View original document

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

Home / Publications / Research / Economic Brief / 2021

Economic Brief
December 2021, No. 21-42

Firm Closures, a Global Phillips Curve, and More: A Recap
of the Fall Research Workshop
By John Mullin

How do firms decide how to locate their stores? Do payday loan regulations help
or harm consumer welfare? How many firms go out of business due to financial
market inefficiencies? These were among the questions addressed by
researchers during a recent research workshop.
Economists from the Federal Reserve Bank of Richmond, the University of Virginia and Duke
University met in Richmond for a research workshop in November. This Economic Brief
summarizes the research presented during the workshop.

Plants in Space
A fundamental part of a firm's decision-making process is to determine the number, size
and location of its plants. (For firms such as Starbucks and Walgreens, plants take the form
of retail stores.) When firms add locations, they increase their proximity to consumers. But
adding new locations comes at a cost, namely increased management costs and loss of
business from existing locations through cannibalization.
Nicholas Trachter of the Richmond Fed discussed how firms locate plants. The paper he
presented, "Plants in Space," was co-authored with Ezra Oberfield and Esteban RossiHansberg of Princeton University and Pierre-Daniel Sarte of the Richmond Fed.1 The paper
advances a model with heterogeneous firms, each of which produces a unique variety of
products at various locations with differing levels of productivity and proximity to
Modeling firms in an economy with a vast number of widely distinct locations is complex
because it involves a massive number of possible outcomes. In mathematical terms, this
translates into a large "combinatorial" problem. Using insights from discrete geometry, the

researchers studied a tractable case of the problem. Their analysis delivers clear
predictions on sorting across space.
Firms with higher productivity place more plants in densely populated areas with high rents
than firms with lower productivity. Conversely, higher productivity firms place fewer plants
in markets with lower population density and low rents. Controlling for the number of
plants, higher productivity firms have larger plants than less productive firms in locations
where both are present.

High-Cost Consumer Credit
Societies have a long history of instituting restrictions on high-cost credit. Yet, various
economic analyses have concluded that restrictions on high-cost consumer loans can
reduce consumer welfare, despite the good intentions of policymakers. Joaquin Saldain of
the University of Virginia presented his paper "A Quantitative Model of High-Cost Consumer
Credit (PDF)," which attempts to contribute to the understanding of this conundrum.
He presented data on U.S. households' use of "payday loans," which are generally
unsecured by collateral. In 2012, the median loan size was $350 and carried an extremely
high annualized interest rate of 322 percent. Although the maturity of the median loan was
14 days, Saldain noted that this number is somewhat misleading because 80 percent of
loans were renewed upon maturity.
He then outlined U.S. payday lending regulations. More than 20 percent of U.S. states have
instituted outright bans on payday loans, and an additional 40 percent have set borrowing
caps of $500 per loan.
Saldain's paper studies the welfare consequences of these regulations. In his model,
borrowers may be willing to borrow at high interest rates during bad times (following health
shocks, for example), but they may also be tempted to consume more now than is desirable
in the long run, and thus overborrow. The pricing of credit by lenders can either exacerbate
overborrowing or limit it, which affects the efficacy and optimality of regulations.
Using estimates based on his model, Saldain finds that one-third of high-cost borrowers
suffer from the temptation to overborrow, but that regulatory borrowing limits and
interest-rate caps tend to reduce the welfare of these households. This result holds
because, even in the absence of regulation, private borrowers in his model impose loan
terms that effectively limit the borrowing of temptation-prone households.

Firm Exit and Financial Friction
Firm exit — or when firms shut their doors for good — is an important contributor to
macroeconomic dynamics. In the U.S., for example, roughly 10 percent of firms go out of
business each year, accounting for about 20 percent of all job losses. According to survey

results, 29 percent of U.S. firms that went out of business cited "low cash flow" as the main
reason for their exit, and another 13 percent cited a "lack of credit." These observations
pose interesting questions for policymakers, including:
How many firms are forced to exit due to frictions caused by financial market
How much do such exits cost the economy?
Laura Castillo-Martinez of Duke University presented research from her forthcoming
working paper "Financial Frictions and Firm Exit: Theory and Facts," which she is coauthoring with Gideon Bornstein of the University of Pennsylvania. The paper builds a twoperiod model of debt and potential default. In the case of default, a firm's debt holders take
possession of the firm, which has been pledged as collateral. Under new ownership, the
firm's profitability declines. The decline in profitability upon default — which can be
interpreted as an inefficiency — creates a positive relationship between the firm's initial
debt level and its probability of exit.
Castillo-Martinez presented empirical results based on data from Italy, Portugal and the
U.K. for the period 2002-2016. She and her co-author found that the probability of a firm's
exit was positively correlated with various indicators of financial health, including the firm's
debt-to-asset and liquidity ratios. Moreover, they found that the relationship between
indicators of financial health and exit becomes stronger during economic recessions. They
conclude that the economy-wide losses from inefficient exit are potentially sizeable.

Consumption Segregation
Increasing inequality and segregation are pressing socioeconomic issues. Geographic
segregation exists across several dimensions, including race, income and education. Such
segregation can amplify inequality and have important implications for welfare, equality of
opportunity and overall economic activity. Yet, little is known about consumption
segregation — the geographical separation of people with relatively high levels of
consumption from those with relatively low levels of consumption.
Elisa Giannone of Pennsylvania State University and the Richmond Fed presented
"Consumption Segregation (PDF)," a forthcoming paper she is co-authoring with Corina
Boar of New York University. The researchers point to several reasons consumption
segregation is important. For example, it can have long-lasting implications because
durable consumption goods can be passed across generations. Moreover, consumption
segregation is arguably more directly related than income segregation to welfare
segregation. Consumption segregation can also have important implications for the design
of place-based policies to reduce inequality.
The working paper describes patterns of consumption segregation based on a data set
drawn from several sources:

Infutor, a new source with detailed geographical information about the ownership of
durable consumption goods such as cars and properties
Nielsen Homescan, which the researchers used to measure the segregation of
nondurable consumption
The American Community Survey, which they used to measure segregation by income
and race
The researchers measured segregation with an entropy index in the case of categorical
variables (such as race and consumption categories) and a rank-order index for continuous
variables (such as consumption expenditure and income).
They found that durable goods consumption in the U.S. is much more segregated than
nondurable goods consumption. In addition, while the segregation of total consumption
(that is, durables plus nondurables) has been relatively stable over the past 15 years, there
has been a modest decline in the segregation of nondurable consumption. They found that
income segregation is the main driver of consumption segregation.

