A Major Shock Makes Prices More Flexible and May Result in a Burst of Inflation or Deflation
NBER Working Paper, March 2023
The US and other advanced countries suffered bursts of severe inflation in 2021 and the first half of 2022, followed by declines of inflation later in 2022, in some countries. In times of high volatility of price determinants -- cost and productivity -- inflation can jump upward and fall downward at high speed, contrary to the uniformly sticky behavior associated with traditional Phillips curves. This paper establishes that sectors with standard New Keynesian price stickiness are vulnerable to rapid transitions from stickiness to flexibility, as sellers elect to reset their prices and abandon anchoring. The paper shows that the cross-industry volatility of price determinants grew substantially in the inflation episode accompanying the pandemic. Volatility remained elevated even in late 2022. The logic of the New Keynesian model of the Phillips curve links inflation to volatility, because a larger fraction of sellers are pushed out of their regions of inaction when volatility is elevated. The New Keynesian Phillips curve becomes much steeper in volatile times.
Short-Selling Threats and Bank Risk-taking: Evidence from the Financial Crisis
Dien Giau Bui et al.
Journal of Banking & Finance, forthcoming
The focus of this paper is whether the Securities and Exchange Commission's Regulation SHO strengthens or weakens the effect of short-selling threats on banks’ risk-taking. The evidence shows that pilot banks with looser constraints on short-selling increased their risk-taking during the financial crisis of 2007–2009. The reason is that short-selling threats improved the information environment and mitigated the agency problems of banks during the pilot program that led to greater risk-taking by pilot banks. Additionally, this effect is mainly driven by pilot banks with poor corporate governance, or high information asymmetry. Overall, our paper provides novel evidence that the disciplinary role of short-sellers had a positive effect on bank risk-taking during the financial crisis.
Monetary Tightening and U.S. Bank Fragility in 2023: Mark-to-Market Losses and Uninsured Depositor Runs?
Erica Xuewei Jiang et al.
NBER Working Paper, March 2023
We analyze U.S. banks’ asset exposure to a recent rise in the interest rates with implications for financial stability. The U.S. banking system’s market value of assets is $2 trillion lower than suggested by their book value of assets accounting for loan portfolios held to maturity. Marked-to-market bank assets have declined by an average of 10% across all the banks, with the bottom 5th percentile experiencing a decline of 20%. We illustrate that uninsured leverage (i.e., Uninsured Debt/Assets) is the key to understanding whether these losses would lead to some banks in the U.S. becoming insolvent-- unlike insured depositors, uninsured depositors stand to lose a part of their deposits if the bank fails, potentially giving them incentives to run. A case study of the recently failed Silicon Valley Bank (SVB) is illustrative. 10 percent of banks have larger unrecognized losses than those at SVB. Nor was SVB the worst capitalized bank, with 10 percent of banks having lower capitalization than SVB. On the other hand, SVB had a disproportional share of uninsured funding: only 1 percent of banks had higher uninsured leverage. Combined, losses and uninsured leverage provide incentives for an SVB uninsured depositor run. We compute similar incentives for the sample of all U.S. banks. Even if only half of uninsured depositors decide to withdraw, almost 190 banks are at a potential risk of impairment to insured depositors, with potentially $300 billion of insured deposits at risk. If uninsured deposit withdrawals cause even small fire sales, substantially more banks are at risk. Overall, these calculations suggest that recent declines in bank asset values very significantly increased the fragility of the US banking system to uninsured depositor runs.
Progressive consumption taxes
Carlos da Costa & Marcelo Santos
Journal of Public Economics, April 2023
Whether consumption or labor income is progressively taxed is irrelevant to household choices and welfare in a static setting. Add dynamics to the problem and these two forms of progressivity have markedly different implications for how earnings vary along the life cycle: in a stylized life-cycle model, the progressive income tax reduces Frisch elasticities of labor supply whereas the progressive consumption tax reduces the elasticity of inter-temporal substitution. We explore the consequences of replacing the current U.S. tax system with one in which labor income taxes are linear and consumption taxes are progressive. We find welfare gains that exceed 10% in consumption equivalent variation terms in steady-state comparisons. An indirect consequence of the more variable earnings profile, greater asset accumulation, is found to be a very if not the most important quantitative aspect of progressive consumption taxes. Also important, when compared to labor income taxes, progressive consumption taxes are more positively correlated with inherited wealth. We take this aspect into account by considering a non–homothetic warm-glow motive that approximates the empirical distribution of wealth. We discuss several issues related to implementation and find that approximately half of the welfare gains are attained by using the information gathered by social security to implement income averaging in the sense of Vickrey (1947).
Martina Cuneo, Jetson Leder-Luis & Silvia Vannutelli
NBER Working Paper, February 2023
Audits are a common mechanism used by governments to monitor public spending. In this paper, we discuss the effectiveness of auditing with theory and empirics. In our model, the value of audits depends on both the underlying presence of abuse and the government’s ability to observe it and enforce punishments, making auditing most effective in middling state-capacity environments. Consistent with this theory, we survey all the existing credibly causal studies and show that government audits seem to have positive effects mostly in middle-state-capacity environments like Brazil. We present new empirical evidence from American city governments, a high-capacity and low-impropriety environment. Using a previously unexplored threshold in federal audit rules and a dynamic regression discontinuity framework, we estimate the effects of these audits on American city finance and find no marginal effect of audits.
