Fiscal Policy during a Pandemic

March 31, 2020

By Miguel Faria-e-Castro

I use a dynamic stochastic general equilibrium model to study the effects of the 2019-20 coronavirus pandemic in the United States. The pandemic is modeled as a large negative shock to the utility of consumption of contact-intensive services. General equilibrium forces propagate this negative shock to the non-services and financial sectors, triggering a deep recession. I use a calibrated version of the model to analyze different types of fiscal policies: (i) government purchases, (ii) income tax cuts, (iii) unemployment insurance benefits, (iv) unconditional transfers, and (v) liquidity assistance to services firms. I find that UI benefits are the most effective tool to stabilize income for borrowers, who are the hardest hit, while savers favor unconditional transfers. Liquidity assistance programs are effective if the policy objective is to stabilize employment in the affected sector.

I usually do not promote the papers of my colleagues on this blog, but this time I have to. This is a very timely paper looking at the policy options in the current context of the Covid-19 pandemic and its very high expected unemployment. It also shows that DGE models can be used to analyze economic phenomena for which we have no empirical history to draw from: theory is the only tool we have. And it can deliver its results very fast (the paper took one week to make it to NEP-DGE, in this context even to slow…).

Supply Chain Disruptions, Time to Build, and the Business Cycle

March 23, 2020

Bt Matthias Meier

We provide new evidence that (i) time to build is volatile and countercyclical, and that (ii) supply chain disruptions lengthen time to build. Motivated by these findings, we develop a general equilibrium model in which heterogeneous firms face non-convex adjustment costs and multi-period time to build. In the model, supply chain disruptions lengthen time to build. Calibrating the model to US micro data, we show that disruptions, which lengthen time to build by 1 month, depress GDP by 1% and aggregate TFP by 0.2%. Structural vector autoregressions corroborate the quantitative importance of supply chain disruptions.

A timely study of supply chain disruptions, within business cycles, though. I doubt that if the current disruption due to Covid-19 last a couple of months, the impact on output will be just a couple of percents. Business cycle models approximated around their steady-state show their limitations in that case. But I wonder what lessons for today we could still draw form this model.

Endogenous Preferences for Parenting and Macroeconomic Outcomes

March 16, 2020

By Nigar Hashimzade

This paper investigates the effects of parenting time on macroeconomic outcomes and welfare when parenting choices are determined by own childhood experience and social norms in an overlapping generations framework. Parenting time and material expenditures on children generate children’s human capital. When the share of parenting time is relatively low and parenting and leisure are complements or weak substitutes the model has two steady-state equilibria with different welfare levels. In the high-welfare equilibrium parents have stronger endogenous taste for parenting and spend more time with children and less in paid work. Higher productivity due to the higher human capital more than compensates for the reduction in working hours, leading to a higher output level, in comparison to the low-welfare equilibrium.

I find the concept of endogenous preferences a bit unsettling, as I was taught that tastes are exogenously given. The idea here, though, is that preferences regarding parenting choices are driven by parents, peers, and own experiences. This can lead to interesting dynamics. But fundamentally, preferences are still exogenous, they simply follow a more complex “algorithm.” Little by little, we are getting closer to the chemical processes that drive our decisions.

The global macroeconomic impacts of COVID-19: Seven scenarios

March 9, 2020

By Warwick McKibbin and Roshen Fernando

The outbreak of coronavirus named COVID-19 has disrupted the Chinese economy and is spreading globally. The evolution of the disease and its economic impact is highly uncertain which makes it difficult for policymakers to formulate an appropriate macroeconomic policy response. In order to better understand possible economic outcomes, this paper explores seven different scenarios of how COVID-19 might evolve in the coming year using a modelling technique developed by Lee and McKibbin (2003) and extended by McKibbin and Sidorenko (2006). It examines the impacts of different scenarios on macroeconomic outcomes and financial markets in a global hybrid DSGE/CGE general equilibrium model.The scenarios in this paper demonstrate that even a contained outbreak could significantly impact the global economy in the short run. These scenarios demonstrate the scale of costs that might be avoided by greater investment in public health systems in all economies but particularly in less developed economies where health care systems are less developed and population density is high.

It did not take long to find an extensive analysis of the economics consequences of the current health crisis.

Micro Jumps, Macro Humps: Monetary Policy and Business Cycles in an Estimated HANK Model

March 2, 2020

By Adrien Auclert, Matthew Rognlie and Ludwig Straub

We estimate a Heterogeneous-Agent New Keynesian model with sticky household expectations that matches existing microeconomic evidence on marginal propensities to consume and macroeconomic evidence on the impulse response to a monetary policy shock. Our estimated model uncovers a central role for investment in the transmission mechanism of monetary policy, as high MPCs amplify the investment response in the data. This force also generates a procyclical response of consumption to investment shocks, leading our model to infer a central role for these shocks as a source of business cycles.

I have reported here about quite a few exciting heterogeneous agent papers that deepen our understanding of economic fluctuations. I have not gone back though all of them, but it is likely true that none of them is able to match the hump-shape response to monetary impulses. Indeed, the marginal propensity to consume of the less fortunate ones is very high and they react immediately to changes in economic conditions. This paper manages to get the hump in one particular way. One cannot exclude that there are other ways to get it, but know we know there is at least one plausible reconciliation of macro and micro facts.

The Minimum Wage Puzzle in Less Developed Countries: Reconciling Theory and Evidence

February 24, 2020

By Christopher Adam and Edward Buffie

We show that a dynamic general equilibrium model with efficiency wages and endogenous capital accumulation in both the formal and (non-agricultural) informal sectors can explain the full range of confounding stylized facts associated with minimum wage laws in less developed countries.

I am actually surprised that minimum wage laws have any bite in countries where the informal sector is substantial and easy to access.

Monetary Policy and Wealth Effects

February 18, 2020

By Nicolas Caramp and Dejanir Silva

This paper studies the role of wealth effects in the monetary transmission mechanism in New Keynesian models. We propose a decomposition of consumption that extends the Slutsky equation to a general equilibrium setting. Wealth effects, and their amplification in general equilibrium, explain a large fraction of the consumption and inflation response to changes in nominal interest rates in the standard equilibrium. In RANK, wealth effects are determined, generically, by the revaluation of public debt and the fiscal response to monetary policy. In a medium-scale DSGE model, we find a fiscal response that is several times larger than the response we estimate in the data. Therefore, the model is unable to generate sufficiently strong effects. In an analytical HANK model with positive private debt, private wealth effects amplify the response to monetary policy and improve the quantitative performance of the DSGE model.

An important paper on the important topic of distributional aspects of monetary policy.