Downward Nominal Wage Rigidity, Currency Pegs, and Involuntary Unemployment

Schmitt–Grohé, Stephanie; Uribe, Martı́n

doi:10.1086/688175

Cited by 355 publications

(166 citation statements)

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“…For example, the relation between household debt and the business cycle is spuriously generated by expected income shocks in the credit demand hypothesis, leaving no special role for regulation. However, under the credit supply hypothesis, households may over-extend themselves when borrowing during a credit supply boom, necessitating the need for macro-prudential regulation.We present a number of results that reject the credit demand hypothesis and support the credit 1 See, e.g., Mian and Sufi (2014) and IMF (2012) for empirical evidence and Eggertsson and Krugman (2012), Guerrieri and Lorenzoni (2015), Farhi and Werning (2015), Korinek and Simsek (2016), Schmitt-Grohé and Uribe (2016), and Martin and Philippon (2014) for theoretical analysis.1 supply hypothesis. We show that an increase in the household debt to GDP ratio over a three year period 2 in a given country predicts subsequently lower output growth.…”

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confidence: 68%

“…We present a number of results that reject the credit demand hypothesis and support the credit 1 See, e.g., Mian and Sufi (2014) and IMF (2012) for empirical evidence and Eggertsson and Krugman (2012), Guerrieri and Lorenzoni (2015), Farhi and Werning (2015), Korinek and Simsek (2016), Schmitt-Grohé and Uribe (2016), and Martin and Philippon (2014) for theoretical analysis.…”

Section: Introductionmentioning

confidence: 77%

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Household Debt and Business Cycles Worldwide

2015

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An increase in the household debt to GDP ratio in the medium run predicts lower subsequent GDP growth, higher unemployment, and negative growth forecasting errors in a panel of 30 countries from 1960 to 2012. Consistent with the "credit supply hypothesis," we show that low mortgage spreads predict an increase in the household debt to GDP ratio and a decline in subsequent GDP growth when used as an instrument. The negative relation between the change in household debt to GDP and subsequent output growth is stronger for countries that face stricter monetary policy constraints as measured by a less flexible exchange rate regime, proximity to the zero lower bound, or more external borrowing. A rise in the household debt to GDP ratio is contemporaneously associated with a consumption boom followed by a reversal in the trade deficit as imports collapse. We also uncover a global household debt cycle that partly predicts the severity of the global growth slowdown after 2007. Countries with a household debt cycle more correlated with the global household debt cycle experience a sharper decline in growth after an increase in domestic household debt. The Great Recession has sparked new questions about the relation between household debt and the macroeconomy. Recent theoretical and empirical research recognizes that a sudden and large increase in household debt could lower subsequent output growth in the presence of monetary and fiscal policy constraints. Moreover, households may not internalize the macroeconomic effects of their own borrowing, making the economy susceptible to "excessive" credit growth. 1 However, empirical evidence on increases in household debt and subsequent economic performance is largely limited to the United States and the most recent global recession. A more systematic evaluation of the empirical relation between household debt and business cycles worldwide is needed in order to understand if recent events are representative of a broader pattern. This is important given the dramatic rise in household debt to GDP ratios over the last 50 years documented by Jordà et al. (2014a). This paper compiles data for 30 countries from 1960 to 2012 and provides several new results that highlight the importance of household credit shocks in driving business cycles worldwide.There are two broad hypotheses that relate household debt to business cycles. The "credit demand hypothesis" posits a positive relationship between current household borrowing and future income. Household borrowing in this view is driven by productivity or technology shocks that increase expected future income, spurring higher consumption and borrowing in anticipation. On the other hand, the "credit supply hypothesis" holds that higher household borrowing is driven by an expansion in the availability of credit. If there are plausible frictions such as nominal rigidities or monetary policy constraints, then households may borrow excessively which leads to an eventual slowdown in GDP growth.Distinguishing the credit demand and credit sup...

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confidence: 68%

Section: Introductionmentioning

confidence: 77%

Household Debt and Business Cycles Worldwide

2015

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“…Another factor proposed by the literature as an explanation for downturns is nominal rigidities, especially on the downside (e.g., Schmitt‐Grohé and Uribe ()). Figure explores the full dynamics of consumer prices and wages in early‐relative to late‐deregulation states.…”

Section: Credit Expansion and Business Cycle Amplificationmentioning

confidence: 99%

How Does Credit Supply Expansion Affect the Real Economy? The Productive Capacity and Household Demand Channels

Mian¹,

Sufi²,

Verner

2020

The Journal of Finance

116

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Credit supply expansion can affect an economy by increasing productive capacity or by boosting household demand. In this study, we develop a test to determine if the household demand channel is present, and we implement the test using both a natural experiment in the United States in the 1980s and an international panel of 56 countries over the last several decades. Consistent with the importance of the household demand channel, we find that credit supply expansion boosts nontradable sector employment and the price of nontradable goods, with limited effects on tradable sector employment. Such credit expansions amplify the business cycle and lead to more severe recessions.

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“…Second, our paper is related to a large literature that investigates possible sources of shocks that trigger long recessions and liquidity traps in environments with New Keynesian frictions. Many papers have emphasized demand shocks driven by household deleveraging or tightening borrowing constraints (Eggertsson and Krugman 2012;Christiano et al 2015;Korinek and Simsek 2016;Schmitt-Grohé and Uribe 2016), long-run factors such as aging demographics or safe asset shortages (Summers 2013;Eggertsson et al 2016;Caballero and Farhi 2017), or overinvestment of capital (Rognlie et al 2014). By highlighting the role of rational asset bubbles, our analysis offers a complementary narrative to those in the literature.…”

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confidence: 96%

Bubbly Recessions

Biswas¹,

Hanson²,

Phan³

2018

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We develop a tractable bubbles model with financial frictions and downward wage rigidity. Competitive speculation in risky bubbles can result in excessive investment booms that precede inefficient busts, where post-bubble aggregate economic activities collapse below the pre-bubble trend. Risky bubbles can reduce ex-ante social welfare, and leaning-against-the-bubble policies that balance the boom-bust trade-off can be warranted. We further show that the collapse of a bubble can push the economy into a "secular stagnation" equilibrium, where the zero lower bound and the nominal wage rigidity constraint bind, leading to a persistent recession, such as the Japanese "lost decades."

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Downward Nominal Wage Rigidity, Currency Pegs, and Involuntary Unemployment

Cited by 355 publications

References 34 publications

Household Debt and Business Cycles Worldwide

Household Debt and Business Cycles Worldwide

How Does Credit Supply Expansion Affect the Real Economy? The Productive Capacity and Household Demand Channels

Bubbly Recessions

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