The Economics of Development

‘The Surprising Instability of Export Specializations,’ Easterly, W. (with R. Daruich, and A. Reshef ), 2016.

We study the instability of hyper-specialization of exports. We have two main findings. (1) Specializations are surprisingly unstable: Export ranks are not persistent, and new top products and destinations replace old ones. Measurement error is unlikely to be the main or only determinant of this pattern. (2) Source-country factors are not the main explanation of this instability: Only 20% of the variation in export growth can be explained by variation in comparative advantage (source-by-product factors), while another 20% of the variation in export growth can be explained by variation in bilateral (source-by-destination) factors. The high share of product, destination, and product-by-destination factors, diminishes the emphasis on the nations where the exports originate. The high share of idiosyncratic variance (residual at the source-product-destination level of variation) of about 30%, also indicates the difficulty to predict export success using source country characteristics. These findings suggest that export performance depends, to a greater extent than previously appreciated, on forces that are outside the realm of national export promotion and industrial policies.

‘Shrinking dictators: how much economic growth can we attribute to national leaders?,’ Easterly, W. (with S. Pennings ), 2017.

National leaders – especially autocratic ones – are often given credit for high average rates of economic growth while they are in office (and draw criticism for poor growth rates). Drawing on the literature assessing the performance of schoolteachers and a simple variance components model, we develop a new methodology to produce optimal (least squares) estimates of each leader’s contribution to economic growth (controlling for commodity prices, regional business cycles, and country effects). While we do sometimes find sizable growth contributions of celebrated “benevolent autocrats”, we also find that (i) they are regularly outranked by other less celebrated leaders and (ii) the ranking and contributions of leaders is often not robust across growth datasets. Moreover, we find that even in world where leaders do affect growth, the average growth rate during a leader’s tenure is mostly uninformative about that leader’s actual growth contribution. Depending on the dataset and methodology, we find that that measured least squares leader contributions and unobserved leader effects can vary just as much in democracies as autocracies

‘A Long History of a Short Block: Four Centuries of Development Surprises on a Single Stretch of a New York City Street,’ Easterly, W. (with L. Freschi, and S. Pennings ), 2016.

Development economists usually (and understandably) evaluate effectiveness of intentional efforts to achieve economic development. There are few opportunities empirically to appreciate the unintended and surprising part of development outcomes portrayed by theories of creative destruction and other theories of spontaneous general equilibrium outcomes not intended by anyone. This paper does a development case study at an extreme micro level (one city block in New York City), but over a long period of time (four centuries). We find that (i) development involves many changes in production as comparative advantage evolves and (ii) most of these changes were unexpected (“surprises”). The block’s history illustrates how difficult it is for overly prescriptive planners to anticipate changes in comparative advantage and how such planning could instead stifle creative destruction.

‘How much long-run economic growth happens at the country level?,’ Easterly, W. (with D. Anzoategui, and S. Pennings ), 2016.

Policy and academic discussions of economic growth usually focus on country-level outcomes and determinants. But how much of the variation in long-run growth really happens at the country level? To answer this question, we collect data on growth at the national level (from standard sources), or at the provincial level (from Gennaioli et al. (2014)), and decompose it into variation due to province, country-level or supra-national factors. Using national growth rates, we find that 2/3 of long run growth is due to country effects and the remaining 1/3 is explained by supra-national factors. In our dataset of provincial growth rates, 1/2 of long run growth is national, 1/5 is provincial and the rest is supra-national. Moreover, year dummies show significant variation, suggesting important non-national effects coming from global cycles or global secular shifts in growth. Consistent with a growing literature, our results suggest that many of the deep determinants of growth (for example institutions, geography or culture) may vary at sub-national or supra-national levels, and the importance of the nation-state for economic growth has been overstated

‘Fiscal Policy and Debt Management with Incomplete Markets,’ Sargent, T. (with A. Bhandari, D. Evans and M. Golosov), 2017.

A Ramsey planner chooses a distorting tax on labor and manages a portfolio of securities in an economy with incomplete markets. We develop a method that uses second order approximations of Ramsey policies to obtain formulas for conditional and unconditional moments of government debt and taxes that include means and variances of the invariant distribution as well as speeds of mean reversion. Asymptotically the planner’s portfolio minimizes a measure of fiscal risk. Analytic expressions that approximate moments of the invariant distribution apply to data on a primary government deficit, aggregate consumption, and returns on traded securities. For U.S. data, we find that the optimal target debt level is negative but close to zero, that the invariant distribution of debt is very dispersed, and that mean reversion is slow.

‘A History of U.S. Debt Limits,’ Sargent, T. (with G. Hall), 2015.

Congress first imposed an aggregate debt limit in 1939 when it delegated decisions about designing US debt instruments to the Treasury. Before World War I, Congress designed each bond and specified a maximum amount of each bond that the Treasury could issue. It usually specified purposes for which proceeds could be spent. We construct and interpret a Federal debt limit before 1939..

‘Global Banks and Systemic Debt Crises,’ Perez, D. (with P. Ottonello, J. Morelli), 2019.

