Timothy J. Kehoe

Current Research

The trick with research is to find good coauthors!

1. Business Cycles and Development

"A Decade Lost and Found:  Mexico and Chile in the 1980s" by Raphael Bergoeing, Patrick J. Kehoe, Timothy J. Kehoe, and Raimundo Soto.
Chile and Mexico experienced severe economic crises in the early 1980s. This paper analyzes four possible explanations for why Chile recovered much faster than did Mexico.  Comparing data from the two countries allows us to rule out a monetarist explanation, an explanation based on falls in real wages and real exchange rates, and a debt overhang explanation.  Using growth accounting, a calibrated growth model, and economic theory, we conclude that the crucial difference between the two countries was the earlier policy reforms in Chile that generated faster productivity growth.  The most crucial of these reforms were in banking and bankruptcy procedures.    (Description of the data and Xcel file with all of the data.)

"Decades Lost and Found:  Mexico and Chile Since 1980" by Raphael Bergoeing, Patrick J. Kehoe, Timothy J. Kehoe, and Raimundo Soto.
(This is a revised and expanded version of the previous paper.)
Both Chile and Mexico experienced severe economic crises in the early 1980s, yet Chile recovered much faster than Mexico. This study analyzes four possible explanations for this difference and rules out three, explanations based on money supply expansion, real wage and real exchange rate declines, and foreign debt overhangs. The fourth explanation is based on government policy reforms in the two countries. Using growth accounting and a calibrated growth model, the study determines that the only policy reforms promising as explanations are those that primarily affect total factor productivity, or how inputs are used, not the inputs themselves. Interpreting historical evidence with economic theory, the study concludes that the crucial difference between Chile and M exico in the 1980s and 1990s is earlier government policy reforms in Chile, particularly reforms in policies affecting the banking system and bankruptcy procedures.

"Great Depressions of the Twentieth Century" by Timothy J. Kehoe and Edward C. Prescott.
(This paper is the introduction to the volume that includes the first paper; it lays out the research methodology and summarizes the results of the whole research project.)
The papers in this volume study nine depressions — both from the interwar period in Europe and America and from more recent times in Japan and Latin America — using a common framework. All of the papers rely on growth accounting to decompose changes in output into the portions due to changes in factor inputs and the portion due to the changes in efficiency with which these factors are used.  All of the papers employ simple applied dynamic general equilibrium models. Collectively, these papers indicate that government policies that affect productivity and hours per working-age person are the crucial determinants of the great depressions of the twentieth century.  (Description of the data and Xcel file with all of the data.)

"Is Switzerland in a Great Depression?" with Kim J. Ruhl. 

Abrahamsen, Aeppli, Atukeren, Graff, Müller and Schips (2005) object to Kehoe and Prescott's (2002) characterization of the Swiss economy as being in a great depression over the period 1974-2000. They argue that (1) depressions should be defined in terms of declines in labor productivity rather than in GDP; (2) examining deviations from trend in GDP is equivalent to examining levels; (3) Swiss data from the 1970s should be ignored because it is of low quality and because the 1970s were a period of turmoil in the Swiss labor market; (4) Swiss GDP data should be adjusted to account for appreciations in the terms of trade; and (5) the change in Swiss national accounts from a system based on SNA68 to one based on SNA93 will make Swiss economic performance look better. In this note, we find that none of these arguments have merit except for, possibly, the need to adjust GDP data for changes in the terms of trade. We conclude that Switzerland has indeed suffered a great depression and, in fact, is mired in it even today. (Description of the data and MS Excel file with all of the data.)

"Policy-Driven Productivity in Chile and Mexico in the 1980s and 1990s"  by Raphael Bergoeing, Patrick J. Kehoe, Timothy J. Kehoe, and Raimundo Soto.
(This short paper summarizes the analysis in the first paper.)
Both Chile and Mexico experienced severe economic crises in the early 1980s, but Chile recovered much faster than did Mexico. Using growth accounting and a calibrated dynamic general equilibrium model, we conclude that the crucial determinant of this difference between the two countries was the faster productivity growth in Chile, rather than higher investment or employment.  Our hypothesis is that this difference in productivity was driven by earlier policy reforms in Chile, the most crucial of which were in banking and bankruptcy procedures.  We propose a theoretical framework in which government policy affects both the allocation of resources and the composition of firms.

