The NBER Reporter 2008 Number 2: Conferences

Twenty-third Annual Conference on Macroeconomics
Demography and the Economy
Innovation Policy and the Economy
Risks of Financial Institutions
Climate Change: Past and Present

Twenty-third Annual Conference on Macroeconomics

The NBER's twenty-third Annual Conference on Macroeconomics, organized by NBER Research Associates Daron Acemoglu of MIT, Kenneth Rogoff of Harvard University, and Michael Woodford of Columbia University, took place in Cambridge on April 4 and 5. The program was:

Giuseppe Moscarini, Yale University and NBER, and Fabien Postel-Vinay, University of Bristol, "The Timing of Labor Market Expansions: New Facts and a New Hypothesis"
Discussants: Robert E. Hall, Stanford University and NBER, and Robert Shimer, University of Chicago and NBER

Jean Boivin, HEC Montréal and NBER; Marc P. Giannoni, Columbia University and NBER; and Benoit Mojon, Federal Reserve Bank of Chicago, "Macroeconomic Dynamics in the Euro Area"

Discussants: Lucrezia Reichlin, European Central Bank, and Harald Uhlig, University of Chicago

Quamrul H. Ashraf and Ashley Lester, Brown University, and David N. Weil, Brown University and NBER, "When Does Improving Health Raise GDP?"
Discussants: Hoyt Bleakley, University of Chicago and NBER, and Simon Johnson, IMF and NBER

Jeremy Greenwood, University of Pennsylvania and NBER, and Nezih Guner Universidad Carlos III de Madrid, "Marriage and Divorce since World War II: Analyzing the Role of Technological Progress on the Formation of Households"
Discussants: Stefania Albanesi, Columbia University and NBER, and Justin Wolfers, University of Pennsylvania and NBER

Markus K. Brunnermeier, Princeton University and NBER; Stefan Nagel, Stanford University and NBER; and Lasse H. Pedersen, New York University and NBER, "Carry Trades and Currency Crises"
Discussants: A. Craig Burnside, Duke University and NBER, and Hanno Lustig, University of California, Los Angeles and NBER

Andrew Atkeson, University of California, Los Angeles and NBER, and Patrick J. Kehoe, Federal Reserve Bank of Minneapolis and NBER, "On the Need for a New Approach to Analyzing Monetary Policy" (No abstract is available for this paper.)
Discussants: John H. Cochrane, University of Chicago and NBER, and Bennett T. McCallum, Carnegie Mellon University and NBER

Moscarini and Postel-Vinay document three new facts about aggregate dynamics in U.S. labor markets over the last 15 years, drawing in part from newly available datasets. The new facts concern a strong co-movement between the employer-to-employer worker transition rate, various measures of wages, and the share of employment at large firms. All three remain below trend several years into the expansion. Then, simultaneously, large firms take over employment, workers start quitting more from job to job, and wages accelerate. The researchers investigate whether this new view of how business cycles evolve and mature is consistent with the transitional dynamics of the Burdett and Mortensen (1998) equilibrium search model, analyzed in a companion paper (Moscarini and Postel-Vinay, 2008). In their model, following a positive aggregate shock to labor demand, wages respond little on impact, and start rising only when firms run out of cheap unemployed hires and start competing to poach and retain employed workers.Aggregate shocks thus are propagated by the hiring behavior of large firms. A calibrated example shows that the model qualitatively captures the essence of the three facts.

Boivin and his co-authors characterize the transmission mechanism of monetary and oil-price shocks across countries of the euro area, document how this mechanism has changed with the introduction of the euro, and explore some potential explanations. The framework they use allows them to jointly model the euro area dynamics and permit the transmission of shocks to be different across countries. They find important heterogeneity across countries in the effect of macroeconomic shocks before the launch of the euro. In particular, they find that German interest-rate shocks triggered stronger responses of interest rates and consumption in some countries, such as Italy and Spain, than in Germany itself. According to their estimates, the creation of the euro has contributed to a greater homogeneity of the transmission mechanisms across countries and to an overall reduction in the effects of this shock. Using a structural open-economy model, they argue that the combination of a change in the policy react function, mainly toward a more aggressive response to inflation and output, and the elimination of an exchange rate risk can explain the evolution of the monetary transmission mechanism observed empirically.

Ashraf and his co-authors quantitatively assess the effect of exogenous health improvements on output, through demographic channels and changes in worker productivity. They consider both changes in general health, proxied by changes in life expectancy, and changes in the prevalence of two particular diseases: malaria and tuberculosis. In general, they find that the effects of health improvements on income are substantially lower than those that are often quoted by policymakers, and may not emerge at all for a third of a century or more after the initial improvement in health.

Since World War II there has been: a rise in the fraction of time that married households allocate to market work; an increase in the rate of divorce; and a decline in the rate of marriage. Greenwood and Guner argue that labor-saving technological progress in the household sector can explain these facts. This makes it more feasible for singles to maintain their own home, and for married women to work. To address this question, the authors develop a search model of marriage and divorce, which incorporates household production. An extension of the model looks back at the prewar era.