Is Economics Self-Correcting? Replications in the American Economic Review
Jörg Ankel-Peters, Nathan Fiala & Florian Neubauer
University of Connecticut Working Paper, February 2023
Replication and constructive controversy are essential for scientific progress. This paper reviews the impact of all replications published as comments in the American Economic Review between 2010 and 2020. We investigate the citation rates of comments and whether a comment affects its original paper’s citation rates. We find that most comments are barely cited, and they have no impact on the original papers’ subsequent citations. This finding holds for original papers for which the comment diagnoses a substantive problem. We conclude from these citation patterns that replications do not update the economics literature. In an online opinion survey, we elicited viewpoints of both comment authors and original authors and find that in most cases, there is no consensus regarding the replication’s success and to what extent the original paper’s contribution sustains. This resonates with the conventional wisdom that robustness and replicability are hard to define in economics.
How relative marginal tax rates affect establishment entry at state borders
Yulong Chen et al.
Small Business Economics, March 2023, Pages 1081–1103
We apply border discontinuity analysis to measure the impact of marginal tax rates on capital income, property, sales, and income on establishment entry on either side of state borders. Establishments are more likely to enter on the side of the border with the lower marginal tax rates. The biggest differences in start-up rates are at borders with the largest tax rate differences, with property tax rate differences mattering most. We rank borders by the differences in start-ups due to tax structure, and we rank states by their distortionary tax structures. The greatest distortion in start-ups due to tax rates is at the Wyoming-Idaho border with an 8.6% lower probability of start-ups on the Idaho side. The most distortionary tax structure is Rhode Island’s at 14.2% lower probability of entry, but it is not as heavily disadvantaged at the border because its neighbor, Connecticut, has the third most distortionary tax structure.
Property Taxation as Compensation for Local Externalities: Evidence from Large Plants
Rebecca Fraenkel & Sam Krumholz
University of California Working Paper, October 2022
The external costs and benefits of large capital-intensive projects often occur on dramatically different spatial scales. When local jurisdictions have control over land use, this spatial mismatch can prevent socially beneficial projects from moving forward or allow socially harmful projects to be built. In this paper, we explore how local control of property taxation, one important localized benefit of these projects, can impact land use decisions in the context of large plants. We first demonstrate that property tax payments from plant openings are both economically large and valued by local residents as measured through changes in home prices. We next show that limiting local jurisdictions’ access to property taxation affects the likelihood that it will contain large plants by using a series of school finance reforms as plausibly exogenous shocks. Following these reforms, we observe significant declines in large manufacturing establishments and local manufacturing employment per capita both in absolute and relative terms. These results suggest that increased property tax revenues are an important local benefit of large externality-producing projects and that policies which affect local property taxation can have major unintended consequences for non-residential land use.
The Impact of New Jersey's Urban Enterprise Zones on Local Employment: A Synthetic Control Approach
Economic Development Quarterly, forthcoming
The designation of enterprise zones is a place-based policy that seeks to revitalize economically blighted areas. The literature on place-based policies has found mixed results regarding their effects on local payroll employment. This paper examines the causal effects of five of New Jersey's Urban Enterprise Zones (UEZs) on local payroll employment: Bayonne, Gloucester City, New Brunswick, Roselle Borough, and The Wildwoods (Wildwood City, Wildwood Crest, North Wildwood, and West Wildwood). All were designated as UEZs by the state in the 2000s, and none have been previously evaluated in the academic literature. The program offers reduced local sales tax, tax credits for newly hired employees, subsidized unemployment insurance costs, worker training assistance, and tax-free purchases on capital equipment and facilities. A synthetic control approach is used with the industrial composition of local firms and poverty rate as the covariate group and no impact of UEZ status on local employment in the treatment periods of the five areas is found. These results suggest that enterprise zones may not be effective job creators for treated areas, particularly for those zones that were added long after the program's inception.
Does the US have an Infrastructure Cost Problem? Evidence from the Interstate Highway System
Matthew Turner, Neil Mehrotra & Juan Pablo Uribe
NBER Working Paper, February 2023
We pose the problem of managing the interstate as an optimal capital stock problem and define user cost as the charge per vehicle mile travelled that rationalizes observed investments in lane miles and pavement quality. We find that user cost is the sum of the opportunity cost of lane miles, pavement quality, and depreciation. Each depends on the price of lane miles and pavement quality. We estimate these prices and evaluate user cost. Despite large increases in the price of lane miles and pavement quality, user cost declines almost 50% from 1992-2008 due to lower interest rates and higher usage. Increased materials costs largely explain the increasing price of pavement quality, and we reject several common hypotheses for the increase in the price of lane miles.