"Recent Great Depressions: Aggregate Growth in New Zealand and Switzerland" with Kim J. Ruhl.
Throughout the 1950s and 60s real GDP per working-age person in New Zealand and Switzerland grew at rates at or above the 2 percent trend growth rate of the United States.  Between 1973 and 2000, however, real GDP per working-age person in both countries has fallen a cumulative 30 percent below the trend growth path.  Our growth accounting attributes almost all of the changes in output growth to changes in the growth of total factor productivity (TFP), and not to changes in labor or capital accumulation.  A calibrated dynamic general equilibrium model that takes TFP as exogenous can explain almost the entire decline in relative output in both New Zealand and Switzerland. To understand the recent growth experiences in New Zealand and Switzerland, it is necessary to understand why TFP growth rates have fallen so much.  (Description of the data and MS Excel file with all of the data.)

"What Can We Learn from the Current Crisis in Argentina?" by Timothy J. Kehoe.
Currently, Argentina is experiencing what the government describes as a “great depression.”  Using the “Great Depressions” methodology developed by Cole and Ohanian (1999) and Kehoe and Prescott (2002), we find that the primary determinants of both the boom in Argentina in the 1990s and the subsequent depression were changes in productivity, rather than changes in factor inputs.  The timing of events links the boom to the currency-board-like Convertibility Plan and the crisis to its collapse.  To gain credibility, the Argentine government took measures to make abandoning the plan more costly.  Because the government was unable to enforce fiscal discipline, however, these increased costs failed to make the plan more credible and instead made the crisis far worse when it failed. (Description of the data and MS Excel file with all of the data.)

2. Capital Flows and Real Exchange Rates

"Capital Flows and Real Exchange Rate Fluctuations Following Spain's Entry into the European Community" by Gonzalo Fernandez de Cordoba and Timothy J. Kehoe.
Spain's 1986 entry into the European Community was followed by a dismantling of restrictions on international capital flows. Initial trade deficits and real exchange rate appreciation were followed by trade surpluses and real exchange rate depreciation. We analyze Spain's financial liberalization using a dynamic general equilibrium model with a traded and nontraded good where a capital poor country opens itself to its capital rich neighbors. A calibrated model has trouble accounting for the large changes in relative prices observed given the small changes in quantities. Variants of the model with frictions in factor mobility between sectors fare better.  

"Real Exchange Rate Movements and the Relative Price of Nontraded Goods" by Caroline M. Betts and Timothy J. Kehoe.
We investigate the relationship between a measure of relative price of nontraded goods to traded goods across countries and the bilateral real exchange rate in a sample of 52 countries and 1326 bilateral pairs over the period 1980-2000. Studying both deviations in levels and yearly changes, we find that directional movements of the two series are highly positively correlated but that fluctuations in the relative price of nontraded goods are smaller than those of the real exchange rate.  Variance decompositions say that about one-third of deviations in levels of the real exchange rate, and about one-fifth of yearly changes, can be accounted for by fluctuations in the relative price of nontraded goods.  The relation between the two series is much stronger, the more important is the trade relation between the countries, and the smaller is the variance of their bilateral real exchange rate.  In these results, there is no bias resulting from the presence of rich country-poor country bilateral pairs, nor from the presence of high inflation country-low inflation country pairs.

"Tradability of Goods and Real Exchange Rate Fluctuations" by Caroline M. Betts and Timothy J. Kehoe.
We develop a simple, multicountry, multisector intertemporal general equilibrium model in which the degree of tradability of output differs across sectors. Tradability is determined both by the degree of substitutability in consumption between units of the same good produced in different countries and by the transactions costs that must be incurred to consume goods outside their country of origin. Home bias is endogenously determined. A vector of country specific shocks is realized at each data, and there are complete contingent claims markets. A calibrated version of the model replicates well the observed relationship between movements in the bilateral real exchange rate between Mexico and the United States and movements in the relative price of comparatively nontraded goods to traded goods across countries. In addition, the shocks induce movements in trade balances and real exchange rate that are consistent with the data. Finally, the model can also match evidence on sectoral deviations from the law of one price.

"U.S. Real Exchange Rate Fluctuations and Relative Price Fluctuations" with Caroline M. Betts.
This paper investigates the relation between the U.S. bilateral real exchange rate with five of her most important trade partners and the associated bilateral relative price of nontraded goods. Traditional theory attributes fluctuations in real exchange rates to changes in the relative prices of nontraded to traded goods.  Some recent research suggests that there is little or no relation between the real exchange rate and this relative price measure. We find that these negative results are not robust and, in particular, that this relation depends crucially on the choice of trade partner and on the choice of price indices used to measure relative prices. The relation is stronger the more important is the trade relationship between the United States and a trade partner. The relation is stronger when we measure relative prices using producer prices rather than consumer prices. (Description of the data, MS Excel file with all of the orginal data, and MS Excel files with all of the final data.)