Brunnermeier and his co-authors document that carry traders are subject to crash risk – that is, that exchange rate movements between high interest rate and low interest rate currencies are negatively skewed. They argue that this negative skewness is attributable to sudden unwinding of carry trades, which tend to occur in periods in which investor risk appetite and funding liquidity decrease. Carry-trade losses reduce future crash risk, but increase the price of crash risk. The researchers also document excess co-movement among currencies with similar interest rates. Their findings are consistent with a model in which carry traders are subject to funding liquidity constraints.

These papers will appear in an annual volume published by the University of Chicago Press. Its availability will be announced in a future issue of the Reporter. They can also be found at "Books in Progress" on the NBER's website.

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Demography and the Economy

NBER Research Associate John B. Shoven of Stanford University organized a conference on "Demography and the Economy" that took place in California on April 11 and 12. These papers were discussed:

Sam H. Preston and Caroline R. Sten, University of Pennsylvania, "The Future of American Fertility"
Discussant: Gopi Shah Goda, Harvard University

Larry E. Jones, University of Minnesota and NBER; Alice Schoonbroodt, Southampton University; and Michele Tertilt, Stanford University and NBER, "Fertility and Income in the Cross Section: Evidence and Theory"
Discussant: Amalia Miller, University of Virginia

Adam Isen and Betsey Stevenson, University of Pennsylvania, "Women's Education and Family Behavior: Trends in Marriage, Divorce, and Fertility"
Discussant: Enrico Moretti, University of California, Berkeley and NBER

Gopi Shah Goda and John B. Shoven, "Adjusting Government Policies for Age Inflation"
Discussant: Warren Sanderson, SUNY Stony Brook

Axel Börsch-Supan, University of Mannheim and NBER, and Alexander Ludwig, University of Mannheim, "Old Europe Ages. Can it Still Prosper?"
Discussant: Alan J. Auerbach, University of California, Berkeley and NBER

Shripad Tuljapurkar, Stanford University, "The Final Inequality: Changes in the Variance in Age at Death over Time"
Discussant: Victor R. Fuchs, Stanford University and NBER

James M. Poterba, MIT and NBER; Steven F. Venti, Dartmouth College and NBER; and David A. Wise, Harvard University and NBER, "Demographic Trends, Housing Equity, and the Financial Security of Future Retirees"
Discussant: Thomas Davidoff, University of California, Berkeley

Sylvester J. Schieber, Social Security Advisory Board, "Richer or Poorer When Death Do Us Part?"
Discussant: Steven F. Venti

Orazio Attanasio, University College London and NBER; Sagiri Kitao, University of Southern California; and Giovanni L.Violante, New York University and NBER, "Financing Medicare: A General Equilibrium Analysis"
Discussant: Moshe Bushinsky, University of California, Los Angeles and NBER

Francesco C. Billari and Guido Tabellini, Universita' Bocconi, "Italians are Late: Does it Matter?"
Discussant: Luigi Pistaferri, Stanford University

The level of fertility is the principal determinant of the shape of a population's age structure, which in turn is a critical factor in the terms-of-trade within a pay-as-you-go system of public pensions. Social Security Administration simulations show that the 75-year actuarial balance of the social security system would be $2.6 trillion higher in present value if fertility were high (2.3 children/woman) rather than low (1.7). Partly because of their long-run effects on population age structure, national fertility levels are considered "too low" by a majority of governments in developed countries. Preston and Sten review the major factors that appear to be affecting fertility levels in the United States, with an eye towards making defensible statements about future directions of fertility. There is no single widely accepted framework for analyzing the determinants of fertility at the level of a population. In its place, the authors pursue an eclectic, inductive approach, surveying the landscape of fertility variation in search of clues about its principal drivers. Their search considers variation over time and space and across individuals.

Jones and his co-authors revisit the relationship between income and fertility. There is overwhelming empirical evidence that fertility is negatively related to income in most countries at most times. Several theories have been proposed to explain this somewhat puzzling fact. The most common is based on the opportunity cost of time being higher for individuals with higher earnings. Alternatively, people might differ in their desire to procreate and, accordingly, some people will invest more in children and less in market-specific human capital and thus have lower earnings. The authors revisit these and other possible explanations. They find that these theories are not as robust as is commonly believed, and that they often depend on assumptions that are open to question.

The production efficiencies of household specialization have declined with the development of technologies that simplify household production and the increase in market substitutes for goods previously provided by homemakers. Additionally, the opportunity cost of having a household specialist has risen as the barriers to women in the workplace have eroded. These developments, which have made way for an increase in the relative importance of the consumption benefits from marriage, have not affected all families similarly. Isen and Stevenson examine how marital and fertility patterns have changed along racial and educational lines for men and women. Marriage and remarriage rates have risen for women with a college degree relative to those with fewer years of education, eroding a long-standing gap caused by greater marriage propensities among less educated women. In contrast, there has been little change in marital patterns by education among men. Divorce has been falling for all groups, but fell earlier and more sharply among college graduates. Further, the authors find that total fertility relative to women's educational attainment has changed little, even though women's educational attainment has been increasing and women have fewer children at higher levels of educational attainment. There has been a widely noted rise in the age of mothers, and the authors show that most of it comes from an increase in the age of childbirth for women with more education, with little change in fertility timing for those with less education.

