Money, e-money and consumer welfare

January 30, 2023

By Francesco Carli and Burak Uras

We develop a micro-founded monetary model to inquire the role of a privately provided e-money instrument for household consumption smoothing and welfare. Different from fiat money, e-money users pay electronic transaction fees, but in turn e-money reduces spatial separation frictions and enables risk-sharing. We characterize the conditions that promotes e-money to be Pareto improving and the conditions when e-money reduces its users’ welfare – despite for the consumption-smoothing it induces. We calibrate our model for the context of M-Pesa in Kenya and conduct a quantitative analysis. Since our quantitative analysis reveals a limited role for privately provided e-money, we recommend the optimality of e-money regulation.

This paper is a fascinating application of money search theory to the emergencies of privately issued mobile money. There are clear advantages from providing a widely adopted transaction system, but monopoly power comes with it, hence the need to regulate. The motivation for regulation here is thus different from regular banking regulation, which is more concerned about systemic financial health.


Job Ladder, Human Capital, and the Cost of Job Loss

January 24, 2023

By Richard Audoly, Federica De Pace and Giulio Fella

High-tenure workers losing their job experience a large and prolonged fall in wages and earnings. The aim of this paper is to understand and quantify the forces behind this empirical regularity. We propose a structural model of the labor market with (i) on-the-job search, (ii) general human capital, and (iii) firm specific human capital. Jobs are destroyed at an endogenous rate due to idiosyncratic productivity shocks and the skills of workers depreciate during periods of non-employment. The model is estimated on German Social Security data. By jointly matching moments related to workers’ mobility and wages, the model can replicate the size and persistence of the losses in earnings and wages observed in the data. We find that the loss of a job with a more productive employer is the primary driver of the cumulative wage losses following displacement (about 50 percent), followed by the loss of firm-specific human capital (about 30 percent).

This is a very interesting question and a cool way to address it. Someone should apply this to other economies, as I suspect the results would not be the same where there is a lot more churn on the labor market, for example.

The Dynamics of the Racial Wealth Gap

January 17, 2023

By Dionissi Aliprantis, Daniel Carroll and Eric Young

What drives the dynamics of the racial wealth gap? We answer this question using a dynamic stochastic general equilibrium heterogeneous-agents model. Our calibrated model endogenously produces a racial wealth gap matching that observed in recent decades along with key features of the current cross-sectional distribution of wealth, earnings, intergenerational transfers, and race. Our model predicts that equalizing earnings is by far the most important mechanism for permanently closing the racial wealth gap. One-time wealth transfers have only transitory effects unless they address the racial earnings gap, and return gaps only matter when earnings inequality is reduced.

This is another paper that steps out of usual DSGE modelling topics to address important questions for which that type of approach is particularly well suited for. Even if you disagree with some of the assumptions or the calibration, it lays down a framework from where the discussion should start. Very promising.


January 17, 2023

By Ayşe İmrohoroğlu and Kai Zhao

This paper examines the effectiveness of several policies in reducing the aggregate share of homeless in a dynamic general equilibrium model. The model economy is calibrated to capture the most at-risk groups and generates a diverse population of homeless with a significant fraction becoming homeless for short spells due to labor market shocks and a smaller fraction experiencing chronic homelessness due to health shocks. Our policy experiments show housing subsidies to be more effective in reducing the aggregate homeless share, mostly by helping those with short spells, than non-housing policies. For the chronically homeless population, a means-tested expansion of disability income proves to be effective. We also find that some policies that result in higher exit rates from homelessness, such as relaxation of borrowing constraints, help the currently homeless population but lead to a larger homeless share at the steady state by increasing the entry rate.

This is an excellent topic and approach. People are going to debate the assumptions, but this is at least a starting point to better understand what can work to curb homelessness. I am looking forward to what will happen to this paper and what will follow.

