The End of Privilege: A Reexamination of the Net Foreign Asset Position of the United States

September 23, 2022

By Andrew Atkeson, Jonathan Heathcote and Fabrizio Perri

The US net foreign asset position has deteriorated sharply since 2007 and is currently negative 65 percent of US GDP. This deterioration primarily reflects changes in the relative values of large gross international equity positions, as opposed to net new borrowing. In particular, a sharp increase in equity prices that has been US-specific has inflated the value of US foreign liabilities. We develop an international macro finance model to interpret these trends, and we argue that the rise in equity prices in the United States likely reflects rising profitability of domestic firms rather than a substantial accumulation of unmeasured capital by those firms. Under that interpretation, the revaluation effects that have driven down the US net foreign asset position are associated with large, unanticipated transfers of US output to foreign investors.

This is a fascinating paper with very interesting results. However, I am afraid that some may draw the wrong policy lessons from it, for example limiting access of foreign investors to US markets. While it would likely “improve” the net foreign asset position, it would also restrict investment into the productive capacity of the US, and this is what matters in the end. A better policy would be to look into why the profits are so high and how that is welfare worsening.

Credit and Saving Constraints in General Equilibrium: A Quantitative Exploration

September 12, 2022

By Catalina Granda-Carvajal, Franz Hamann and Cesar Tamayo

In this paper we build an incomplete-markets model with heterogeneous households and firms to study the aggregate effects of saving constraints and credit constraints in general equilibrium. We calibrate the model using survey data from Colombia, a developing country in which informal saving and credit frictions are pervasive. Our quantitative results suggest that reducing savings costs increases selection into formal saving, but the effect on aggregate outcomes and welfare is dwarfed by that of a policy which ameliorates borrowing constraints. Such a policy improves resource allocation and increases returns to capital and labor, resulting in higher savings and welfare gains for both households and firms.

In other words, it is very nice to get unbanked people into formal banks, but the real impact is by getting access to formal credit. At least for the aspects considered by the paper. Being unbanked has other consequences, such as the risk of losing savings kept in cash in your home and more difficult payments, in particular online. That is unlikely (my guess) to be more important that what this paper highlights, though.

Monetary policy in the open economy with digital currencies

August 26, 2022

By Pietro Cova, Alessandro Notarpietro, Patrizio Pagano and Massimiliano Pisani

We assess the transmission of a monetary policy shock in a two-country New Keynesian model featuring a global private stablecoin and a central bank digital currency (CBDC). In the model, cash and digital currencies are imperfect substitutes that differ as to the liquidity services they provide. We find that in a digital-currency economy, where the stablecoin is a significant means of payment, the domestic and international macroeconomic effects of a monetary policy shock can be smaller or larger than in a (benchmark) mainly-cash economy, depending on how the assets backing the stablecoin supply respond to the shock. The benchmark transmission of the monetary policy shock can nonetheless substantially be restored in the digital-currency economy 1) if the stablecoin is fully backed by cash or 2) if the CBDC is a relevant means of payment.

I guess I need to be educated as to what the value of a fully-backed stablecoin is in the presence of a CBDC. To me they look identical. And it does not look like monetary policy would differ either, even compared to a world without either of them. It all boils down to the fact that imperfectly substitutable goods leads to the same responses if they always move together, and thus for policy purposes they are perfectly substitutable.

Transmission of Flood Damage to the Real Economy and Financial Intermediation: Simulation Analysis using a DSGE Model

July 29, 2022

By Ryuichiro Hashimoto and Nao Sudo

This paper quantitatively assesses the indirect effect of floods on the real economy and financial intermediation in Japan by estimating a dynamic stochastic general equilibrium (DSGE) model that incorporates a mechanism through which floods cause the capital stock and the public infrastructure to depreciate exogenously, using the data on flood damage recorded in the Flood Statistics released by the Japanese government. The result of the analysis is twofold. First, flood shocks dampen GDP from the supply side by reducing the capital stock inputs. The decline in GDP then impairs the balance sheets of firms and financial intermediaries, resulting in disruptions to financial intermediation and thus dampening GDP further from the demand side. Even when the direct damage due to floods is fully covered by insurance, the downward pressure on GDP endogenously deteriorates the balance sheets of these sectors, causing the same mechanism to operate. Second, the quantitative impacts of flood shocks on GDP up to now have been minor compared to the standard structural shocks that are considered important in existing macroeconomic studies, including shocks to total factor productivity (TFP) and the subjective discount factor. According to the estimates that use the relationship between the key variables in our model together with climate change scenarios published by an external organization, the impacts of these shocks could become somewhat larger in the future.

Given that we are recovering from flooding in St. Louis, this hit a nerve. Of course, if you destroy some capital, the economy suffers. But there is this persistent myth that a natural disaster is good because it provides jobs for the recovery. I wonder whether this class of models could say something in this regard when there is under-employment or when a geographically limited area is hit (leading to reallocations).

Fertility and migration

July 14, 2022

By Arianna Garofalo

Over the past three decades, the drop in fertility rates has been accompanied by high rates of migration in several developing countries. We argue that migration affects fertility negatively in the countries of origin. To analyze the effect of migration we build a fertility choice model, based on De La Croix (2014), with endogenous migration decisions. In this framework, when a member of the household migrates abroad, income increases due to remittances but at the same time, individuals left at home face a much higher opportunity cost time. This means that household members have less time to devote to taking care of the children and the consequence is a decrease in fertility. We calibrate the model to match the migration rates and to quantify the effect of migration on the fertility rate in those countries. To this end, we first show that the model can replicate the high rate of migrations in several developing countries. Then we perform two counterfactual exercises to address the effect of our mechanism. In the first exercise, we keep the migration constant as in the benchmark model while we give a higher value to the time cost of migration. The result is an increase in fertility. In the second exercise, we quantify how the differences in the time cost of migration affect the differences in fertility. We found that the time cost of migration accounts for 53% of the fall in the fertility of the developing countries in our sample between 1990 and 2017.

Open migration is the solution to several global problems. This paper shows that it can also contribute is important ways to reducing population growth, at least if the children members remain in the origin country and thus rely on remittances.

Optimal bank capital requirements: What do the macroeconomic models say?

June 27, 2022

By Adam Gulan, Esa Jokivuolle and Fabio Verona

The optimal level of banks’ capital requirements has been a key research topic since at least the introduction of the Basel rules in the late 1980s. In this paper, we review the literature, focusing on recent findings from quantitative structural macroeconomic models. While dynamic stochastic general equilibrium models capture second-round (general equilibrium) effects such as the feedback effects from macroeconomic outcomes back to financial intermediation and the dynamic evolution of the economy following regulatory changes, they suffer from tractability issues, including treatment of nonlinear effects, that typically force modeling simplifications. Additionally, studies tend to be concerned with determining the optimal level of fixed capital requirements. Only a handful offer estimates of the optimal size of the dynamic buffers. Since optimal dynamic macroprudential policies depend heavily on the nature of the underlying shocks, questions arise regarding the robustness and potential side effects of such plicies. Despite progress, the optimal level of bank capital requirements – in either fixed or dynamic form – remains largely an open research question.

Having tried myself many moons ago to address the question of optimal capital requirements and then facing big difficulties in modelling this properly and then having to come up with unique solution procedures, I can only emphasize how this is an important, and yet very difficult, question this is. With the recent progress in solving highly non-linear heterogeneous agent models more people should tackle this!

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.