We study the role of global financial intermediaries in international lending. We construct a model of the world economy, where heterogeneous borrowers issue risky securities purchased by financial intermediaries. Aggregate shocks transmit internationally through financial intermediaries’ net worth. The strength of this transmission is governed by the degree of frictions intermediaries face financing their risky investments. We provide direct empirical evidence on this mechanism showing that, around Lehman Brothers’ collapse, emerging-market bonds held by more-distressed global banks experienced larger price contractions. A quantitative analysis of the model shows that global financial intermediaries play a relevant role driving borrowing-cost and consumption fluctuations in emerging-market economies, both during debt crises and in regular business cycles. The portfolio of financial intermediaries and the distribution of bond holdings in the world economy are key to determine aggregate dynamics.

‘Structured Uncertainty and Model Misspecification∗,’ Sargent, T. (with L.P. Hansen), 2019.

An ambiguity averse decision maker evaluates plans under a restricted family of structured models and unstructured alternatives that are statistically close to them. Structured models include parametric models in which parameter values vary over time in ways that the decision maker cannot describe probabilistically. Because he suspects that all parametric models are misspecified, the decision maker also evaluates plans under alternative probability distributions with much less structure.

‘A Case for Incomplete Markets,’ Cogley, T. and T. Sargent (with L.E. Blume, D.A. Easley, and V. Tsyrennikov), 2015.

We propose a new welfare criterion that allows us to rank alternative financial market structures in the presence of belief heterogeneity. We analyze economies with complete and incomplete financial markets and/or restricted trading possibilities in the form of borrowing limits or transaction costs. We describe circumstances under which variousrestrictions on financial markets are desirable according to our welfare criterion.

‘On Money as a medium of exchange in near-cashless credit economies,’ Lagos, R. (with S. Zhang), 2019.

We study the transmission of monetary policy in credit economies where money serves as a medium of exchange. We find that—in contrast to current conventional wisdom in policy-oriented research in monetary economics—the role of money in transactions can be a powerful conduit to asset prices and ultimately, aggregate consumption, investment, output, and welfare. Theoretically, we show that the cashless limit of the monetary equilibrium (as the cash-and-credit economy converges to a pure-credit economy) need not correspond to the equilibrium of the nonmonetary pure-credit economy. Quantitatively, we find that the magnitudes of the responses of prices and allocations to monetary policy in the monetary economy are sizeable—even in the cashless limit. Hence, as tools to assess the effects of monetary policy, monetary models without money are generically poor approximations—even to idealized highly developed credit economies that are able to accommodate a large volume of transactions with arbitrarily small aggregate real money balances.

‘An Empirical Study of Trade Dynamics in the Fed Funds Market,’ Lagos, R. (with G. Afonso), 2014.

We use minute-by-minute daily transaction-level payments data to document the cross-sectional and time-series behavior of the estimated prices and quantities negotiated by commercial banks in the fed funds market. We study the frequency and volume of trade, the size distribution of loans, the distribution of bilateral fed funds rates, and the intraday dynamics of the reserve balances held by commercial banks. We find evidence of the importance of the liquidity provision achieved by commercial banks that act as de facto intermediaries of fed funds.

‘Monetary Exchange in Over-the-Counter Markets: A Theory of Speculative Bubbles, the Fed Model, and Self-fulfilling Liquidity Crises,’ Lagos, R. (with S. Zhang), 2015.

We develop a model of monetary exchange in over-the-counter markets to study the effects of monetary policy on asset prices and standard measures of financial liquidity, such as bid-ask spreads, trade volume, and the incentives of dealers to supply immediacy, both by participating in the market-making activity and by holding asset inventories on their own account. The theory predicts that asset prices carry a speculative premium that reflects the asset’s marketability and depends on monetary policy as well as the microstructure of the market where it is traded. These liquidity considerations imply a positive correlation between the real yield on stocks and the nominal yield on Treasury bonds—an empirical observation long regarded anomalous. The theory also exhibits rational expectations equilibria with recurring belief driven events that resemble liquidity crises, i.e., times of sharp persistent declines in asset prices, trade volume, and dealer participation in market-making activity, accompanied by large increases in spreads and abnormally long trading delays.

‘Turnover Liquidity and the Transmission of Monetary Policy,’ Lagos, R. (with S. Zhang), 2018.

We study the severity of liquidity constraints in the U.S. housing market using a life-cycle model with uninsurable idiosyncratic risks in which houses are illiquid, but agents have the option to extract home equity by refinancing their long-term mortgages. The model implies that three quarters of homeowners are liquidity constrained and willing to pay an average of 5 cents to extract an additional dollar of liquidity from their home. Most homeowners value liquidity for precautionary reasons, anticipating the possibility of income declines and the need to make mortgage payments in future periods. Mortgage assistance policies structured as credit lines to homeowners who experience a shortfall in income greatly reduce the severity of liquidity constraints.

‘Stress Tests and Bank Portfolio Choice,’ Williams, B., 2017.

How informative should bank stress tests be? I use Bayesian persuasion to formalize stress tests and show that regulators can reduce the likelihood of a bank run by performing tests which are only partially informative. Optimal stress tests give just enough failing grades to keep passing grades credible enough to avoid runs. The worse the state of the banking system, the more stringent stress tests must be to prevent runs. I find that optimal stress tests, by reducing the probability of runs, reduce the optimal level of banks’ liquidity cushions. I also examine the impact of anticipated stress tests on banks’ ex ante incentive to invest in risky versus safe assets.