Introduction Jeffrey Frankel, Harvard and NBER Christopher Pissarides, London School of Economics The International Seminar on Macroeconomics (ISOM) meets every June in a different European city, bringing together American and European economists to study a variety of topics within “macroeconomics” defined very broadly. NBER’s 34th International Seminar on Macroeconomics (ISOM) took place on June 17 and 18, 2011. Jeffrey Frankel is overall codirector of ISOM on behalf of the NBER, with Francesco Giavazzi as his European counterpart. We continue to work with a local host in a different European country each summer, and to divide the authors and discussants equally between Americans and Europeans. Geographically, ISOM has been venturing farther afield than its origins in the major countries of Western Europe. Since 2005 we have often held meetings among countries that have recently acceded, or hope to accede, to the European Union or euro. Our 2011 host country, Malta, joined the European Union in 2004 and the euro in 2008. Frankel and Christopher Pissarides organized this year’s program. The papers published here have gone through a rigorous refereeing process, chiefly by the ISOM Board. The University of Chicago Press Journals Division publishes them as a companion volume to the NBER Macroeconomics Annual. Overview of the Volume The eight papers published in the 34th volume of ISOM, as usual, cover quite a range of topics. While the subject matter of the papers ranges widely, one can weave some overarching themes. The chapters fall roughly into three categories, represented by three parts of the vol © 2011 by the National Bureau of Economic Research. All rights reserved. 978-0-226-26034-1/2011/2011-0001$10.00 book isom2011.indb 1 1/5/12 12:26 PM 2 Frankel and Pissarides ume: productivity in the international economy; in what countries are downturns not susceptible to demand stimulus; and nominal and real exchange rates. Part I: Productivity in the International Economy The first three papers concern aspects of productivity. In the fi rst chapter, “Long-Term Barriers to the International Diffusion of Innovations,” Enrico Spolaore and Romain Wacziarg explore what is perhaps the important question in economics: what determines which countries are able to achieve rapid progress in total factor productivity and hence per capita income? In particular, why do some countries adopt the latest technological innovations quickly, and others slowly or not at all? The authors’ approach begins with the observation that people do not necessarily know whether a given new technology will work, and tend to adopt it only if the new technique is visibly demonstrated or explained to them in a way that they can understand it. The authors’ central hypothesis is that countries where the population is more closely related, in a biological (genetic) sense, to the country that is at the frontier of the technology in question, will adopt the technology more quickly than countries that are genetically distant from the frontier. Presumably an American entrepreneur who is ethnically Chinese is better able to transfer a given manufacturing technology to China than is someone of a different ethnicity. The authors offer a theoretical model, and then test various hypotheses empirically. They use data that were originally collected by population geneticists, providing allele frequencies for 120 gene loci covering 42 world populations, and an implied measure of measure of genetic distance between pairs of these populations. (The Danish and the English are found to be the closest pair genetically, Mbuti Pygmies and Papua New Guineans the most distant.) They also use data collected by economists on the extent to which 24 specific technologies were used among each of 113 contemporary conturies in 1500 and the extent to which 33 modern technologies are in use in various countries today. They find that societies which are genetically more distant from the technological frontier tend to face higher imitation costs and thus tend to be slower to adopt the new technologies. Schumpeter introduced “creative destruction,” the idea that aggregate economic productivity rises over time as inefficient old fi rms go book isom2011.indb 2 1/5/12 12:26 PM Introduction 3 out of business and energetic new firms take their place. In “Firm Heterogeneity, Endogenous Entry, and the Business Cycle,” Gianmarco Ottaviano explores the tendency of new firms to enter when the economy is booming, more so than in downturns, and the tendency of old fi rms to exit the economy in downturns, more so than in booms. These patterns are reminiscent of the view that recessions ultimately serve a useful role by “cleansing” the economy of subpar performers. The paper addresses the implications of these cyclical patterns of entry and exit for movements in overall productivity in the economy and in the overall markup rate, averaging across strong and weak firms. It builds in variation in markups over the business cycle, which are low when fi rms must compete with many rivals and face high elasticities of demand. Crucially, firms are not all the same. As a result, entry and exit affect the overall elasticity of demand. The author implements a numerical version of the model. He then concludes that when a positive productivity shock causes a cyclical upswing, the tendency of new firms to enter the expanding economy works to dampen the increase in average productivity because the composition shifts toward marginal fi rms. In “The Risk Content of Exports: A Portfolio View of International Trade,” Julian di Giovanni