August 24, 2013
By Mark Gerlter and Nobuhiro Kiyotaki
We develop a variation of the macroeconomic model of banking in Gertler and Kiyotaki (2011) that allows for household liquidity risks and bank runs as in Diamond and Dybvig (1983). As in Gertler and Kiyotaki, because bank net worth fluctuates with aggregate production, the spread in the expected rates of return on bank asset and deposit fluctuates countercyclically. However, because bank assets have a longer maturity than deposits, bank runs are possible as in Diamond and Dybvig. Whether a bank run equilibrium exists depends on bank balance sheets and a liquidation price for bank assets in equilibrium. While in normal times a bank run equilibrium may not exist, the possibility can arise in a recession. Overall, the goal is to present a framework that synthesizes the macroeconomic and microeconomic approaches to banking and banking instability.
It is notoriously difficult to satisfy both macroeconomists and microeconomists, so wel will see whether Gertler and Kiyotaki will manage to pull that off. The paper is very certainly very interesting for macroeconomists, who have long been on the lookout for an elegant, tractable and credible way to think about banking crises and in particular bank runs in a context where the rest of the economy may independently and interdependently be in some sort of trouble as well. This paper will provide a starting point for many others.
August 11, 2013
By Michael Ben-Gad
How much can governments shift the cost of government expenditure from today’s voters to tomorrow’s generations of immigrants, without resorting to taxation that is explicitly discriminatory? I demonstrate that if their societies are absorbing continuous flows of new immigrants, we should expect governments that represent the interests of today’s population, even if that population is altruistically linked to future generations, to choose policies that shift some portion of the tax burden to the future. This bias in favour of deficit finance is not infinite. Today’s population or their descendants, together with future immigrants, ultimately pay the higher taxes necessary to finance the accumulated debt, and live with the additional excess burdens these higher taxes generate. For a given rate of immigration and policy horizon, governments balance the dead weight losses associated with fluctuating tax rates against the benefits that accrue to the initial resident population from shifting part of the burden of financing government expenditure to future immigrant families. To measure the deficit bias, I analyse the dynamic behaviour of an optimal growth model with overlapping dynasties and factor taxation, calibrated for the US economy. Models with overlapping infinite-lived dynasties allow for a very clear distinction between natural population growth (an increase in the size of existing dynasties) and immigration (the addition of new dynasties). They also provide an alternative to the strict dichotomy between models with overlapping generations, where agents disregard the impact of their choices on future generations, and the quasi-Ricardian world of infinite-lived dynasties with representative agents that fully participate in both the economy and the political system in every period. The trajectory of the debt burden predicted by the model is a good match for the rise in US Federal government debt since the early 1980’s, as well as the increases in debt projected by the Congressional Budget Office over the next few decades.
This paper makes the interesting point that a developed economy that expects higher immigration in the future can afford higher public deficits now. This is because the immigrants are not part of the citizenship, which includes the current residents and their descendants. The distortions of future taxes therefore in part apply to people outside of the set the government cares about, and it can thus delay more the taxes.
August 8, 2013
By Athanasios Geromichalos, Lucas Herrenbrueck and Kevin Salyer
A consistent empirical feature of bond yields is that term premia are, on average, positive. That is, investors in long term bonds receive higher returns than investors in similar (i.e. same default risk) shorter maturity bonds over the same holding period. The majority of theoretical explanations for this observation have viewed the term premia through the lens of the consumption based capital asset pricing model. In contrast, we harken to an older empirical literature which attributes the term premium to the idea that short maturity bonds are inherently more liquid. The goal of this paper is to provide a theoretical justification of this concept. To that end, we employ a model in the tradition of modern monetary theory extended to include assets of different maturities. Short term assets always mature in time to take advantage of random consumption opportunities. Long term assets do not, but agents may liquidate them in a secondary asset market, characterized by search and bargaining frictions a la Duffie, Garleanu, and Pedersen (2005). In equilibrium, long term assets have higher rates of return to compensate agents for their relative lack of liquidity. Consistent with empirical findings, our model predicts a steeper yield curve for assets that trade in less liquid secondary markets.
Interesting concept I was not aware of: longer bond maturities are less liquid, even on secondary markets, and thus require higher returns to hold. While this paper demonstrates the theoretical possibility, it is a natural consequence that one should study whether the model can deliver the right quantitative conclusions.