Government policies based on age do not adjust to the fact that, because of improvements in mortality, a given age is associated with higher remaining life expectancy and lower mortality risk relative to earlier time periods. Goda and Shoven examine four possible methods for adjusting the eligibility ages for Social Security, Medicare, and Individual Retirement Accounts to determine what eligibility ages would be today, and in 2050, if adjustments for mortality improvement were taken into account. They find that historical adjustment of eligibility ages for age inflation would have increased ages of eligibility by approximately 0.15 years annually. Failure to adjust for mortality improvement implies that the percent of the population eligible to receive full Social Security benefits and Medicare will increase substantially relative to the share eligible under a policy of age adjustment.

Population aging will be a major determinant of long-run economic development in industrial and developing countries. The extent of the demographic changes is dramatic in some countries and will deeply affect future labor, financial, and goods markets. The expected strain on public budgets and especially social security already has received prominent attention, but aging poses many other economic challenges that threaten productivity and growth if they are not addressed. There is no shortage of policy proposals to address population aging. However, little is known about behavioral reactions, for example, to pension and labor market reform. Börsch-Supan and Ludwig shed light on such reactions in three large Continental European countries. France, Germany, and Italy have large pay-as-you-go pension systems and vulnerable labor markets. At the same time, they show remarkable resistance against pension and labor market reform. The key issues discussed in this paper are: interactions between pension and labor market policies, and the behavioral reactions to reform. Which behavioral reactions will strengthen, and which will weaken reform policies? Can Old Europe prosper even if behavioral reactions counter current reform efforts?

Tuljapurkar attempts to show that the variance in age at death for adults is a useful and important dimension of mortality change. Trends in this variance are informative about the speed and the age-pattern of mortality change. The decomposition of this variance with respect to risk factors provides useful insights into the explanatory power of different factors that are correlated with mortality. Historical and economic analyses can benefit from an examination of variance in age at death in addition to the traditionally important studies of life expectancy.

Poterba, Venti, and Wise have two key goals in this paper: 1) to understand the extent of uncertainty about home equity at older ages; and 2) to explore how one might project the trend in the home equity of younger cohorts as they approach retirement. They begin by describing the change over time in the relationships between age, home ownership, and home values. They find that the age profile of home ownership rates has changed little over the past two decades. On the other hand, there have been very large increases in the value of owner-occupied homes, and in home equity, over the past two decades. Using cohorts attaining retirement age in 1990 and in 2010, the authors simulate the evolution of home values over the course of a typical retirement to explore the relationship between home equity at retirement and home equity at older ages, when it tends to be drawn down. Because real home prices rose during the sample period they use to forecast future price patterns, for both cohorts, their projections suggest that home equity at older ages is likely to be much greater than equity at retirement. Even when they truncate their sample of house price changes before the most recent market declines, their projections suggest a probability of between 10 and 14 percent that real home equity will decline between the ages of 59 and 79. That probability rises substantially when they expand their sample of housing returns to include the experience of the most recent two years. Cross-section and cohort data also show that over a 20-year period marked by very large fluctuations in the growth rate of home value, very large increases in household wealth, and a large decline in mortgage rates, the ratio of home equity to total non-pension wealth remained remarkably stable. This empirical regularity leads them to consider whether projections of the home equity of future retirees might be based on forecasts of the wealth of future households. The recent turmoil in the housing market adds interest to such projections but also, by drawing attention to the large changes in home value and home equity that can occur over a short period of time, raises speculation about whether the past empirical regularity will continue in the future.

Some analysts conclude that aging societies must radically modify their retirement systems in order to deal with new economic realities. There are several examples where the response to population aging has been to restructure pay-as-you-go pension programs toward greater funding. From a microeconomic perspective, many workers may not discern any practical effect from the restructuring of the approach to financing their pensions. Even from a macroeconomic perspective, there are questions over whether some of the move toward pension funding that has arisen in recent years is more cosmetic than real. Whether pension plans are funded or not, population aging will likely result in slower labor forces growth in most cases. This slower labor force growth has two important implications. First, labor force growth rates are one of the primary drivers that underlie economic growth. Second, a growing aged population in the face of a stable or diminished work force implies significant increases in aged dependency. The combination of these forces will limit future growth in living standards in the developed economies of the world. If our economies cannot meet public expectations about economic performance, pension policy will play a major role in allocating the economic disappointment. Schieber suggests that some countries face such significant demographic shifts toward older populations that pension funding will offer little practical relief. In these cases, the whole concept of retirement that has persisted over much of the past century will have to be revisited.

Attanasio and his co-authors develop a general equilibrium, overlapping-generations model of the U.S. economy where households face uncertain health status that in turn determines their mortality rate and their medical expenditures. Households make consumption and labor supply decisions, and can imperfectly insure health shocks through markets. The government provides partial insurance through Medicare and "social assistance," and runs a Pay-As-You-Go social security system. The authors calibrate the model based on the projected demographic and medical expenditures trends for the next 75 years. The model is used to study the macroeconomic and welfare implications of alternative funding schemes for Medicare. In the baseline closed-economy model, they find, the labor income tax will have to increase from 23 percent in 2005 to 36 percent in 2080 to finance the rising costs of Medicare. However, under an open-economy scenario, the tax would have to rise by much less. Limiting the increase in the wage tax through either a rise in the Medicare premium or a delay in the age of retirement is welfare improving.