A Theory of Simplicity in Games
Economists use game theory to study the outcomes produced by the interacting choices of
economic agents. In the case of some simple games, the optimal strategies of participants
can be identified with relative ease. However, for more complicated games, it is often
difficult to identify a single optimal strategy.
A large literature has been devoted to characterizing and finding the "solutions" to
complicated games. Peter Troyan of the University of Virginia presented his recent
contribution to this literature, "A Theory of Simplicity in Games and Mechanism Design,"
which he co-authored with Marek Pycia of the University of Zurich.
In this paper, agents playing in what are known as "extensive-form games" don't forecast all
the way to final outcomes. Instead, they plan only for simple paths based on their current
perspectives. Then, they update their so-called "strategic plan" as the game progresses.
Also, players' moves are considered "simply dominant" only if they lead to unambiguously
better outcomes, no matter what occurs over non-simple histories.
The researchers acknowledge that the relatively demanding "simplicity standards"
proposed in their paper may reduce the flexibility of game designers in some cases.
However, they also note that this is not always true, and many well-known game
mechanisms are simple:
Ascending auctions
Posted prices
Serial dictatorship-style mechanisms

In particular, the researchers explain the widespread popularity of the well-known random
priority mechanism by characterizing it as the unique mechanism that is efficient, fair and
simple to play.

Education, Marriage and Child Development
What determines sorting patterns in what economists refer to as the "marriage market"?
What is the role of complementarities in household production? How do marriage and
child-rearing affect the formation of economic inequality and its transmission across
generations? These are just some of the questions that motivated the research of Pengpeng
Xiao of Duke University and the Institute for Fiscal Studies, who presented "Education,
Marriage and Child Development," a forthcoming paper co-authored with Pierre-André
Chiappori of Columbia University, Monica Costa Dias of the Institute for Fiscal Studies and
Costas Meghir of Yale University.
The researchers' goal is to understand how tax and welfare policies interact with education
choices, marriage, divorce and investments in children. To that end, they develop a unified
framework in which these various elements can be studied and quantified. Their framework
is a life-cycle model with three stages:
1. Educational choices are influenced by the prospective returns they can yield in both the
marriage and labor markets. More schooling yields higher income streams and increases
the probability of marrying a highly educated spouse, which, in turn, increases the
surplus obtained in marriage.
2. Marriage provides benefits of risk sharing and gains from complementarity in household
3. Life-cycle choices (including investment in children, labor supply, consumption and
divorce) are influenced by tax and welfare policies.
The researchers plan to estimate the life-cycle model using data from the Panel Study of
Income Dynamics (PSID). The PSID data includes a sample of over 18,000 individuals living
in 5,000 families in the U.S. from 1968 to 2015 with information on education, employment,
wages, marriage and children.

The Global Phillips Curve
GDP growth and inflation tend to co-move across countries. For example, when the rates of
GDP growth and inflation declined in the U.S. during the 2007-2009 recession, they also
declined in Europe, Canada, Japan and China. When the rates reversed course during the
subsequent U.S. recovery, they also reversed course abroad. These co-movements indicate
spillover effects transmitted through global asset and goods markets.
Exploring such global economic linkages, Felipe Schwartzman of the Richmond Fed
presented research that will appear in the forthcoming paper, "The Global Phillips Curve,"
which he is writing jointly with Paul Ho and Pierre-Daniel Sarte, both also of the Richmond

Fed. The researchers aim to estimate a model that can explain the co-movements of
inflation, GDP growth and interest rates across multiple global markets.
The economics literature exploring cross-market linkages typically takes one of two
The first approach is to build a two-country model.
The second approach is to build a model of a small open economy, one affected by
movements in foreign asset and goods prices but too small to influence those prices.
In contrast, the researchers are developing a multi-country model, where multiple foreign
countries are not simply combined into a "rest of the world" aggregate.
The researchers are taking a structural approach that includes multilateral trade linkages.
In their model, the co-movements of prices and output are induced by global factors,
common policies and the international transmission of foreign shocks. The model seeks to
incorporate the intuitive idea that multilateral trade connects countries through a network
in which the impact of trade shocks is transmitted through knock-on effects that effectively
echo across the globe. In their model, multilateral trade and sticky prices give rise to a
global Phillips curve that helps to explain cross-country co-movements in GDP growth and
John Mullin is a senior economics writer in the Research Department at the Federal Reserve
Bank of Richmond.

1 Trachter also summarized this research in his October 2021 article "How Do Firms Choose

Where to Place Establishments?"

This article may be photocopied or reprinted in its entirety. Please credit the author, source,
and the Federal Reserve Bank of Richmond and include the italicized statement below.
Views expressed in this article are those of the author and not necessarily those of the Federal
Reserve Bank of Richmond or the Federal Reserve System.

Subscribe to Economic Brief

Receive an email notification when Economic Brief is posted online:
Email address


Contact Us
RC Balaban
(804) 697-8144

© 1997-2021 Federal Reserve Bank of Richmond