Data Revisions and DSGE Models

March 23, 2017

By Ana Beatriz Galvao

http://d.repec.org/n?u=RePEc:wrk:wrkemf:11&r=dge

The typical estimation of DSGE models requires data on a set of macroeconomic aggregates, such as output, consumption and investment, which are subject to data revisions. The conventional approach employs the time series that is currently available for these aggregates for estimation, implying that the last observations are still subject to many rounds of revisions. This paper proposes a release-based approach that uses revised data of all observations to estimate DSGE models, but the model is still helpful for real-time forecasting. This new approach accounts for data uncertainty when predicting future values of macroeconomic variables subject to revisions, thus providing policy-makers and professional forecasters with both backcasts and forecasts. Application of this new approach to a medium-sized DSGE model improves the accuracy of density forecasts, particularly the coverage of predictive intervals, of US real macro variables. The application also shows that the estimated relative importance of business cycle sources varies with data maturity.

Yes, you can run successful forecasts with DSGE models, and they become even better when you use vintage data from ALFRED.


Heterogeneous Household Finances and the Effect of Fiscal Policy

March 16, 2017

By Javier Andrés, José E. Boscá, Javier Ferri and Cristina Fuentes-Albero

http://d.repec.org/n?u=RePEc:fda:fdaddt:2017-05&r=dge

This paper develops a model with heterogeneous households in terms of net worth and collaterizable assets. Using sample weights estimated from the PSID, we show that balance sheet heterogeneity is key to characterizing the aggregate effects of government spending along different dimensions. We find that: (i) the response of individual consumption to a government spending shock is negatively correlated with household’s net worth and also depends on her access to mortgage and non-mortgage credit, which implies that the size of the fiscal multiplier is sensitive to the distribution of household types; (ii) the response of aggregate employment is negatively correlated with the share of impatient households; as the weight of these households in total population increases firms rely more on adjustments in the intensive margin to meet the fiscal induced boost in aggregate demand, thus generating jobless recoveries; (iii) the output multiplier is positively correlated with wealth inequality; and (iv) while a government spending shock has a welfare cost for wealthy households, it delivers a welfare gain for constrained households.

A good reminder that the impact of fiscal policy is very heterogeneous, and that income is only a part of the equation.


Capital Accumulation and Dynamic Gains from Trade

March 14, 2017

By B. Ravikumar, Ana Maria Satacreu and Michael Sposi

http://d.repec.org/n?u=RePEc:fip:fedlwp:2017-005&r=dge

We compute welfare gains from trade in a dynamic, multicountry model with capital accumulation. We examine transition paths for 93 countries following a permanent, uniform, unanticipated trade liberalization. Both the relative price of investment and the investment rate respond to changes in trade frictions. Relative to a static model, the dynamic welfare gains in a model with balanced trade are three times as large. The gains including transition are 60 percent of those computed by comparing only steady states. Trade imbalances have negligible effects on the cross-country distribution of dynamic gains. However, relative to the balanced-trade model, small, less-developed countries accrue the gains faster in a model with trade imbalances by running trade deficits in the short run but have lower consumption in the long-run. In both models, most of the dynamic gains are driven by capital accumulation.

Nobody should be surprised that removing trade frictions increases trade, and that this leads to welfare gains. And neither should it surprise you that taking into account the dynamic effects through capital accumulation may amplify these results. But that the amplification is that big is a big deal, even more in the current policy context.


Reforming the Social Security Earnings Cap: The Role of Endogenous Human Capital

March 10, 2017

By Adam Blandin

http://d.repec.org/n?u=RePEc:vcu:wpaper:1603&r=dge

Old age Social Security benefits in the US are funded by a 10.6% payroll tax up to a cap, currently set at $118,500. Despite calls from policy circles to eliminate the cap on taxable earnings, there has been little work examining the likely outcomes of such a policy change. I use a life-cycle human capital model with heterogeneous individuals to investigate the aggregate and distributional steady state impacts of several policy changes to the earnings cap. I find: (1) Eliminating the earnings cap generates large reductions in aggregate output and consumption, between 2.1- 3.1%. (2) The role of endogenous human capital is first order: when I do not allow the life-cycle human capital profiles of workers to adjust across policy regimes, the change in economic aggregates is roughly cut in half. (3) While eliminating the earnings cap increases revenues from the payroll tax by 12%, the decline in output lowers tax revenues from other sources, so that total federal tax revenues never increase by more than 1.2%. (4) Eliminating the earnings cap produces modest welfare gains for about 2/3 of workers, while about 1/3 of workers experience welfare losses, which are typically large. (5) Lowering the earnings cap to a level near the mean of earnings increases aggregate output by 1.3%, and also increases welfare for the vast majority of workers.

While I do not think such a policy experiment is likely in the current political climate, this paper presents an interesting thought experiment. As with studies about the estate tax, I would though whether the models reflect the cluelessness of youth making schooling choice that will matter only much later in life. Sure, the models use discount rates, but it is hard to think that a teenager thinking about college is pondering whether his income decades in the future will hit the payroll cap tax.