Italians start adult activities, such as leaving the parental home, at a much later age than is common in other countries at comparable levels of development. Billari and Tabellini ask whether this late transition into adulthood influences the lifetime economic opportunities of individuals. A priori, it is not clear if such influence exists, and what its direction is. After providing stylized cross-country evidence on the potential negative impact of the late transition to adulthood, the authors consider a longitudinal survey of Italian men in their mid-30s. As a measure of transition into adulthood, they focus on leaving the parental home for the first time; they find that individuals who leave the parental home earlier in life earn a higher income in their mid-30s. Estimation by instrumental variables suggests that the authors capture a causal effect, from the age of leaving the parental home to subsequent economic outcomes, and the result is robust to various specification of the model. The authors speculate on the potential mechanisms through which this effect might operate. Given these results, policies that aim at speeding up the transition to adulthood of young Italians might have positive economic effects.

These papers will appear in an NBER Conference Volume published by the University of Chicago Press. Its availability will be announced in a future issue of the NBER Reporter. They will also be available at "Books in Progress" on the NBER's website.

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Innovation Policy and the Economy

The NBER's ninth annual Conference on Innovation Policy and the Economy took place in Washington on April 15. The conference was organized by NBER Research Associates Adam B. Jaffe of Brandeis University, Joshua Lerner of Harvard University, and Scott Stern of Northwestern University. The following papers were discussed:

Richard Freeman, Harvard University and NBER, and John Van Reenen, London School of Economics and NBER, "What if Congress Doubled R and D Spending on the Physical Sciences?"

Joseph Farrell, University of California, Berkeley, "Intellectual Property as a Bargaining Environment"

Douglas Lichtman, University of California, Los Angeles, "Pricing Patents"

Alvin Roth, Harvard University and NBER, "What Have We Learned from Market Design?"

Peter Cramton, University of Maryland, "Innovation and Market Design"

Many business, academic, and scientific groups have recommended that the Congress substantially increase R and D spending in the near future. President Bush's American Competitiveness Initiative calls for a doubling of spending over the next decade in selected agencies that deal with the physical sciences, including the National Science Foundation. Freeman and Van Reenen consider the rationale for increased R and D spending in the context of the globalization of economic activity. To assess the likely consequences of a large increase in R and D spending, they examine how the 1998-2003 doubling of the NIH budget affected the bio-medical sciences. They find that the rapid increase and ensuing deceleration in NIH spending created substantial adjustment problems in the market for research, particularly for younger investigators, and failed to address long-standing problems with scientific careers that are likely to deter many young persons from choosing a scientific career. They argue that funding agencies should tilt their awards to younger researchers on the grounds that any research project does two things: it produces knowledge and adds to the human capital of researchers, which has greater value for younger persons because of their longer future career life-spans.

Patent (and other intellectual property) policy anticipates and relies on firms negotiating "in the shadow of the law" when it comes to licensing and using existing patents, and the economics of that process have been studied extensively. But there has been much less study of private agreements that go deeper than that and agree in advance on how future patents, or patents not yet identified, will be treated. One can think of such agreements as setting up a zone of "private law". This can be either good or bad, and a traditional antitrust-based approach tries to ban the bad ones and allow the good ones. But because private negotiation is often imperfect and difficult, it makes sense to consider whether and how public policy can facilitate beneficial private agreements and learn from them, not merely allow them. Farrell explores some of these issues.

Lichtman notes that over the last many years, patent reform efforts have focused primarily and understandably on the problem of incorrectly issued patents. These efforts have pointed out fundamental flaws in the system for evaluating patent applications, rightly exhibiting concern that many patents are issued today despite the fact that the purported inventions are not meaningfully different from what was known before. There is a second substantial problem undermining the patent system, however, and that is the mistaken approach to setting damages and influencing the terms of licensing arrangements. In this regard, the patent system is built on an intuition that prices and other deal terms ought to be set in the market, and thus that patent remedies ought to be designed with an eye toward driving parties to engage in market-based negotiation. But that is quite simply a mistake. In theory, markets would be a preferred mechanism for setting the terms of patent deals. In a host of common infringement situations, however, market-based negotiation is either not an option or not a trustworthy measure of patent value.

Roth discusses some things we have learned about markets, in the process of designing marketplaces to fix market failures. To work well, marketplaces have to provide thickness, that is they need to attract a large enough proportion of the potential participants in the market; they have to overcome the congestion that thickness can bring, by making it possible to consider enough alternative transactions to arrive at good ones; and they need to make it safe and sufficiently simple to participate in the market, as opposed to transacting outside of the market, or having to engage in costly and risky strategic behavior. Roth draws on recent examples of market design ranging from labor markets for doctors and new economists, to kidney exchange, and school choice in New York City and Boston.