3. General Equilibrium Theory

"Liquidity Constrained Markets versus Debt Constrained Markets" by Timothy J. Kehoe and David K. Levine.
We compare two different models in a common environment. The first model has liquidity constraints in that consumers save a single asset that they cannot sell short. The second model has debt constraints in that consumers cannot borrow so much that they would want to default, but is otherwise a standard complete markets model. Both models share the features that individuals are unable to completely insure against idiosyncratic shocks and that interest rates are lower than subjective discount rates. In a stochastic environment, the two models have quite different dynamic properties, with the debt constrained model exhibiting simple stochastic steady states, while the liquidity constrained model has greater persistence of shocks.

"Lotteries, Sunspots, and Incentive Constraints" by Timothy J. Kehoe, David K. Levine, and Edward C. Prescott.
We study a prototypical class of exchange economies with private information and indivisibilities. We establish an equivalence between lottery equilibria and sunspot equilibria and show that the welfare and existence theorems hold. To establish these results, we introduce the concept of the stand-in consumer economy, which is a standard, convex, finite consumer, finite good, pure exchange economy. With decreasing absolute risk aversion and no indivisibilities, we prove that no lotteries are actually used in equilibrium. We provide a simple numerical example with increasing absolute risk aversion in which lotteries are necessarily used in equilibrium. We also show how the equilibrium allocation in this example can be implemented in a sunspot equilibrium.

4. Trade Theory

"An Evaluation of the Performance of Applied General Equilibrium Models of the Impact of NAFTA" by Timothy J. Kehoe.
This paper uses data to evaluate the performances of three of the most prominent multisectoral static applied general equilibrium models that were used to predict the impact of the North American Free Trade Agreement. These models drastically underestimated the impact of NAFTA on North American trade. Furthermore, the models failed to capture much of the relative impacts on different sectors.  Ex-post performance evaluations of applied GE models are essential if policy makers are to have confidence in the results produced by these models.  Just as importantly, such evaluations help make applied GE analysis a scientific discipline in which there are well-defined puzzles and clear successes and failures for alternative theories. Analyzing sectoral trade data indicates that a new theoretical mechanism for generating trade in the models is needed, a mechanism in which large increases in trade can take place in product categories with little or no previous trade.  To capture changes in macroeconomic aggregates, the models need to be able to capture changes in productivity.

"How Important is the New Goods Margin in International Trade?" by Timothy J. Kehoe and Kim J. Ruhl.
We examine the bilateral trade patterns of countries involved in significant trade liberalizations using detailed data on the value of trade flows by commodity.  We find a striking relationship between a good's pre-liberalization share in trade and its growth subsequent to liberalization.  The goods that were traded the least before the liberalization account for a disproportionate share in trade following the reduction of trade barriers.  The set of goods that accounted for only ten percent of trade before the liberalization may account for as much as 40 percent of trade following the liberalization.  This new finding cannot be accounted for by the standard models of trade, which rely on increases in previously traded goods to produce trade growth. We modify the standard Dornbusch-Fischer-Samuelson model of Ricardian trade to provide a model capable of delivering these new facts.  Our specification improves on previous Ricardian models by providing a technology process that can be calibrated using data on intra-industry trade.

"Trade Theory and Trade Facts" by Raphael Bergoeing and Timothy J. Kehoe.
We quantitatively test the "new trade theory'' based on product differentiation, increasing returns, and imperfect competition. We employ a standard model, which allows both changes in the distribution of output among industrialized countries, emphasized by Helpman and Krugman (1985), and nonhomothetic preferences, emphasized by Markusen (1986), to effect trade directions and volumes. In addition, we generalize the model to allow changes in relative prices to have large effects. We test the model by calibrating it to 1990 data and then "backcasting'' to 1961 to see what changes in crucial variables between 1961 and 1990 are predicted by the theory. The results show that, although the model can explain much of the increased concentration of trade among industrialized countries and the increased amount of intraindustry trade, it is not capable of explaining the enormous increase in the ratio of trade to output. It seems that it is policy changes, rather than the elements emphasized in the new trade theory, that have been the most significant determinants of the increase in trade volume.

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Last modified: 21 July 2005 12:57