April 27, 2013
By Jonathan Heathcote and Fabrizio Perri
This paper is structured in three parts. The first part outlines the methodological steps, involving both theoretical and empirical work, for assessing whether an observed allocation of resources across countries is efficient. The second part applies the methodology to the long-run allocation of capital and consumption in a large cross section of countries. We find that countries that grow faster in the long run also tend to save more both domestically and internationally. These facts suggest that either the long-run allocation of resources across countries is inefficient, or that there is a systematic relation between fast growth and preference for delayed consumption. The third part applies the methodology to the allocation of resources across developed countries at the business cycle frequency. Here we discuss how evidence on international quantity comovement, exchange rates, asset prices, and international portfolio holdings can be used to assess efficiency. Overall, quantities and portfolios appear consistent with efficiency, while evidence from prices is difficult to interpret using standard models. The welfare costs associated with an inefficient allocation of resources over the business cycle can be significant if shocks to relative country permanent income are large. In those cases partial financial liberalization can lower welfare.
While the allocation (or misallocation) of resources within a country, a sector or a firm are much studies, the international allocation is rarely looked at. This monumental paper, a forthcoming chapter in the Handbook for International Economics surveys the relevant literature, lays out the methodological foundations and takes a quantitative example with business cycle fluctuations among developed economies. The last statement of the abstract is intriguing. Indeed, financial autarky may be preferable in some circumstances, namely when shocks generate large differences in permanent income (very persistent, large innovations). The reasons is that if you only have bonds, they provide poor insurance as they are non-contingent. In addition, introducing bonds changes interest rate responses in a way that amplifies the impact of shocks. The interest rate in the country benefiting from a positive shock declines less than under autarky, leading to a additional wealth effect as it lending. The same would apply if the other country had a negative shock. Now think about it in the context of Germany and the European financial crisis.
April 15, 2013
By Jeremy Greenwood, Philipp Kircher, Cezar Santos and Michele Tertilt
Eleven percent of the Malawian population is HIV infected. Eighteen percent of sexual encounters are casual. A condom is used one quarter of the time. A choice-theoretic general equilibrium search model is constructed to analyze the Malawian epidemic. In the developed framework, people select between different sexual practices while knowing the inherent risk. The analysis suggests that the efficacy of public policy depends upon the induced behavioral changes and general equilibrium effects that are typically absent in epidemiological studies and small-scale field experiments. For some interventions (some forms of promoting condoms or marriage), the quantitative exercise suggests that these effects may increase HIV prevalence, while for others (such as male circumcision or increased incomes) they strengthen the effectiveness of the intervention. The underlying channels giving rise to these effects are discussed in detail.
This paper confirms some of the results of my research with Douglas Gollin: general equilibrium effects are important, behavioral responses are very important, and protection methods may be useless, or in this case counter-productive, once behavioral responses are taken into account. I also think that this is another example where the lack of reliable data can be efficiently supplemented with good use of theory.
April 9, 2013
By Sewon Hur and Illenin Kondo
Emerging economies, unlike advanced economies, have accumulated large foreign reserve holdings. We argue that this policy is an optimal response to an increase in foreign debt rollover risk. In our model, reserves play a key role in reducing debt rollover crises (“sudden stops”), akin to the role of bank reserves in preventing bank runs. We find that a small, unexpected, and permanent increase in rollover risk accounts for the outburst of sudden stops in the late 1990s, the subsequent increase in foreign reserves holdings, and the salient resilience of emerging economies to sudden stops ever since. Finally, we show that a policy of pooling reserves can substantially reduce the reserves needed by emerging economies.
Interesting paper that shows that rather small events can trigger larger ones. While this is applied to emerging economies, one can wonder whether this can carry over to Europe today. Of course, the handling of foreign reserves is completely different, but precisely the fact that they are bundled across member countries to address imbalances looks like what the authors are calling for. Maybe this is a real-life test of their proposed policy.
April 2, 2013
By Kai Zhao
This paper studies the effects of health shocks on the demand for health insurance and annuities, precautionary saving, and the welfare implications of public policies in a simple life-cycle model. I show that when the health shock simultaneously increases health expenses and reduces longevity, the following results can be obtained via closed-form solutions. First, utility-maximizing agents would neither fully insure their uncertain health expenses nor fully annuitize their wealth, even in the absence of market frictions and bequest motives. Second, the effect of uncertain health expenses on precautionary saving may be smaller than what has been found in previous studies. Under certain conditions, uncertain health expenses may even reduce precautionary saving. Third, mandatory health insurance (e.g. public health insurance) tends to benefit the poor more, while mandatory annuitization (e.g. public pension) is more likely to favor the rich. A simple numerical application of the model to the US long term care (LTC) insurance market suggests that the simultaneous effect of health shock on health expenses and longevity is a quantitatively important reason why agents (especially the rich) do not purchase more private LTC insurance.
The major take-away I get from this paper is that health shocks have less of an impact on savings than we thought. I would add it is even less, as I think the high costs of US health care are not sustainable. Sooner or later, the government, insurers and employers will manage to squeeze the high profit margins of the health industry and get health expenses closer to what they are in comparable economies. Health shocks will then be “milder.”