The Lifetime Costs of Bad Health

November 17, 2017

By Mariacristina De Nardi, Svetlana Pashchenko and Ponpoje Porapakkarm

http://d.repec.org/n?u=RePEc:hka:wpaper:2017-079&r=dge

Health shocks are an important source of risk. People in bad health work less, earn less, face higher medical expenses, die earlier, and accumulate much less wealth compared to those in good health. Importantly, the dynamics of health are much richer than those implied by a low-order Markov process. We first show that these dynamics can be parsimoniously captured by a combination of some lag-dependence and ex-ante heterogeneity, or health types. We then study the effects of health shocks in a structural life-cycle model with incomplete markets. Our estimated model reproduces the observed inequality in economic outcomes by health status, including the income-health and wealth-health gradients. Our model has several implications concerning the pecuniary and non-pecuniary effects of health shocks over the life-cycle. The (monetary) lifetime costs of bad health are very concentrated and highly unequally distributed across health types, with the largest component of these costs being the loss in labor earnings. The non-pecuniary effects of health are very important along two dimensions. First, individuals value good health mostly because it extends life expectancy. Second, health uncertainty substantially increases lifetime inequality by affecting the variation in lifespans.

This paper has already received quite a bit of attention, but I still want to highlight it this week. Indeed, imagine a new type of insurance that would insure you against being born with bad genes. There is nothing you can do about bad genes (yet), and you carry that weight your whole life (which may be shorter). This paper allows you to quantify the payout in the gene lottery. Presumably, the lucky ones would have to pay in.

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Labor Market Liquidity

November 10, 2017

By Korie Amberger and Jan Eeckhout

http://d.repec.org/n?u=RePEc:red:sed017:839&r=dge

Labor market liquidity (flows to and from employment) have decreased sharply in the US in the last decades while the unemployment rate has remained constant; and across developed economies, there are also huge differences in flows. This poses very different risk profiles for workers: low labor market liquidity makes employment more attractive (higher job security) and unemployment less so (lower reemployment security). In this paper we ask which regime offers better insurance and higher welfare: job security or reemployment security? Except for very high levels of labor market liquidity, we find that welfare for a given asset level is increasing in liquidity for both the unemployed and employed. To avoid being borrowing constrained in an illiquid labor market, unemployed workers dissave more slowly, and the employed increase their savings, whose value is affected by equilibrium prices (wages and the interest rate). However, allowing capital markets to readjust generates higher aggregate welfare as flows decrease, completely through improved job security and asset accumulation for the low-skilled employed. The aggregate welfare gains from lower liquidity are sizable, 1.4% of consumption when comparing across countries. Optimal Unemployment Insurance (UI) is around 40% in the benchmark US economy and is increasing with lower labor market liquidity. A skill-specific optimal policy heavily favors the less wealthy low skilled but less so in a more illiquid labor market. Finally, we find lower flows decrease wealth inequality.

What is the better labor market? A US-like one with high turnover and no job security, or a European-style with life-long jobs and long-term unemployment? This paper shows the former seems to dominate, as the high turnover acts like an insurance mechanism that requires less unemployment insurance and pushes people to save more, both of of which contribute to positive general equilibrium effects. The model could have added more incentive effects and they would have reinforced the result, like the fact that in a fluid labor market workers need more to stay productive to survive or that job maching will end up better if more matches are tried.


Occupational Hazards and Social Disability Insurance

November 3, 2017

By Amanda Michaud and Davic Wiczer

http://d.repec.org/n?u=RePEc:nys:sunysb:17-11&r=dge

Using retrospective data, we introduce evidence that occupational exposure significantly affects disability risk. Incorporating this into a general equilibrium model, social disability insurance (SDI) affects welfare through (i) the classic, risk-sharing channel and (ii) a new channel of occupational reallocation. Both channels can increase welfare, but at the optimal SDI they are at odds. Welfare gains from additional risk-sharing are reduced by overly incentivizing workers to choose risky occupations. In a calibration, optimal SDI increases welfare by 2.3% relative to actuarially fair insurance, mostly due to risk sharing.

This is the classic insurance conundrum: it enhances welfare through risk-sharing, but also reduces it through encouraging risk-taking. Here it is with disability insurance that influences occupational choice. In the paper, the disability is expressed as not being able to general labor income. I wonder if accounting for the physical hurt of a disability would significantly affect the outcome. I can understand that this is difficult to model and calibrate, though.