and Andrei Levchenko study why some countries experience high volatility via international trade and others low volatility. One might expect the answer to depend on how open to trade the country is or on whether the products that it specializes in happen to be highly volatile (on world markets). But the authors develop a model of trade that a country’s decision which sectors to specialize its production in depends on their volatility as much as it is a determinant of volatility. In classical trade theory, countries that have a strong comparative advantage in a particular sector (due, for example, to factor endowments or productivity) will specialize entirely in that sector. Similarly in the authors’ model, a country with a comparative advantage in a low-risk product will specialize in that product: they reap the advantages of both greater efficiency and lower risk. For a country with a comparative advantage in a high-risk product, the comparative advantage must be especially strong, so that the effi ciency gain overwhelms the effects of risk-aversion, if it is to specialize entirely in that sector. For countries in between, which have some comparative advantage in the high-risk product but only weakly so, they will not specialize at all, but produce both products. By diversifying in this way, the country reduces its overall economic risk. book isom2011.indb 3 1/5/12 12:26 PM 4 Frankel and Pissarides Part II: In What Countries Are Downturns Unsusceptible to Demand Stimulus? The next three papers might be viewed through the lens of the high level of unemployment that most advanced countries experienced in the recent global recession. Did it refl ect a defi ciency of aggregate demand that fiscal stimulus might be able to ameliorate? Different observers had very different answers to this question. To some extent, the correct answer might be different for different countries. In “The Cyclical Behavior of Unemployment and Vacancies in the United States and Europe,” Alejandro Justiniano and Claudio Michelacci construct a real business cycle model in which search and matching frictions in the labor market give rise to unemployment and vacancies. This follows in a line of research for which the 2011 Economics Science Prize in Memory of Nobel was awarded. Different possible shocks include matching shocks, job destruction shocks, and a residual category labeled technology shocks. The model is statistically estimated for the United States, United Kingdom, Germany, France, Sweden, and Norway. They find that different kinds of shocks dominate in different countries. Matching shocks and job destruction shocks play a larger role in most European countries than in the United States. This sounds consistent with the observed international experience in the great recession of 2007–2009: unemployment rose and vacancies declined sharply in the United States, but not in Germany and some other European countries. Labor markets on the Continent have long been considered more rigid, but German unemployment hardly rose at all in the recession. The trans-Atlantic difference found by the authors is consistent with the idea that the United States suffered from a deficiency of aggregate demand after the global financial crisis, but Germany did not. Economists disagree on such questions as the extent to which downturns refl ect deficient aggregate demand versus supply shocks and the extent to which fiscal expansion is a useful tool to remedy defi cient aggregate demand. In “Toward a Political Economy of Macroeconomic Thinking,” Gilles Saint-Paul ventures into underexplored territory by considering what happens, not just if different economists expound different models because it is genuinely hard to figure out what model is right, but if those differences are the outcome of deliberate deception on the part of each economist in an effort to influence public policy in the direction that he or she prefers. (That such deception is conscious is characterized as a stark assumption.) For concreteness, he considers book isom2011.indb 4 1/5/12 12:26 PM Introduction 5 that the economist could be either a “conservative” or a “progressive.” Conservative economists will tend to report a lower Keynesian multiplier, and a greater long-term inflationary impact of output expansions, in order to infl uence public policy in the direction of fi scal expansion. But the economist is constrained by “autocoherence conditions,” and so cannot say anything he or she wants. A progressive economist who promotes a Keynesian multiplier larger than it really is, must, to remain consistent, also claim that demand shocks are more volatile than they really are. Otherwise, people will be disappointed by the stabilization performance of fiscal policy and reject the hypothesized value of the multiplier. In some cases, autocoherence induces the experts to make, loosely speaking, ideological concessions on some parameter values. The author looks at data from Survey of Professional Forecasters and finds evidence that forecasters who believe that expansions are less infl ationary, indeed tend to believe that public spending is more expansionary. In “The Fiscal Stimulus of 2009–2010: Trade Openness, Fiscal Space, and Exchange Rate Adjustment,” Joshua Aizenman and Yothin Jinjarak study econometrically why some countries responded to the recession with strong increases in government spending and others did not. Some large emerging market countries such as China, Russia, and South Korea undertook larger fiscal expansion than many European countries, for example. First, they fi nd that an important