Research: JIM COSTAIN

Productivity Shocks and the Business Cycle: Reconciling Recent VAR Evidence.
Joint with Beatriz de Blas Pérez (U. Navarra). Work in progress.

Abstract: Gali (1999) used a VAR with productivity and hours worked to argue that technology shocks are negatively correlated with labor and are unimportant for the business cycle. More recently, Beaudry and Portier (2003) studied a VAR in productivity and stock prices. Remarkably, they found that the component which has a permanent impact on productivity is almost identical to that which has no immediate impact on productivity. Moreover, either of these components explains most business cycle variation. Like Gali's results, these observations are inconsistent with early RBC models, but on the other hand they contradict Gali's claim that technology shocks are unimportant for cycles.
In this paper, we study trivariate VARs in productivity, hours worked, and stock prices to see how these apparently contradictory results can be reconciled. We find one VAR specification that qualitatively and quantitatively matches the findings of Gali (so that long-run technology shocks drive hours down), and a second specification that matches the main findings of Beaudry and Portier (so that long-run technology shocks increase hours, are similar to the short-run shock to stock prices, and play a major role in generating business cycles). Surprisingly, the difference between these two specifications has nothing to do with estimating in levels or in differences, or with running VARs or VECMs, or with the ordering of variables. The only difference between the two specifications lies in which productivity variable is used: labor productivity (to generate results like Gali's) or TFP (to generate results like those of Beaudry and Portier). Both the original Beaudry and Portier estimations, as well as our findings on the productivity specification, add to the evidence that Gali's findings are not robust. Apparently the cyclical role of technology shocks is only picked up when a sufficiently cyclical productivity series is used in the estimation.

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Abstract: This paper considers a dynamic matching model with imperfectly observable worker effort, combining the matching technology of Mortensen and Pissarides (1994) with the shirking problem of Shapiro and Stiglitz (1984). In equilibrium, the wage distribution is truncated from below in order to satisfy a no-shirking condition. This downward wage rigidity induces the same type of inefficient churning and "contractual fragility" as in Ramey and Watson (1997). Nonetheless, the surprising lesson of our analysis is that workers' shirking motive reduces the cyclical fluctuations in job destruction, because firms are forced to terminate some marginal jobs in booms which they cannot commit to maintain in recessions. This time-inconsistency problem casts doubt on the importance of inefficient churning as an explanation of observed employment fluctuations. On the other hand, the no-shirking condition implies that firms' share of surplus is procyclical, which can amplify fluctuations in job creation. Thus, our model is consistent with recent evidence that job creation is more important than job destruction in driving labor market fluctuations. Furthermore, unlike most models with endogenous job destruction, we obtain a robust Beveridge curve.

Stabilization versus Insurance: Welfare Effects of Procyclical Taxation under Incomplete Markets.
Joint with Michael Reiter (U. Pompeu Fabra). Nov. 2004; revised Aug. 2005.

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Abstract: We construct and calibrate a general equilibrium business cycle model with unemployment and precautionary saving. We compute the cost of business cycles and locate the optimum in a set of simple cyclical fiscal policies.
Our economy exhibits productivity shocks, giving firms an incentive to hire more when productivity is high. However, business cycles make workers' income riskier, both by increasing the unconditional probability of unusually long unemployment spells, and by making wages more variable, and therefore they decrease social welfare by around one-fourth or one-third of 1% of consumption. Optimal fiscal policy offsets the cycle, holding unemployment benefits constant but varying the tax rate procyclically to smooth hiring. By running a deficit of 4% to 5% of output in recessions, the government eliminates half the variation in the unemployment rate, most of the variation in workers' aggregate consumption, and most of the welfare cost of business cycles.

Multiple Outcomes of Speculative Behavior in Theory and in the Laboratory.
Joint with Frank Heinemann (U. Munich) and Peter Ockenfels (U. Frankfurt). Nov. 2004, revised Apr. 2005.

NOTE: a preliminary version of this paper is available via email from the author.
Abstract: This paper shows that Morris and Shin's (AER 1998) argument that the outcome of a speculative attack is uniquely determined by macroeconomic fundamentals fails if decisions are not simultaneous. As long as most agents observe the choices of a few others before making their own decisions, we find that there is a range of fundamentals where multiple outcomes occur, as Obstfeld (1996) claimed.
In our experimental sessions, eight to sixteen players observe signals about the aggregate state and may also observe a random subset of previous actions. We find a unique mapping between fundamentals and the fraction of players attacking if previous actions are unobserved. But when most previous actions are observed, there is an intermediate interval of fundamentals (which is usually statistically significant) where all players attacking, and no players attacking, both occur with more than 1% probability.

Business Cycles, Unemployment Insurance, and the Calibration of Matching Models.
Joint with Michael Reiter (U. Pompeu Fabra). CESifo Working Paper #1008, Aug. 2003; U. Pompeu Fabra Economics Working Paper #872, July 2005; revised Oct. 2006.

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Abstract: This paper theoretically and empirically documents an empirical puzzle that arises when an RBC economy with a job matching function is used to model unemployment. The standard model can generate sufficiently large cyclical fluctuations in unemployment, or a sufficiently small response of unemployment to labor market policies, but it cannot do both. Variable search and separation, finite UI benefit duration, efficiency wages, and capital all fail to resolve this puzzle. However, either sticky wages or match-specific productivity shocks can improve the model's performance by making the firm's flow of surplus more procyclical, which makes hiring more procyclical too.