Market design plays an essential role in promoting innovation. Cramton examines emission allowance auctions, air slot auctions, spectrum auctions, and electricity markets, and demonstrates how the market design can encourage innovation. Improved pricing information is one source of innovation. Enhancing competition is another driver of innovation seen in all of the applications. Market design fosters innovation in other ways as well by addressing other potential market failures.

These papers will appear in an annual volume published by the University of Chicago Press. Its availability will be announced in a future issue of the Reporter. They can also be found at "Books in Progress" on the NBER's website.

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Risks of Financial Institutions

The NBER held a conference on "Risks of Financial Institutions" at the University of Chicago's Gleacher Center on April 24. Conference organizers Mark Carey, Federal Reserve Board of Governors, and Rene M. Stulz, NBER and Ohio State University, chose these papers for discussion:

Markus K. Brunnermeier, Princeton University and NBER, "Deciphering the 2007/8 Liquidity and Credit Crunch"
Discussant: Raghuram Rajan, University of Chicago and NBER

Atif Mian, University of Chicago and NBER, and Amir Sufi, University of Chicago, "The Consequences of Mortgage Credit Expansion: Evidence from the 2007 Mortgage Default Crisis" (NBER Working Paper No. 13936)
Discussant: Stuart Gabriel, University of California, Los Angeles

Robert H. Litzenberger, Azimuth Asset Management, and David M. Modest, J.P. Morgan Chase, "Crisis and Non-Crisis Risk in Financial Markets: A Unified Approach to Risk Management"
Discussant: Philippe Jorion, University of California, Irvine

Philippe Jorion, and Gaiyan Zhang, University of Missouri, "Credit Contagion from Counterparty Risk"
Discussant: Richard Cantor, Moody's Investors Service

Amir Khandani, MIT, and Andrew Lo, MIT and NBER, "What Happened to the Quants in August 2007?"
Discussant: Kent Daniel, Northwestern University

Monica Billio and Loriana Pelizzon, University of Venice, and Mila Getmansky, University of Massachusetts, "Crises and Hedge Fund Risk"
Discussant: Tobias Adrian, Federal Reserve Bank of New York

Brunnermeier studies the underlying forces that drove adverse events in the financial markets in 2007 and 2008. He explains how new structured financial products, off-balance sheet vehicles, and the transformation from a classical banking model to an "originate and distribute model" led to a deterioration of lending standards and to a boom in house prices. He provides an event-log book about the current market turmoil and identifies various amplification mechanisms that explain how shocks to the financial system could cause such large dislocations. The first mechanism is attributable to borrowers' balance sheet effects involving liquidity spirals. When asset prices and market liquidity drop during times of crisis, funding requirements for financial institutions increase. This happens because the collateral value of the assets on borrowers' balance sheets erodes, and margins rise, or investors are unable to rollover their short-term liabilities. Higher margins force financial institutions to cut back on leverage, exacerbating the initial price decline. A key problem is the maturity mismatch caused by leveraged financing. The second set of amplification mechanisms works through the lending channel. Uncertainty about future funding needs, combined with potentially limited access to the lending market at that time, can lead to hoarding and interest rate surges in the interbank market. Brunnermeier also discusses runs on financial institutions. Runs occur when each individual financier has an incentive to curtail funding before others. Finally, when financial institutions are lenders and borrowers at the same time, network and gridlock risk might emerge. In a gridlock situation, each individual institution is not able to pay its obligation only because the others are not paying theirs. While coordination might resolve this, it is difficult to achieve in today's complex and interweaved financial system.

Mian and Sufi offer evidence that a rapid expansion in the supply of mortgages driven by disintermediation explains a large fraction of recent U.S. house price appreciation and subsequent mortgage defaults. They identify the effect of shifts in the supply of mortgage credit by exploiting within-county variation across zip codes that differed in latent demand for mortgages in the mid-1990s. From 2001 to 2005, high latent-demand zip codes experienced large relative decreases in denial rates, increases in mortgages originated, and increases in house price appreciation, despite the fact that these zip codes experienced significantly negative relative income and employment growth over this time period. These patterns for high latent-demand zip codes were driven by a sharp relative increase in the fraction of loans sold by originators shortly after origination, a process that the authors refer to as "disintermediation." The increase in disintermediation-driven mortgage supply to high latent-demand zip codes from 2001 to 2005 led to subsequent large increases in mortgage defaults from 2005 to 2007. The results suggest that moral hazard on behalf of originators selling mortgages is a main culprit for the U.S. mortgage default crisis.

Litzenberger and Modest develop an analytically tractable risk management metric that measures potential exposures to financial crises and also captures volatility during non-crisis times. Their multiple-regime stress-loss risk framework assumes markets are characterized by quiescent (non-crisis) periods most of the time, interspersed with infrequent crisis periods where 4-5 sigma events can occur with non-negligible probabilities. The framework is flexible and can incorporate arbitrary numbers and types of crises. One of the primary lessons of 1998 and 2007 is that returns can be correlated because collections of trades (or strategies) are sometimes financed from a common pool of capital, even though returns to the strategies have low correlations during quiescent periods.

