Optimal Life Cycle Unemployment Insurance

By Claudio Michelacci and Hernan Ruffo

http://d.repec.org/n?u=RePEc:eie:wpaper:1411&r=dge

We argue that US welfare would rise if unemployment insurance were increased for younger and decreased for older workers. This is because the young tend to lack the means to smooth consumption during unemployment and want jobs to accumulate high-return human capital. So unemployment insurance is most valuable to them, while moral hazard is mild. By calibrating a life cycle model with unemployment risk and endogenous search effort, we find that allowing unemployment replacement rates to decline with age yields sizeable welfare gains to US workers.

This paper may seem obvious, but 1) it quantifies that this is economically significant, and 2) did you think about this? Targeting transfers to the population that needs them most is always going to improve things. This paper highlights one such target.

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The zero lower bound and parameter bias in an estimated DSGE model

By Yasuo Hirose and Atsushi Inoue

http://d.repec.org/n?u=RePEc:van:wpaper:vuecon-sub-14-00009&r=dge

This paper examines how and to what extent parameter estimates can be biased in a dynamic stochastic general equilibrium (DSGE) model that omits the zero lower bound (ZLB) constraint on the nominal interest rate. Our Monte Carlo experiments using a standard sticky-price DSGE model show that no significant bias is detected in parameter estimates and that the estimated impulse response functions are quite similar to the true ones. However, as the probability of hitting the ZLB increases, the parameter bias becomes larger and therefore leads to substantial differences between the estimated and true impulse responses. It is also demonstrated that the model missing the ZLB causes biased estimates of structural shocks even with the virtually unbiased parameters.

Beyond the issue that this paper highlights, we should remember that for any estimation that covers the past decade we likely cannot use the standard methods that assume symmetric responses for positive and negative deviations from the mean in the data. I suspect we are going to see a lot of lousy regressions that blindly throw variables into a non-structural estimation and pretend to get reliable results.

The effects of a money-financed fiscal stimulus

By Jordi Galí

http://d.repec.org/n?u=RePEc:upf:upfgen:1441&r=dge

I analyze the effects of an increase in government purchases financed entirely through seignorage, in both a classical and a New Keynesian framework, and compare them with those resulting from a more conventional debt-financed stimulus. My findings point to the importance of nominal rigidities in shaping those effects. Under a realistic calibration of such rigidities, a money-financed fiscal stimulus is shown to have very strong effects on economic activity, with relatively mild inflationary consequences. If the steady state is sufficiently inefficient, an increase in government purchases may increase welfare even if such spending is wasteful.

On a regular basis, I get emails enquiring how to publish on RePEc some new system that will solve all of the world’s economic problems. Usually, this involves distributing money. This paper is also about distributing money to solve economic problems, but there are two major differences: Jordi Galí is no lunatic, and he only seeks to deal with temporary economic problems as they arise during a business cycle. The key here that nominal rigidities in prices and wages can do their magic and increase aggregate demand. Of course, prices eventually rise and the stimulus dissipates, but the temporary boosts is valuable when it matters most, given a level of rigidity that is plausible. The good old unemployment-inflation trade-off, only with a lag. I wonder though what will happen to the ridigity of prices and wages in a world where money policy becomes active in such ways. Wouldn’t they become more flexible in anticipation of more frequent money stimuli?

Exploiting the monthly data flow in structural forecasting

By Domenico Giannone, Francesca Monti and Lucrezia Reichlin

http://d.repec.org/n?u=RePEc:boe:boeewp:0509&r=dge

This paper shows how and when it is possible to obtain a mapping from a quarterly dynamic stochastic general equilibrium (DSGE) model to a monthly specification that maintains the same economic restrictions and has real coefficients. We use this technique to derive the monthly counterpart of the well-known DSGE model by Galí, Smets and Wouters (GSW) for the US economy. We then augment it with auxiliary macro indicators which, because of their timeliness, can be used to obtain a nowcast of the structural model. We show empirical results for the quarterly growth rate of GDP, the monthly unemployment rate and GSW’s welfare-relevant output gap. Results show that the augmented monthly model does best for nowcasting.

While temporal interpolation at higher frequencies is not new, it is nifty that a structural model is used here instead of a purely statistical setup. It is significantly more complicated than traditional methods, though.

Illiquidity and its Discontents: Trading Delays and Foreclosures in the Housing Market

By Aaron Hedlind

http://d.repec.org/n?u=RePEc:umc:wpaper:1417&r=dge

This paper investigates the macroeconomic effects of search risk in the housing market. To do so, I introduce a tractable directed search model of housing with multidimensional buyer and seller heterogeneity. I incorporate this framework in an incomplete markets macroeconomic model with long-term mortgages and equilibrium default. I show that search risk spills over into higher foreclosure risk by creating a debt overhang problem. Heavily indebted sellers post high selling prices, take a long time to sell, and frequently end up in foreclosure. As a result, search risk increases mortgage default premia and tightens credit constraints, thus exacerbating the debt overhang problem by making refinancing more difficult. This mechanism establishes a novel link between housing and mortgage markets based on the illiquidity of housing.

The illiquidity of the house market, along with the high correlation of house prices with local income, has always made me wonder why homeownership is so much encouraged. This paper gives a further argument why homeownership is a poor investment vehicle. And this paper applies to the US, where house markets are remarkably liquid in international comparison.