Showing papers in "B E Journal of Macroeconomics in 2020"

The welfare effects of infrastructure investment in a heterogeneous agents economy

Abstract: Public infrastructure is one of the foundations for the economic growth of a country. While there is a strong consensus regarding infrastructure’s effect on growth, less is known about the effect of infrastructure on welfare and the distribution of wealth. In this paper, we examine the quantitative effect of infrastructure investment on welfare and the degree of inequality present within a developing country. In so doing, we characterize the effects resulting from increased infrastructure investment by tracing out the entire transition path between steady states. Three results standout: (i) both average and individual welfare effects are sizable, regardless of how the additional investment is financed, (ii) when distortionary taxes are adjusted to finance additional investment, poorer agents benefit more when the interest income tax is used, while richer agents benefit more when either the consumption or labor income taxes are used, (iii) inequality, as measured by the wealth Gini, rises in the short-run, but the long-run effect depends on which financing method is chosen.

The macroeconomic impact of shocks to bank capital buffers in the Euro Area

Abstract: While the global financial crisis revealed a need for macroprudential policy tools to mitigate the build-up of risk in the financial system, the impact of such policies on the banking sector and the macroeconomy remains largely uncertain. We contribute to the empirical literature that estimates the impact of shocks to bank capital buffers on bank lending and the macroeconomy by estimating a Bayesian VAR model identified with sign restrictions. We use bank-level data for large euro area listed banks to construct an aggregate bank capital buffer for the euro area, which is included as another variable in the model. We estimate three shocks affecting the euro area economy, namely a demand shock, a monetary policy shock and a shock to bank capital buffers. We find that banks curtail lending and reduce their relative exposure to riskier assets in response to a shock to the bank capital buffer. Historical shock decomposition analysis shows that shocks to bank capital buffers have contributed to impair bank lending growth and to widen bank lending spreads, hence depressing economic activity.

An empirical study on the New Keynesian wage Phillips curve: Japan and the US

Abstract: We present an empirical analysis on the New Keynesian Wage Phillips Curve (NKWPC), which is derived by Gali (2011) as a micro-founded structural relationship between wage inflation and the unemployment rate under a sticky wage framework using data for Japan and the US. We find that the empirical fit of the NKWPC is generally superior for Japan. We also find that the slope of the NKWPC is much steeper in Japan than in the US. These results suggest that wages are less sticky in Japan than in the US. Inflation indexation plays a key role in the US, but is less important in Japan. Rolling estimations indicate that the NKWPC has flattened over time in Japan. Analysis of recent data indicates that in both countries the role of inflation indexation is quantitatively smaller than before, although this result might be influenced by low and stable inflation rates over the past few decades.

Home Production and Leisure during the COVID-19 Recession

Abstract: Between the months of February and April of 2020, average weekly market hours in the U.S. dropped by 6.25, meanwhile 36% of workers reported switching to remote work arrangements. In this paper, we examine implications of these changes for the time allocation of different households, and on aggregate. We estimate that home production activity increased by 2.65 h a week, or 42.4% of lost market hours, due to the drop in market work and rise in remote work. The monthly value of home production increased by $39.65 billion - that is 13.55% of the concurrent $292.61 billion drop in monthly GDP. Although market hours declined the most for single, less educated individuals, the lost market hours were absorbed into home production the most by married individuals with children. Adding on the impact of school closures, our estimate of weekly home production hours increases by as much as 4.92 h. The increase in the value of monthly home production between February and April updates to $73.57 billion. We also report the estimated impact of labor markets and telecommuting on home production for each month in 2020. © 2021 Walter de Gruyter GmbH, Berlin/Boston 2021.

The welfare cost of inflation with banking time

Abstract: The paper presents the welfare cost of inflation in a banking time economy that models exchange credit through a bank production approach. The estimate of welfare cost uses fundamental parameters of utility and production technologies. It is compared to a cash-only economy, and a Lucas (2000) shopping economy without leisure, as special cases. The paper estimates the welfare cost of a 10% inflation rate instead of zero, for comparison to other estimates, as well as the cost of a 2% inflation rate instead of a zero inflation rate. The zero rate is specified as the US inflation rate target in the 1978 Employment Act amendments. The paper provides a conservative welfare cost estimate of 2% inflation instead of zero at $33 billion a year. Estimates of the percent of government expenditure that can be financed through a 2% vs. zero inflation rate are also provided.

Dynamics of female labor force participation and welfare with multiple social reference groups

Abstract: I develop a model with status concerns to analyze how different economic factors affect female labor participation and welfare, as well as average household incomes and wages. Reductions in the price of domestic goods and increases in female wages have positive effects on female participation. Increases in male wages have different effects on female participation depending on whether they affect female wages or not. Events that lead to increases in female participation are usually associated with decreases in the welfare of stay-at-home wives but are not necessarily associated with increases in welfare of working wives. Allowing for part-time work can lead to an increase in overall female labor force participation, but some women that would have worked full-time end up working part-time. If female wages are endogenous, an increase in male wages leads to an increase in the female participation rate even if it is not associated with a decrease in the gender wage gap. The positive feedback of increased female participation on their wages can lead to hysteresis of dual equilibria of high and low female labor force participation and a discontinuous transition between these equilibria.

