Education Policy and Intergenerational Transfers in Equilibrium

February 16, 2013

By Brant Abbott, Giovanni Gallipoli, Costas Meghir and Giovanni Violante

This paper compares partial and general equilibrium effects of alternative financial aid policies intended to promote college participation. We build an overlapping generations life-cycle, heterogeneous-agent, incomplete-markets model with education, labor supply, and consumption/saving decisions. Altruistic parents make inter vivos transfers to their children. Labor supply during college, government grants and loans, as well as private loans, complement parental transfers as sources of funding for college education. We find that the current financial aid system in the U.S. improves welfare, and removing it would reduce GDP by two percentage points in the long-run. Any further relaxation of government-sponsored loan limits would have no salient effects. The short-run partial equilibrium effects of expanding tuition grants (especially their need-based component) are sizeable. However, long-run general equilibrium effects are 3-4 times smaller. Every additional dollar of government grants crowds out 20-30 cents of parental transfers.

This is a monster of a paper, both in length and in the details of the model. It also give a rather complete picture of the various ways a student could finance college and how various policies could impact this. And while this is a very complex model, one is tempted to ask for more: what if the cost of studying is endogenous to financing policies? What if tuition support were dramatically expanded? What about policies where students are taxed on future income? Or where student loans depend on expected future capacity to pay? This is a quality of a good paper: it begs for more questions to be answered.


February Calls for Paper

February 13, 2013

Before the calls for papers, let me mention that the number of subscribers to the NEP-DGE mailing list now tops 1000. Encourage colleagues, co-authors, students and others to subscrbe as well. As you know, it is free. For the list of all fields that are available, see NEP.

Earliest deadlines first (do not forget the SED in Seoul is this Friday):

Quantitative Society for Pensions and Savings Summer Workshop, Logan (Utah), 23-25 May 2013

Southern Workshop in Macroeconomics, Wellington (NZ), 26-27 April 2013.

Minnesota Workshop in Macroeconomics Theory, Minneapolis, 30 July-2 August 2013

Summer School in Economic Growth, Coventry (UK), 8-12 July 2013

The Role of Consumer Leverage in Generating Financial Crises

February 11, 2013

By Dilyana Dimova

Consumer leverage can generate financial crises characterized by increased bankruptcy, tightened credit access and reduced demand for goods. This paper embeds financial frictions in the mortgage contracts of homeowners within a two-sector economy to show that even at moderate initial levels, household indebtedness can create a lasting financial downturn such as the subprime mortgage crisis. Using two seemingly positive disturbances that triggered the subprime mortgage crisis – an increased housing supply and a relaxation of borrowing conditions – the model demonstrated that the subprime downturn was not a precedent but the natural consequence of financial frictions. The oversupply of houses lowers asset prices and reduces the value of the real estate collateral used in the mortgage. This worsens the leverage of indebted consumers and raised their bankruptcy prospects generating a pro-cyclical risk premium. A relaxation of borrowing conditions turns credit-constrained households into a potential source of disturbances themselves when market optimism allows them to overleverage with little downpayment. In both cases, the resulting excessive consumer leverage impairs household credit access for a lengthy after-shock period and diverts resources from their consumption. Their reduced demand for goods may propagate the downturn to the rest of the economy depressing output in other sectors. Adding credit constraints in the financial sector that provides housing mortgages deepens the negative impact of the shocks and makes recovery even more protracted.

Much has been written about over-leveraging of banks. While over-leveraging of households has been a concern, I do not think its macroeconomic impact is well understood. This paper shows that it can not only generate much wider fluctuations, but that they can also last much longer than with more “reasonable” leverage ratios. A precondition for this to happen, though, is a lowering of lending standards. This brings us back to what happened in the banks and provides another good reason for regulating them.

Mismatch, Sorting and Wage Dynamics

February 6, 2013

By Jeremy Lise, Costas Meghir and Jean-Marc Robin

We develop an empirical search-matching model which is suitable for analyzing the wage, employment and welfare impact of regulation in a labor market with heterogeneous workers and jobs. To achieve this we develop an equilibrium model of wage determination and employment which extends the current literature on equilibrium wage determination with matching and provides a bridge between some of the most prominent macro models and microeconometric research. The model incorporates productivity shocks, long-term contracts, on-the-job search and counter-offers. Importantly, the model allows for the possibility of assortative matching between workers and jobs due to complementarities between worker and job characteristics. We use the model to estimate the potential gain from optimal regulation and we consider the potential gains and redistributive impacts from optimal unemployment insurance policy. Here optimal policy is defined as that which maximizes total output and home production, accounting for the various constraints that arise from search frictions. The model is estimated on the NLSY using the method of moments.

I have highlighted several search-and-matching papers lately because I think this filed is making significant progress towards understand the processes in the labor market. This paper is certainly part of this current that bridge micro and macro aspects of employment. It shows how one can include relevant complexity in the markets while still be able to solve for an equilibrium and relate it to data in a sensible way and obtain plausible results.