Credit Misallocation and Macro Dynamics with Oligopolistic Financial Intermediaries

November 30, 2022

By Alessandro Villa

Bank market power shapes firm investment and financing dynamics and hence affects the transmission of macroeconomic shocks. Motivated by a secular increase in the concentration of the US banking industry, I study bank market power through the lens of a dynamic general equilibrium model with oligopolistic banks and heterogeneous firms. The lack of competition allows banks to price discriminate and charge firm-specific markups in excess of default premia. In turn, the cross-sectional dispersion of markups amplifies the impact of macroeconomic shocks. During a crisis, banks exploit their market power to extract higher markups, inducing a larger decline in real activity. When a “big” (i.e., non-atomistic) bank fails, the remaining banks use their increased market power to control the supply of credit, worsening and prolonging the recession. The results suggest that bank market power could be an important concern when formulating appropriate bail-out polices.

Positive implications of market power are really hard to come by. This paper shows that this also applies to the banking sector, but not in the usual to-big-to-fail way. Market power here is making things worse in times of crisis in non-negligible ways (about 6% excess output drop in case of major bank failure), which is why it must be dealt with already in non-crisis times.


Full-Information Estimation of Heterogeneous Agent Models Using Macro and Micro Data

November 27, 2022

By Laura Liu and Mikkel Plagborg-Møller

We develop a generally applicable full-information inference method for heterogeneous agent models, combining aggregate time series data and repeated cross sections of micro data. To handle unobserved aggregate state variables that affect cross-sectional distributions, we compute a numerically unbiased estimate of the model-implied likelihood function. Employing the likelihood estimate in a Markov Chain Monte Carlo algorithm, we obtain fully efficient and valid Bayesian inference. Evaluation of the micro part of the likelihood lends itself naturally to parallel computing. Numerical illustrations in models with heterogeneous households or firms demonstrate that the proposed full-information method substantially sharpens inference relative to using only macro data, and for some parameters micro data is essential for identification.

Holy guacamole. I am thoroughly impressed by this work. Only a few years ago we were struggling to simulate models that include aggregate-state dependent distributions, and now we are estimating them. Wow.

Optimal carbon pricing with fluctuating energy prices – emission targeting vs. price targeting

November 24, 2022

By Alkis Blanz, Ulrich Eydam, Maik Heinemann and Matthias Kalkuhl

Prices of primary energy commodities display marked fluctuations over time. Market-based climate policy instruments (e.g., emissions pricing) create incentives to reduce energy consumption by increasing the user cost of fossil energy. This raises the question of whether climate policy should respond to fluctuations in fossil energy prices? We study this question within an environmental dynamic stochastic general equilibrium (E-DSGE) model calibrated on the German economy. Our results indicate that the welfare implications of dynamic emissions pricing crucially depend on how the revenues are used. When revenues are fully absorbed, a reduction in emissions prices stabilizes the economy in response to energy price shocks. However, when revenues are at least partially recycled, a stable emissions price improves overall welfare. This result is robust to different modeling assumptions.

Interesting topic. I always wondered whether there would be value in energy price smoothing through taxation. Also, looking at the political economy of carbon taxes, would it make sense to increase the latter while energy prices are declining rather than whenever the law kicks in?

The macroeconomics of establishing a basic income grant in South Africa

November 21, 2022

By Daan Steenkamp, Roy Havemann and Hylton Hollander

This paper quantifies the effect of fiscal transfers on the trade-off between social relief and debt accumulation, and discusses the economic growth and fiscal implications of different combinations of expanded social support and funding choices. Given South Africa’s already high level of public debt, the opportunity to fund a basic income grant through higher debt is limited. Using a general equilibrium model, the paper shows that extending the social relief of distress grant could be fiscally feasible provided taxes rise to fund such a programme. Implementing such a policy would, however, have a contractionary impact on the economy. A larger basic income grant (even at the level of the food poverty line) would threaten fiscal sustainability as it would require large tax increases that would crowd-out consumption and investment. The model results show that sustainably expanding social transfers requires structurally higher growth, which necessitates growth-enhancing reforms that crowd-in the private sector through, for example, relieving the energy constraint, increasing government infrastructure investment and expanding employment programmes.

This is the thoroughest analysis of a basic income program I have seen so far. The results are not surprising: any program that lacks targeting is prohibitively expensive whichever way you finance it. I tried to address a similar question and came to the same conclusion, though using a much lower unemployment rate that was is usual in South Africa.