Monetary Policy in Disaster-Prone Developing Countries

May 23, 2022

By Chris Papageorgiou, Giovanni Melina, Alessandro Cantelmo and Nikos Fatouros

This paper analyzes monetary policy regimes in emerging and developing economies where climate-related natural disasters are major macroeconomic shocks. A narrative analysis of IMF reports published around the occurrence of natural disasters documents their impact on important macroeconomic variables and monetary policy responses. While countries with at least some degree of monetary policy independence typically react by tightening the monetary policy stance, in a sizable number of cases monetary policy was accommodated. Given the lack of consensus on best practices in these circumstances, a small-open-economy New-Keynesian model with disaster shocks is leveraged to evaluate welfare under alternative monetary policy rules. Results suggest that responding to inflation while allowing temporary deviations from its target is the welfare maximizing policy. Alternative regimes such as strict inflation targeting, exchange rate pegs, or Taylor rules explicitly responding to economic activity or the exchange rate would be welfare-detrimental. With climate change projected to expand the list of disaster-prone countries, these findings are likely to be soon relevant also for richer or larger economies.

I wonder why this analysis would be limited to emerging and developing economies. Developed economies also suffer major shocks. Covid-19 was in many ways like a natural disaster shock (sudden unavailability of staff, supply disruptions, liquidity needs) leading to major price changes.

Dynamic spatial general equilibrium

May 17, 2022

By Benny Kleinman, Ernest Liu and Stephen Redding

We develop a dynamic spatial general equilibrium model with forward-looking investment and migration decisions. We characterize analytically the transition path of the spatial distribution of economic activity in response to shocks. We apply our framework to the re-allocation of US economic activity from the Rust Belt to the Sun Belt from 1965-2015. We find slow convergence to steady-state, with US states closer to steady-state at the end of our sample period than at its beginning. We find substantial heterogeneity in the effects of local shocks, which depend on capital and labor dynamics, and the spatial and sectoral incidence of these shocks.

Many moons ago I tried to develop a spacial dynamic general equilibrium to study the diffusion of inflation, and the considerable lag from shock to inflation change. I got hopelessly lost in the complexities. I am glad to see that this kind of work looks feasible now.

Liquidity constraints and fiscal multipliers

May 10, 2022

By Diogo Sá

Although recent studies identified the percentage of constrained agents as the crucial force driving many fiscal policy mechanisms, the values attained were purely the result of model calibrations. We make use of household-level data to estimate the fraction of hand-to-mouth households for several European countries. We calibrate an overlapping generations model with heterogeneous agents to match the net liquid wealth distribution and study the impact of credit constraints on the effectiveness of fiscal consolidation policies. Our findings suggest that the share of hand-to-mouth agents is no longer quantitatively relevant to explain the cross-country heterogeneity in fiscal multipliers when we calibrate the model to match empirically plausible estimates of that share. These results may be driven by the characteristics of the model we employ, which excludes the wealthy hand-to-mouth.

I am intrigued by this result that the proportion of hand-to-mouth households does not matter, at least within the empirically relevant range (20-37%). Indeed, the recent literature has been insisting so much on this feature of household data.

Dollar Invoicing, Global Value Chains, and the Business Cycle Dynamics of International Trade

April 28, 2022

By Nikhil Patel and David Cook

Recent literature has highlighted that international trade is mostly priced in a few key vehicle currencies and is increasingly dominated by intermediate goods and global value chains (GVCs). Taking these features into account, this paper reexamines the relationship between monetary policy, exchange rates and international trade flows. Using a dynamic stochastic general equilibrium (DSGE) framework, it finds key differences between the response of final goods and GVC trade to both domestic and foreign shocks depending on the origin and ultimate destination of value added and the intermediate shipments involved. For example, the model shows that in response to a dollar appreciation triggered by a US interest rate increase, direct bilateral trade between non-US countries contracts more than global value chain oriented trade which feeds US final demand, and exports to the US decline much more when measured in gross as opposed to value added terms. We use granular data on GVCs at the sector level to document empirical evidence in favor of these key predictions of the model.

This is why not every currency is fit to be a vehicle currency. Not only should the underlying economy be sufficiently large, market participants should also view the monetary policy as sound and little disruptive, even if the central bank acts only in the interest of the home country. Think about that before declaring that the days of the US dollar as the global currency are over.

Migrant Smuggling to Europe: a Matching Model

April 27, 2022

By Olivier Charlot, Claire Naiditch and Radu Vranceanu

This paper develops a matching model à la Pissarides (2000) to analyze the migrant smuggling market, building on the empirical evidence related to the smuggling of migrants from the Horn of Africa and the Middle East to the European region in the last decade. The model allows us to determine the equilibrium numbers of smugglers and of incoming irregular migrants as well as the total migrant welfare. Most of the coercion-based measures targeting the smugglers achieve the reduction in the number of irregular migrants and smugglers at the expense of migrants’ overall welfare. Slightly increasing legal migration opportunities has the interesting feature of drastically reducing irregular flows, without deteriorating migrants’ welfare nor increasing the total number of migrants. The model reveals that an extremely restrictive asylum policy has similar effects in terms of the flows of irregular migrants as a quite loose one, with the largest flows of irregular migrants reached for a “middle-range” policy. Finally, the stay-home incentive of generous humanitarian policies might be partially offset by higher profits and a higher smuggling activity.

The main conclusion of this paper: no matter what you do, you will essentially have the same number of immigrants. Thus you may then do what is the best for economic well-being, which is to have regular opportunities for legal immigration. The important question is whether this result applies to other immigration flows.