A Herding Perspective on Global Games and Multiplicity.
U. Carlos III Economics Working Paper 03-29 (08), May 2003; revised March 2006.

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Abstract: Recently, it has been claimed that full-information multiple equilibria in games with strategic complementarities are not robust, because generalizing to allow slightly heterogeneous information implies uniqueness. This paper argues that this ``global games'' uniqueness result is itself not robust. If we generalize by allowing most agents to observe a few previous actions before choosing, instead of forcing players to move exactly simultaneously, then multiplicity of outcomes is restored. Only a small sample of observations is needed to make our herding equilibrium behave like a full-information sunspot equilibrium instead of a global games equilibrium.

On Payoff Heterogeneity in Games with Strategic Complementarities.
Joint with Antonio Ciccone (U. Pompeu Fabra). Oxford Economic Papers 56 (4), Oct. 2004, pp. 701-34.

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Abstract: Recent papers involving binary choices have argued that increasing heterogeneity decreases positive feedback. We show that no such result holds in models where all agents make interior choices. The results in the binary choice case arise for two reasons. First, if we increase heterogeneity without limit but impose a bounded choice set, then almost all players eventually become completely unresponsive, preferring some corner so strongly that they do not react to any feasible change in the behavior of others. Second, discrete choice permits the construction of strong, but fragile, positive feedbacks through composition effects.

Computing Business Cycles with Endogenous Risk.
Joint with Michael Reiter (U. Pompeu Fabra). March 2001.

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A Simple Model of Multiple Equilibria Based on Risk.
U. Pompeu Fabra Economics Working Paper #407, July 1999; revised Oct. 2000.

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Abstract: This paper shows how risk may aggravate fluctuations in economies with imperfect insurance and multiple assets. A two period job matching model is studied, in which risk averse agents act both as workers and as entrepreneurs. They choose between two types of investment: one type is riskless, while the other is a risky activity that creates jobs. Equilibrium is unique under full insurance. If investment is fully insured but unemployment risk is uninsured, then precautionary saving behavior dampens output fluctuations. However, if both investment and employment are uninsured, then an increase in unemployment gives agents an incentive to shift investment away from the risky asset, further increasing unemployment. This positive feedback may lead to multiple Pareto ranked equilibria. An overlapping generations version of the model may exhibit poverty traps or persistent multiplicity. Greater insurance is doubly beneficial in this context since it can both prevent multiplicity and promote risky investment.

On the Quantitative Importance of Wage Bargaining Models.
U. Pompeu Fabra Economics Working Paper #262, Jan. 1998.

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Abstract: Four general equilibrium search models are compared quantitatively. The baseline framework is a calibrated macroeconomic model of the US economy designed for a welfare analysis of unemployment insurance policy. The other models make three simple and natural specification changes, regarding tax incidence, monopsony power in wage determination, and the relevant threat point. These specification changes have a major impact on the equilibrium and on the welfare implications of unemployment insurance, partly because search externalities magnify the effects of wage changes. The optimal level of unemployment insurance depends stongly on whether raising benefits has a larger impact on search effort or on hiring expenditure.

Unemployment Insurance with Endogenous Search Intensity and Precautionary Saving.
U. Pompeu Fabra Economics Working Paper #243, Nov. 1997. Latest version: Nov. 1999.

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Abstract: A welfare analysis of unemployment insurance (UI) is performed in a general equilibrium job matching model. Risk averse workers choose consumption and saving, as well as search effort when unemployed; firms hire workers, purchase capital, and pay taxes to finance worker benefits. The model is calibrated to US data, including microeconomic studies of UI and unemployment spells. The consumption smoothing benefits of UI are small, especially under logarithmic utility. Likewise, moral hazard is not very important. The most significant welfare effects of UI arise from decreased work disutility, and from search and investment externalities implied by the matching framework.

A Note on Wage Bargaining in Matching Models.
March 1996.

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Abstract: This paper asks which threat point is appropriate for matching models: the threat to quit, or the threat to strike. I find that both may be correct, depending on whether or not striking workers occasionally obtain alternative job offers. Unfortunately, after finishing this paper, I discovered that its main results had already been shown by Wolinsky (J.E.T. 1987). Readers may nonetheless be interested in my paper's comments on the role of asset holdings in wage bargaining, on the limiting wage as matching rates increase, and on the relation between one-time and repeated wage bargaining.

General Equilibrium Unemployment Insurance: the Exponential Utility Case.
Nov. 1995.

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Abstract: A welfare analysis of unemployment insurance (UI) is performed in a general equilibrium job matching model. UI raises unemployment through its effects on firms' hiring decisions, but it also benefits workers, who are risk averse, by helping them smooth their consumption. Two key assumptions help make the model tractable. First, workers are assumed to have constant absolute risk aversion. Second, the threat point in wage bargaining is assumed to be delay (a strike) instead of separation (quitting). These assumptions simplify consumption and wealth dynamics, allowing an analytical characterization of the steady-state distribution of wealth. The baseline parameterization implies an optimal replacement ratio of 25%. Higher risk aversion increases optimal UI.

The Battle of the Box: a Two-Agent Rational Choice Model of Conflict and Property Rights.
June 1992.

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Abstract: In this model, property rights are made endogenous by explicitly allowing for conflict. Two rational agents who value consumption and leisure decide whether or not to fight by weighing costs and benefits. Possible outcomes include peace, fighting, and surrender, depending on the initial distribution of wealth and power. The model makes clear that there may be costly fighting even when the outcome is known by both sides in advance.