Long-Term Economic Implications of Demeny Voting: A Theoretical Analysis

December 26, 2022

By Luigi Bonatti and Lorenza Alexandra Lorenzetti

This paper places itself at the intersection between the literature on “Demeny voting” (the proposal of letting custodial parents exercise their children’s voting rights until they come of age) and the vast literature on formal models with endogenous fertility that address the problem of fiscal redistribution between young and old cohorts in the presence of an aging population. Linking these issues to the process of economic growth through a simple overlapping generations model, we show that, even if the government is myopic, in the sense that it cares only about the current well being of the living (and voting) generations, an increase in the relative importance that it attaches to the interests of the young cohort (for instance, due the introduction of Demeny voting) leads in the long run to a higher population growth rate and raises the consumption level of each young adult, the capital stock per worker and the output per adult. We also show that in the long run such a reform raises the well being that individuals can expect at birth to achieve during their lifetime.

Today I learned about Demeny voting. It interesting to see that fertility not only increases because the benefits from having children improve, but also because having more children gives more voting power. I wonder how this would pan out if the model would include some benefits go to parents without improving the well-being on children, that is, we could get a situation where children are pawns to political game.

Optimal GDP-indexed Bonds

December 23, 2022

By Yasin Kürsat Önder

I investigate the introduction of GDP-indexed bonds as an additional source of government borrowing in a quantitative default model. The idea of linking debt payments to developments in GDP resurfaced with the 1980s debt crisis and peaked with the COVID-19 outbreak. I show that the gains from this idea depend on the underlying indexation method and are highest if payments are symmetrically tied to developments in GDP. Optimized indexed debt can eradicate default risk, halve consumption volatility, and increase asset prices while raising the government’s debt balances. These changes occur because an optimally chosen indexation method does a better job at completing the markets.

This is not the first paper on this kind of bond that I mention on the blog. Visibly, we are dealing with market incompleteness and people are suggesting particular assets to complete the market. Here, one asset is proposed that has characteristics that make it resemble more a stock share than a bond: highly variable dividends that depend on how an underlying asset (the national economy) performs. Under some metric, this asset is optimal, but can it really complete the market? That is unlikely. For this to happen you would need a menu of different assets that would be individually priced on a competitive market. We are still far from that. But if the constraint is that you can only have one asset, then this paper shows how it would look like.

Crisis Propagation in a Heterogeneous Self-Reflexive DSGE Model

December 11, 2022

By Federico Guglielmo Morelli, Michael Benzaquen, Jean-Philippe Bouchaud and Marco Tarzia

We study a self-reflexive DSGE model with heterogeneous households, aimed at characterising the impact of economic recessions on the different strata of the society. Our framework allows to analyse the combined effect of income inequalities and confidence feedback mediated by heterogeneous social networks. By varying the parameters of the model, we find different crisis typologies: loss of confidence may propagate mostly within high income households, or mostly within low income households, with a rather sharp crossover between the two. We find that crises are more severe for segregated networks (where confidence feedback is essentially mediated between agents of the same social class), for which cascading contagion effects are stronger. For the same reason, larger income inequalities tend to reduce, in our model, the probability of global crises. Finally, we are able to reproduce a perhaps counter-intuitive empirical finding: in countries with higher Gini coefficients, the consumption of the lowest income households tends to drop less than that of the highest incomes in crisis times.

If you also wondered what a self-reflexive DSGE model is, here is the lowdown. This is a mixture of HANK (Heterogeneous Agent New-Keynesian) models and ABM (Agent-Based Model). You have the general equilibrium, the heterogeneity and the dynamics of HANK, but some aspects of heterogeneity are fixed (say, skills, earnings, market structure) but new dimensions are added, such as social interaction. A household’s consumption preferences may be determined by the consumption of its neighbors. This is not quite like the habit formation models (or “catch-up-with-the-Joneses”), where the reference is aggregate consumption, here a network with local interactions is built. Of course, things are going to depend on how the network is set up, and for this particular paper, how rich and poor interact. Potentially crucially, these interactions do not change as the economy slides into a crisis. Also, the parameterization of the network appears to be impossible, thus results are provided for all possible values, showing that almost anything is possible. One would need to narrow this down to give some valuable conclusions.

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?