New: Natural Experiments in Macroeconomics
A growing literature relies on natural experiments to establish causal effects in macroeconomics. In diverse applications, natural experiments have been used to verify underlying assumptions of conventional models, quantify specific model parameters, and identify mechanisms that have major effects on macroeconomic quantities but are absent from conventional models. We discuss and compare the use of natural experiments across these different applications and summarize what they have taught us about such diverse subjects as the validity of the permanent income hypothesis, the size of the fiscal multiplier, and about the effects of institutions, social structure, and culture on economic growth. We also outline challenges for future work in each of these fields, give guidance for identifying useful natural experiments, and discuss the strengths and weaknesses of the approach.
REVISION: The Power of the Street: Evidence from Egypt's Arab Spring
During Egypt's Arab Spring, unprecedented popular mobilization and protests brought down Hosni Mubarak's government and ushered in an era of competition between three groups: elites associated with Mubarak's National Democratic Party (NDP), the military, and the Islamist Muslim Brotherhood. Street protests continued to play an important role during this power struggle. We show that these protests are associated with differential stock market returns for firms connected to the three groups. Using daily variation in the number of protesters, we document that more intense protests in Tahrir Square are associated with lower stock market valuations for firms connected to the group currently in power relative to non-connected firms, but have no impact on the relative valuations of firms connected to other powerful groups. We further show that activity on social media may have played an important role in mobilizing protesters, but had no direct effect on relative valuations. According to ...
REVISION: Forward and Spot Exchange Rates in a Multi-Currency World
We decompose violations of uncovered interest parity into a cross-currency, a between-time-and-currency, and a cross-time component. We show that most of the systematic violations are in the cross-currency dimension. By contrast, we find no statistically reliable evidence that currency risk premia respond to deviations of forward premia from their time- and currency-specific mean. These results imply that the forward premium puzzle (FPP) and the carry-trade anomaly are separate phenomena that may require separate explanations. The carry trade is driven by static differences in interest rates across currencies, whereas the FPP appears to be driven primarily by cross-time variation in all currency risk premia against the US dollar. Models that feature two symmetric countries thus cannot explain either of the two phenomena. Once we make the appropriate econometric adjustments we also cannot reject the hypothesis that the elasticity of risk premia with respect to forward premia in all ...
REVISION: Information Aggregation in a DSGE Model
We introduce the information microstructure of a canonical noisy rational expectations model (Hellwig, 1980) into the framework of a conventional real business cycle model. Each household receives a private signal about future productivity. In equilibrium, the stock price serves to aggregate and transmit this information. We find that dispersed information about future productivity affects the quantitative properties of our real business cycle model in three dimensions. First, households' ability to learn about the future affects their consumption-savings decision. The equity premium falls and the risk-free interest rate rises when the stock price perfectly reveals innovations to future productivity. Second, when noise trader demand shocks limit the stock market's capacity to aggregate information, households hold heterogeneous expectations in equilibrium. However, for a reasonable size of noise trader demand shocks the model cannot generate the kind of disagreement observed in the ...
REVISION: The Social Cost of Near-Rational Investment
We show that the stock market may fail to aggregate information even if it appears to be efficient and that the resulting decrease in the information content of stock prices may drastically reduce welfare. We solve a macroeconomic model in which information about fundamentals is dispersed and households make small, correlated errors around their optimal investment policies. As information aggregates in the market, these errors amplify and crowd out the information content of stock prices. When stock prices reflect less information, the volatility of stock returns rises. The increase in volatility makes holding stocks unattractive, distorts the long-run level of capital accumulation, and causes costly (first-order) distortions in the long-run level of consumption.
REVISION: The Social Cost of Near-Rational Investment
We show that the stock market may fail to aggregate information even if it appears to be efficient; the resulting collapse in the dissemination of information may drastically reduce welfare. We solve a macroeconomic model in which information about fundamentals is dispersed and households make small, correlated errors around their optimal investment policies. As information aggregates in the market, these errors amplify and crowd out the information content of stock prices. When stock prices reflect less information, the perceived and the actual volatility of stock returns rise. This increase in financial risk makes holding stocks unattractive, distorts the long-run level of capital accumulation, and causes costly ( first-order) distortions in the long-run level of consumption.
REVISION: Country Size, Currency Unions, and International Asset Returns
Differences in real interest rates across developed economies are puzzlingly large and persistent. I propose a simple explanation: Bonds issued in the currencies of larger economies are expensive because they insure against shocks that affect a larger fraction of the world economy. I show that differences in the size of economies indeed explain a large fraction of the cross-sectional variation in currency returns. The data also support a number of additional implications of the model: The introd
REVISION: The Economic Impact of Social Ties: Evidence from German Reunification
We use the fall of the Berlin Wall in 1989 to show that personal relationships which individuals maintain for non-economic reasons can be an important determinant of regional economic growth. We show that West German households who have social ties to East Germany in 1989 experience a persistent rise in their personal incomes after the fall of the Berlin Wall. Moreover, the presence of these households significantly affects economic performance at the regional level: it increases the returns to
REVISION: Market Sentiment: A Tragedy of the Commons
We present a model with dispersed information in which investors decide whether or to what degree they want to allow their behavior to be influenced by "market sentiment". Investors who choose to insulate their decision from market sentiment earn higher expected returns, but incur a small mental cost. We show that if information is moderately dispersed across investors, even a very small mental cost (on the order of 0.001% of consumption) may generate a significant amount of sentiment in equilib
REVISION: Social Structure and Development: A Legacy of the Holocaust in Russia
We document a statistical association between the severity of the persecution and mass murder of Jews (the Holocaust) by the Nazis during World War II and long-run economic and political outcomes within Russia. Cities that experienced the Holocaust most intensely have grown less, and both cities and administrative districts (oblasts) where the Holocaust had the largest impact have worse economic and political outcomes since the collapse of the Soviet Union. Although we cannot rule out the possib