Cross-Sectional and Aggregate Labor Supply

October 30, 2019

By Yongsung Chang, Sun-Bin Kim, Kyooho Kwon and Richard Rogerson

Standard heterogeneous agent macro models that highlight idiosyncratic productivity shocks do not generate the near zero cross-sectional correlation between hours and wages found in the data. We ask whether matching this moment matters for business cycle properties of these models. To do this we explore two extensions of the model in Chang et al. (2019) that can match this empirical cross-section correlation. One of these departs from the assumption of balanced growth preferences. The other introduces an idiosyncratic shock to the opportunity cost of market work that is highly correlated with the shock to market productivity. While both extensions can match the empirical correlation, they have large and opposing effects on the cyclical volatility of the labor market. We conclude that the cross-sectional moment is important for business cycle analysis and that more work is needed to distinguish the potential mechanisms that can generate it.

The time series correlation between hours and wages has been a real struggle with representative agent business cycle model. Now it pops up again as a stumbling block with heterogeneous agents, this time as a cross-sectional correlation. I expect this to be the first of many papers on the subject.

Household Labor Search, Spousal Insurance, and Health Care Reform

October 28, 2019

By Hanming Fand and Andrew Shepherd

Health insurance in the United States for the working age population has traditionally been provided in the form of employer-sponsored health insurance (ESHI). If employers offered ESHI to their employees, they also typically extended coverage to their spouse and dependents. Provisions in the Affordable Care Act (ACA) significantly alter the incentive for firms to offer insurance to the spouses of employees. We evaluate the long-run impact of the ACA on firms’ insurance offerings and on household outcomes by developing and estimating an equilibrium job search model in which multiple household members are searching for jobs. The distribution of job offers is determined endogenously, with compensation packages consisting of a wage and menu of insurance offerings (premiums and coverage) that workers select from. Using our estimated model we find that households’ valuation of employer-sponsored spousal health insurance is significantly reduced under the ACA, and with an “employee-only” health insurance contract emerging among low productivity firms. We relate these outcomes to the specific provisions in the ACA.

The health insurance system in the United States is very peculiar in the sense that it is provided by employers (or at least most of them) and includes coverage for spouses. The fact that health insurance is tied to one’s job does not look good for the insurance aspect of it, but it sure gives unlimited research potential for economists thanks to all the general equilibrium effects this entails in all sorts of markets. That paper is a nice example of this.

Inside Money, Investment, and Unconventional Monetary Policy

October 25, 2019

By Likas Altermatt

I develop a new monetarist model to analyze why an economy can fall into a liquidity trap, and what the effects of unconventional monetary policy measures such as helicopter money and negative interest rates are under these circumstances. I find that liquidity traps can be caused by a decrease in the bonds-to-money ratio, by a decrease in productivity of capital, or by an increase in demand for consumption. The model shows that, while conventional monetary policy cannot control inflation in a liquidity trap, unconventional monetary policies allow the monetary authority to regain control over the inflation rate, and that an increase in the bonds-to-money ratio is the only welfare-improving policy.

It is an intriguing insight that it all depends on the bonds-to-money ratio, and hence to improve its yield differential goes through negative interest rates on reserves if bond yields are too low.

Loss-Offset Provisions in the Corporate Tax Code and Misallocation of Capital

October 25, 2019

By Baris Kaymak and Immo Schott

The corporate tax code allows corporations to write off operating losses against past or future tax obligations, resulting in effective tax rates that are firm-specific and dependent on the history of the firm’s performance. Since losses are partly an indication of a drop in productivity, which is generally persistent over time, firms with higher expected productivity face, on average, higher marginal taxes on their investment. In this paper, we analyze the distortionary effects of loss-offset provisions on investment and assess the associated aggregate output losses implied by the misallocation of capital. We find that replacing the corporate income tax with a revenue-neutral value-added tax which eliminates the firm-level differences in effective tax rates leads to a 13.9 percent increase in aggregate output.

Wow. I would never have expected 1) such a large distortion, and 2) that VAT would be so powerful.

Central Bank Digital Currency and Banking

October 23, 2019

By Jonathan Chiu, Janet Hua Jiang, Seyed Mohammadreza Davoodalhosseini and Yu Zhu

This paper builds a model with imperfect competition in the banking sector. In the model, banks issue deposits and make loans, and deposits can be used as payment instruments by households. We use the model to assess the general equilibrium effects of introducing central bank digital currency (CBDC). We identify a new channel through which CBDC can improve the efficiency of bank intermediation and increase lending and aggregate output even if its usage is low, i.e., CBDC serves as an outside option for households, thus limiting banks’ market power in the deposit market. We then calibrate the model to evaluate the quantitative implication of this channel.

This paper claims that CBDC can improve outcomes by make the deposit market more competitive remove some of the rents that banks enjoy. But it seems to be that this does not need to be a digital currency, in other words having the central bank open deposit accounts for non-financial institutions would achieve the same outcome.

