Working Paper: The Aggregate Implications of Regional Business Cycles (with Martin Beraja and Erik Hurst)

Status: Revise and Resubmit Econometrica

Our work: Paper    On-line Appendix       Slides       Data and Code

Abstract: We argue that it is difficult to make inferences about the drivers of aggregate business cycles using regional variation alone because (i) the local and aggregate elasticities to the same type of shock are quantitatively different and (ii) purely aggregate shocks are differenced out when using cross-region variation. We highlight the importance of these issues in a monetary union model, and by contrasting the behavior of US aggregate time-series and cross-state patterns during the Great Recession. In particular, using household and retail scanner data for the US, we document a strong relationship across states between local employment growth and local nominal and real wage growth. These relationships are much weaker in US aggregates. In order to identify the shocks driving aggregate (and regional) business cycles we develop a methodology that combines regional and aggregate data. The methodology uses theoretical restrictions implied by a wage setting equation that holds in many monetary union models with nominal wage stickiness. We show how to estimate this equation using cross-state variation—thus linking particular regional patterns to particular aggregate shock decompositions. Applying the methodology to the US, we find that a combination of both "demand" and "supply" shocks are necessary to account for the joint dynamics of aggregate prices, wages and employment during the 2007-2012 period while only "demand" shocks are necessary to explain most of the observed cross-state variation. We conclude that the wage stickiness necessary for demand shocks to be the primary cause of aggregate employment decline during the Great Recession is inconsistent with the flexibility of wages estimated from cross-state variation.

Presentations: Berkeley, Boston University, Brown, Chicago, Chicago Federal Reserve, Columbia, Duke, Harvard, Michigan, Minneapolis Federal Reserve, Minnesota Workshop in Macroeconomic Theory, MIT, NBER’s Summer Institute EF&G, NBER’s Summer Institute Prices Program, Northwestern, Princeton, Rochester, St. Louis Federal Reserve, UCLA, Yale’s Cowles Conference on Macroeconomics, the Board of Governors of the Federal Reserve, and the Bank of England, Banco de la República de Colombia, Uchicago Social Sciences Division Research Conference.

Media coverage: WSJ Blog (pdf)       WSJ Heard on the Street (pdf)       Washington Post (pdf)      Capital Ideas (pdf)        Marginal Revolution     Noahpinion Blog