September 14, 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, Alex Conner, Georgia Nabors, and Louise Sheiner.

Large shocks travel fast

Alberto Cavallo of Harvard, Ken Miyahara of the University of Chicago, and Francesco Lippi of Luiss University build on literature finding that firms change prices more quickly when they confront large changes in costs than when they confront small ones. The authors modify price-setting behavior in a standard New Keynesian model (where a small, fixed share of firms revise prices each period) to make firms revise prices more often when the difference between the current price and profit-maximizing price is large. They show that their calibration describes recent inflation and price adjustment behavior in a panel of developed economies. Small shocks behave almost identically in both the standard and the modified model, but, in the authors’ words, “large cost shocks incite firms to react more swiftly than usual, resulting in a rapid pass-through to prices – large shocks travel fast.” They note that central banks don’t yet employ models with rich price-setting behavior, which may be important to understand large shocks in the future. 

Digital goods produce large welfare gains

To calculate the welfare generated from online platforms such as Google Search and YouTube, Erik Brynjolfsson of Stanford and co-authors asked nearly 40,000 Facebook users to place a monetary value on their use of the platform. Using these results to inform estimates for other digital products, they find that 10 widely used digital goods produce $2.5 trillion of value to consumers each year for the 13 countries included in the study, equivalent to nearly 6% of combined GDP. The welfare gains are larger for low-income individuals and nations with lower GDP per capita relative to their high-income counterparts. Because they generate disproportionate benefits for those with lower incomes, free public digital goods can alleviate welfare disparities between and within countries.

Corporate profits are in line with pre-COVID trends after accounting for government support

Berardino Palazzo of the Federal Reserve Board challenges the view that the recent spike in inflation resulted in fatter profits. He says that profits were boosted by direct government support to businesses and decreases in interest rates that occurred during the pandemic, rather than price increases on final goods that exceeded increases in input costs. Using a measure of corporate profits equal to the difference between revenues and labor and depreciation costs, he finds that profits at publicly traded, nonfinancial corporations have been in line with trends from 2019. Using this measure, corporate profit margins do not look abnormally high, and middle-sized publicly traded firms have actually seen weak profitability since the onset of the COVID-19 pandemic.

Real median household income has been declining since 2019

Chart courtesy of the U.S. Census Bureau

Quote of the week:

"There is a lot to be learned from this experience, including about how to communicate in uncertain times. But I ask that people keep in mind the circumstances we faced in 2020. It was a very scary time. An unknown virus was sweeping the world, our international borders were closed, people couldn’t move across state lines, we were being told to stay in our homes, temporary morgues were being set up, and a vaccine was thought to be years away. There were credible projections that the unemployment rate would rise to 15% and that there would be a deep and lasting economic contraction. And even well into 2021 large parts of country were still in stringent lockdowns…. At the RBA, we wanted to do what we could to build a bridge across to better times and to provide some insurance against the very worst outcomes. I know that the government had a similar mindset. This approach worked. The Australian economy avoided falling into the abyss and then bounced back well," says Philip Lowe, Governor of the Reserve Bank of Australia.

"With the benefit of hindsight, my view is that we did do too much. But hindsight is a wonderful thing. None of us can predict the future and we have had to make decisions under great uncertainty and with incomplete information. We got some things right, but we got other things wrong."