Studies in this week’s Hutchins Roundup find that house prices drive the growth of young firms, fiscal policy has large spillover effects, and more.
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Young businesses, an important driver of dynamism in an economy, tend to be hit harder in recessions and grow faster during expansions relative to older firms. Stephen Davis of the University of Chicago and John Haltiwanger of the University of Maryland pin this on housing markets because new businesses often rely on housing wealth for financing. When house prices decline, would-be entrepreneurs lose collateral and liquidity from housing and pull back from starting or expanding firms. Conversely, increases in house prices improve entrepreneurs’ financial positions. The authors find that the 1998-2006 housing boom increased the share of employment at young firms by 2 percentage points, and that the housing bust during the Great Recession reduced it by 2.5 percentage points. They also find that the contraction of local bank loan supply during the recession reduced the share of employment at young firms by an additional percentage point. The findings suggest that the decline in house prices, and to a lesser extent, credit conditions, played a significant role in the stagnation of young firm growth after the Great Recession and, ultimately, the pace of the recovery.
Economists have long debated whether government spending encourages or crowds out private-sector economic activity. Using data from the U.S. Department of Defense (DOD), Alan Auerbach and Yuriy Gorodnichenko of the University of California at Berkeley and Daniel Murphy of the University of Virginia find that cities that win DOD spending contracts see higher employment in the industries receiving the contracts as well as in other unrelated industries like food services and health care. In addition, DOD spending in one city leads to higher output and employment in nearby cities, suggesting that government spending produces net positive growth rather than crowding out local or neighboring industries. They estimate that $1 of DOD spending in a city increases GDP in that city by $1 and increases GDP in nearby cities by 50 cents.
Most macroeconomic models assume that when the economy slows, firms are more prone to lay off workers than reduce nominal wages. However, Ekaterina Jardim of Amazon, Gary Solon of the University of Washington, and Jacob Vigdor of the University of Arizona show that wage cuts are more common than these models assume. Using administrative data from 2005 to 2015 for the state of Washington, they show that more than 20 percent of workers who remained at the same job for more than one year experienced nominal wage reductions. The share of workers experiencing reductions climbed to 33 percent during the Great Recession, suggesting that many workers will accept nominal wage cuts if the alternative is losing their job.
“So, how should the Fed respond to an outlook of slowing growth and one that’s less certain than, say, this time last year? In a word: carefully. At the start of 2018, when the economy was growing well above trend and interest rates still were still quite low, gradually raising rates was the obvious and necessary choice. Twelve months later, the tailwinds have lost their gust, interest rates are closer to normal levels, and inflation is tame. The approach we need is one of prudence, patience, and good judgment. The motto of ‘data dependence’ is more relevant than ever. If growth continues to come in well above sustainable levels, somewhat higher interest rates may well be called for at some point,” says John Williams, president of the Federal Reserve Bank of New York.