Standard credit risk models cannot explain the observed clustering of default, sometimes described as "credit contagion." Jorion and Zhang provide the first empirical analysis of credit contagion via direct counterparty effects. Using a unique database, they examine the wealth effects of bankruptcy announcements on creditors. On average, creditors experience severe negative abnormal equity returns and increases in CDS spreads. In addition, creditors are more likely to suffer from financial distress later. These effects are stronger for industrial creditors than financials. Simulations calibrated to these results indicate that counterparty risk can potentially explain the observed excess clustering of defaults. This suggests that counterparty risk is an important additional channel of credit contagion and that current portfolio credit risk models understate the likelihood of large losses.

During the week of August 6, 2007 a number of quantitative long/short equity hedge funds experienced unprecedented losses. Based on TASS hedge-fund data, TAQ data, and simulations of a specific long/short equity strategy, Khandani and Lo hypothesize that the losses were initiated by the rapid "unwind" of one or more sizable quantitative equity market-neutral portfolios. Given the speed and price impact with which this occurred, it was likely the result of a forced liquidation by a multi-strategy fund or proprietary-trading desk, possibly because of a margin call or a risk reduction. These initial losses then put pressure on a broader set of long/short and long-only equity portfolios, causing further losses by triggering stop/loss and de-leveraging policies. A significant rebound of these strategies occurred on August 10, which is also consistent with the unwind hypothesis. The dislocation was triggered by events outside the long/short equity sector---in a completely unrelated set of markets and instruments---suggesting that systemic risk in the hedge-fund industry may have increased in recent years.

Billio, Pelizzon, and Getmansky study the effect of financial crises on hedge fund risk. Using a regime-switching beta model, they separate systematic and idiosyncratic components of hedge fund exposure. The systematic exposure to various risk factors is conditional on market volatility conditions. They find that in the high-volatility regime (when the market is rolling-down and is likely to be in a crisis state) most strategies are negatively and significantly exposed to the Large-Small and Credit Spread risk factors. This suggests that liquidity risk and credit risk are potentially common factors for different hedge fund strategies in the down-state of the market, when volatility is high and returns are very low. They further explore the possibility that all hedge fund strategies exhibit a high volatility regime of the idiosyncratic risk, which could be attributed to contagion among hedge fund strategies. In their sample, this event happened only during the Long-Term Capital Management crisis of 1998. Other crises, including the recent subprime mortgage crisis, affected hedge funds only through systematic risk factors and did not cause contagion among hedge funds.

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Climate Change: Past and Present

An NBER/Universities Research Conference on "Climate Change: Past and Present," organized by Gary D. Libecap, University of California, Santa Barbara and NBER, and Richard H. Steckel, Ohio State University and NBER, took place in Cambridge on May 30 and 31. These papers were discussed:

Richard H. Steckel, "Tree Rings Climate Change and Impacts: Sketching a Research Agenda"

Melissa Dell, MIT; Benjamin F. Jones, Northwestern University and NBER; and Benjamin A. Olken, Harvard University and NBER, "Climate Change and Economic Growth: Evidence from the Last Half Century"

Zeynep K. Hansen, Boise State University and NBER; Gary D. Libecap; and Scott E. Lowe, Boise State University, "Climate Variability and Water Infrastructure: Historical Experience in the Western United States"

Richard Sutch, University of California, Riverside and NBER, "Henry Agard Wallace, the Iowa Corn Yield Tests, and the Adoption of Hybrid Corn: American Corn Yields, 1866-2002"

Raghav Gaiha, Vani S. Kulkarni, and Kenneth Hill, Harvard University; and Shantanu Mathur, International Fund for Agricultural Development, "On Devastating Droughts"

Alan L. Olmstead, University of California, Davis and NBER, and Paul W. Rhode, University of Arizona and NBER, "Adjusting to Climatic Variation: Historical Perspectives from North American Agricultural Development"

Wolfram Schlenker, Columbia University and NBER, and Michael Roberts, USDA, "Estimating the Impact of Climate Change on Crop Yields: The Importance of Nonlinear Temperature Effects"(NBER Working Paper No. 13799)

Hoyt Bleakley, University of Chicago and NBER, and Sok Chul Hong, University of Chicago, "The Impact of Weather on U.S. Farm Productivity: Historical Patterns and Relation to the Changing Disease Environment"

Karen Clay, Carnegie Mellon and NBER, and Werner Troesken, George Mason University and NBER, "On the Seasonality of Disease: Implications for the Effects of Climate Change on Health"

Haggay Etkes, Hebrew University, "The Impact of Short-Term Climate Fluctuations on Rural Population in the Desert Frontier Nahiye of Gaza (ca. 1519-57)"

Price Fishback, University of Arizona and NBER; Trevor Kollman, University of Arizona; Michael Haines, Colgate College and NBER; Paul W. Rhode; Melissa Thomasson, Miami University and NBER; and Shawn Kantor, University of California, Merced and NBER, "The Health Consequences of Natural and Economic Disasters: 1930-1940"

Valerie A. Mueller and Daniel E. Osgood, Columbia University, "Long-term Consequences of Short-term Precipitation Shocks: Evidence from Brazilian Migrant Households"

Economists and other social scientists who seek to measure the relationship between climate and socioeconomic activity are limited to somewhat more than one century of data from instrument records. Fortunately for this research agenda, dendochronologists have been rapidly expanding our knowledge of past precipitation and temperature. Tree rings reliably reconstruct the Palmer Drought Severity Index (PDSI), which measures effective or net precipitation. Dendochronologists have estimated the PDSI in North America for a grid of 286 locations based on 835 tree-ring chronologies that go back hundreds of years. Steckel briefly explains the methodology of climate reconstruction in North America based on tree rings, discusses various databases that are available, and considers some applications of these data for studying settlement of the continent; demographic patterns of health and migration; agricultural prices; financial stress; and government responses to climate change.

