November 8, 2018
By Hikaru Saijo
This paper studies the macroeconomic impact of an uncertainty shock about fiscal policy in a dynamic general equilibrium framework. Motivated by the observation that many fiscal policies are redistributive and that a sizable fraction of U.S. households do not own capital, I introduce household heterogeneity in the form of limited capital market participation. I show that household heterogeneity significantly magnifies the aggregate effect and induces co-movement of macroeconomic variables in a contraction that is generated by a fiscal uncertainty shock. This is because the limited capital market participation model captures individual uncertainty about redistribution that is absent in representative agent models. When agents are ambiguity averse, this uncertainty about redistribution has first-order effects because it shows up as heterogeneous worst-case scenarios. As a result, the model matches the empirical responses of macro variables to fiscal uncertainty shocks better than the representative agent counterpart.
Very simple point. And it is important as the quantitative exercise shows.
October 30, 2018
By Ian King and Frank Frank Stähler
We present a dynamic general equilibrium model in which both unemployment and capital utilization are determined endogenously in an environment with directed search frictions. The model allows for proportions of both labor and capital to be idle in equilibrium, where the degree of capital utilization determines its depreciation. We show that, under certain conditions, multiple steady state equilibria exist. In stable equilibria, both unemployment and capital utilization rates decline as productivity increases.
Getting endogenous idleness for two factors of production is tricky, and this paper makes a good attempt at this. I am intrigued by the result of multiple equilibria though, in particular whether it is only valid locally. What I have in mind is the observation that less productive economies seem to have a lot of idle capital and people, at least compared to developed ones.
October 29, 2018
By William Barnett, Chan Wang, Xue Wang and Liyuan Wu
What is the appropriate inflation target for a currency union, when conducting monetary policy: core inflation or headline inflation? We answer the question in a two-country New Keynesian model with an energy sector. We derive the welfare loss function and find that optimal monetary policy should target output gaps, the terms of trade gap, the Prouder Price Index inflation rates, and the real marginal cost gaps. We use the welfare loss function to evaluate two alternative Taylor-type monetary policy rules. We find that the choice of preferred policy rule depends on the shocks. Specifically, when productivity shocks hit the economy, the policymaker should follow the headline inflation Taylor rule, while the core inflation Taylor rule should be followed when a negative energy endowment shock hits the economy.
Thus, the monetary policy target depends on the state of the economy. To me, this sounds like having this kind of target is a bad idea, as you do not learn the state of the economy in real time. This idea of have a target was to have some real-time statistic to set policy with, after all.
October 26, 2018
By Marcin Kolasa
This paper proposes a novel explanation for why foreign currency denominated loans to households have become so popular in some emerging economies. Our argument is based on what we call the debt limit channel, which arises when multi-period contracts are offered to financially constrained borrowers against collateral that is established on newly acquired assets. Whenever the difference between domestic and foreign interest rates is positive, this effect biases borrowers’ choices towards foreign currency, even if the exchange rate is known to depreciate as implied by the interest parity condition. We demonstrate in a simple macroeconomic framework that the debt limit channel is quantitatively important and can result in dollarization of debt also when borrowing in foreign currency is risky. We next use a small open economy DSGE model and show that, if first-order effects related to the debt limit channel are neutralized by appropriate adjustment in debt contracts, the equilibrium share of foreign currency loans is small.
I think the point of the paper is that mortgage holders in countries with a currency that depreciates (and thus has a higher interest rate) borrow in a foreign currency so that they can borrow more. This is reminiscent of balloon mortgages in the US. Do the borrowers really know what they are getting into? Do the lenders realize that the borrowers are likely facing difficulties?
October 25, 2018
By Fabian Kindermann, Lukas Mayr and Dominik Sachs
The taxation of bequests can have a positive impact on the labor supply of heirs through wealth effects. This leads to an increase in future labor income tax revenue on top of direct bequest tax revenue. We first show in a theoretical model that a simple back-of-the-envelope calculation, based on existing estimates for the reduction in earnings after wealth transfers, fails: the marginal propensity to earn out of unearned income is not a sufficient statistic for the calculation of this effect because (i) heirs anticipate the reduction in net bequests and adjust their labor supply already prior to inheriting, and (ii) when bequest receipt is stochastic, even those who ex post end up not inheriting anything respond ex ante to the implied change in their distribution of net bequests. We quantitatively elaborate the size of the overall revenue effect due to labor supply changes of heirs by using a state of the art life-cycle model that we calibrate to the German economy. Besides the joint distribution of income and inheritances, quasi-experimental evidence regarding the size of wealth effects on labor supply is a key target for this calibration. We find that for each Euro of bequest tax revenue the government mechanically generates, it obtains an additional 9 Cents of labor income tax revenue (in net present value) through higher labor supply of (non-) heirs.
This paper makes an interesting point in the debate on estate taxation: the labor supply of potential heirs is elastic to the expected inheritance. This is a unique case where increasing a tax rate also increases GDP! It is, however, not clear what the impact on welfare is, as household need to do more precautionary savings and enjoy less leisure. Too bad the paper is silent on this.
October 24, 2018
By Juan Carlos Córdoba and Marla Ripoll
Dynastic models common in macroeconomics use a single parameter to control the willingness of individuals to substitute consumption both intertemporally, or across periods, and intergenerationally, or across parents and their children. This paper defines the concept of elasticity of intergenerational substitution (EGS), and extends a standard dynastic model in order to disentangle the EGS from the EIS, or elasticity of intertemporal substitution. A calibrated version of the model lends strong support to the notion that the EGS is significantly larger than one. In contrast, estimates of the EIS suggests that it is at most one. What disciplines the identification is the need to match empirically plausible fertility rates for the US.
This has flavors of hyperbolic discounting, but intergenerational and for the elasticity of substitution. This could have important implications as we evaluate policies that span generations.
October 20, 2018
By Pascal Michaillat and Emmanuel Saez
This paper extends the New Keynesian model by introducing wealth, in the form of government bonds, into the utility function. The extension modifies the Euler equation: in steady state the real interest rate is negatively related to consumption instead of being constant, equal to the time discount rate. Thus, when the marginal utility of wealth is large enough, the dynamical system representing the equilibrium is a source not only in normal times but also at the zero lower bound. This property eliminates the zero-lower-bound anomalies of the New Keynesian model, such as explosive output and inflation, and forward-guidance puzzle.
I have to confess that I have a hard time with the innovative assumption of this paper. Do people really really care about their wealth beyond what it brings in terms of future consumption? OK, wealth brings status, but does this matter this much? And is this status wealth in government bonds? I would have thought that to rather be in oversized housed, expensive cars and golden toilets.