Research
Academic Papers
with David Baqaee
[Full Text] [NBER]
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We analyze economies with quotas and other quantity-based distortions. We show that any feasible, distorted allocation of resources can be implemented as the competitive equilibrium of an economy with quotas. Unlike economies with wedges, economies with quotas are constrained efficient and thus satisfy macro-envelope conditions. This means that the effects of changes in technologies, distortions, or policies can be expressed in terms of a small set of sufficient statistics. We provide a non-parametric and nonlinear characterization of the effects of quota and productivity changes on aggregate output. We also calculate the costs of misallocation due to quotas. These costs are expressed in terms of the price elasticities of an inverse demand system capturing how quota prices respond to changes in quota levels. We illustrate our results using several examples: we estimate efficiency gains from increasing the cap on H-1B visas, relaxing zoning restrictions on single-family housing in American cities, removing capital controls in Argentina, phasing out U.S. quotas on Chinese clothing and textiles, and eliminating the taxicab medallion system in New York City. Our results offer a flexible method for quantifying the costs of quota distortions and the effects of policy reforms across these settings.
[Full Text] [SSRN]
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Empirical studies find that the pass-through of input cost changes to prices is incomplete: a 10 percent increase in costs causes downstream prices to rise less than 10 percent, even at long horizons. Using microdata from gas stations, food products, and manufacturing industries, we find that incomplete pass-through in percentages often disguises complete pass-through in levels: a $1/unit increase in input costs leads to $1/unit higher downstream prices. Pass-through appears incomplete in percentages due to a gap between prices and costs. Complete pass-through in levels contrasts with workhorse macroeconomic models that feature homothetic demand systems. We identify an alternative class of demand systems that yields pass-through in levels and highlight four implications. First, measuring pass-through in percentages can lead to spurious evidence of asymmetry and size-dependence. Second, pass-through in levels can explain dynamics of industry gross margins, operating profits, and entry in the data that are at odds with workhorse models. Third, demand systems that generate pass-through in levels can explain different pass-through rates for labor costs relative to other inputs. Finally, incorporating pass-through in levels into an input-output model of the U.S. economy can reconcile the low volatility of consumer price inflation with microeconomic estimates of markups.
New version coming soon! (Some results now in companion paper, "Complete Pass-Through in Levels")
[Full Text] [SSRN] [VoxEU Summary] [Slides]
Media: Macro Roundup
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We document a new, within-category source of fluctuations in inflation inequality. When the cost of upstream inputs rise, products within a category tend to have similar absolute price increases. However, identical absolute price increases appear as higher inflation rates for low-price products, resulting in excess inflation at the low end ("cheapflation"). Since low-income households tend to consume products with lower prices, inflation rates faced by low-income households are disproportionately sensitive to upstream costs. Using data on food-at-home purchases, we show that this mechanism generates cycles in food-at-home inflation inequality and excessive volatility in inflation rates for low-income households relative to high-income households. This channel parsimoniously accounts for the surge in cheapflation and inflation inequality from 2020--2023. We provide evidence that this mechanism applies to other consumption categories beyond food-at-home, suggesting substantial cyclical fluctuations in inflation inequality that are not captured in existing statistics.
[Full Text] [SSRN] [Slides]
Media: Marginal Revolution
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We examine the relationship between customer income and firm markups using data on household transactions and wholesale costs. Doubling a household’s income is associated with a 2–3 percent increase in retail markups paid. This elasticity of markups to household income is two times larger than previous estimates that compare prices paid for identical products alone. We estimate that doubling the income of all households in an economy leads to an 8–15 percent increase in the aggregate markup due to spillovers across households. We develop a macroeconomic model with consumer search that can account for these facts. Consistent with the model’s predictions, we document that retail markups across cities rise with both per-capita income and inequality. Through the lens of the model, changes in the income distribution since 1950 account for a 11pp rise in retail markups, with 25 percent of the increase due to growing income dispersion. This increase consists of both within-firm markup increases and a reallocation of sales to high-markup firms, which occurs without any change to the nature of firm production or competition.
