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.

Monetary theory reversed: Virtual currency issuance and miners’ remuneration

March 14, 2018

By Luca Marchiori


This study analyzes the macroeconomic implications of virtual currency issuance. It builds on a standard cash-in-advance model extended with (i) ‘virtual’ goods, sold against virtual currency, and (ii) miners, the agents providing payment services. The main finding is that virtual currency growth may have effects opposite to those predicted by monetary theory when miners are rewarded with newly created coins. Declining currency issuance, as in Bitcoin, raises the price of virtual goods, which counteracts the traditional impact of a reduced inflation tax. The paper also shows how fiat money growth affects the welfare effects of virtual currency creation.

What this paper is saying is that there is a sweet spot for virtual currencies where they have been accepted for transactions but are not yet too close to the supply limit. Once supply is too limited to reasonably reward miners, the later start charging higher transaction fees and the cost of the goods bought with virtual currency increases, leading to a net welfare loss. In other words, virtual currencies are cool for a while but are not there to stay.

Are Consumers’ Spending Decisions in Line With an Euler Equation?

March 6, 2018

By Lena Dräger and Giang Nghiem


Evaluating two new survey datasets of German consumers, we test whether individual consumption spending decisions are formed according to an Euler equation derived from consumption life-cycle models. Measured in qualitative individual changes, our results suggest that current and planned spending are positively correlated, thus supporting the hypothesis of consumption smoothing. Also, current spending is positively correlated with inflation expectations, and negatively with nominal interest rate expectations. Interestingly, the effect of perceived real interest rates is only significant for financial market participants, financially unconstrained households and those with high financial literacy, implying that these are important conditions for the ability to smooth consumption over time. Moreover, these households are better positioned in the wealth and income distributions. In that sense, the ability to smooth consumption may be a channel through which distributional effects of policy shocks may occur. Finally, news on inflation and monetary policy observed by the consumer strengthen the effect of their inflation expectations on current spending, suggesting that imperfect information may also influence the Euler equation relationship.

There are many papers estimating Euler equations, but they usually do it on aggregate data. This paper uses two German surveys and it is with great relief that we learn that the consumption Euler equation is still working well.

Two papers on unemployment insurance and misallocation

March 5, 2018

Unemployment Insurance Take-up Rates in an Equilibrium Search Model

By Stéphane Auray, David Fuller and Lkhagvasuren Damba


From 1989-2012, on average 23% of those eligible for unemployment insurance (UI) benefits in the US did not collect them. In a search model with matching frictions, asymmetric information associated with the UI non-collectors implies an inefficiency in non-collector outcomes. This inefficiency is characterized along with the key features of collector vs. non-collector allocations. Specifically, the inefficiency implies that noncollectors transition to employment at a faster rate and a lower wage than the efficient levels. Quantitatively, the inefficiency amounts to 1.71% welfare loss in consumption equivalent terms for the average worker, with a 3.85% loss conditional on non-collection. With an endogenous take-up rate, the unemployment rate and average duration of unemployment respond significantly slower to changes in the UI benefit level, relative to the standard model with a 100% take-up rate.

Social Insurance and Occupational Mobility

By German Cubas and Pedro Silos


This paper studies how insurance from progressive taxation improves the matching of workers to occupations. We propose an equilibrium dynamic assignment model to illustrate how social insurance encourages mobility. Workers experiment to find their best occupational fit in a process filled with uncertainty. Risk aversion and limited earnings insurance induce workers to remain in unfitting occupations. We estimate the model using microdata from the United States and Germany. Higher earnings uncertainty explains the U.S. higher mobility rate. When workers in the United States enjoy Germany’s higher progressivity, mobility rises. Output and welfare gains are large.

By chance, there a two papers with a similar message about unemployment insurance in this week’s issue of NEP-DGE. Both argue that UI is essential in getting good fits on the labor market. This is especially true as the jobs and the labor market become more and more specialized.

Home Equity Extraction and the Boom-Bust Cycle in Consumption and Residential Investment

February 27, 2018

By Xiaoqing Zhou


The consumption boom-bust cycle in the 2000s coincided with large fluctuations in the volume of home equity borrowing. Contrary to conventional wisdom, I show that homeowners largely borrowed for residential investment and not consumption. I rationalize this empirical finding using a calibrated two-goods, multiple-assets, heterogeneous-agent life-cycle model with borrowing frictions. The model replicates key features of the household-level and aggregate data. The model offers an alternative explanation of the consumption boom-bust cycle. This cycle is caused by large fluctuations in the number of borrowers and hence in total home equity borrowing, even though the fraction of borrowed funds spent on consumption is small.

That is going to surprise quite a few: there was no borrowing frenzy and real estate was not being used as a cash cow for consumption. The increase in total borrowing was just the result of the expansion of the extensive margin, not the intensive margin.