point where either consumption or investment declines so as balance the goods market. The second one is that the monetary authorities let the increase in demand directly translate into increased output, but this will require an increase in inflation to reduce profit margins in order for the goods market to balance. In neither case will there be a noninflationary generalized expansion of consumption, investment, and hours worked. The reason is that changes in perceptions never lead to a situation where it is optimal for the representative agent to increase both consumption and investment if leisure is a normal good, as this is well known (at least) since Barro and King (1984).Now let us contrast this situation with a case where there are two type of agents; one working in the consumption sector and one working in the investment sector. Following a change in perception that favors the accumulation of the investment good, the agent in the consumption sector will now want to trade with the agent in the investment sector by exchanging the consumption good for the investment, generally leading to an increase in activity in both secto
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