May 23, 2013
By Gaetano Lisi
In the housing markets three basic facts have been repeatedly reported by empirical studies: the existence of price dispersion, the positive correlation between housing price and time-on-the-market, and between housing price and trading volume. Since housing markets are characterised by a decentralised framework of exchange with important search and matching frictions, this paper examines whether the baseline search and matching model can account for these three basic facts. We find that the standard matching framework allows to obtain a direct relationship between market frictions and house prices which represents the key mechanism to explain the basic facts of the housing market.
This remarkably short paper shows that it does not take much to match the three principal facts of the housing market. Yet, I do not think search models have been much exploited to study housing markets. I hope this paper will encourage more people to pursue this research agenda.
May 18, 2013
By Venky Venkateswaran and Randall Wright
When limited commitment hinders unsecured credit, assets help by serving as collateral. We study models where assets differ in pledgability – the extent to which they can be used to secure loans – and hence liquidity. Although many previous analyses of imperfect credit focus on producers, we emphasize consumers. Household debt limits are determined by the cost households incur when assets are seized in the event of default. The framework, which nests standard growth and asset-pricing theory, is calibrated to analyze the effects of monetary policy and financial innovation. We show that inflation can raise output, employment and investment, plus improve housing and stock markets. For the baseline calibration, optimal inflation is positive. Increases in pledgability can generate booms and busts in economic activity, but may still be good for welfare.
When you want to trade today but can only offer a counterpart tomorrow, you either pledge an asset or use some asset as collateral. But this is fraught with frictions, the quality of the asset may be uncertain, for example.Traders should thus endogenously determine how much asset should be used as a medium of exchange or collateral, depending on circumstances. In such a context, inflation in fiat money, which is used for transactions as well , has a positive impact: as the opportunity cost of money increases, agents substitute into other assets and thus increase working capital. Higher steady-state inflation can thus mean higher output. That result is quite difficult to obtain in micro-founded models where the Friedman Rule tends to prevail.
May 8, 2013
By Francisco Blasques
This paper proposes a functional specification approach for dynamic stochastic general equilibrium (DSGE) models that explores the properties of the solution method used to approximate policy functions. In particular, the solution-driven specification takes the properties of the solution method directly into account when designing the structural model in order to deliver enhanced flexibility and facilitate parameter identification within the structure imposed by the underlying economic theory. A prototypical application reveals the importance of this method in improving the specification of functional nonlinearities that are consistent with economic theory. The solution-driven specification is also shown to have the potential to greatly improve model fit and provide alternative policy recommendations when compared to standard DSGE model designs.
Traditionally, we specify a model, calibrate it and then apply a solution method. The latter has an impact on the result, though. For example, if a solution uses polynomial functions and it only preserve the properties of functions locally around the steady state, there is no need to use functional forms that have required properties beyond locally, especially if global properties impose additional unwelcome constraints. This means that functional-form choice depends on the solution method. And as the example in the paper shows, it can matter.
May 5, 2013
By Sophie Osotimehin and Francesco Pappadà
Recessions are conventionally considered as times when the least productive firms are driven out of the market. Do credit frictions hamper this cleansing effect of recessions? We build and calibrate a model of firm dynamics with endogenous exit and credit frictions to investigate this question. We find that, despite their distortionary effect on the selection of exiting firms, credit frictions do not reverse the cleansing effect of recession. Average idiosyncratic productivity rises following an adverse aggregate shock. Our results also suggest that recessions have a modest impact on average productivity whatever the level of credit frictions
Bernanke-Gertler meets Schumpeter, and neither seems to matter much. I was expecting the cleansing during recessions to be more important. As for frictions, it was not clear which way it would go, as more productive firms may face fewer frictions but frictions become more important in recessions, or something like that. In any case, it turns out that the popular claim that an occasional recession is good for the economy is not that true.
April 27, 2013
By Jonathan Heathcote and Fabrizio Perri
This paper is structured in three parts. The first part outlines the methodological steps, involving both theoretical and empirical work, for assessing whether an observed allocation of resources across countries is efficient. The second part applies the methodology to the long-run allocation of capital and consumption in a large cross section of countries. We find that countries that grow faster in the long run also tend to save more both domestically and internationally. These facts suggest that either the long-run allocation of resources across countries is inefficient, or that there is a systematic relation between fast growth and preference for delayed consumption. The third part applies the methodology to the allocation of resources across developed countries at the business cycle frequency. Here we discuss how evidence on international quantity comovement, exchange rates, asset prices, and international portfolio holdings can be used to assess efficiency. Overall, quantities and portfolios appear consistent with efficiency, while evidence from prices is difficult to interpret using standard models. The welfare costs associated with an inefficient allocation of resources over the business cycle can be significant if shocks to relative country permanent income are large. In those cases partial financial liberalization can lower welfare.