with Namrata Narain
Accepted, International Journal of Central Banking
[Full Text] [SSRN] [VoxEU Summary]
Media: Wall Street Journal, Financial Times, Bloomberg, Brookings, Marketwatch, Bloomberg Opinion, Semafor, Investopedia
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We document a shift in the market impact of the press conference given by the Federal Reserve Chair at the close of FOMC meetings. Using intraday trading data, we find that market volatility is more than three times higher during press conferences given by current Chair Jerome Powell than during press conferences by predecessors Janet Yellen and Ben Bernanke. Press conferences since the start of Covid-19 are largely responsible for the heightened market volatility during Chair Powell's conferences. During this period, we find that the market tends to move in the opposite direction during the press conferences compared to its movement following the FOMC statement publication. In contrast, press conferences by Chairs Bernanke and Yellen tended to reinforce the market's initial reaction to the information released in the FOMC statement. Text analysis of the Q&A portions of Powell’s press conferences suggests that his choice of language correlates with these market movements. We find that Fed communications during the recent period have been less effective in reducing forward-looking interest rate uncertainty.
with David Rezza Baqaee and Emmanuel Farhi
Review of Economic Studies, 91 (3) 2024: 1373-1405
[Full Text] [NBER] [VoxEU Summary] [Code for Evaluating Demand System]
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How does an increase in market size, say due to globalization, affect welfare? We study this question using a model with monopolistic competition, heterogeneous markups, and fixed costs. We characterize changes in welfare and decompose changes in allocative efficiency into three different effects: (1) reallocations across firms with heterogeneous price elasticities due to intensifying competition, (2) reallocations due to the exit of marginally profitable firms, and (3) reallocations due to changes in firms’ markups. Whereas the second and third effects have ambiguous implications for welfare, the first effect, which we call the Darwinian effect, always increases welfare regardless of the shape of demand curves. We non-parametrically calibrate demand curves with data from Belgian manufacturing firms and quantify our results. We find that mild increasing returns at the micro level can catalyze large increasing returns at the macro level. Between 70–90% of increasing returns to scale come from improvements in how a larger market allocates resources. The lion’s share of these gains are due to the Darwinian effect, which increases the aggregate markup and concentrates sales and employment in high-markup firms. This has implications for policy: an entry subsidy, which harnesses Darwinian reallocations, can improve welfare even when there is more entry than in the first-best.
with David Rezza Baqaee and Emmanuel Farhi
Journal of Political Economy, 132 (4) 2024: 1065-1112
[Full Text] [NBER] [VoxEU Summary]
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We propose a supply-side channel for the transmission of monetary policy. We show that in an economy with heterogeneous firms and endogenous markups, demand shocks such as monetary shocks have a first-order effect on aggregate productivity. If high-markup firms have lower pass-throughs than low-markup firms, as is consistent with empirical evidence, then a monetary easing reallocates resources to high-markup firms and alleviates misallocation. Consequently, positive “demand shocks” are accompanied by endogenous positive “supply shocks” that raise output and productivity, lower inflation, and flatten the Phillips curve. We derive a tractable four-equation dynamic model and use it to show that monetary shocks generate a procyclical hump-shaped response in TFP and endogenous cost-push shocks in the New Keynesian Phillips curve. A calibration of our model suggests that the supply-side effect increases the half-life of a monetary shock’s effect on output by about 30% and amplifies the total impact on output by about 70%. Using identified monetary shocks, we provide empirical evidence for both the macro- and micro-level predictions of our model.
Other Writings
VoxEU, December 2023
[Link]
with David Baqaee
VoxEU, August 2021
[Link]
with David Baqaee and Emmanuel Farhi
VoxEU, January 2021
[Link]
with Paul Brest, Shereen Griffith, Damira Khatam, Demoni Newman, Reirui Ri, Alessandra Santiago, Mengyi Xu, and Lucie Zikova
[Full Text]
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Impact investing often takes place in developing or frontier markets, and, as a result, impact investors will likely encounter problems unique to investing in countries where legal institutions are weak, ineffective, or entirely absent. The absence of credible legal institutions—and hence the lack of credible penalties for misbehavior—exposes the impact investor to a wider berth of actions from counterparties, as well as political and market uncertainties often present in these settings. This paper discusses the various risks and describes mitigation techniques.