determinant of how much the fiscal expansion of countries in 2009–2010 was the amount of “fiscal space” that existed before the crisis. This makes sense: if public debt is already large, then there is not much capacity to run further deficits. (By 2008, debt levels in many advanced countries had climbed above those in many emerging market countries.) Second, they also find that higher openness to trade is associated with a smaller fi scal stimulus, and with greater exchange rate depreciation. This fi nding is just what we would expect from the open-economy Keynesian model developed long ago by James Meade. In a highly open economy, a high fraction of spending “leaks abroad” through spending on imports (or tradable goods, more generally). As a result, the Keynesian multiplier is smaller and fiscal policy is a less useful instrument. But this effect is mitigated if the country has a floating exchange rate, because the currency automatically depreciates and thus stimulates net exports. These effects on policy estimated by the authors are substantial: a one standard deviation increase of the public debt / average tax base lowers the size of the fiscal stimulus by 2% of GDP. A one standard deviation book isom2011.indb 5 1/5/12 12:26 PM 6 Frankel and Pissarides increase of trade / GDP increases the extent of nominal depreciation by about 7 percentage points. Part III: Exchange Rates, Nominal and Real The final two papers concern exchange rates—nominal exchange rates in one case and real exchange rates (relative prices) in the other. In “Flexing Your Muscles: Abandoning a Fixed Exchange Rate for Greater Flexibility,” Barry Eichengreen and Andrew Rose study how countries that move from a regime of pegged exchange rates to greater fl exibility— not under the pressure of a balance of payments crisis, but in a controlled manner at a time of their choosing—fare subsequently. This question arose in the 1990s, when some countries that attempted to cling to fi xed exchange rates eventually suffered crises (Italy, Mexico, Thailand, Korea, Russia, Turkey, Argentina), while others that arguably had exited from their pegs during relatively good times, before coming under severe downward pressure, did better (Australia, Chile, Colombia, Israel). In recent years many economists have argued that China should take advantage of the period of upward pressure on its currency to allow increased flexibility (which would presumably result in a strong appreciation) rather than waiting for some future time when a crisis pushes the yuan off its target. The authors look at the historical record: 51 instances since 1957 when a country moved from a regime that is classified as fixed to a regime that is classified as fl exible, under circumstances where the outcome was either an appreciation or a small depreciation (anything but a large depreciation). Of necessity, many of these observations are nondollar currencies around the time of the break-up of the Bretton Woods system, 1971–1973. Subsequent economic performance is quite varied within this set of cases. Generalization is difficult, especially without observation of the counterfactual as to what would have happened to such countries if they had sought to maintain their pegs as long as possible. But the authors report several findings. Countries with high investment rates and rapidly growing trade experienced declines in growth, while more open economies and countries with more international reserves tended to experience falls in infl ation. In the final chapter, “Traded and Nontraded Goods Prices, and International Risk Sharing: An Empirical Investigation,” Giancarlo Corsetti, Luca Dedola, and Francesca Viani focus on a correlation that is considered important to evaluating the ability of international fi nancial mar- book isom2011.indb 6 1/5/12 12:26 PM Introduction 7 kets to share risk efficiently across countries. According to a prominent theory, consumption should be relatively low in countries where its international relative price (the real exchange rate) is high. Indeed, the correlation coefficient should actually be 1.0. But the standard empirical fi nding is, if anything, the opposite: consumption is relatively high in countries where its international relative price is also high (Backus and Smith 1993). The contribution of this paper involves the fact that the Q1 domestic price index includes goods that are not traded internationally along with those that are. The authors decompose the overall real exchange rate into the relative price of nontraded goods and the domestic price of traded goods relative to the world price of traded goods (the terms of trade). (In their theoretical model, they derive a necessary condition for perfect risk sharing in models with nontraded goods and Harrod-Balassa-Samuelson effects: a rise in relative consumption must be associated with a tradable depreciation that is large enough to more than offset the rise in the price of nontradables.) Using data for Organization of Economic Cooperation and Development (OECD) countries, the authors find in most cases that the perverse positive correlation with consumption holds for both components of the real exchange rate: relative prices of traded goods and relative prices of nontraded goods. Endnote For acknowledgments, sources of research support, and disclosure of the authors’ material financial relationships, if any, please see http: // www.nber.org / chapters / c12479 .ack. book isom2011.indb 7 1/5/12 12:26 PM Author Queries.Intro.doc Author Query Q1 Au: Please provide a reference entry for the Backus and Smith 1993 citation.