Pension Policies in a Model with Endogenous Fertility

June 19, 2018

By Giam Pietro Cipriani and Francesco Pascucci

We set up an overlapping generations model with endogenous fertility to study pensions policies in an ageing economy. We show that an increasing life expectancy may not be detrimental for the economy or the pension system itself. On the other hand, conventional policy measures, such as increasing the retirement age or changing the social security contribution rate could have undesired general equilibrium effects. In particular, both policies decrease capital per worker and might have negative effects on the fertility rate, thus exacerbating population ageing.

This paper is a perfect illustration of how general equilibrium effects can be very important and even deliver very counter-intuitive results if you were conditioned by partial equilibrium results. Will this convince policymakers?


Monetary Policy and Inequality under Labor Market Frictions and Capital-Skill Complementarity

June 18, 2018

By Juan Dolado, Gergö Motyovszki and Evi Pappa

In order to improve our understanding of the channels through which monetary policy has distributional consequences, we build a New Keynesian model with incomplete asset markets, asymmetric search and matching (SAM) frictions across skilled and unskilled workers and, foremost, capital-skill complementarity (CSC) in the production function. Our main finding is that an unexpected monetary easing increases labor income inequality between high and low-skilled workers, and that the interaction between CSC and SAM asymmetry is crucial in delivering this result. The increase in labor demand driven by such a monetary shock leads to larger wage increases for high-skilled workers than for low-skilled workers, due to the smaller matching frictions of the former (SAM-asymmetry channel). Moreover, the increase in capital demand amplifies this wage divergence due to skilled workers being more complementary to capital than substitutable unskilled workers are (CSC channel). Strict inflation targeting is often the most successful rule in stabilizing measures of earnings inequality even in the presence of shocks which introduce a trade-off between stabilizing inflation and aggregate demand.

One could argue that the mandate of central banks is for aggregate outcomes, not distributional ones, and that fiscal policy is much more suited than monetary policy to address redistribution. However, monetary policy also should not unnecessarily undo what fiscal policy is trying to do (and vice-versa). Combining aggregate and distributional goals is hard, in part because the objective function needs to be defined, and in part because the policy formation is difficult. This paper is a step in that direction for the second difficulty.

Jobless Recovery, Liquidity Trap, Tight Monetary Policy and the Cost Channel

June 16, 2018

By Lasitha R.C. Pathberiya

In this study, I examine the robustness of an unconventional monetary policy in a cost channel economy. The unconventional monetary policy proposed by Schmitt-Grohé and Uribe (2017, American Economic Journal: Macroeconomics, SGU henceforth), recommends a tight monetary policy during a liquidity-trapped recession to stimulate the economy and to avoid jobless recovery. The results of my study show that the existence of the cost channel implies that the SGU policy induces sharp initial contractions in the employment rate and the growth rate, and a sharp increase in inflation following a negative confidence shock. Welfare is lower in cost channel economies compared to no-cost channel economies due to the SGU policy recommendation. Two alternative interest rate-based exit policies are also examined. The Overshoot interest rate policy, irrespective of the presence of the cost channel, is superior to the SGU policy with regard to welfare. The Staggered policy has lower immediate pain in the cost channel economy compared to the SGU policy or the Overshoot policy. However, welfare-wise, the Staggered policy is inferior to the other two policies examined in both economies considered.

In other words, one should not be afraid to use shock therapy. Easier said than done for a policymaker.

Capital Income Taxation, Economic Growth, and the Politics of Public Education

June 15, 2018

By Tetsuo Ono and Yuki Uchida

This study considers the politics of public education and its impacts on economic growth and welfare across generations. Public education is funded by taxing the labor income of the working generation and capital income of the retired. We employ probabilistic voting to demonstrate the politics of taxes and expenditure and show that aging results in a shift of the tax burden from the old to the young and a slowdown of economic growth. We then consider three alternative constraints that limit the choice of taxes and/or expenditure: a minimum level of public education expenditure, an upper limit of the capital income tax rate, and a combination of the two. These constraints all create a trade-off between current and future generations in terms of welfare.

Japan worried about the consequences of population ageing on the economy. Not only is the share of the working-age population declining, it is also decreasing in absolute numbers. This paper highlights yet another worry: The old will vote for less public education.

Sovereign Money Reforms and Welfare

May 15, 2018

By Philippe Bacchetta and Elena Perazzi

A monetary reform is submitted for vote to the Swiss people in 2018. The Sovereign Money Initiative proposes that all sight deposits should be controlled by the Swiss National Bank (SNB) and that the SNB could distribute its additional resources. While a sovereign money reform would clearly affect the structure of the banking sector, it would also have macroeconomic implications, in particular because it transfers resources from banks to the central bank. The objective of this paper is to analyze these macroeconomic implications using a simple infinite-horizon open-economy model calibrated to the Swiss economy. While we consider several policy experiments, we find that there is a key trade-off between a reduction in distortionary labor taxes and an increase in the opportunity cost of holding money. However, in the proposed Swiss reform it is this latter cost that dominates and we find that the reform unambiguously lowers welfare.

Swiss get to vote on all sorts of proposals, some of them rather silly. This time it is about “full money”, i.e., banks cannot create money except through the central bank. The paper shows nicely how this is a bad idea. I hope the Swiss can follow expert advice.

Crisis, contagion and international policy spillovers under foreign ownership of banks

May 14, 2018

By Michał Brzoza-Brzezina, Marcin Kolasa and Krzysztof Makarski

This paper checks how international spillovers of shocks and policies are modified when banks are foreign owned. To this end we build a two-country macroeconomic model with banking sectors that are owned by residents of one (big and foreign) country. Consistently with empirical findings, in our model foreign ownership of banks amplifies spillovers from foreign shocks. It also strengthens the international transmission of monetary and macroprudential policies. We next use the model to replicate the financial crisis in the euro area and show how, by preventing bank capital outflow in 2009, the Polish regulatory authorities managed to reduce its contagion to Poland. We also find that under foreign bank ownership such policy is strongly preferred to a recapitalization of domestic banks. Finally, we check how foreign ownership of banks affects transmission of domestic shocks to find that it has a stabilizing effect.

Interesting idea that foreign ownership of banks could serve as insurance mechanism against domestic shocks. I wonder, however, how a policy of preventing capital outflow could influence the incidence of foreign ownership, though.

Time-Consistent Consumption Taxation

May 13, 2018

By Sarolta Laczo and Raffaele Rossi

We characterise optimal tax policies when the government has access to consumption taxation and cannot credibly commit to future policies. We consider a neoclassical economy where factor income taxation is distortionary within the period, due to endogenous labour and capital utilisation and non-tax-deductibility of depreciation. Contrary to the case where only labour and capital income are taxed, the optimal time-consistent policies with consumption taxation are remarkably similar to their Ramsey counterparts. The welfare gains from commitment are negligible, while they are substantial without consumption taxation. Further, the welfare gains from taxing consumption are much higher without commitment.

I am getting more and more confused by the optimal tax literature. The reason is that there are so many complete reversals of the results when some assumptions are changed. This paper is one example. If you have a good understanding of this literature, I have a project for you, please contact me.