Attention and Fluctuations in Macroeconomic Uncertainty

April 18, 2022

By Yu-Ting Chiang

This paper studies a dispersed information economy in which agents can exert costly attention to learn about an unknown aggregate state of the economy. Under certain conditions, attention and four measures of uncertainty are countercyclical: Agents pay more attention when they expect the economy to be in a bad state, and their reaction generates higher (i) aggregate output volatility, (ii) cross-sectional output dispersion, (iii) forecast dispersion about aggregate output, and (iv) subjective uncertainty about aggregate output faced by each agent. All these phenomena are prominent features of the U.S. data. When attention cost is calibrated to forecast survey data, the model generates countercyclical fluctuations in attention and uncertainty, consistent with untargeted moments from the data. Fluctuations in attention and uncertainty are higher-order properties of the model. A new method is developed to solve higher-order dynamics of the equilibrium under an infinite regress problem.

The study of how attentive people are to economic news is incredibly important, as it lies at the heart of expectation formation. Ironically, understanding the simple rules people may use is outrageously difficult. To be frank, I have a real hard time figuring out what is going on in this paper, as for other papers in this literature. I also do not know how this could be applied in the simpler fashion to the standard models. I hope someone works on that. It is really important.

(In)Efficient Commuting And Migration Choices: Theory And Policy In An Urban Search Model

April 16, 2022

By Luca Marchiori, Julien Pascal and Olivier Pierrard

We develop a monocentric urban search-and-matching model in which workers can choose to commute or to migrate within the region. The equilibrium endogenously allocates the population into three categories: migrants (relocate from their hometown to the city), commuters (traveling to work in the city) and home stayers (remaining in their hometown). We prove that the market equilibrium is usually not optimal: a composition externality may generate under- or over-migration with respect to the central planner’s solution, which in all cases results in under-investment in job vacancies and therefore production. We calibrate the model to the Greater Paris area to reproduce several gradients observed in the data, suggesting over-migration. We show how policy interventions can help to reduce inefficiencies.

Interesting paper with a surprising result, and I wonder whether it holds up for other cases. My anecdotal experience is that people are generally unhappy about their commute yet they choose that equilibrium because others chose it as well. That suggests to me that there is a coordination problem leading to a second best, and that more migration closer to the workplace should be encouraged.

In this context is Paris special? Again from anecdotal observation, I am struck how many people choose to live within city limits even though they work elsewhere (suburbs and even other cities). This looks like under-migration to me, but maybe I do not know representative people.

Land is back, it should be taxed, it can be taxed

April 7, 2022

By Odran Bonnet, Guillaume Chapelle, Alain Trannoy and Etienne Wasmer

Land is back. The increase in wealth in the second half of 20th century arose from housing and land. It should be taxed. We introduce land and housing structures in Judd’s standard setup: first best optimal taxation is achieved with a property tax on land and requires no tax on capital. With positive taxes on housing rents, a first best is still possible but with subsidies to rental housing investments, and either with differential land tax rates or with a tax on imputed rents. It can be taxed. Even absent land taxes, one can tax it indirectly and reach a Ramsey-second best still with no tax on capital and positive housing rent taxes in the steady-state. This result extends to the dynamics under restrictions on parameters.

In the ongoing saga about optimal capital taxation, the new player in town is land and it changes once more everything. And, of course, land is important, is often inherited and its value more determined by externalities than by what the owner puts into it. In other words, taxing it makes sense in more than a Georgian way. Interestingly, the first best leads to no tax on capital.

This literature is making me dizzy. I need someone to put together a RePEc Biblio topic about it.

Opportunity and Inequality across Generations

March 30, 2022

By Winfried Koeniger and Carlo Zanella

We analyze how intergenerational mobility and inequality would change relative to the status quo if dynasties had access to optimal insurance against low ability of future generations. Based on a dynamic, dynastic Mirrleesian model, we find that insurance against intergenerational ability risk increases in the social optimum relative to the status quo. This implies less intergenerational mobility in terms of welfare but no quantitatively significant change in earnings mobility. Earnings mobility is thus similar across economies with different incentives and welfare, illustrating that changes in earnings mobility cannot be interpreted readily in welfare terms without further analysis.

I must confess that I have a hard time buying that it can be socially optimal to insure successful people against the failures of their offspring. It is natural that talent and entrepreneurship regress to the mean over generations, and successful dynasties insure themselves against that risk by building wealth and buying education and entrance into the right circles. Why would society subsidize that if it leads to lower aggregate outcomes? I think the issue is that when we think about an untalented rich kid going to a top school, it is taking away the spot of a talented poor kid, thus hurting the social outcome. There is not such trade-off in the model. Or maybe I am just confused, there are a lot of margins in play here.

Minimum Wage Shocks in an Estimated DSGE Model with Underreporting

March 25, 2022

By Alisher Tolepbergen

We build and estimate a New Keynesian DSGE model to analyze the macroeconomic effects of minimum wage shocks in an economy characterized by a high degree of wage underreporting. The estimation results suggest that the effect of the minimum wage shocks to all economic aggregates but employment is not significant. The impulse response analysis shows that a higher degree of underreporting results in less responsive dynamics to the minimum wage shocks. In addition, the magnitude of the responses is also affected by the share of Non-Ricardian households in the economy. Overall, we find that an increase in the minimum wage in the economy with a high degree of underreporting does not significantly affect the dynamics of macroeconomic variables.

Not all DSGE models need to be about the US or other western economies. There are good insights to be gained for other economies. This paper is using data from Kazakhstan to study how minimum wages can influence the economy when employers quite systematically report lower wages. Not much. This is mainly due to the leakage, as a simulation with little underreporting show some impact. Thus, while on the surface the economy may show higher wages after an increase in the minimum wage, not much actually changed.