Rethinking the Welfare State

October 19, 2021

By Nezih Guner, Remzi Kaygusuz and Gustavo Ventura

The U.S. spends non trivially on non-medical transfers for its working-age population in a wide range of programs that support low and middle-income households. How valuable are these programs for U.S. households? Are there simpler, welfare-improving ways to transfer resources that are supported by a majority? What are the macroeconomic effects of such alternatives? We answer these questions in an equilibrium, life-cycle model with single and married households who face idiosyncratic productivity risk, in the presence of costly children and potential skill losses of females associated with non-participation. Our findings show that a potential revenue-neutral elimination of the welfare state generates large welfare losses in the aggregate. Yet, most households support eliminating current transfers since losses are concentrated among a small group. We find that a Universal Basic Income program does not improve upon the current system. If instead per-person transfers are implemented alongside a proportional tax, a Negative Income Tax experiment, there are transfer levels and associated tax rates that improve upon the current system. Providing per-person transfers to all households is quite costly, and reducing tax distortions helps to provide for additional resources to expand redistribution.

It is no surprise that it is a bad idea to remove insurance that targets support to those who need it. What I find more interesting is that there is no political support for welfare programs. My experience comparing UBI with unemployment unsirance is that the latter has wide support because it is a risk that everyone faces, though with different probabilities. It should be no different with health. I suppose the difference is that the richness of this model takes into account how people may lock themselves into particular states (getting married, having children) and differ by gender and age, and may thus not care about the other states that they will never reach (again).

The Decline in Capital-Skill Complementarity

October 14, 2021

By Gonzalo Castex, Stanley Cho and Evgenia Dechter

We revisit the capital-skill complementarity hypothesis and examine whether and under what conditions this mechanism can explain the developments in wage inequality and labor share in the 1963-2016 period. Krusell, Ohanian, Rios-Rull, and Violante (2000) show that a model with capital-skill complementarity mechanism matches the data well and can account for the changes in wage inequality in the 1963-1992 period. We show that applying the model to the 1963-2016 period delivers a good fit for the skill premium; however, it does not predict the declining pattern in labor share in the last two decades. We modify the model to allow for a flexible technology structure and show that the degree of capital-skill complementarity is declining over time. The model with time-varying capital-skill complementarity can match the changes in skill premium and labor share in the 1963-2016 period.

This shows that replication is important, not only to verify the original results are valid, but also to see whether they remain valid with more recent data or along dimensions that have come to prominence since the original study.

Downward Interest Rate Rigidity

October 11, 2021

By Grégory Levieuge and Jean-Guillaume Sahuc

Empirical evidence suggests that bank lending rates are downward rigid: banks tend to adjust their rates more slowly and less completely to short-term market rates decreases than to increases. We investigate the macroeconomic consequences of this downward interest rate rigidity by introducing asymmetric bank lending rate adjustment costs in a macrofinance dynamic stochastic general equilibrium model. Calibrating the model to the euro area economy, we find that the difference in the initial response of GDP to positive and negative economic shocks of similar amplitude can reach up to 25%. This means that a central bank would have to cut its policy rate much more to obtain a symmetric medium-run impact on GDP. We also show that downward interest rate rigidity is stronger when policy rates are stuck at their effective lower bound, further disrupting monetary policy transmission. These findings imply that neglecting asymmetry in retail interest rate adjustments may yield misguided monetary policy decisions.

It would be very interesting to see whether the data looks different where banks lending rates are not similarly asymmetric. I an thinking of Switzerland, where mortgage rates are highly politicized, and thus banks hesitate a lot to increase them.

The Neoclassical Model and the Welfare Costs of Selection

October 8, 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.

This is a really neat paper with an interesting solution and an interesting result. However, it assumes perfect competition as selection becomes stronger. I wonder how welfare results would change as markets likely become less competitive in such a case.

Optimizing the life cycle path of pension premium payments and the pension ambition in the Netherlands

October 5, 2021

By Harry ter Rele, Carolijn de Kok, Nicoleta Ciurila and Peter Zwaneveld

Pension premium rates and pension benefits are independent of age or family situation in the second pillar of the Dutch pension system. In a life cycle model calibrated on Dutch data we investigate the optimal arrangement of pension premiums and benefits taking into consideration two factors: the fact that incomes generally rise with age and the presence of children in the early years of the household. Our analysis points out that due to these factors lifetime welfare can be raised by a delay of pension premium payments towards later working ages. A lower pension ambition further enhances lifetime welfare. Taking these factors into consideration when designing the pension system increases lifetime welfare by an amount that equals a 3.4 percent increase in lifetime consumption if no borrowing constraints are imposed and 2.8 percent if, more realistically, we impose these constraints. Family size (i.e. number of children) has a large impact on optimal pension premiums and optimal pension ambition. Policy conclusions from our results should carefully weigh the calculated welfare gain against possible negative and positive effects of non-modelled aspects.

I do not think many countries modulate pension contributions by age and family situation. Some do define a minimum age for contributions, though. However, taxation rules do allow for dependent credits and child allowances, thus the policies the authors are looking for are available indirectly. But then, you would need to look beyond the pension system. Who said economics is simple and easy?