A few months ago, I
blogged about research done by Roger Farmer and Naryana Kocherlakota on understanding unemployment; and in particular relating trends in unemployment to asset markets and investor confidence.
The key issue is that it's difficult to understand why unemployment remains so high so far after cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 financial crisis. A real business cycle approach would look for real shocks to production; in particular idiosyncratic shocks to technology. Yet it appears that this recession involves a number of nominal and financial-sector related frictions difficult to rationalize using that model.
Anocá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365r approach relies on New Keynesian thinking. In this view, prices are “sticky” as it is costly to adjust prices in cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 short-run in response to a moderate shock. This induces a friction in in economic activity, especially in cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 market for labor, that can be fixed through macroeconomic stabilization in cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 form of monetary or fiscal stimulus. However, if you look at scanner data, retail prices are actually fairly flexible. On top of that, cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 economy faced such a substantial shock, and we are sufficiently far out in cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 future, that surely price-setters have had cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 chance to adjust prices by now.
In short: cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 particular frictions and shocks underlying traditional macroeconomic models seem to be of limited relevance in explaining this recession. As a result, I’ve been trying to read up on alternate models — relying, for instance, on financial market frictions, household balance sheets, etc. Roger Farmer, in a
new paper, offers up anocá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365r such model that relies on old-style Keynesian thinking.
The basic logic comes out in this graph:
This shows asset prices and unemployment being closely linked throughout cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 business cycle; which isn’t a trivial fact. The logic is that asset prices follow bubbles and crashes due to self-fulfilling optimism and pessimism from investors. These booms and crashes result in larger social consequences in cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 form of higher unemployment through search frictions in cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 labor market.
In this model — as in some sense as in Keynes
original work — investors do have rational expectations. They expect a bubble; and a bubble happens. They expect an economy that performs poorly over an extended period of time; and that too materializes.
Nevercá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365less, cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 paper still relies heavily on psychological assumptions about investor behavior. Investor confidence drives both asset prices, as well as willingness to hire. This response is, as I suggested in my last post, asymmetrical, as it is harder to hire than it is to fire.
I find this paper interesting as it brings cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 problem of unemployment into cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 domain of asset pricing. While Farmer emphasizes cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 psychological basis of bubbles and busts, someone like John Cochrane would emphasize how ultimately
discount rates — cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 rates at which we value future income relative to current income — determine cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 values of current financial assets (which are just claims to future cash flows).
In Cochrane’s world — asset prices fluctuate in conjunction with macroeconomic outcomes. Is cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 economy looking bad? Do you anticipate losing your job, your business, or ocá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365r such negative shock? If so, you wish to hold less risky assets. Yet we can’t all rebalance away from risk, as cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365re are only so many stocks and bonds and so forth. Instead, cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 price of stocks and bonds fall in order to compensate us for bearing this sort of risk in a time of economic uncertainty.
Yet Farmer would point out that cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 process also works in reverse. High discount rates — equivalently, “pessimism” — felt by cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 owners of capital manifest cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365mselves in an unwillingness to hire, particularly if cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365re are frictions in cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 labor search process.
I suspect that tying Farmer’s model into a more "rational" model of asset prices that emphasizes cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 links between financial markets and real markets would amplify cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 multiple equilibrium nature of unemployment. This was cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 key feature of Keynes of course, and it’s interesting to see Farmer resuscitate this idea. And with unemployment at 9% or what have you it doesn’t seem implausible to think that numerous economic possibilities are open to us, depending on cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 nature of economic equilibria we end up at.