Money and Capital as Competing Media of Exchange in a News Economy

June 28, 2010

By David Andolfatto and Fernando Martin

Conventional theory suggests that fiat money will have value in capital poor economies. We demonstrate that fiat money may also have value in capital-rich economies, if the price of capital is excessively volatile. Excess asset-price volatility is generated by news; information that has no social value, but is privately useful in forming forecasts over the short-run return to capital. One advantage of fiat money is that its expected return is not linked directly to news concerning the prospects of an underlying asset. When money and capital compete as media of exchange, excess volatility in the short-term returns of liquid asset portfolios is mitigated and welfare is improved. A legal restriction that prohibits the use of capital as a payment instrument renders the expected return to money perfectly stable and, as a consequence, may generate an additional welfare benefit.

Fiat money is a strange object, and its value sometimes is sometimes determined in a counter-intuitive fashion. In this case, money should have little value if there is ample capital available as a store of value and medium of exchange. However, value uncertainty of capital may overcome its dominance over money. That makes sense, and is expressed nowadays by a large increase in money demand. The surprising bit is that forcing people not to use capital for payment is welfare improving.


Unemployment Insurance with Hidden Savings

June 23, 2010

By Matthew Mitchell and Yuzhe Zhang

This paper studies the design of unemployment insurance when neither the searching effort nor the savings of an unemployed agent can be monitored. If the principal could monitor the savings, the optimal policy would leave the agent savings-constrained. With a constant absolute risk-aversion (CARA) utility function, we obtain a closed form solution of the optimal contract. Under the optimal contract, the agent is neither saving nor borrowing constrained. Counter-intuitively, his consumption declines faster than implied by Hopenhayn and Nicolini [4]. The efficient allocation can be implemented by an increasing benefit during unemployment and a constant tax during employment.

I find this paper very unsettling. The optimal unemployment insurance literature has consistently advocated that benefits should decrease with unemployment tenure, even after finding a job, and this paper puts everything on its head.

Deep habits and the cyclical behaviour of equilibrium unemployment and vacancies

June 15, 2010

By Federico de Pace and Renato Faccini

We extend the standard textbook search and matching model by introducing deep habits in consumption. The cyclical fluctuations of vacancies and unemployment in our model can replicate those observed in the US data, with labour market tightness being 20 times more volatile than consumption. Vacancies display a hump-shaped response to technology shocks as well as autocorrelation coefficients that are in line with the empirical evidence. Our model preserves the assumption of fully flexible wages for the new hires and the calibration is consistent with the estimated elasticity of unemployment to unemployment benefits. The numerical simulations generate an artificial Beveridge curve which is in line with the data.

This paper is a new attempt to resolve the Shimer puzzle. To increase the volatility of labor market variables, the model assumes deep habits: consumers develop very persistent consumption in particular goods, which firms encourage by supplying more goods. They can achieve this by hiring more workers when such opportunities arise.

Conditional forecasts in DSGE models

June 7, 2010

By Junior maih

New-generation DSGE models are sometimes misspecified in dimensions that matter for their forecasting performance. The paper suggests one way to improve the forecasts of a DSGE model using a conditioning information that need not be accurate. The technique presented allows for agents to anticipate the information on the conditioning variables several periods ahead. It also allows the forecaster to apply a continuum of degrees of uncertainty around the mean of the conditioning information, making hard-conditional and unconditional forecasts special cases. An application to a small open-economy DSGE model shows that the benefits of conditioning depend crucially on the ability of the model to capture the correlation between the conditioning information and the variables of interest.

DSGE models are more and more used for forecasting, despite not being designed for that purpose, and thus with varying fortunes. This paper presents a technique that may give them a better chance,

Trading Off Generations: Infinitely-Lived Agent Versus OLG

June 7, 2010

By Maik T. Schneider, Christian Traeger and Ralph Winkler

The prevailing literature discusses intergenerational trade-offs predominantly in infinitely-lived agent models despite the finite lifetime of individuals. We discuss these trade-offs in a continuous time OLG framework and relate the results to the infinitely-lived agent setting. We identify three shortcomings of the latter: First, underlying normative assumptions about social preferences cannot be deduced unambiguously. Second, the distribution among generations living at the same time cannot be captured. Third, the optimal solution may not be implementable in overlapping generations market economies. Regarding the recent debate on climate change, we conclude that it is indispensable to explicitly consider the generations’ life cycles.

It is pretty obvious humans are finitely-lived, yet we often model them as infinitely-lived. This is quite convenient, but does it matter? Naturally, this depends on the research question. Also, we all know that if there is a sufficient level of intergenerational altruism, the two approaches are essentially equivalent. This paper looks at the analysis of climate change, where policy to a large extend makes only sense if we care for future generations. Thus, is modeling infinitely-lived agents still bad?

The Effects of Fiscal Policy on Output: A DSGE Analysis

June 2, 2010

By: Davide Furceri and Annabelle Mourougane

This paper examines the effects of fiscal policy on output in the euro area. For this purpose we develop a DSGE Fiscal Model with endogenous government bond yields to assess the impact of different fiscal policy shocks on output, its components and on government debt. The simulations suggest that fiscal policy is effective in supporting activity, especially in the short term. In particular, the largest fiscal multipliers are found for an increase in public investment, public consumption and a cut in the wage tax. The results are robust to different parameter calibrations and are economically significant. Amongst the different structural parameters, the share of liquidity constrained households and price persistence are found to be the ones which affect the most fiscal multipliers.

DSGE models do not find large multipliers from government expenses because the Ricardian Equivalence holds, or almost holds. In this paper, liquidity constraints allow for strong deviations from Ricardian Equivalence, and thus more substantial multipliers.