July calls for papers

July 31, 2013

Two calls this month:

The Causes and Macroeconomic Consequences of Uncertainty, in Dallas 3-4 October 2013. Deadline is today!

Fall 2013 Midwest Macro Meeting, in Minneapolis 8-10 November 2013.

Slow Moving Debt Crises

July 25, 2013

By Guido Lorenzoni and Ivan Werning


What circumstances or policies leave sovereign borrowers at the mercy of self-fulfilling increases in interest rates? To answer this question, we study the dynamics of debt and interest rates in a model where default is driven by insolvency. Fiscal deficits and surpluses are subject to shocks but influenced by a fiscal policy rule. Whenever possible the government issues debt to meet its current obligations and defaults otherwise. We show that low and high interest rate equilibria may coexist. Higher interest rates, prompted by fears of default, lead to faster debt accumulation, validating default fears. We call such an equilibrium a slow moving crisis, in contrast to rollover crises where investor runs precipitate immediate default. We investigate how the existence of multiple equilibria is affected by the fiscal policy rule, the maturity of debt, and the level of debt.

The debt crisis in Europe looks like a long freight train that takes a very long time to garner speed, and to break. This is part of what this paper is trying to understand, contrasting this with other crises that happen suddenly and quickly. This one is different because of feedback rules that amplify initial shocks, but slowly and without creating an immediate expectation that the path is irremediably unsustainable, as government commitment is imperfect. Another interesting outcome is that there is multiplicity of equilibria from a Laffer curve effect of interest rates on public debt. With high interests rates, debt increases faster, generating more default fears and again higher interest rates. With low interest rates, they tend to remain that way as less debt is accumulated.

The age-time-cohort problem and the identification of structural parameters in life-cylce models

July 22, 2013

By Sam Schulhofer-Wohl


The standard approach to estimating structural parameters in life-cycle models imposes sufficient assumptions on the data to identify the “age profile” of outcomes, then chooses model parameters so that the model’s age profile matches this empirical age profile. I show that the standard approach is both incorrect and unnecessary: incorrect, because it generally produces inconsistent estimators of the structural parameters, and unnecessary, because consistent estimators can be obtained under weaker assumptions. I derive an estimation method that avoids the problems of the standard approach. I illustrate the method’s benefits analytically in a simple model of consumption inequality and numerically by reestimating the classic life-cycle consumption model of Gourinchas and Parker (2002).

Intriguing paper, especially as one can obtain an age profile that peaks much later than in previous studies, which I find to be more intuitive. But this is not the point of the paper, which is rather that the estimation of the other structural parameters can be severely affected by the difficulties of estimating this age profile. Indeed, as Sam puts it, “To find the effect of age on [income], all else equal, a researcher must collect data at the same instant on two people who were born simultaneously but are now different ages. But this is impossible.” Hence the importance of a method that does not require estimating this.

Signaling Effects of Monetary Policy

July 19, 2013

By Leonardo Melosi


We develop a DSGE model in which the policy rate signals to price setters the central bank’s view about macroeconomic developments. The model is estimated with likelihood methods on a U.S. data set that includes the Survey of Professional Forecasters as a measure of price setters’ inflation expectations. We find that the model fits the data better than a prototypical New Keynesian DSGE model because the signaling effects of monetary policy help the model account for the run-up in inflation expectations in the 1970s. The estimated model with signaling effects delivers large and persistent real effects of monetary disturbances even though the average duration of price contracts is fairly short. While the signaling effects do not substantially alter the transmission of technology shocks, they bring about deflationary pressures in the aftermath of positive demand shocks. The signaling effects of monetary policy have contributed (i ) to heightening inflation expectations in the 1970s, (ii ) to raising inflation and to exacerbating the recession during the first years of Volcker’s monetary tightening, and (iii ) to subduing inflation and to stimulating economic activity from 1991 through 2007.

The model’s premise is that the central bank is more informed than the rest of the economy. Thus anything the central bank does is a signal about the true state of the economy, and the other economic agents observe and act on it. This is welfare improving, and could be even more so if the central bank could be credibly announcing the true state of the economy, and I am not sure you need the model’s price rigidities to get this result. As recent evidence shows, it is not that easy for the central bank to be that informed. That would likely make the model’s results less pronounced, and if the central bank is really confused could lead to welfare losses. But these are my conjectures.

Efficient Risk Sharing with Limited Commitment and Storage

July 14, 2013

By Árpád Ábrahám and Sarolta Laczó


We extend the model of risk sharing with limited commitment (Kocherlakota, 1996) by introducing both a public and a private (non-contractible and/or non-observable) storage technology. Positive public storage relaxes future participation constraints and may hence improve risk sharing, contrary to the case where hidden income or effort is the deep friction. The characteristics of constrained-efficient allocations crucially depend on the storage technology’s return. In the long run, if the return on storage is (i) moderately high, both assets and the consumption distribution may remain time-varying; (ii) sufficiently high, assets converge almost surely to a constant and the consumption distribution is time-invariant; (iii) equal to agents’ discount rate, perfect risk sharing is self-enforcing. Agents never have an incentive to use their private storage technology, i.e., Euler inequalities are always satisfied, at the constrained-efficient allocation of our model, while this is not the case without optimal public asset accumulation.

From my experience, the risk-free interest rate does not matter much for outcomes in models with risk sharing with borrowing contraints, as long as this interest rate is within reasonable bounds. This paper shows that this should not hold for extensions of the model. And those extensions are quite relevant, as people do have assets that can be verified and others that do not have to be reported or in some cases are not permissible. It becomes then an important question which interest rate is then appropriate for these models.

Credit-crunch dynamics with uninsured investment risk

July 6, 2013

By Jonathan Goldberg


I study the effects of credit tightening in an economy with uninsured idiosyncratic investment risk. In the model, entrepreneurs require an equity premium because collateral constraints limit insurance. After collateral constraints tighten, the equity premium and the riskiness of consumption rise and the risk-free interest rate falls. I show that, both immediately after the shock and in the long run, the equity premium and the riskiness of consumption increase more than they would if the risk-free rate were constant. Indeed, the long-run increase in the riskiness of consumption growth is purely a general-equilibrium effect: if the risk-free rate were constant (as in a small open economy), an endogenous decrease in risk-taking by entrepreneurs would, in the long run, completely offset the decrease in their ability to diversify. I also show that the credit shock leads to a decrease in aggregate capital if the elasticity of intertemporal substitution is sufficiently high. Finally, I show that, due to a general-equilibrium effect, there is no “overshooting” in the equity premium: in response to a permanent decrease in firms’ ability to pledge their future income, the equity premium immediately jumps to its new steady-state level and remains constant thereafter, even as aggregate capital adjusts over time. However, if idiosyncratic uncertainty is sufficiently low, credit tightening has no short- or long-run effects on aggregate capital, the equity premium, or the riskiness of consumption. Thus my paper highlights how investment risk affects the economy’s response to a credit crunch.

Interesting paper on the many interactions in credits markets. I would add that with current low-interest policy, the equity-premium would further increase, exacerbating the general-equilibrium effects this paper highlights. I do not think policy makers take this into account, which reinforces that policy-making is very complex.