Dell and her co-authors use annual variation in temperature and precipitation over the past 50 years to examine the impact of climatic changes on economic activity throughout the world. They find three primary results. First, higher temperatures substantially reduce economic growth in poor countries but have little effect in rich countries. Second, higher temperatures appear to reduce growth rates, rather than just the level of output, in poor countries. Third, higher temperatures have wide effects in poor nations, reducing agricultural output, industrial output, and aggregate investment, and increasing political instability. Should future impacts of climate change mirror these historical effects, the negative effect on poor countries might be substantial.

Hansen and his co-authors have constructed (and are still expanding) an integrated dataset on water supply and water infrastructure in the states west of the one hundredth meridian. This county-level dataset includes details on all the constructed dams and canals as well as aquifers and streams. The dam data starts in 1850 and goes through 2001. This extensive dataset will account for the entire water supply and water distribution infrastructure in the western United States. The dataset is spatially linked to topographic characteristics, historical climate data, historical agricultural data, and historical population data at a county level using GIS. The authors use this dataset to seek answers to several questions. First, they are interested in understanding the historical pattern of these construction projects. Specifically, they examine the factors and influences that explain the timing and the location decisions of these dams and canals. They are most interested in investigating and establishing the potential link between the climate variability (changes in annual precipitation totals and mean monthly temperatures) and the construction of water infrastructure in the western states. In addition, they analyze the impact of the water infrastructure construction on agricultural production, and on flood control. They also are interested in analyzing other determinants of investment in water storage and distribution channels, including population growth and the increased electrification of urban residences. They have detailed information on the purpose of dam construction, ranked in terms of priority. Thus, they can separately focus on dams constructed mostly for flood control, for irrigated agriculture, and water/power supply for the areas with larger populations. They hypothesize that counties, which are included in the water supply and distribution infrastructure, were better able to deal with the problems of short-term climatic variability (either because of natural variability in the hydrologic cycle or disruptions of the cycle) in terms of smoothing out agricultural production over time relative to similar counties without such infrastructure. Having identified major drought periods over time, they can look at the variation in agricultural production during these periods before and after dam/canal construction as well as during normal climatic times in a difference-in-difference setting. Similarly, they hypothesize that the problems related to flooding in flood -prone counties would lessen after the construction of dams. Since they have all the major dams and canals constructed in last 150 years in their dataset, they will examine the impact of the growth in water infrastructure construction on agricultural composition and production, and on flood control over time.

Sutch [2007] makes the following claims: 1) There was not an unambiguous yield advantage of hybrid corn over the open-pollinated varieties before 1936. 2) The early adoption of hybrid corn can be explained better by a sustained propaganda campaign conducted by the U.S. Department of Agriculture at the direction of the Secretary of Agriculture, Henry Agard Wallace. The Department's campaign echoed that of the commercial seed companies. 3) The early adopters of hybrid seed were followed by later adopters as a consequence of the droughts of 1934 and 1936. The eventual improvement of yields as newer varieties were introduced explains the continuation and acceleration of the process.

Droughts often turn into famines. Loss of agricultural output and food shortage are, however, not the only consequences. There are often large second round effects, some of which persist over time. By the time these effects play out, the overall economic loss is substantially greater than the first round loss of income. Hardships manifest in malnutrition, poverty, disinvestment in human capital (for example, withdrawal of children from school), liquidation of assets (for example, sale of livestock) with impairment of future economic prospects, and, in extreme cases, mortality, given the incompleteness of credit and insurance markets. Gaiha and his co-authors build on the extant literature. While the frequency of droughts has risen, their deadliness has declined. This paper sheds light on the underlying geographical, institutional, development indicators in explaining inter-country differences in mortality. The analysis also confirms the favorable effects of openness in saving human lives. That much of this devastation appears to be avoidable through a timely and speedy entitlement protection strategy. Furthermore, even moderate learning has the potential to avert a large fraction of deaths. But capacity building – synonymous with availability of more resources for disaster prevention – also has considerable potential in averting deaths. In fact, these findings are broadly consistent with the view that fatalities are greater in countries with weak governments and pervasive poverty.

Providing greater historical perspective would enlighten current discussions about future human responses to climatic variation. During the nineteenth and twentieth centuries, new biological technologies allowed North American farmers to push cropping into environments previously thought too arid, too variable, and too harsh to cultivate. Olmstead and Rhode document these changes for three major staple crops, noting that the climatic challenges that previous generations of farmers overcame often rivaled the climatic changes predicted for the next hundred years in North America. Further analysis is needed to understand the timing, causes, and costs of these adjustments, they conclude.