While the allocation (or misallocation) of resources within a country, a sector or a firm are much studies, the international allocation is rarely looked at. This monumental paper, a forthcoming chapter in the Handbook for International Economics surveys the relevant literature, lays out the methodological foundations and takes a quantitative example with business cycle fluctuations among developed economies. The last statement of the abstract is intriguing. Indeed, financial autarky may be preferable in some circumstances, namely when shocks generate large differences in permanent income (very persistent, large innovations). The reasons is that if you only have bonds, they provide poor insurance as they are non-contingent. In addition, introducing bonds changes interest rate responses in a way that amplifies the impact of shocks. The interest rate in the country benefiting from a positive shock declines less than under autarky, leading to a additional wealth effect as it lending. The same would apply if the other country had a negative shock. Now think about it in the context of Germany and the European financial crisis.
April 15, 2013
By Jeremy Greenwood, Philipp Kircher, Cezar Santos and Michele Tertilt
Eleven percent of the Malawian population is HIV infected. Eighteen percent of sexual encounters are casual. A condom is used one quarter of the time. A choice-theoretic general equilibrium search model is constructed to analyze the Malawian epidemic. In the developed framework, people select between different sexual practices while knowing the inherent risk. The analysis suggests that the efficacy of public policy depends upon the induced behavioral changes and general equilibrium effects that are typically absent in epidemiological studies and small-scale field experiments. For some interventions (some forms of promoting condoms or marriage), the quantitative exercise suggests that these effects may increase HIV prevalence, while for others (such as male circumcision or increased incomes) they strengthen the effectiveness of the intervention. The underlying channels giving rise to these effects are discussed in detail.
This paper confirms some of the results of my research with Douglas Gollin: general equilibrium effects are important, behavioral responses are very important, and protection methods may be useless, or in this case counter-productive, once behavioral responses are taken into account. I also think that this is another example where the lack of reliable data can be efficiently supplemented with good use of theory.
April 9, 2013
By Sewon Hur and Illenin Kondo
Emerging economies, unlike advanced economies, have accumulated large foreign reserve holdings. We argue that this policy is an optimal response to an increase in foreign debt rollover risk. In our model, reserves play a key role in reducing debt rollover crises (“sudden stops”), akin to the role of bank reserves in preventing bank runs. We find that a small, unexpected, and permanent increase in rollover risk accounts for the outburst of sudden stops in the late 1990s, the subsequent increase in foreign reserves holdings, and the salient resilience of emerging economies to sudden stops ever since. Finally, we show that a policy of pooling reserves can substantially reduce the reserves needed by emerging economies.
Interesting paper that shows that rather small events can trigger larger ones. While this is applied to emerging economies, one can wonder whether this can carry over to Europe today. Of course, the handling of foreign reserves is completely different, but precisely the fact that they are bundled across member countries to address imbalances looks like what the authors are calling for. Maybe this is a real-life test of their proposed policy.
April 2, 2013
By Kai Zhao
This paper studies the effects of health shocks on the demand for health insurance and annuities, precautionary saving, and the welfare implications of public policies in a simple life-cycle model. I show that when the health shock simultaneously increases health expenses and reduces longevity, the following results can be obtained via closed-form solutions. First, utility-maximizing agents would neither fully insure their uncertain health expenses nor fully annuitize their wealth, even in the absence of market frictions and bequest motives. Second, the effect of uncertain health expenses on precautionary saving may be smaller than what has been found in previous studies. Under certain conditions, uncertain health expenses may even reduce precautionary saving. Third, mandatory health insurance (e.g. public health insurance) tends to benefit the poor more, while mandatory annuitization (e.g. public pension) is more likely to favor the rich. A simple numerical application of the model to the US long term care (LTC) insurance market suggests that the simultaneous effect of health shock on health expenses and longevity is a quantitatively important reason why agents (especially the rich) do not purchase more private LTC insurance.
The major take-away I get from this paper is that health shocks have less of an impact on savings than we thought. I would add it is even less, as I think the high costs of US health care are not sustainable. Sooner or later, the government, insurers and employers will manage to squeeze the high profit margins of the health industry and get health expenses closer to what they are in comparable economies. Health shocks will then be “milder.”
March 24, 2013
By Alejandro Justiniano, Giorgio Primiceri and Andrea Tambalotti
U.S. households’ debt skyrocketed between 2000 and 2007, but has since been falling. This leveraging and deleveraging cycle cannot be accounted for by the liberalization and subsequent tightening of mortgage credit standards that occurred during the period. We base this conclusion on a quantitative dynamic general equilibrium model calibrated using macroeconomic aggregates and microeconomic data from the Survey of Consumer Finances. From the perspective of the model, the credit cycle is more likely due to factors that impacted house prices more directly, thus affecting the availability of credit through a collateral channel. In either case, the macroeconomic consequences of leveraging and deleveraging are relatively minor because the responses of borrowers and lenders roughly wash out in the aggregate.
What I take from this paper is that changes in credit standards and thus lenders cannot be blamed. Anything that would have increased house prices “excessively” is still a potential culprit, including herd behavior, too low interest rates, excessive expectations, or a bubble.