Home production and Social Security reform

March 23, 2012

By Michael Dotsey, Wenli Li and Fang Yang


This paper incorporates home production into a dynamic general equilibrium model of overlapping generations with endogenous retirement to study Social Security reforms. As such, the model differentiates both consumption goods and labor effort according to their respective roles in home production and market activities. Using a calibrated model, we find that eliminating the current pay-as-you-go Social Security system has important implications for both labor supply and consumption decisions and that these decisions are influenced by the presence of a home production technology. Comparing our benchmark economy to one with differentiated goods but no home production, we find that eliminating Social Security benefits generates larger welfare gains in the presence of home production. This result is due to the self insurance aspects generated by the presence of home production. Comparing our economy to a one-good economy without home production, we show that the welfare gains of eliminating Social Security are magnified even further. These policy analyses suggest the importance of modeling home production and distinguishing between both time use and consumption goods depending on whether they are involved in market or home production.

This is by far not the first time home production is used, but usually it is added to a model to explain some quirk in the data. Here, it matters in very fundamental ways. It gives the households more options (and margins) in their life-cycle choices, and thereby eliminates the need for the retirement portion of Social Security. Of course, this may be associated with important transition costs, which may or may not wipe out the long-run benefits of this reform.


Macroeconomics with Financial Frictions: A Survey

March 15, 2012

By Markus Brunnermeier, Thomas Eisenbach and Yuliy Sannikov


This article surveys the macroeconomic implications of financial frictions. Financial frictions lead to persistence and when combined with illiquidity to non-linear amplification effects. Risk is endogenous and liquidity spirals cause financial instability. Increasing margins further restrict leverage and exacerbate downturns. A demand for liquid assets and a role for money emerges. The market outcome is generically not even constrained efficient and the issuance of government debt can lead to a Pareto improvement. While financial institutions can mitigate frictions, they introduce additional fragility and through their erratic money creation harm price stability.

This a paper is a long read, 100 pages. Yet, it should be a required reading for anybody arguing that macroeconomics has been ignoring financial frictions or the financial sector in general. I have highlighted a few recent papers here, but this survey also looks at older ones and puts them all into context.

Search Capital

March 9, 2012

By Carlos Carrillo-Tudela and Eric Smith


We construct a simple equilibrium search model in which workers accumulate information about previously met employment contacts. We term the latter search capital. Here search capital (partially) insures workers against adverse shocks. The model provides a theory of job-to-job transitions that are associated with voluntary or involuntary mobility and with wage rises or wage cuts. It also shows why low wage and younger workers are associated with a higher probability of becoming unemployed.

Nice paper that takes into account an important aspect of the network aspect of job search. I guess the next step is to include in this capital “acquaintances,” that is, former colleagues who can recommend you.