CKM

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CKMs Business Cycle Accounting

• Lawrence J. Christiano
• Joshua M. Davis

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Background

• A strategy for identifying promising directions
  for model development
• Fit simple RBC model to data
• Identify wedges
• Distortions between marginal rates of
  substitution in preferences and technology
  necessary to reconcile model and data
• Decompose movements in data into components due
  to various wedges

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CKMs Conclusion

• Frictions that Enter Household Intertemporal
  Margin (i.e. Investment) not Important for
  Understanding the US Great Depression
• Standard models of financial frictions (e.g.
  Carlstrom-Fuerst and Bernanke-Gertler-Gilchrist)
  not useful directions for research

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• CKM Finding Potentially of Major Interest
• Early Phases of Great Depression Accompanied By
  Major Decline in the Stock Market Unusually
  Massive Decline in Investment
• Numerous Students of Great Depression Infer that
  Financial Market Imperfections Were Important
• CKM Finding Purports to Eliminate a Major
  Hypothesis About Great Depression From Further
  Consideration

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CKMs Result of Significant Interest

• Early phases of Great Depression accompanied by
  massive decline in investment and the stock
  market
• Numerous students of Great Depression infer that
  financial market imperfections were important
• CKMs results oppose this conventional wisdom

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Our Points

• Small Changes in CKM Analysis Overturn their
  Conclusion
• Fundamental (Fatal?) Identification Problem
  Complicates the Analysis

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Computational Details

• CKM Approach
• Estimate Model Based on Linear Approximation of
  Solution, and Linear Kalman Filter in Estimation
• Recover Wedges Using Nonlinear Approximation to
  Model
• Our Approach
• Do Nonlinear Approximation In Estimation and
  Wedge Recovery
• Turns Out Our Strategy and CKM Computational
  Strategy Yield Similar Results

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Results

• First, We Reproduce CKM Calculations
• CKM Results Suggest Financial Frictions Not
  Important for Output, Investment and Employment
• Our CKM Simulation Assumptions No Adjustment
  Costs
• Same Finding With Alternative Identification

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A Problem with the Preceding Result Based on
Adjustment Costs

• When We Estimate Adjustment Cost Parameter
  Maximum Likelihood Does Not Like It (Drives a0)
• But, A Priori Considerations Also Seem to Go
  Against CF Friction for Great Depression
• A Tightening of Financial Frictions Implies,
  According to CF, that the Price of Capital Should
  Have Gone Up
• But, the Price of Capital Seems to Have Fallen
  During Great Depression (See Stock Market).
• This Motivates Considering an Alternative Form of
  Financial Friction

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• When We Estimate Adjustment Costs with BGG Wedge,
  Parameter, a, Wants to be Very High (a70).
• We Set a Conservatively
• Tobins q Elasticity 1.28 Percent
• a10

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Conclusion

• Key Conclusion of CKM Analysis Financial
  Frictions that Enter Intertemporal Euler Equation
  Not Important for Understanding Great Depression
• Our Finding Small Changes in CKM Environment
  Overturn Their Conclusion
• We Estimate Degree of Adjustment Costs and Use a
  More A Priori Plausible Model of Financial
  Frictions
• Estimate That Financial Frictions Account for
  30-40 of fall in output
• Deeper Identification Problem to Worry About