Sovereign Money Reforms and Welfare

May 15, 2018

By Philippe Bacchetta and Elena Perazzi

A monetary reform is submitted for vote to the Swiss people in 2018. The Sovereign Money Initiative proposes that all sight deposits should be controlled by the Swiss National Bank (SNB) and that the SNB could distribute its additional resources. While a sovereign money reform would clearly affect the structure of the banking sector, it would also have macroeconomic implications, in particular because it transfers resources from banks to the central bank. The objective of this paper is to analyze these macroeconomic implications using a simple infinite-horizon open-economy model calibrated to the Swiss economy. While we consider several policy experiments, we find that there is a key trade-off between a reduction in distortionary labor taxes and an increase in the opportunity cost of holding money. However, in the proposed Swiss reform it is this latter cost that dominates and we find that the reform unambiguously lowers welfare.

Swiss get to vote on all sorts of proposals, some of them rather silly. This time it is about “full money”, i.e., banks cannot create money except through the central bank. The paper shows nicely how this is a bad idea. I hope the Swiss can follow expert advice.


Crisis, contagion and international policy spillovers under foreign ownership of banks

May 14, 2018

By Michał Brzoza-Brzezina, Marcin Kolasa and Krzysztof Makarski

This paper checks how international spillovers of shocks and policies are modified when banks are foreign owned. To this end we build a two-country macroeconomic model with banking sectors that are owned by residents of one (big and foreign) country. Consistently with empirical findings, in our model foreign ownership of banks amplifies spillovers from foreign shocks. It also strengthens the international transmission of monetary and macroprudential policies. We next use the model to replicate the financial crisis in the euro area and show how, by preventing bank capital outflow in 2009, the Polish regulatory authorities managed to reduce its contagion to Poland. We also find that under foreign bank ownership such policy is strongly preferred to a recapitalization of domestic banks. Finally, we check how foreign ownership of banks affects transmission of domestic shocks to find that it has a stabilizing effect.

Interesting idea that foreign ownership of banks could serve as insurance mechanism against domestic shocks. I wonder, however, how a policy of preventing capital outflow could influence the incidence of foreign ownership, though.

Time-Consistent Consumption Taxation

May 13, 2018

By Sarolta Laczo and Raffaele Rossi

We characterise optimal tax policies when the government has access to consumption taxation and cannot credibly commit to future policies. We consider a neoclassical economy where factor income taxation is distortionary within the period, due to endogenous labour and capital utilisation and non-tax-deductibility of depreciation. Contrary to the case where only labour and capital income are taxed, the optimal time-consistent policies with consumption taxation are remarkably similar to their Ramsey counterparts. The welfare gains from commitment are negligible, while they are substantial without consumption taxation. Further, the welfare gains from taxing consumption are much higher without commitment.

I am getting more and more confused by the optimal tax literature. The reason is that there are so many complete reversals of the results when some assumptions are changed. This paper is one example. If you have a good understanding of this literature, I have a project for you, please contact me.

On the effects of ranking by unemployment duration

May 11, 2018

By Javier Fernandez-Blanco and Edgar Preugschat

We propose a theory based on the firm’s hiring behavior that rationalizes the observed significant decline of callback rates for an interview and exit rates from unemployment and the mild decline of reemployment wages over unemployment duration. We build a directed search model with symmetric incomplete information on worker types and non-sequential search by firms. Sorting due to firms’ testing of applicants in the past makes expected productivity fall with duration, which induces firms to rank applicants by duration. In equilibrium callback and exit rates both fall with unemployment duration. In our numerical exercise using U.S. data we show that our model can replicate quite well the observed falling patterns, with the firm’s ranking decision accounting for a sizable part.

Cool result. The next question is then whether firms really do rank sort like this.

Competitiveness and Wage Bargaining Reform in Italy

May 10, 2018

By Alvar Kangur

The growth of Italian exports has lagged that of euro area peers. Against the backdrop of unit labor costs that have risen faster than those in euro area peers, this paper examines whether there is a competitiveness challenge in Italy and evaluates the framework of wage bargaining. Wages are set at the sectoral level and extended nationally. However, they do not respond well to firm-specific productivity, regional disparities, or skill mismatches. Nominally rigid wages have also implied adjustment through lower profits and employment. Wage developments explain about 45 percent of the manufacturing unit labor cost gap with Germany. In a search-and-match DSGE model of the Italian labor market, this paper finds substantial gains from moving from sectoral- to firm-level wage setting of at least 3.5 percentage points lower unemployment (or higher employment) rate and a notable improvement in Italy’s competitiveness over the medium term.

Italy is stagnating and could do well to look at its labor market. As this paper clearly shows, nothing beats a flexible labor market. And if you have to have some rigidities, Italy’s are exactly the wrong ones.

Feldstein Meets George: Land Rent Taxation and Socially Optimal Allocation in Economies with Environmental Externality

April 26, 2018

By Nguyen Thang Dao and Ottmar Edenhofer

We consider an overlapping generations (OLG) economy with land as a fixed factor of production and an environmental externality on production in which tax revenue from land rent and/or from other schemes such as labor income, capital income, and production taxation can be used for environmental protection through investment in emission mitigation. We show that, for any given target of stationary stock of pollution, the land rent taxation scheme leads to a higher steady state capital accumulation than the other schemes, and hence the steady state consumption of agents when young under this scheme is also higher than under the others. In addition, under an ambitious mitigation target when the efficiency of the mitigation technology is relatively high compared to the dirtiness of production, the land rent taxation also provides a higher steady state consumption when old, resulting in higher social welfare, than the others. In the second part of the paper, we propose a period-by-period balanced budget policy, which includes land rent and capital income taxes with intergenerational transfers, to decentralize the socially optimal allocation during the transitional phase to the social planner’s steady state.

Land rent taxation à la George is not as wide-spread as it should. Maybe this has to do with the fact that land owners are typically key in getting taxation schemes approved. But this paper shows that once pollution is also taken into account, welfare improvement are substantial. Enough to get approval from land owners?

Financial Fragility with SAM?

April 12, 2018

By Tim Landvoigt, Stijn Van Nieuwerburgh and Daniel Greenwald

Shared Appreciation Mortgages (SAMs) feature mortgage payments that adjust with house prices. Such mortgage contracts can stave off home owner default by providing payment relief in the wake of a large house price shock. SAMs have been hailed as an innovative solution that could prevent the next foreclosure crisis, act as a work-out tool during a crisis, and alleviate fiscal pressure during a downturn. They have inspired Fintech companies to offer home equity contracts. However, the home owner’s gains are the mortgage lender’s losses. We consider a model with financial intermediaries who channel savings from saver households to borrower households. The financial sector has limited risk bearing capacity. SAMs pass through more aggregate house price risk and lead to financial fragility when the shock happens in periods of low intermediary capital. We compare house prices,mortgage rates, the size of the mortgage sector, default and refinancing rates, as well as borrower and saver consumption between an economy with standard mortgage contracts and an economy with SAMs.

I had not heard of the concept of shared appreciation mortgages. Interesting idea with some counter-intuitive results. For example, I would have expected to see a higher steady-state mortgage interest rate, as the risk is shifted more to the lender. Well, no, because there are hardly any foreclosures, the risk is actually going down.