Regional evidence on business cycle fluctuations and countercyclical policy.

• Author: Hurst, Erik

Studying cross-region variation in economic outcomes within a country is an increasingly common empirical research strategy in labor, public, and urban economics. (1) For example, local exposure to trade with China has been shown to reduce local employment rates and wages. (2) Cross-state variation has been used to estimate the incidence of local taxes. (3) Large local public work programs have been used to document the existence of agglomeration economies in manufacturing. (4) Crossregion variation provides macro economic researchers with richer information on economic fluctuations than aggregate time series data at the national level. For example, during the Great Recession in the United States, some metropolitan areas--Las Vegas, for example--experienced larger declines in employment than many others. Explaining this variation can shed light on potential causes of the aggregate recession. (5)

Drawing inferences about the aggregate economy from data on regional variation is complicated by two issues, however. First, the way a regional economy responds to a given economic shock could be substantively different from the way a national economy responds because of both factor mobility and general equilibrium forces. (6) Factors such as Federal

Reserve policy may respond to aggregate shocks but not to local shocks. Ignoring such general equilibrium factors can yield estimates of local employment elasticities to a given shock that are two to three times larger than the aggregate employment elasticity to the same shock. (7) Second, regional comparisons cannot shed any light on shocks that affect the entire economy in the same way. Such shocks are "differenced away" when the different experiences of different regions are compared. Much of my current research uses a combination of local and aggregate data to learn about the drivers of aggregate business cycles and to explore the regional consequences of aggregate government policies. A combination of local and aggregate data, along with a structural economic model, often is needed to use local variation to address macro questions.

Understanding the Causes of the Great Recession

Despite aggregate employment rates falling substantially during the Great Recession, aggregate real wage growth during the 2008-2010 period remained on its pre-recession trend. If employment fell because of a labor demand decline, the employment decline during the recession should have been accompanied by a decline in real wages. Many people who believe that the Great Recession was primarily caused by a lack of demand appeal to wages being "sticky" as the reason a decline in real wages during the Great Recession did not accompany the sharp decline in employment. (8) [See Figure 1.]

In new work with Martin Beraja and Juan Ospina, I estimate the amount of wage stickiness using cross-state variation. (9) Using a variety of data sources, we show that states with the largest relative employment declines had the smallest relative wage increases. We construct state-level measures of real wages by combining state-level nominal wage data from the American Community Survey with state-level price indices constructed from scanner data. From this analysis, we estimate that wages are fairly flexible. While there is some stickiness to wages at the local level, real wages do respond to contemporaneous local labor demand shocks. [See Figure 2.]

To understand the broad causes of the Great Recession, we construct a model of local economies that can aggregate to the national economy. The model allows for the trade of goods across local economies, and for a national monetary authority that sets a common interest rate across local economies. We embed within the model four shocks: a shock to households' intertemporal consumption decisions, a shock to firms' marginal products of labor...