Changes in nominal rigidities in Poland – a regime switching DSGE perspective

April 27, 2016

By Paweł Baranowski and Zbigniew Kuchta

We estimate a dynamic stochastic general equilibrium model that allows for regimes Markov switching (MS-DSGE). Existing MS-DSGE papers for the United States focus on changes in monetary policy or shocks volatility, contributing the debate on the Great Moderation and/or Volcker disinflation. However, Poland which here serves as an example of a transition country, faced a wider range of structural changes, including long disinflation, EU accession or tax changes. The model identifies high and low rigidity regimes, with the timing consistent with menu cost explanation of nominal rigidities. Estimated timing of the regimes captures the European Union accession and indirect tax changes. The Bayesian model comparison results suggest that model with switching in both analyzed rigidities is strongly favored by the data in comparison with switching only in prices or in wages. Moreover, we find significant evidence in support of independent Markov chains.

We all know price rigidities à la Calvo are a really bad idea when there are major changes in the economic environment. They impose a fixed probability of prices changing even when, say, inflation or market conditions change. This paper looks whether there are been such rigidity changes in Poland, an economy that went through fairly dramatic structural changes. And yes, it turns out the rigidity parameter does change. Unfortunately, it is only modeled as a Markov-switching process, thus not allowing for rigidity to be state-dependent. That could have allowed to figure out what makes rigidity adapt: is it market competition, inflation, or tax treatment? That could have been a really great insight.


Policy Distortions and Aggregate Productivity with Endogenous Establishment-Level Productivity

April 21, 2016

By Jose-Maria Da-Rocha, Marina Mendes Tavares and Diego Restuccia

The large differences in income per capita across countries are mostly accounted for by differences in total factor productivity (TFP). What explains the differences in TFP across countries? Empirical evidence points to factor misallocation across heterogeneous production units as an important factor. We study factor misallocation in a model where establishment-level productivity is endogenous. In this framework, policy distortions not only misallocate resources across a given set of productive units, but also worsen the productivity distribution of establishments and this effect is substantial quantitatively. Reducing the dispersion in revenue productivity by half to the level of the U.S. benchmark in the model implies an increase in aggregate output and TFP by a factor of 7.8-fold. Improved factor allocation accounts for 38 percent of the gain, whereas the change in the productivity distribution accounts for the remaining 62 percent.


To be fair, the frictions that a removed to obtain this tremendous increase in TFP are related to various forms of regulation, some of which are detrimental (rent seeking), others that may have a good reason to be imposed. But given the huge impact they have on TFP, one should think hard whether they are still worth imposing, and whether they are imposed well. Say you want to impose some minimal safety standards for workers: that seems worthwhile, but it should not be done in a way that favors inefficient firms over efficient ones.

Demographics and Real Interest Rates: Inspecting the Mechanism

April 13, 2016

By Carlos Viana de Carvalho, Andrea Ferrero, and Fernanda Necchio

The demographic transition can affect the equilibrium real interest rate through three channels. An increase in longevity – or expectations thereof – puts downward pressure on the real interest rate, as agents build up their savings in anticipation of a longer retirement period. A reduction in the population growth rate has two counteracting effects. On the one hand, capital per-worker rises, thus inducing lower real interest rates through a reduction in the marginal product of capital. On the other hand, the decline in population growth eventually leads to a higher dependency ratio (the fraction of retirees to workers). Because retirees save less than workers, this compositional effect lowers the aggregate savings rate and pushes real rates up. We calibrate a tractable life-cycle model to capture salient features of the demographic transition in developed economies, and find that its overall effect is a reduction of the equilibrium interest rate by at least one and a half percentage points between 1990 and 2014. Demographic trends have important implications for the conduct of monetary policy, especially in light of the zero lower bound on nominal interest rates. Other policies can offset the negative effects of the demographic transition on real rates with different degrees of success.

Interesting paper in the light of the recent discussion about the decrease in the real interest rate across developed economies. There is no doubt that demographics have a role to play. One has to be careful, though, as there are many interest rates out there, and they may be also composed of various risk premia and influenced by broader portfolio considerations than aggregate savings. Still, the paper shows that the demographic factors can account for a very substantial decrease in interest rates.

Education Policy and Intergenerational Transfers in Equilibrium

April 5, 2016

By Brant Abbott, Giovanni Gallipoli, Costas Meghir and Giovanni Violante

This paper examines the equilibrium effects of alternative financial aid policies intended to promote college participation. We build an overlapping generations life-cycle, heterogeneous-agent, incomplete-markets model with education, labor supply, and consumption/saving decisions. Driven by both altruism and paternalism, parents make inter vivos transfers to their children. Both cognitive and non-cognitive skills determine the non-pecuniary cost of schooling. Labor supply during college, government grants and loans, as well as private loans, complement parental resources as means of funding college education. We find that the current financial aid system in the U.S. improves welfare, and removing it would reduce GDP by 4-5 percentage points in the long-run. Further expansions of government- sponsored loan limits or grants would have no salient aggregate effects because of substantial crowding-out: every additional dollar of government grants crowds out 30 cents of parental transfers plus an equivalent amount through a reduction in student’s labor supply. However, a small group of high-ability children from poor families, especially girls, would greatly benefit from more generous federal aid.

This paper shows that despite being decried as being unaffordable, the US higher education system is pretty close to optimal: people pay for what they get, and borrowing constraints are largely taken care of by family, loans and grants. There remains an information issue, though, as you do not want talented people from poor backgrounds to fall through the cracks. That said, the paper assumes that tuition is constant across all policy experiments. That is likely not correct, as I believe that loans and grants have increased the ability to pay tuition (which is not necessarily bad). This is still a great paper, and adding that wrinkle to an incredibly rich model is likely too much. And the paper has already 104 pages…