[a previous version of this post had the wrong paper title]


Is Marriage for White People? Incarceration and the Racial Marriage Divide

October 18, 2017

By Elizabeth Caucutt, Nezih Guner and Christopher Rauh

http://d.repec.org/n?u=RePEc:red:sed017:779&r=dge

The differences between black and white households and family structure have been a concern for policy makers for a long time. The last few decades, however, have witnessed an unprecedented retreat from marriage among black individuals. In 1970, about 89% of black women between ages 25 and 54 were ever married, in contrast to only 51% today. Wilson (1987) suggests that the lack of marriageable black men due to incarceration and unemployment is behind this decline. In this paper, we take a fresh look at the Wilson Hypothesis. We argue that the current incarceration policies and labor market prospects make black men much riskier spouses than white men. They are not only more likely to be, but also to become, unemployed or incarcerated than their white counterparts. We develop an equilibrium search model of marriage, divorce and labor supply that takes into account the transitions between employment, unemployment and prison for individuals by race, education, and gender. We calibrate this model to be consistent with key statistics for the US economy. We then investigate how much of the racial divide in marriage is due to differences in the riskiness of potential spouses, heterogeneity in the education distribution, and heterogeneity in wages. We find that differences in incarceration and employment dynamics between black and white men can account for about 76% of the existing black-white marriage gap in the data. We also study how “The War on Drugs” in the US might have affected the structure of black families, and find that it can account for between 13% to 41% of the racial marriage gap.

I chose to highlight this paper because it addresses an important question and it shows how the DSGE methodology allows to study scenarios that you cannot run in real life. This paper shows that if incarceration policies were different, there would be quite different outcomes on the labor and marriage markets, and many people would be living in a very different world.


From Childhood to Adult Inequality: Parental Investments and Early Childhood Development

October 18, 2017

By Diego Daruich

http://d.repec.org/n?u=RePEc:red:sed017:770&r=dge

Standard macroeconomic analysis of inequality focuses on the optimal choice of progressive taxation. However, early childhood environment has been shown to significantly impact adult outcomes. Using children’s time diaries, we show that parental quality time with children is strongly associated with children’s skills—which is later associated with their education. To compare the quantitative role of standard policies to ones that target early childhood, we extend the standard general-equilibrium heterogeneous-agent life-cycle model with earnings risk and credit constraints to allow for endogenous education, parental time and money investments towards children’s skill development, and family transfers. The model includes two types of college majors: STEM and non-STEM. We evaluate three policies: progressive taxation, college tuition subsidies, and parenting education. Progressive taxation is the most effective at reducing disposable income inequality, but it does not promote the development of skills necessary to increase college graduation or social mobility. College subsidies promote only non-STEM graduation, since STEM is a better alternative only for high-skilled individuals. Parenting education is the most effective at increasing intergenerational mobility and the only one able to promote STEM graduation.

There is hardly anything surprising in the results of this paper, but they really need to be emphasized: Reducing college tuition is not helping with subsequent income inequality and the very first years of life are the most important for adult outcomes. Public policies should focus on helping parents doing the right thing when they are catapulted into parenthood.


Leverage and deepening business cycle skewness

October 17, 2017

By Henrik Jensen, Ivan Petrella, Søren Hove Ravn and Emiliano Santoro

http://d.repec.org/n?u=RePEc:bde:wpaper:1732&r=dge

We document that the U.S. economy has been characterized by an increasingly negative business cycle asymmetry over the last three decades. This finding can be explained by the concurrent increase in the financial leverage of households and firms. To support this view, we devise and estimate a dynamic general equilibrium model with collateralized borrowing and occasionally binding credit constraints. Higher leverage increases the likelihood that constraints become slack in the face of expansionary shocks, while contractionary shocks are further amplified due to binding constraints. As a result, booms become progressively smoother and more prolonged than busts. We are therefore able to reconcile a more negatively skewed business cycle with the Great Moderation in cyclical volatility. Finally, in line with recent empirical evidence, financially-driven expansions lead to deeper contractions, as compared with equally-sized non-financial expansions.

The fact that increasing financial leverage can explain the Great Moderation and the last recession is nothing new. The fact that it could explain the strong asymmetry between the sharp drop ten years ago and the slow recovery since is, however, new. By now, it should be clear that models relying on symmetry around a steady-state can be shelved for good.


Systemic Risk: A New Trade-Off for Monetary Policy?

October 9, 2017

By Stefan Laséen, Andrea Pescatoriand Jarkko Turunen

http://d.repec.org/n?u=RePEc:hhs:rbnkwp:0341&r=dge

We introduce time-varying systemic risk (Ă  la He and Krishnamurthy, 2014) in an otherwise standard New-Keynesian model to study whether simple leaning-against-the-wind interest rate rules can reduce systemic risk and improve welfare. We find that while financial sector leverage contains additional information about the state of the economy that is not captured in inflation and output leaning against financial variables can only marginally improve welfare because rules are detrimental in the presence of falling asset prices. An optimal macroprudential policy, similar to a countercyclical capital requirement, can eliminate systemic risk raising welfare by about 1.5%. Also, a surprise monetary policy tightening does not necessarily reduce systemic risk, especially during bad times. Finally, a volatility paradox à la Brunnermeier and Sannikov (2014) arises when monetary policy tries to excessively stabilize output.

I think it is no surprise that adding a policy objective requires adding a policy instrument. The question here is whether the new instrument messes up the others in a major way. If things are difficult with a double mandate, imagine what this becomes with a triple one.