Monetary Policy over the Lifecycle

September 23, 2021

By Anton Braun and Daisuke Ikeda

A tighter monetary policy is generally associated with higher real interest rates on deposits and loans, weaker performance of equities and real estate, and slower growth in employment and wages. How does a household’s exposure to monetary policy vary with its age? The size and composition of both household income and asset portfolios exhibit large variation over the lifecycle in Japanese data. We formulate an overlapping generations model that reproduces these observations and use it to analyze how household responses to monetary policy shocks vary over the lifecycle. Both the signs and the magnitudes of the responses of a household’s net worth, disposable income and consumption depend on its age.

I wonder whether these results carry over for an aging economy, especially as there may be general equilibrium effects that may amplify or reduce the implications.


The Neoclassical Model and the Welfare Costs of Selection

September 16, 2021

By Fabrice Collard and Omar Licandro

This paper embeds firm dynamics into the Neoclassical model and provides a simple framework to solve for the transitional dynamics of economies moving towards more selection. As in the Neoclassical model, markets are perfectly competitive, there is only one good and two production factors (capital and labor). At equilibrium, aggregate technology is Neoclassical, but the average quality of capital and the depreciation rate are both endogenous and positively related to selection. At steady state, output per capita and welfare both raise with selection. However, the selection process generates transitional welfare losses that may reduce in around 60% long term (consumption equivalent) welfare gains. The same property is shown to be true in a standard general equilibrium model with entry and fixed production costs.

The selection mechanism is important in any economy, and this paper shows this is indeed the case. Selection, however, does not always work that well: sometimes, the most efficient firms do not survive. This is the crux of a lot of the less developed economies. But even for developed ones, selection leads to some degree of market power, which can be welfare decreasing.

No country is an island: International cooperation and climate change

September 14, 2021

By Ferrari Massimo and Pagliari Maria Sole

In this paper we explore the cross-country implications of climate-related mitigation policies. Specifically, we set up a two-country, two-sector (brown vs green) DSGE model with negative production externalities stemming from carbon-dioxide emissions. We estimate the model using US and euro area data and we characterize welfare-enhancing equilibria under alternative containment policies. Three main policy implications emerge: i) fiscal policy should focus on reducing emissions by levying taxes on polluting production activities; ii) monetary policy should look through environmental objectives while standing ready to support the economy when the costs of the environmental transition materialize; iii) international cooperation is crucial to obtain a Pareto improvement under the proposed policies. We finally find that the objective of reducing emissions by 50%, which is compatible with the Paris agreement’s goal of limiting global warming to below 2 degrees Celsius with respect to pre-industrial levels, would not be attainable in absence of international cooperation even with the support of monetary policy.

nice paper that highlights the importance of dynamic general equilibrium and transition costs for claimte change response. It shows that it is possible to reach climate goals and both fiscal and monetary tools are required. And, of course, international cooperation.

The Long-Term Effects of Capital Requirements

September 6, 2021

By Gianni De Nicolo, Nataliya Klimenko, Sebastian Pfeil and Jean-Charles Rochet

We build a stylized dynamic general equilibrium model with financial frictions to analyze costs and benefits of capital requirements in the short-term and long-term. We show that since increasing capital requirements limits the aggregate loan supply, the equilibrium loan rate spread increases, which raises bank profitability and the market-to-book value of bank capital. Hence, banks build up larger capital buffers which (i) lowers the public losses in case of a systemic crisis and (ii) restores the banking sector’s lending capacity after the short-term credit crunch induced by tighter regulation. We confirm our model’s dynamic implications in a panel VAR estimation, which suggests that bank lending has even increased in the long-run after the implementation of Basel III capital regulation.

People have been afraid that implicit or explicit tightening of capital requirements would hinder lending in Basel III. But with less risk in banks, their ability to raise funds and lend improves. It is cool such model predictions from before Basel III can be seen in real live, this was true out-of-sample forecasting.

Monetary Policy and the Persistent Aggregate Effects of Wealth Redistribution

September 3, 2021

By Martin Kuncl and Alexander Ueberfeldt

We identify a sizable wealth redistribution channel which creates a monetary policy trade-off whereby short-term economic stimulus is followed by persistently lower output over the medium term. This trade-off is stronger in economies with more nominal household debt but weakened by a more aggressive monetary policy stance and underprice-level targeting. Given this trade-off, low-for-long episodes can lead to persistently depressed output. The medium-term implications of the wealth redistribution channel rely on the presence of labor supply heterogeneity, which we show both analytically and in the context of an estimated New Keynesian general equilibrium model with household heterogeneity.

Monetary policy cannot ignore distributional effects any more. Especially when they have aggregate affects, and as this paper shows, long-term aggregate effects. This is making the conduct of policy really difficult. Having more instruments would come in handy…