The effects of a money-financed fiscal stimulus

October 23, 2014

By Jordi Galí

I analyze the effects of an increase in government purchases financed entirely through seignorage, in both a classical and a New Keynesian framework, and compare them with those resulting from a more conventional debt-financed stimulus. My findings point to the importance of nominal rigidities in shaping those effects. Under a realistic calibration of such rigidities, a money-financed fiscal stimulus is shown to have very strong effects on economic activity, with relatively mild inflationary consequences. If the steady state is sufficiently inefficient, an increase in government purchases may increase welfare even if such spending is wasteful.

On a regular basis, I get emails enquiring how to publish on RePEc some new system that will solve all of the world’s economic problems. Usually, this involves distributing money. This paper is also about distributing money to solve economic problems, but there are two major differences: Jordi Galí is no lunatic, and he only seeks to deal with temporary economic problems as they arise during a business cycle. The key here that nominal rigidities in prices and wages can do their magic and increase aggregate demand. Of course, prices eventually rise and the stimulus dissipates, but the temporary boosts is valuable when it matters most, given a level of rigidity that is plausible. The good old unemployment-inflation trade-off, only with a lag. I wonder though what will happen to the ridigity of prices and wages in a world where money policy becomes active in such ways. Wouldn’t they become more flexible in anticipation of more frequent money stimuli?

Exploiting the monthly data flow in structural forecasting

October 5, 2014

By Domenico Giannone, Francesca Monti and Lucrezia Reichlin

This paper shows how and when it is possible to obtain a mapping from a quarterly dynamic stochastic general equilibrium (DSGE) model to a monthly specification that maintains the same economic restrictions and has real coefficients. We use this technique to derive the monthly counterpart of the well-known DSGE model by Galí, Smets and Wouters (GSW) for the US economy. We then augment it with auxiliary macro indicators which, because of their timeliness, can be used to obtain a nowcast of the structural model. We show empirical results for the quarterly growth rate of GDP, the monthly unemployment rate and GSW’s welfare-relevant output gap. Results show that the augmented monthly model does best for nowcasting.

While temporal interpolation at higher frequencies is not new, it is nifty that a structural model is used here instead of a purely statistical setup. It is significantly more complicated than traditional methods, though.

Illiquidity and its Discontents: Trading Delays and Foreclosures in the Housing Market

October 2, 2014

By Aaron Hedlind

This paper investigates the macroeconomic effects of search risk in the housing market. To do so, I introduce a tractable directed search model of housing with multidimensional buyer and seller heterogeneity. I incorporate this framework in an incomplete markets macroeconomic model with long-term mortgages and equilibrium default. I show that search risk spills over into higher foreclosure risk by creating a debt overhang problem. Heavily indebted sellers post high selling prices, take a long time to sell, and frequently end up in foreclosure. As a result, search risk increases mortgage default premia and tightens credit constraints, thus exacerbating the debt overhang problem by making refinancing more difficult. This mechanism establishes a novel link between housing and mortgage markets based on the illiquidity of housing.

The illiquidity of the house market, along with the high correlation of house prices with local income, has always made me wonder why homeownership is so much encouraged. This paper gives a further argument why homeownership is a poor investment vehicle. And this paper applies to the US, where house markets are remarkably liquid in international comparison.

Can Removing the Tax Cap Save Social Security?

September 28, 2014

By Shantanu Bagchi

The maximum amount of earnings in a calendar year that can be taxed by Social Security in the U.S. is currently capped at $106,800. In this paper, I use a general-equilibrium overlapping-generations model to examine if removing this cap can solve Social Security’s budgetary problems. I find that in general, removal of the cap increases Social Security revenues, but by only a small percentage, and most of these extra revenues go towards paying benefits to high-income retirees no longer subject to the cap. Even when the cap is removed only from taxes but retained on the amount of earnings creditable towards Social Security benefits, the fiscal advantages are quite small.

I consider this paper part of a new research agewnda that seeks to determine whether taxing more the rich can help reduce budget shortfalls. Two papers discussed a month ago did not find much margin as one would hope, and this one confirms it if you focus solely on old age pension, which turns out not to be that great at revenue generating or redistribution.

The great housing boom of China

September 15, 2014

By Kaiji Chen and Yi Wen

This paper provides a theory to explain the paradoxical features of the great housing boom in China —the persistently faster-than-GDP housing price growth, exceptionally high capital returns, and excessive vacancy rates. The expectation that high capital returns driven mainly by resource reallocation are not sustainable in the long run can induce the very productive entrepreneurs to speculate in housing during economic transition. This creates a self-fulfilling growing housing bubble, which can create severe resource misallocation. A calibrated version of the theory accounts quantitatively for both the growth dynamics of house prices and other salient features of the recent Chinese experience.

My trip to China last year gave me a big puzzle. Why are housing prices skyrocketing when there is an unbelievable amount of construction going on and entire satellite cities that appear empty? This paper is showing this can indeed happen, and it does not look good for the future.

News Driven Business Cycles: Insights and Challenges

September 10, 2014

By Paul Beaudry and Franck Portier

There is a widespread belief that changes in expectations may be an important independent driver of economic fluctuations. The news view of business cycles offers a formalization of this perspective. In this paper we discuss mechanisms by which changes in agents’ information, due to the arrival of news, can cause business cycle fluctuations driven by expectational change, and we review the empirical evidence aimed at evaluating its relevance. In particular, we highlight how the literature on news and business cycles offers a coherent way of thinking about aggregate fluctuations, while at the same time we emphasize the many challenges that must be addressed before a proper assessment of its role in business cycles can be established.

If you are interested in how news and expectations in general matter for the business cycle, this is a must read. Beaudry and Portier have been very influential in getting this literature moving with modern methods. Much like the topic, the paper is also forward-looking in the sense that it opens all sorts of avenues that merit exploration.

Housework and Fiscal Expansions

September 8, 2014

BY Stefano Gnocchi, Daniela Hauser and Evi Pappa

We build an otherwise-standard business cycle model with housework, calibrated consistently with data on time use, in order to discipline consumption-hours complementarity and relate its strength to the size of fiscal multipliers. We show that if substitutability between home and market goods is calibrated on the empirically relevant range, consumption-hours complementarity is large and the model generates fiscal multipliers that agree with the evidence. Hence, our analysis supports the relevance of consumption-hours complementarity for fiscal multipliers. However, we also find that explicitly modeling the home sector is more appealing than restricting to the consumption-leisure margin and/or to the preferences proposed by Greenwood, Hercowitz and Huffman (1988). A housework model can imply substantial complementarity, without low wealth effects contradicting the microeconomic evidence.

It has been fashionable again to look at home production, and it is important. Indeed, it is difficult to understand the labor supply without its outside option. And this paper is a nice example of why it matters.


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