Time Preferences over the Life Cycle and Household Saving Puzzles

March 29, 2021

By Wataru Kureishi; Hannah Paule-Paludkiewicz; Hitoshi Tsujiyama; Midori Wakabayashi


Most economic models assume that time preferences are stable over time, but the evidence on their long-term stability is lacking. We study whether and how time preferences change over the life cycle, exploiting representative long-term panel data. We provide new evidence that discount rates decrease with age and the decline is remarkably linear over the life cycle. Decreasing discounting helps a canonical life-cycle model to explain the household saving puzzles of undersaving when young and oversaving after retirement. Relative to the model with constant discounting, the model’s fit to consumption and asset data profiles improves by 40% and 30%, respectively.

If one thinks that discounting has to do with survival probabilities, one is sorely mistaken, apparently. Note that a discount rate that declines over a life time is consistent with aging economies having lower interest rates. The implications from the paper are interesting.

Risk shocks and divergence between the Euro area and the US in the aftermath of the Great Recession

March 22, 2021

By Thomas Brand and Fabien Tripier


Highly synchronized during the Great Recession of 2008-2009, the Euro area and the US have diverged in the period that followed. To explain this divergence, we provide a structural interpretation of these episodes through the estimation for both economies of a business cycle model with financial frictions and risk shocks, measured as the volatility of idiosyncratic uncertainty in the financial sector. Our results show that risk shocks have stimulated US growth in the aftermath of the Great Recession and have been the main driver of the double-dip recession in the Euro area. They play a positive role in the Euro area only after 2015. Risk shocks therefore seem well suited to account for the consequences of the sovereign debt crisis in Europe and the subsequent positive effects of unconventional monetary policies, notably the ECB’s Asset Purchase Programme (APP).

This shows how the Great Recession was different form previous recessions: risk was the major factor, and it mattered foremost in the subsequent recovery (or lack thereof). If every new recession now requires a new type of shock, we will be in constant need of rethinking the economic models (soon after, a pandemic hits…).

Imperfect Banking Competition and Macroeconomic Volatility: A DSGE Framework

March 15, 2021

By Jiaqi Li


This paper studies the impact of imperfect banking competition on aggregate fluctuations using a DSGE framework that features a Cournot banking sector. The paper highlights a new propagation mechanism of imperfect banking competition that operates via the dynamics of the expected marginal product of capital. Since capital is partly financed by bank loans, a higher expected return on capital implies that firms are more willing to borrow to invest in capital, making their capital and thus loan demand more inelastic. Market power enables banks to take advantage of the lower loan demand elasticity by charging a higher loan rate markup. Given that different shocks affect the dynamics of the expected return on capital differently, this paper finds that while the loan rate markup after a contractionary monetary policy shock increases and thus amplifies aggregate fluctuations, the impact of imperfect banking competition after a productivity shock is less clear and depends on the persistence of the shock.

Banking regulators worry about mergers and acquisitions of banks a lot, because of the “too big to fail” problem and local competition issues. This paper takes a macro view to competition issues and shows that lack of competition is something to worry about. The next question is: how can you measure whether there is enough competition? For example, are the six large banks dominating the Canadian market sufficiently competitive?

Sovereign default and imperfect tax enforcement

March 8, 2021

By Francesco Pappadà and Yanos Zylberberg


The effect of fiscal policy on default risk is mitigated by the response of tax compliance. To explore the consequences of this stylized fact, we build a model of sovereign debt with limited commitment and imperfect tax enforcement. Fiscal policy persistently affects the size of the informal economy, which impacts future fiscal revenues and default risk. The interaction of imperfect tax enforcement and limited commitment strongly constrains the dynamics of optimal fiscal policy and leads to costly uctuations in consumption.

This sounds obvious, but needs reinforcing. If a state has weak enforcement of taxation, it is more at risk of default because the tax base shrinks right when it is most needed. Fund tax agencies well, it is worth it!

Universal Basic Income in Developing Countries: Pitfalls and Alternatives

March 1, 2021

By Pedro Cavalcanti Ferreira, Marcel Cortes, Peruffo and André Cordeiro Valério


This article studies the short -and long-term effects of Universal Basic Income programs – a uniform transfer to every individual in society – in the context of a developing economy and compares this policy with other schemes that condition the transfer on household characteristics such as income and education. We construct a dynastic heterogeneous-agent model, featuring uninsurable idiosyncratic risk, investment in physical and human capital, and choice of labor effort. We calibrate the model to Brazilian data and introduce a UBI transfer equivalent to roughly 4.5% of average household income. We find that, over the short run, this policy alleviates poverty and increases welfare, especially for the poor. Over time, however, income falls and poverty and inequality increase as fewer people stay in school, labor supply decreases, and savings fall. We then explore the consequences of an equivalent transfer that is both subject to means testing and requires recipients to enroll their children in school. This policy outperforms the UBI in several dimensions, increasing overall income, reducing poverty and inequality, and improving welfare. This result is robust to varying the magnitude of the cash transfer. We then investigate which aspects of the CCT make it so effective, and find that the schooling conditionality is crucial in ensuring its long- and even short- run success.

It is very rare to find a well-thought-out and quantitative evaluation of universal basic income, and I can speak from experience. This one is really well done and looks at good alternatives. An important contribution to the UBI discussion.