February 2016 calls for papers

February 27, 2016

PIER Workshop on Quantitative Tools for Macroeconomic Policy Analysis, Philadelphia, 9-13 May 2016.

Minnesota Workshop in Macroeconomics Theory, Minneapolis, 26-29 July 2016.

Annual DYNARE conference, Roma, 29-30 September 2016.

Policy Uncertainty and the Cost of Delaying Reform: A case of aging Japan

February 25, 2016

By Sagiri Kitao


In an economy with aging demographics and a generous pay-as-you-go social security system established decades ago, reform to reduce benefits is inevitable unless there is a major increase in taxes. Often times, however, there is uncertainty about the timing and structure of reform. This paper explicitly models policy uncertainty associated with a social security system in an aging economy and quantifies economic and welfare effects of uncertainty as well as costs of delaying reform. Using the case of Japan, which faces the severest demographic and fiscal challenges, we show that uncertainty can significantly affect economic activities and welfare. Delaying reform or reducing its scope involves a sizeable welfare tradeoff across generations, in which middle to old-aged individuals gain the most at the cost of young and future generations.

Much has been written how policy uncertainty can have an impact of the economy, including on this blog. But as far as I can see, this uncertainty was pertaining to fiscal or monetary policy. The uncertainty this paper addresses, social security reform, is an order of magnitude more important because it implies bigger policy shifts that are perceived as permanent and have potential large impact on many people, in particular regarding labor supply decisions. And the uncertainty is potential larger, too, as policy makers tend to put off such politically dangerous reforms for many years.


Global Banking, Trade, and the International Transmission of the Great Recession

February 22, 2016

By Zeno Enders and Alexandra Peter


The global financial crisis of 2007-2009 spread through different channels from its origin in the United States to large parts of the world. In this paper we explore the financial and the trade channels in a unified framework and quantify their relative importance for this transmission. Specifically, we employ a DSGE model of an open economy with an internationally operating banking sector. We investigate the transmission of the crisis via the collapse of export demand and through losses in the value of cross-border asset holdings. Calibrated to German and UK data, the model attributes around half of the observed maximum output decline in Germany to these channels, and 87% for the UK. While the trade channel explains 30% of the empirical output decline in both countries, the financial channel plays a much larger role in the UK than in Germany. The UK’s larger vulnerability to financial shocks is due to higher foreign-asset holdings, which simultaneously serve as an automatic stabilizer in case of plummeting foreign demand. The transmission via the financial channel triggers a much longer-lasting recession relative to the trade channel, resulting in larger cumulated output losses and a prolonged crisis particularly in the UK. Stricter bank capital regulations would have deepened the initial slump while simultaneously speeding up the recovery.

Opening an economy and diversifying internationally an asset portfolio are almost always considered as the best thing to do. One has to keep in mind that this exposes oneself to foreign shocks, and the last recession in Europe is a prime example of that. This paper nicely decomposes the effects and shows how the UK and Germany were differentially hurt. The reaction, however, should not be to close the borders. Indeed, the international diversification also allows to smooth out domestic shocks, and usually more so than foreign shocks hurt. And there is also a positive level effect from diversification.

Do Job Destruction Shocks Matter in the Theory of Unemployment?

February 19, 2016

By Melvyn Coles and Ali Moghaddasi Kelishomi


The current DMP approach to labor markets presumes job destruction shocks are small. We relax that assumption and also allow unfilled jobs, like unemployment, to evolve as a state variable. Calibrating an otherwise standard DMP framework, we identify a remarkable, (almost) perfect, fit of the empirical facts as reported in Shimer (2005, 2012). The results, how- ever, are also consistent with the insights of Davis and Haltiwanger (1992): that unemployment volatility is driven by large but infrequent job separation shocks. The approach not only provides an important synthesis of two literatures which, in other contexts, have appeared contradictory, it also identifies a more traditional view of the timing and progression of recessions.

I find it quite amazing how the Diamond-Mortensen-Pissarides model keeps on giving. Here is a variation that successfully tackles the Shimer (2005) puzzles that once gave DMP much trouble. Several solutions have been offered, and I find this one quite convincing.

Fiscal Austerity during Debt Crises

February 16, 2016

By Cristina Arellano and Yan Bai

This paper constructs a dynamic model in which fiscal restrictions interact with government borrowing and default. The government faces fiscal constraints; it cannot adjust tax rates or impose lump-sum taxes on the private sector, but it can adjust public consumption and foreign debt. When foreign debt is sufficiently high, however, the government can choose to default to increase domestic public and private consumption by freeing up the resources used to pay the debt. Two types of defaults arise in this environment: fiscal defaults and aggregate defaults. Fiscal defaults occur because of the government’s inability to raise tax revenues. Aggregate defaults occur even if the government could raise tax revenues; debt is simply too high to be sustainable. In a quantitative exercise calibrated to Greece, we find that our model can predict the recent default, but that increasing taxes would not have prevented it. In fact, increasing taxes would have made the recession deeper because of the distortionary effects of taxation.

Or: stop thinking that a country can get out of a debt crisis by raising taxes. The Laffer curve may apply even earlier in such cases.

Optimal time-consistent government debt maturity

February 15, 2016

By Davide Debortoli, Ricardo Nunes and Pierre Yared


This paper develops a model of optimal government debt maturity in which the government cannot issue state-contingent bonds and cannot commit to fiscal policy. If the government can perfectly commit, it fully insulates the economy against government spending shocks by purchasing short-term assets and issuing long-term debt. These positions are quantitatively very large relative to GDP and do not need to be actively managed by the government. Our main result is that these conclusions are not robust to the introduction of lack of commitment. Under lack of commitment, large and tilted positions are very expensive to finance ex-ante since they exacerbate the problem of lack of commitment ex-post. In contrast, a flat maturity structure minimizes the cost of lack of commitment, though it also limits insurance and increases the volatility of fiscal policy distortions. We show that the optimal time-consistent maturity structure is nearly flat because reducing average borrowing costs is quantitatively more important for welfare than reducing fiscal policy volatility. Thus, under lack of commitment, the government actively manages its debt positions and can approximate optimal policy by confining its debt instruments to consols.

Interesting intuition that solves the government’s lack of commitment. It will, however, be difficult to sell to the public that the government debt is never going to be reimbursed, seeing how difficult it is already to make them understand that government debt is not like household debt. Can thus the government really commit to finance only through consols?