Two calls for papers

November 26, 2012

First, the latest EconomicDynamics Newsletter is out, and it contains among other great things the call for the 2013 meeting of the Society for Economic Dynamics in Seoul.

Second, the Philadelphia Fed is organizing its seventh Annual Conference on Macroeconomics Across Time and Space for those interested in modern economic analysis of historic questions.


The macroeconomic effects of large-scale asset purchase programs

November 24, 2012

By Han Chen, Vasco Cúrdia, and Andrea Ferrero

We simulate the Federal Reserve second Large-Scale Asset Purchase program in a DSGE model with bond market segmentation estimated on U.S. data. GDP growth increases by less than a third of a percentage point and inflation barely changes relative to the absence of intervention. The key reasons behind our findings are small estimates for both the elasticity of the risk premium to the quantity of long-term debt and the degree of financial market segmentation. Absent the commitment to keep the nominal interest rate at its lower bound for an extended period, the effects of asset purchase programs would be even smaller.

This paper seems to indicate that the various quantitative easing programs of the Fed and other central banks have minimal impact despite their enormous size. As they will eventually have to be undone, this should alleviate the fears about significantly negative outcomes in the future. An even if the impact is small, impact there is, and the central banks made considerable profits with this policy intervention, profits they transfered to the government.

The Supply of Skills in the Labor Force and Aggregate Output Volatility

November 20, 2012

By Steven Lugauer

The cyclical volatility of U.S. gross domestic product suddenly declined during the early 1980s and remained low for over 20 years. I develop a labor search model with worker heterogeneity and match-specific costs to show how an increase in the supply of high-skill workers can contribute to a decrease in aggregate output volatility. In the model, firms react to changes in the distribution of skills by creating jobs designed specifically for high-skill workers. The new worker-firm matches are more profitable and less likely to break apart due to productivity shocks. Aggregate output volatility falls because the labor market stabilizes on the extensive margin. In a simple calibration exercise, the labor market based mechanism generates a substantial portion of the observed changes in output volatility.

The employment and hours volatilities of skilled workers are lower than for unskilled workers. As the proportion of skilled workers has increased, it is natural to ask whether this can explain a substantial part of the Great Moderation. An interesting extension would be to see whether this could explain also less frequent, but deeper and longer recessions like the last one.

Optimal Policy for Macro-Financial Stability

November 16, 2012

By Gianluca Benigno, Huigang Chen, Chris Otrok, Alessandro Rebucci and Eric Young

In this paper we study whether policy makers should wait to intervene until a financial crisis strikes or rather act in a preemptive manner. We study this question in a relatively simple dynamic stochastic general equilibrium model in which crises are endogenous events induced by the presence of an occasionally binding borrowing constraint as in Mendoza (2010). First, we show that the same set of taxes that replicates the constrained social planner allocation could be used optimally by a Ramsey planner to achieve the first best unconstrained equilibrium: in both cases without any precautionary intervention. Second, we show that the extent to which policymakers should intervene in a preemptive manner depends critically on the set of policy tools available and what these instruments can achieve when a crisis strikes. For example, in the context of our model, we find that, if the policy tools is constrained so that the first best cannot be achieved and the policy maker has access to only one tax instrument, it is always desirable to intervene before the crisis regardless of the instrument used. If however the policy maker has access to two instruments, it is optimal to act only during crisis times. Third and finally, we propose a computational algorithm to solve Markov-Perfect optimal policy for problems in which the policy function is not differentiable.

Interesting paper on the question whether policy should be proactive or reactive with respect to financial crises. What I find particularly interesting is that a well-tooled policy-maker should rather be reactive, which I find counter-intuitive. The reason is somewhat difficult to explain in a few words: During a crisis, two instruments allow to intervene with one and undo detrimental distortions from the first with the second. If there is only one instrument, it is best not to intervene during the crisis, as the distortion cannot be undone, but one can act preemptively.