Home Equity Extraction and the Boom-Bust Cycle in Consumption and Residential Investment

February 27, 2018

By Xiaoqing Zhou

http://d.repec.org/n?u=RePEc:bca:bocawp:18-6&r=dge

The consumption boom-bust cycle in the 2000s coincided with large fluctuations in the volume of home equity borrowing. Contrary to conventional wisdom, I show that homeowners largely borrowed for residential investment and not consumption. I rationalize this empirical finding using a calibrated two-goods, multiple-assets, heterogeneous-agent life-cycle model with borrowing frictions. The model replicates key features of the household-level and aggregate data. The model offers an alternative explanation of the consumption boom-bust cycle. This cycle is caused by large fluctuations in the number of borrowers and hence in total home equity borrowing, even though the fraction of borrowed funds spent on consumption is small.

That is going to surprise quite a few: there was no borrowing frenzy and real estate was not being used as a cash cow for consumption. The increase in total borrowing was just the result of the expansion of the extensive margin, not the intensive margin.

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Improved Matching, Directed Search, and Bargaining in the Credit Card Market

February 21, 2018

By Gajendran Raveendranathan

http://d.repec.org/n?u=RePEc:mcm:deptwp:2018-05&r=dge

I build a model of revolving credit in which consumers face idiosyncratic earnings risk, and credit card firms direct their search to consumers. Upon a match, they bargain over borrowing limits and borrowing interest rates — fixed for the duration of the match. Using the model, I show that improved matching between consumers and credit card firms, calibrated to match the rise in the population with credit cards, accounts for the rise in revolving credit and consumer bankruptcies in the United States. I also provide empirical evidence consistent with the two key features in my model: directed search and bargaining. The lifetime consumption gains from improved matching are 3.55 percent— substantially larger than those previously estimated by alternative explanations for the rise in revolving credit and consumer bankruptcies (0.03-0.57 percent). Finally, I analyze how the credit card firm’s bargaining power impacts the welfare of introducing stricter bankruptcy laws.

That is going to surprise a few: the higher credit card debt and default are actually welfare improving. Or at least if they are the consequence of better matching and bargaining. Which means that one should not necessarily worry if the credit card market should more defaults.


Dealing with Misspecification in DSGE Models: A Survey

February 10, 2018

By Alessia Paccagnini

http://d.repec.org/n?u=RePEc:pra:mprapa:82914&r=dge

Dynamic Stochastic General Equilibrium (DSGE) models are the main tool used in Academia and in Central Banks to evaluate the business cycle for policy and forecasting analyses. Despite the recent advances in improving the fit of DSGE models to the data, the misspecification issue still remains. The aim of this survey is to shed light on the different forms of misspecification in DSGE modeling and how the researcher can identify the sources. In addition, some remedies to face with misspecification are discussed.

I have occasionally pointed out on this blog various misspecification issues in the estimation of DSGE models. This handy survey addresses a lot of such worries with some remedies.


What’s News in International Business Cycles

February 7, 2018

By Daniele Siena

http://d.repec.org/n?u=RePEc:red:sed017:1206&r=dge

The role of news shocks in international business cycles is first evaluated using a structural factor-augmented VAR model (FAVAR). An international FAVAR model is shown to be necessary to recover the correct news shocks in open economies, except the US, without incurring in the ‘non-fundamentalness’ problem. Then, a standard two-country, two-good real business cycle model, featuring news shocks, investment adjustment costs and variable wealth elasticity of the labor supply is used to match and explain the empirical evidence. News shocks are only marginal drivers of international business cycles synchronization.

There is plenty of literature, including some relayed on this blog, that shows that news shocks are important in explaining business cycles. Why that suddenly vanishes once you look at the international dimension is interesting. This is certainly not the first time in the history of studying business cycles that this happens. I wonder what the disturbing mechanism is this time.