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HUMP

Heterogeneity, Uncertainty and Macroeconomic Performance

 

Principal Investigator

Prof. Dr. Christian Bayer
Department of Economics
Macroeconomics and Econometrics Group
Kaiserplatz 7-9
53113 Bonn


Abstract

Micro-level uncertainty and borrowing constraints are first order issues in macroeconomics and fluctuations in uncertainty and borrowing constraints can be expected to have strong consequences for business cycles. Not least the Great Recession provides a strong example. At the same time, almost all macroeconomic models with heterogeneous agents abstract from nominal rigidities to ensure numerical tractability. Yet, this restricts their applicability to business-cycle research drastically. Vice versa, the standard sticky-prices representative-agent approach to business-cycle research assumes away the role of idiosyncratic uncertainty and heterogeneity outright; again for reasons of tractability.
This significantly limits our understanding of what might be an important component of business cycles. To give an example: In a standard incomplete markets model, it depresses consumption if there is a temporary increase in uncertainty or borrowing constraints. In a flexible price setup this implies a boom driven by higher investment and an increase in labour supply. This contradicts existing empirical evidence showing that idiosyncratic uncertainty is countercyclical. However, sticky prices may be able to quantitatively align model prediction and evidence as they make aggregate output demand determined.
This motivates the proposed research, where the first objective is to develop a quantitative framework that merges nominal rigidities with market incompleteness. In this framework, I then analyse income risk from unemployment as a propagation mechanism and fluctuations in borrowing constraints as potential drivers of business cycles.
As income risk from the labour market is a central building block of any incomplete markets model, this first set of projects is complemented by analysing the micro structure of job and worker flows to grasp the frictions in hiring workers or creating jobs. A good understanding of these frictions helps to gauge the effect of policies aimed at mitigating the idiosyncratic uncertainty, such as unemployment insurance, subsidized part-time layoffs, or legal restrictions on firing. These projects build on a unique data set generated by a small team around me at the Institute of Employment Research of the German Federal Employment Agency, which covers all quarterly worker- and job flows for the universe of German plants since 1975 with detailed information on workers and plants.

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