A Theory of Housing Demand Shocks

October 23, 2019

By Zheng Liu, Pengfei Wang and Tao Zha

Housing demand shocks are an important source of housing price fluctuations and, through the collateral channel, they drive macroeconomic fluctuations as well. However, these reduced-form shocks in the standard macro models fail to generate the observed large fluctuations in the housing price-to-rent ratio. We build a tractable heterogeneous-agent model that provides a microeconomic foundation for housing demand shocks. Households with high marginal utility of housing face binding credit constraints, giving rise to a liquidity premium in the aggregated housing Euler equation. The liquidity premium drives a wedge between the house price and the average rent and allows credit supply shocks to generate large fluctuations in house prices and the price-to-rent ratio.

In other words, house prices are very volatile because of the households who insist of having as much house as possible as allowed by the bank. They are very sensitive to economic conditions and are the marginal buyers, thus driving prices.

Time-consistent decisions and rational expectation equilibrium existence in DSGE models

October 23, 2019

By Minseong Kim

We demonstrate that if all agents in an economy make time-consistent decisions and policies, then there exists no rational expectation equilibrium in a dynamic stochastic general equilibrium (DSGE) model, unless under very restrictive and special circumstances. Some time-consistent interest rate rules, such as Taylor rule, worsen the equilibrium non-existence issue in general circumstances. Monetary policy needs to be lagged in order to avoid equilibrium non-existence due to agents making time-consistent decisions. We also show that due to the transversality condition issue, either fiscal-monetary coordination may need to be modeled, or it may be necessary to write a model such that bonds or money provides utility as medium of exchange or has liquidity roles.

This is one of those rare papers where you start thinking: “Really? How has everybody missed this for so long?” This seems to be a quite fundamental issue and I am eager to see how others react to it.

Can We Save the American Dream? A Dynamic General Equilibrium Analysis of the Effects of School Financing on Local Opportunities

October 19, 2019

Fabian Eckert and Tatjana Kleineberg

Neighborhoods in the US differ substantially in the educational and economic opportunities that they offer to children who grow up in them. We develop and estimate a structural spatial equilibrium model of residential and education choice to study the effects of school financing policies on education outcomes, intergenerational mobility, and welfare at the local and aggregate level. Our model generates persistent effects of children’s neighborhoods on adult outcomes through local labor market access and local human capital formation. Local school funding is an important component of the latter. Schools are funded through income taxation and local rent taxation. We estimate the model using a range of US Census datasets by fitting model predictions to regional data of the actual US geography. We use the estimated model to study the effects of counterfactual policy interventions, in particular, the equalization of school funding across all students and the use of rent subsidies. We find that general equilibrium responses in local prices and local skill compositions significantly dampen the partial equilibrium effects of the policy, so that effects on education outcomes and intergenerational mobility are positive but only moderate in general equilibrium.

I find the result of this very good paper very disappointing. There is a sense that a lot of Einsteins are missed because of the uneven distribution of school funding in the United States. This paper shows that education remains mostly prohibitive for the poor if you centralize school funding. This is because their neighborhoods become more expensive.

Optimal Fiscal Policy without Commitment: Beyond Lucas-Stokey

October 19, 2019

By Davide Debortoli, Pierre Yared and Ricardo Nunes

According to the Lucas-Stokey result, a government can structure its debt maturity to guarantee commitment to optimal fiscal policy by future governments. In this paper, we overturn this conclusion, showing that it does not generally hold in the same model and under the same definition of time-consistency as in Lucas-Stokey. Our argument rests on the existence of an overlooked commitment problem that cannot be remedied with debt maturity: a government in the future will not tax on the downward slopping side of the Laffer curve, even if it is ex-ante optimal to do so. In light of this finding, we propose a new framework to characterize time-consistent policy. We consider a Markov Perfect Competitive Equilibrium where a government reoptimizes sequentially and may deviate from the optimal commitment policy. We find that, in a deterministic economy, any stationary distribution of debt maturity must be flat, with the government owing the same amount at all future dates.

I must confess I have a hard time wrapping my head around this paper. My difficulty lies in the example that it provides: why would it ever be ever ex-ante optimal for a government to tax on the downward-sloping side of the Laffer curve? The entire point of the Laffer curve is that you do not want to be there.

Bad Jobs and Low Inflation

October 19, 2019

Renato Faccini and Leonardo Melosi

Since 2014 the U.S. economy has been characterized by (i) a tight labor market with a record-low unemployment rate and very high job finding rates, (ii) disappointing labor productivity growth, and (iii) low inflation. We propose a model with the job ladder that can reconcile these three facts. In the model inflation picks up only when most jobs are concentrated at the high rung of the ladder: as firms compete for efficiently allocated employed workers, outside offers are declined and matched, triggering an increase in production costs that is not backed by an increase in productivity. The model is estimated using unemployment and quit rates, which allow the model to precisely identify the distribution of the quality of jobs. After the Great Recession, the observed structural drop in the job-to-job rate has slowed down the pace at which the U.S. labor market turns bad jobs into good jobs. As a result, inflation has not escalated even though the labor market appears to be very tight. Furthermore, the model predicts that labor productivity persistently fell by up to 70 bps in the post-Great Recession recovery owing to this protracted misallocation in the labor market.

This paper addresses an important question that is puzzling many in an elegant way. However, I am still left hungry: what triggered that change in job-to-job transitions that is taken exogenously here?