December 24, 2018
By Marco Bassetto, Zhen Huo and José-Víctor Ríos-Rull
This paper proposes a new equilibrium concept – organizational equilibrium – for models with state variables that have a time inconsistency problem. The key elements of this equilibrium concept are: (1) agents are allowed to ignore the history and restart the equilibrium; (2) agents can wait for future agents to start the equilibrium. We apply this equilibrium concept to a quasi-geometric discounting growth model and to a problem of optimal dynamic fiscal policy. We find that the allocation gradually transits from that implied by its Markov perfect equilibrium towards that implied by the solution under commitment, but stopping short of the Ramsey outcome. The feature that the time inconsistency problem is resolved slowly over time rationalizes the notion that good will is valuable but has to be built gradually.
This is not an easy paper and one that will take time to digest. However, this organizational equilibrium opens interesting avenues for the study of economic (and other) policies where the limited time horizon of policy makers leads to time inconsistencies.
December 20, 2018
By Oliver Pardo
This paper assess the macroeconomic and welfare effects of the 2017 tax reform in the US. This assessment is carried out by simulating the enacted business tax cuts in a dynamic general equilibrium model calibrated to replicate the household income distribution in the US. The simulation suggests that the cuts will lead to increases in investment, wages and output, although the welfare gains are quite unevenly distributed across households. Long-run investment increases by one percentage point of the baseline GDP, leading to a 1.3% increase in the steady-state wages and a 1.7% increase in the steady-state output. However, there is a sudden and permanent drop in tax revenue equivalent to 0.5% of the baseline GDP. The necessary cuts in government spending imply that households in the poorest quintile may face a welfare loss equivalent to 1.6% of the GDP. Mean-while, households in the richest quintile can expect a gain of 4.4% of the GDP. Overall, the welfare gains of all households add up 4.7% of the GDP. Hence, the aggregated welfare gains from all but the richest quintile is barely positive.
While the results are hardly surprising, it is nice to see a first evaluation of this tax policy using serious modeling. There should be more of it.
December 13, 2018
By Vladimir Asriyan, Luc Laeven and Alberto Martín
We develop a new theory of information production during credit booms. In our model, entrepreneurs need credit to undertake investment projects, some of which enable them to divert resources towards private consumption. Lenders can protect themselves from such diversion in two ways: collateralization and costly screening, which generates durable information about projects. In equilibrium, the collateralization-screening mix depends on the value of aggregate collateral. High collateral values raise investment and economic activity, but they also raise collateralization at the expense of screening. This has important dynamic implications. During credit booms driven by high collateral values (e.g. real estate booms), the economy accumulates physical capital but depletes information about investment projects. As a result, collateral-driven booms end in deep crises and slow recoveries: when booms end, investment is constrained both by the lack of collateral and by the lack of information on existing investment projects, which takes time to rebuild. We provide new empirical evidence using US firm-level data in support of the model’s main mechanism.
This is an interesting take at the slow recovery for the Great Recession. I am also wondering how this theory could explain endogenous herding behavior during such a boom.
December 6, 2018
By Wei Cui and Vincent Sterk
Is Quantitative Easing (QE) an effective substitute for conventional monetary policy? We study this question using a quantitative heterogeneous-agents model with nominal rigidities, as well as liquid and partially liquid wealth. The direct effect of QE on aggregate demand is determined by the difference in marginal propensities to consume out of the two types of wealth, which is large according to the model and empirical studies. A comparison of optimal QE and interest rate rules reveals that QE is indeed a very powerful instrument to anchor expectations and to stabilize output and inflation. However, QE interventions come with strong side effects on inequality, which can substantially lower social welfare. A very simple QE rule, which we refer to as Real Reserve Targeting, is approximately optimal from a welfare perspective when conventional policy is unavailable. We further estimate the model on U.S. data and find that QE interventions greatly mitigated the decline in output during the Great Recession.
This is a very interesting paper on a policy that is still poorly understood.
November 29, 2018
By Guilherme Bandeira, Jordi Caballé, and Eugenia Vella
High unemployment and fiscal austerity during the Great Recession have led to significant migration outflows in those European countries that suffered a deep deterioration of their economy, Greece being the most obvious case. This paper introduces endogenous migration in a small open economy DSGE model to analyze the business cycle effects from the interaction of fiscal consolidation instruments with migration. A tax-based consolidation induces the strongest increase in emigration, leading to the highest costs in terms of aggregate GDP and unemployment in the medium run. As a result, the unemployment gains from migration are only temporary. However, in terms of per capita GDP, cuts in the components of public spending that are either productive or utility-enhancing can lead to a deeper contraction than tax hikes or wasteful spending cuts. The introduction of potential migration by the employed implies even higher unemployment costs, a deeper demand contraction, and an increase in both the tax hike and the time required to achieve the same size of fiscal consolidation.
The same applies to internal migration and fiscal policy in a federal state. Important lessons here.
November 16, 2018
By Stéphane Auray, David L. Fuller and Damba Lkhagvasuren
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; private information associated with the UI non-collectors implies the market equilibrium is not Pareto optimal. The cause of the Pareto inefficiency is characterized along with the key features of collector vs. non-collector outcomes. Non-collectors transition to employment at a faster rate and a lower wage relative to the Pareto optimal arrival rates and wages. Quantitatively; this implies 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.
Why are people leave money on the sidewalk? There must be some sort of cost that people face in picking up that money. In the case on unemployment insurance, there is no clear and obvious cost, so the authors try it out with a heterogeneous utility cost to obtaining insurance benefits. Results are interesting and could lead the way to an identification strategy: try all the different potential reasons in a model and then check whether results make sense for observables.
November 8, 2018
By Hikaru Saijo
This paper studies the macroeconomic impact of an uncertainty shock about fiscal policy in a dynamic general equilibrium framework. Motivated by the observation that many fiscal policies are redistributive and that a sizable fraction of U.S. households do not own capital, I introduce household heterogeneity in the form of limited capital market participation. I show that household heterogeneity significantly magnifies the aggregate effect and induces co-movement of macroeconomic variables in a contraction that is generated by a fiscal uncertainty shock. This is because the limited capital market participation model captures individual uncertainty about redistribution that is absent in representative agent models. When agents are ambiguity averse, this uncertainty about redistribution has first-order effects because it shows up as heterogeneous worst-case scenarios. As a result, the model matches the empirical responses of macro variables to fiscal uncertainty shocks better than the representative agent counterpart.
Very simple point. And it is important as the quantitative exercise shows.