The United States produces 41 percent of the world's corn and 38 percent of the world's soybeans, so any impact on U.S. crop yields will have implications for world food supply. Schlenker and Roberts pair a panel of county-level crop yields in the United States with a fine-scale weather dataset that incorporates the whole distribution of temperatures between the minimum and maximum within each day and across all days in the growing season. Yields increase in temperature until about 29C for corn, 30C for soybeans, and 32C for cotton, but temperatures above these thresholds become very harmful. The slope of the decline above the optimum is significantly steeper than the incline below it. The same nonlinear and asymmetric relationship is found whether the authors consider time-series or cross-sectional variation in weather and yields. This suggests limited potential for adaptation within crop species because the latter includes farmers' adaptations to warmer climates and the former does not. Area-weighted average yields given current growing regions are predicted to decrease by 31-43 percent under the slowest warming scenario and 67-79 percent under the most rapid warming scenario by the end of the century.

Bleakley and Hong consider the impact of weather on farm values. Using both cross-sectional and panel methods, they document economically and statistically significant differences in the response of farm productivity to weather over time. In recent decades, farm value has been (weakly) increasing in temperature and rainfall. On the other hand, high levels of temperature or rain depressed farm value in the nineteenth century. This suggests an important role for technological adaptation in reducing the impact on farm productivity of hotter and wetter weather (a possible outcome of climate change in some places). One particular adaptation—the eradication of malaria—accounts for a substantial fraction of this difference over time. These results also suggest that malaria reduced farm productivity by a factor of 2-3 in the most malarious parts of the South relative to the Plains in the late 1800s.

Clay and Troesken hope to establish the robustness of the seasonality of disease and to better understand the mechanisms that underlie the connection between climatic variation and disease. Their paper has three parts. Part I explores the seasonal patterns in deaths from six causes: pneumonia, typhoid fever, scarlet fever, diphtheria, infant mortality, and smallpox. They find that these infectious diseases are highly sensitive to seasonal variation in temperature or rainfall but that the effects of temperature are not uniform or linear. Part I also asks why seasonal variation in temperature affects disease rates. The central finding here is that exposure to organic and inorganic pathogens depends heavily on temperature. Part II looks for evidence of what demographers and epidemiologists refer to as harvesting, such that unusually high or low temperatures are killing only the weakest and most unhealthy individuals, people who would have died anyway even without the extremes in temperature. Part II also asks a related question: whether poor socioeconomic groups were more vulnerable to changes in temperature than wealthier groups. Part III explores how public health interventions altered seasonal disease patterns and helped protect populations against the diseases related to temperature change.

Etkes explores the impact of short-term climate fluctuations on rural population by examining the differences in the latter's growth rates within the Gaza nahiye (ca. 1519-57). This small administrative unit (a trapezoid of about 60X35 Km) borders the desert and included both southern semi-arid and northern Mediterranean climate zones. The demographic data – the number of rural taxpayers – were deciphered from Ottoman tax surveys, and the indications for historical climate fluctuations include tree rings, grain prices, and qualitative evidence derived from historical documents. The study shows that the population in southern semi-arid villages was more sensitive to climate fluctuations than the population in northern Mediterranean villages. In other words, dry years were followed by a relatively slow demographic growth in southern villages, while bountiful years were followed by accelerated southern demographic growth. The study interprets this pattern as south-north migration aimed at smoothing consumption across wet and dry years. Similar circular migration are familiar as survival strategy in other regions such as the Sahel in Sub-Saharan Africa.

During the 1930s, the economy experienced the worst Depression in U.S. history. In addition, the American population faced the trials of Job as it was struck by a series of natural disasters. Everybody remembers the Dust Bowl as it kicked up huge amounts of particulates into the air, but this was only the most famous of many other disasters. Other parts of the country were struck by extreme and severe droughts. Meanwhile, excessive flooding and severe rainfall struck other sections. Recent corrections to the climate data show that the 1930s included several of the hottest years on record in American climate history. Fishback and his co-authors examine the impact of natural disasters and economic disasters on infant mortality rates and adult mortality rates during the course of the 1930s. They have constructed an annual panel data set for over 3000 counties for the years 1930 through 1940. The dataset includes annual data on infant mortality rates in both rural and city areas within the counties. When they examine the pure relationships between climate and natural disasters and infant mortality, they find that high temperatures and severe wetness and flooding were associated with higher infant mortality. After controlling for income and many government programs during the 1930s, they find that climate has very little impact on infant mortality rates. These preliminary results suggest that climate variation and natural disasters influence infant mortality by affecting income and other economic features, while having only a small direct effect after controlling for those factors.

Mueller and Osgood find that large short-term precipitation shocks damage the long-term income of households that have permanently migrated from rural to urban areas. This outcome is consistent with the behavior of credit-constrained rural households who are willing to accept lower long-term income in urban areas following the depletion of their productive assets during an adverse shock. The acceptance of lower income persists into the long term, as long as mechanisms for rebuilding capital remain unavailable. Their empirical evidence suggests that there may be a link between large precipitation shocks in rural areas and urban poverty. Further exploration is warranted on the mechanisms by which natural disasters cause these long-term losses.

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