August 24, 2023

The Hutchins Roundup brings the latest thinking in fiscal and monetary policy to your inbox. Have something you'd like us to include in the next Roundup? Email us and we'll take a look.

This edition was written by Elijah Asdourian, Sam Boocker, Georgia Nabors, and David Wessel.

Estimates of consumption’s responsiveness to changes in income are too large

Standard estimates of how consumers adjust their spending in response to a change in their income—the marginal propensity to consume (MPC)—find that consumption is very responsive to income changes. Jacob Orchard of the Federal Reserve Board and Valerie Ramey and Johannes Wieland of the University of California, San Diego, say that using traditional MPC estimates to estimate how total consumption would have behaved absent the 2008 tax rebate produces unreasonably large declines in aggregate consumption. The authors argue that prevailing MPC estimates are biased upward. After adjusting for this bias and accounting for supply responses to increased demand, the authors find that for each additional dollar of the total 2008 rebate, total consumption increased by less than 20 cents. 

Liquidity stress persists even after central banks expand balance sheets

Viral Acharya of New York University and Raghuram Rajan of the University of Chicago find that private sector responses to central bank balance sheet expansions challenge standard economic intuition, which predicts substantial increases in the supply of liquidity. Central banks expand their balance sheets by issuing reserves. These reserves increase the supply of liquidity, but commercial banks often finance them with short-term liabilities such as uninsured deposits, offsetting that added liquidity. Additionally, when the economy becomes liquidity stressed, healthy banks may hoard reserves in order to be perceived as safe, rather than lending them to stressed banks. As a result, the increase in liquidity supply from central bank balance sheet expansions may be more than offset by increased demand for liquidity. This may help explain liquidity shocks in recent years despite large central bank balance sheet expansions.  

Animal spirits in the economy

Since John Maynard Keynes, economists have debated the extent to which “animal spirits”—people’s tendency to be overly optimistic or pessimistic about the future economy—serve as a driving force for both real economic activity and stock market volatility. Using data on long-term earnings growth from analysts’ forecasts for S&P 500 firms from 1980-2022, Pedro Bordalo of Oxford University and co-authors demonstrate that long-term market expectations explain movement in stock prices as well as fluctuations in investment and the business cycle. These results support the idea that animal spirits, through the “predictable disappointment of optimism,” are an important ingredient in understanding variation in economic activity and the stock market. 

30-year fixed mortgage rates hit two-decade high

Chart courtesy of The Wall Street Journal

Quote of the week:

"The pandemic was a very difficult period for young people and their parents, many of whom were forced to choose between continuing to work and caring for their children. It is encouraging to see that many of these challenges have eased, and that we can focus more intently on what young people need most to succeed," says Michelle Bowman, member of the Federal Reserve Board of Governors.

"One positive development that is supporting the transition of young people into the labor force has been the tight labor market and the reversal of pandemic-period trends for young workers, who typically have limited work experience. In the wake of economic downturns, it is usually those young workers who are most impacted by unemployment and take the longest to regain lost ground. During this period, however, the share of 18-to-24-year-olds who are employed has recovered to around where it was just before the pandemic and has outpaced the employment recovery since the pandemic low for those in their prime working years, between ages 25 and 54. In addition, wages for young workers have grown more quickly over the past several years than wages for prime-age workers. Although this is great news for today's youth, young people still face significant longer‑term challenges. For example, the share of 'disconnected' young adults, who are not participating in the workforce or continuing their education, has been rising over the past 20 years. Young adults who disengage from these wealth- and income-building opportunities often face long-term disadvantages, which is concerning both for the individual and for the economy as a whole."