Monetary theory reversed: Virtual currency issuance and miners’ remuneration

March 14, 2018

By Luca Marchiori

This study analyzes the macroeconomic implications of virtual currency issuance. It builds on a standard cash-in-advance model extended with (i) ‘virtual’ goods, sold against virtual currency, and (ii) miners, the agents providing payment services. The main finding is that virtual currency growth may have effects opposite to those predicted by monetary theory when miners are rewarded with newly created coins. Declining currency issuance, as in Bitcoin, raises the price of virtual goods, which counteracts the traditional impact of a reduced inflation tax. The paper also shows how fiat money growth affects the welfare effects of virtual currency creation.

What this paper is saying is that there is a sweet spot for virtual currencies where they have been accepted for transactions but are not yet too close to the supply limit. Once supply is too limited to reasonably reward miners, the later start charging higher transaction fees and the cost of the goods bought with virtual currency increases, leading to a net welfare loss. In other words, virtual currencies are cool for a while but are not there to stay.


Are Consumers’ Spending Decisions in Line With an Euler Equation?

March 6, 2018

By Lena Dräger and Giang Nghiem

Evaluating two new survey datasets of German consumers, we test whether individual consumption spending decisions are formed according to an Euler equation derived from consumption life-cycle models. Measured in qualitative individual changes, our results suggest that current and planned spending are positively correlated, thus supporting the hypothesis of consumption smoothing. Also, current spending is positively correlated with inflation expectations, and negatively with nominal interest rate expectations. Interestingly, the effect of perceived real interest rates is only significant for financial market participants, financially unconstrained households and those with high financial literacy, implying that these are important conditions for the ability to smooth consumption over time. Moreover, these households are better positioned in the wealth and income distributions. In that sense, the ability to smooth consumption may be a channel through which distributional effects of policy shocks may occur. Finally, news on inflation and monetary policy observed by the consumer strengthen the effect of their inflation expectations on current spending, suggesting that imperfect information may also influence the Euler equation relationship.

There are many papers estimating Euler equations, but they usually do it on aggregate data. This paper uses two German surveys and it is with great relief that we learn that the consumption Euler equation is still working well.

Two papers on unemployment insurance and misallocation

March 5, 2018

Unemployment Insurance Take-up Rates in an Equilibrium Search Model

By Stéphane Auray, David Fuller and Lkhagvasuren Damba

From 1989-2012, on average 23% of those eligible for unemployment insurance (UI) benefits in the US did not collect them. In a search model with matching frictions, asymmetric information associated with the UI non-collectors implies an inefficiency in non-collector outcomes. This inefficiency is characterized along with the key features of collector vs. non-collector allocations. Specifically, the inefficiency implies that noncollectors transition to employment at a faster rate and a lower wage than the efficient levels. Quantitatively, the inefficiency amounts to 1.71% welfare loss in consumption equivalent terms for the average worker, with a 3.85% loss conditional on non-collection. With an endogenous take-up rate, the unemployment rate and average duration of unemployment respond significantly slower to changes in the UI benefit level, relative to the standard model with a 100% take-up rate.

Social Insurance and Occupational Mobility

By German Cubas and Pedro Silos

This paper studies how insurance from progressive taxation improves the matching of workers to occupations. We propose an equilibrium dynamic assignment model to illustrate how social insurance encourages mobility. Workers experiment to find their best occupational fit in a process filled with uncertainty. Risk aversion and limited earnings insurance induce workers to remain in unfitting occupations. We estimate the model using microdata from the United States and Germany. Higher earnings uncertainty explains the U.S. higher mobility rate. When workers in the United States enjoy Germany’s higher progressivity, mobility rises. Output and welfare gains are large.

By chance, there a two papers with a similar message about unemployment insurance in this week’s issue of NEP-DGE. Both argue that UI is essential in getting good fits on the labor market. This is especially true as the jobs and the labor market become more and more specialized.

Home Equity Extraction and the Boom-Bust Cycle in Consumption and Residential Investment

February 27, 2018

By Xiaoqing Zhou

The consumption boom-bust cycle in the 2000s coincided with large fluctuations in the volume of home equity borrowing. Contrary to conventional wisdom, I show that homeowners largely borrowed for residential investment and not consumption. I rationalize this empirical finding using a calibrated two-goods, multiple-assets, heterogeneous-agent life-cycle model with borrowing frictions. The model replicates key features of the household-level and aggregate data. The model offers an alternative explanation of the consumption boom-bust cycle. This cycle is caused by large fluctuations in the number of borrowers and hence in total home equity borrowing, even though the fraction of borrowed funds spent on consumption is small.

That is going to surprise quite a few: there was no borrowing frenzy and real estate was not being used as a cash cow for consumption. The increase in total borrowing was just the result of the expansion of the extensive margin, not the intensive margin.

Improved Matching, Directed Search, and Bargaining in the Credit Card Market

February 21, 2018

By Gajendran Raveendranathan

I build a model of revolving credit in which consumers face idiosyncratic earnings risk, and credit card firms direct their search to consumers. Upon a match, they bargain over borrowing limits and borrowing interest rates — fixed for the duration of the match. Using the model, I show that improved matching between consumers and credit card firms, calibrated to match the rise in the population with credit cards, accounts for the rise in revolving credit and consumer bankruptcies in the United States. I also provide empirical evidence consistent with the two key features in my model: directed search and bargaining. The lifetime consumption gains from improved matching are 3.55 percent— substantially larger than those previously estimated by alternative explanations for the rise in revolving credit and consumer bankruptcies (0.03-0.57 percent). Finally, I analyze how the credit card firm’s bargaining power impacts the welfare of introducing stricter bankruptcy laws.

That is going to surprise a few: the higher credit card debt and default are actually welfare improving. Or at least if they are the consequence of better matching and bargaining. Which means that one should not necessarily worry if the credit card market should more defaults.

Dealing with Misspecification in DSGE Models: A Survey

February 10, 2018

By Alessia Paccagnini

Dynamic Stochastic General Equilibrium (DSGE) models are the main tool used in Academia and in Central Banks to evaluate the business cycle for policy and forecasting analyses. Despite the recent advances in improving the fit of DSGE models to the data, the misspecification issue still remains. The aim of this survey is to shed light on the different forms of misspecification in DSGE modeling and how the researcher can identify the sources. In addition, some remedies to face with misspecification are discussed.

I have occasionally pointed out on this blog various misspecification issues in the estimation of DSGE models. This handy survey addresses a lot of such worries with some remedies.

What’s News in International Business Cycles

February 7, 2018

By Daniele Siena

The role of news shocks in international business cycles is first evaluated using a structural factor-augmented VAR model (FAVAR). An international FAVAR model is shown to be necessary to recover the correct news shocks in open economies, except the US, without incurring in the ‘non-fundamentalness’ problem. Then, a standard two-country, two-good real business cycle model, featuring news shocks, investment adjustment costs and variable wealth elasticity of the labor supply is used to match and explain the empirical evidence. News shocks are only marginal drivers of international business cycles synchronization.

There is plenty of literature, including some relayed on this blog, that shows that news shocks are important in explaining business cycles. Why that suddenly vanishes once you look at the international dimension is interesting. This is certainly not the first time in the history of studying business cycles that this happens. I wonder what the disturbing mechanism is this time.