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.

Out of Sync Subnational Housing Markets and Macroprudential Policies

April 10, 2018

By Michael Funke; Petar Mihaylovski; Adrian Wende


n view of regional house prices drifting apart, we examine whether regionally differentiated macroprudential policies can address financial stability concerns and moderate house price differences. To this end, we disaggregate both the household sector and the housing stock in a two-region DSGE model with out of sync subnational housing markets and compare four macroprudentail policy types: standard monetary policy by means of a standard Taylor rule, leaning against the wind monetary policy, national macroprudential policy or one that targets region-specific LTV ratios. In terms of reducing variances of house prices, regionally differentiated macroprudential policy performs best, provided the policy authorities are concerned with stabilising output and house prices rather than simply minimising the variance of inflation. Thus the findings point to a critical role for policy in regionalising macroprudential tools.

The problem with monetary unions, or very large countries, is that monetary policy cannot account for regional differences. This papers offers a policy solution by differentiating regionally the macroprudential solution. Good idea, although I worry about the political ramifications: what region can expect help is going to be a political game.

Term structure and real-time learning

April 7, 2018

By Pablo Aguilar and Jesús Vázquez


This paper introduces the term structure of interest rates into a medium-scale DSGE model. This extension results in a multi-period forecasting model that is estimated under both adaptive learning and rational expectations. Term structure information enables us to characterize agents’ expectations in real time, which addresses an imperfect information issue mostly neglected in the adaptive learning literature. Relative to the rational expectations version, our estimated DSGE model under adaptive learning largely improves the model fit to the data, which include not just macroeconomic data but also the yield curve and the consumption growth and inflation forecasts reported in the Survey of Professional Forecasters. Moreover, the estimation results show that most endogenous sources of aggregate persistence are dramatically undercut when adaptive learning based on multi-period forecasting is incorporated through the term structure of interest rates.

Adaptive learning is not new in DSGE models, but here is it done in a way that reflects current information much better than using historic information by using the yield curve. Interesting. This makes me think whether anyone used archived vintage data like from ALFRED for expectation formation.

Fiscal transfers in a monetary union with sovereign risk

March 23, 2018

By Guilherme Bandeira


This paper investigates the welfare and economic stabilization properties of a fiscal transfers scheme between members of a monetary union subject to sovereign spread shocks. The scheme, which consists of cross-country transfer rules triggered when sovereign spreads widen, is incorporated in a two-country model with financial frictions. In particular, banks hold government bonds in their portfolios, being exposed to sovereign risk. When this increases, a drop bank’s equity value forces them to contract credit and to raise lending rates at the same time as they retain funds to build up their net worth. I show that, when domestic fiscal policy is not distortionary, fiscal transfers improve welfare and macroeconomic stability. This is because fiscal transfers can reduce banks’ exposure to government debt, freeing credit supply to the private sector. On the contrary, when domestic fiscal policy is distortionary, fiscal transfers cause welfare losses, despite stabilizing the economy. This result arises because the distortions caused by funding the scheme outweigh the positive effects of fiscal transfers in smoothing the adjustment of the economy hit by the shock.

Cool paper that shows that such an automatic balancing mechanism across countries may not be a good idea due to the distortionary nature of taxes. That said, I do not understand the European obsession with avoiding sovereign spreads. They reflect risk differentials and sovereign should be sensitive to such price signals. If they are not, they should pay for the consequences of their policies.