Credit and Saving Constraints in General Equilibrium: Evidence from Survey Data

June 14, 2017

By Catalina Granda, Franz Hamann and Cesar E. Tamayo

In this paper, we build a heterogeneous agents-dynamic general equilibrium model wherein saving constraints interact with credit constraints. Saving constraints in the form of fixed costs to use the financial system lead households to seek informal saving instruments (cash) and result in lower aggregate saving. Credit constraints induce misallocation of capital across producers that in turn lowers output, productivity, and the return to formal financial instruments. We calibrate the model using survey data from a developing country where informal saving and credit constraints are pervasive. Our quantitative results suggest that completely removing saving and credit constraints can have large effects on saving rates, output, TFP, and welfare. Moreover, we note that a sizable fraction of these gains can be more easily attained by a mix of moderate reforms that lower both types of frictions than by a strong reform on either front.

Nice paper that shows how financial development can have some dramatic impact, and that relatively little reform can yield significant benefits.

Knightian uncertainty and credit cycles

June 13, 2017

By Eddie Gerba and Dawid Żochowski

The Great Recession has been characterised by the two stylized facts: the buildup of leverage in the household sector in the period preceding the recession and a protracted economic recovery that followed. We attempt to explain these two facts as an information friction, whereby agents are uncertain about a new state of the economy following a financial innovation. To this end, we extend Boz and Mendoza (2014) by explicitly modelling the credit markets and by modifying the learning to an adaptive set-up. In our model the build-up of leverage and the collateral price cycles takes longer than in a stylized DSGE model with financial frictions. The boom-bust cycles occur as rare events, with two systemic crises per century. Financial stability is achieved with an LTV-cap regulation which smooths the leverage cycles through quantity (higher equity participation requirement) and price (lower collateral value) effects, as well as by providing an anchor in the learning process of agents.

Interesting hypothesis that the prolonged recovery is due to economic agents tapping in the dark. One could say the same of policy makers, and of economic agents trying to read them, and vice-versa.

Should Unconventional Monetary Policies Become Conventional?

June 1, 2017

By Dominic Quint and Pau Rabanal

The large recession that followed the Global Financial Crisis of 2008-09 triggered unprecedented monetary policy easing around the world. Most central banks in advanced economies deployed new instruments to affect credit conditions and to provide liquidity at a large scale after shortterm policy rates reached their effective lower bound. In this paper, we study if this new set of tools, commonly labeled as unconventional monetary policies (UMP), should still be used when economic conditions and interest rates normalize. In particular, we study the optimality of asset purchase programs by using an estimated non-linear DSGE model with a banking sector and long-term private and public debt for the United States. We find that the benefits of using such UMP in normal times are substantial, equivalent to 1.45 percent of consumption. However, the benefits from using UMP are shock-dependent and mostly arise when the economy is hit by financial shocks. When more traditional business cycle shocks (such as supply and demand shocks) hit the economy, the benefits of using UMP are negligible or zero.

Few have tackled seriously the modeling of unconventional monetary policy. While one may argue about several of their modeling choices, Quint and Rabanal have the merit of taking a stand and setting the basis for analysis. And their results should provide fodder to possibly making unconventional policy conventional.

Exchange Rate Disconnect in General Equilibrium

May 21, 2017

By Oleg Itskhoki and Dmitry Mukhin

We propose a dynamic general equilibrium model of exchange rate determination, which simultaneously accounts for all major puzzles associated with nominal and real exchange rates. This includes the Meese-Rogoff disconnect puzzle, the PPP puzzle, the terms-of-trade puzzle, the Backus- Smith puzzle, and the UIP puzzle. The model has two main building blocks — the driving force (or the exogenous shock process) and the transmission mechanism — both crucial for the quantitative success of the model. The transmission mechanism — which relies on strategic complementarities in price setting, weak substitutability between domestic and foreign goods, and home bias in consumption — is tightly disciplined by the micro-level empirical estimates in the recent international macroeconomics literature. The driving force is an exogenous small but persistent shock to international asset demand, which we prove is the only type of shock that can generate the exchange rate disconnect properties. We then show that a model with this financial shock alone is quantitatively consistent with the moments describing the dynamic comovement between exchange rates and macro variables. Nominal rigidities improve on the margin the quantitative performance of the model, but are not necessary for exchange rate disconnect, as the driving force does not rely on the monetary shocks. We extend the analysis to multiple shocks and an explicit model of the financial sector to address the additional Mussa puzzle and Engel’s risk premium puzzle.

After all those years, we still do not have a good model of exchange rates. This paper advances an idea I had not seen before, international asset demand shocks, that I had not seen before. Results look really promising. We’ll see whether this will stick to the wall.

House Prices, Geographical Mobility, and Unemployment

May 17, 2017

By Marcus Mølbak Ingholt

Geographical mobility correlates positively with house prices and negatively with unemployment over the U.S. business cycle. I present a DSGE model in which declining house prices and tight credit conditions impede the mobility of indebted workers. This reduces the workers’ cross-area competition for jobs, causing wages and unemployment to rise. A Bayesian estimation shows that this channel more than quadruples the response of unemployment to adverse housing market shocks. The estimation also shows that adverse housing market shocks caused the decline in mobility during the Great Recession. Absent this decline, the unemployment rate would have been 0.5 p.p. lower.

I have always been apprehensive about the policy recommendation to favor owner occupied housing. Think of the admittedly extreme example of Flint, Michigan, where workers lost their jobs when the factories closed and lost their assets as local house prices fell. It became impossible for them to move as they cannot afford housing elsewhere. This paper shows that this issue is no to be neglected in an aggregate way either, as it generates serious geographic miss-allocations of labor.

May 2017 calls for papers

May 15, 2017

Time for a round of calls for papers. Note that the QM&RBC Agenda tries to be current with those.

  • Workshop of the Australasian Macroeconomics Society, Canberra, 17-19 August 2017.

  • Workshop on Time-Varying Uncertainty in Macro, St. Andrews, 2-3 September 2017.

  • Canadian Macro Study Group, Ottawa, 10-11 November 2017.

  • Information heterogeneity, housing dynamics and the business cycle

    May 10, 2017

    By Zi-Yi Guo

    Empirical evidence shows that house prices are highly volatile and closely correlated with the business cycle, and the fact is at odds with the evidence that rental prices are relatively stable and almost uncorrelated with the business cycle. To explain the fact, we introduce information heterogeneity into a standard dynamic stochastic general equilibrium (DSGE) model with financial frictions. Agents are endowed with heterogeneous shocks, and rationally extract information from market activities. Since agents are confused by changes in average private signals about future fundamentals, the model generates an amplified effect of technology shocks on house prices, which accounts for the disconnect between house prices and the discounted sum of future rents. In addition, the model provides insights for the lead-lag relationship between residential and nonresidential investment over the business cycle. The solution method developed in this paper can be applied in other DSGE models with heterogeneous information.

    Interesting paper. While the emphasis is on the price volatility result, I find the implications for the leads-lags of residential and non-residential investment more exciting. This has been a tough nut to crack for a long time.