Shadow Bank Run, Housing and Credit Market: The Story of a Recession

Abstract: This paper proposes a DSGE model with bank runs which improves Gertler and Kiyotaki (2015) to assess the impact of housing and credit markets in financial instability and shadow banking activities. This paper illustrates that a negative TFP shock is amplified by macro-financial and macro-housing channels through household’s balance sheet, bank’s balance sheet and liquidity channels. If the shock makes the shadow banking system insolvent, two equilibria, no-run and run equilibrium, coexist. In this view, run is a sunspot coordination failure; if households receive a negative signal from fundamentals and stop rolling over deposits to the financial sector, banks are not able to fund their losses by new deposits. So they are forced to liquidate their assets at an endogenous fire sale price. The main finding of this paper is that the model with housing comprehensively details the consequences of economic crises, namely home price double-dip, the output downward spiral and lengthy recovery period. In addition, the paper indicates that macroprudential policy tools in the form of capital adequacy buffers and loan-to-value ratios can be helpful for eliminating bank-run equilibrium. They safeguard the economy against extreme busts and help mitigate systemic risks by insulating asset prices.

Financial Deepening in a Two-Sector Endogenous Growth Model with Productivity Heterogeneity

Abstract: We develop a tractable two-sector endogenous growth model in which heterogeneous entrepreneurs face borrowing constraints and the government collects tax to fund public eduction. This model is isomorphic to a Uzawa-Lucas model and there exists a balanced-growth path equilibrium in which the growth rate depends on the financial deepening level. We show that the policy tax rate exerts inverted U-shaped effects on the growth rate. Additionally, at the optimal policy tax rates the model's predictions are consistent with correlational regularities documented from 35 OECD countries with regards to financial deepening, factor accumulation and working hours.

Household borrowing constraints and monetary policy in emerging economies

Abstract: Credit markets in emerging economies can be distinguished from those in advanced economies in many respects, including the collateral required for households to borrow This work proposes a DSGE framework to analyze one peculiarity that characterizes the credit markets of some emerging markets: payroll-deducted personal loans We add the possibility for households to contract long-term debt and compare two different types of credit constraints with one another, one based on housing and the other based on future income We estimate the model for Brazil using a Bayesian technique The model is able to solve a puzzle of the Brazilian economy: responses to monetary shocks at first appear to be strong but dissipate quickly This occurs because income – and the amount available for loans – responds more rapidly to monetary shocks than housing prices To smooth consumption, agents (borrowers) compensate for lower income and for borrowing by working more hours to repay loans and erase debt in a shorter time Therefore, in addition to the income and substitution effects, workers consider the effects on their credit constraints when deciding how much labor to supply, which becomes an additional channel through which financial frictions affect the economy

Job competition, human capital, and the lock-in effect: can unemployment insurance efficiently allocate human capital

Abstract: Workers, firms and policymakers often face a trade-off between shorter unemployment spells on the one hand, and better quality matches on the other. During recessions this manifests itself through job competition, where high skilled workers misallocate their labor to positions for which they are over-qualified in order get back to work faster. In the presence of job-specific human capital, as high skilled workers gain experience in this low skilled sector they may find themselves “locked in” to these jobs. This is because workers will not want to lose their seniority by searching for a job that better utilizes their general human capital. As a result, this misallocation can persist even in economic recoveries leading to inefficient outcomes. This paper explores such an economy and finds that a UI system that becomes more generous during a recession increases welfare and better allocates human capital over the business cycle.

Animal spirits in an open economy: an interaction-based approach to the business cycle

Abstract: This paper examines the effects of boundedly rational expectation on the business cycle in a two-country New Keynesian model. Forecast heuristics in a closed-economy, De Grauwe’s (2011) model, is extended, and the effects of heterogeneous agents are incorporated in an open economy. In particular, the expectation formation process is constrained by waves of optimists and pessimists – the so-called “animal spirits.” As a result, the model is able to explain group behavior based on forecast performance, which has significant effects on output and inflation dynamics in the two countries. The simulation results suggest that heterogeneity in group behavior and nominal rigidities, as well as a moderate degree of international trade, amplify spillover effects on international business cycles leading to high cross-correlations in output and inflation.

Fiscal policy and the output costs of sovereign default

Abstract: We introduce fiscal policy into a sovereign debt model with endogenous default costs and examine the implications for the determination of the output costs of default. We find that the quantitative properties of the output costs of default, and their dependence on primitives such as the elasticity of labor supply, are distinctly different depending on the margin of fiscal adjustment. The consideration of fiscal policy thus has potentially important implications for the quantitative properties of models of sovereign debt and default.

Supply-side Effects of Pandemic Mortality: Insights from an Overlapping-generations Model

Abstract: We use an overlapping-generations model to explore the implications of mortality during pandemics for the economy's productive capacity. Under current epidemiological projections for the progression of COVID-19, our model suggests that mortality will have, in itself, only small effects on output and factor prices because projected mortality is small in proportion to the population and skewed toward individuals who are retired from the labor force. That said, we show that if the spread of COVID-19 is not contained, or if the ongoing pandemic were to follow a mortality pattern similar to the 1918-1920 Great Influenza pandemic, then the effects on the productive capacity would be economically significant and persist for decades. © 2021 Walter de Gruyter GmbH, Berlin/Boston 2021.

Computing sunspot solutions to rational expectations models with timing restrictions

Abstract: Rational expectations (RE) frameworks featuring informational constraints are becoming increasingly popular in macroeconomic research. A recent strand of literature has explored the analytics of RE models with informational subperiods, in which the occurrence of exogenous shocks is period-specific and decision makers condition their own choices and expectations upon a sequence of nested information sets (timing restrictions). Assuming the unrestricted (full information) RE model satisfies saddle-path stability, this paper provides (i) necessary and sufficient conditions for existence of an uncountably infinite set of linearly perturbed solutions to its restricted (informationally constrained) counterpart, and (ii) an algorithm for computing the full set of sunspot solutions when equilibrium indeterminacy occurs.

Risk averse banks and excess reserve fluctuations

Abstract: Abstract We develop a model to study how risk averse banks use excess reserves to manage risk on their asset portfolios. Our model predicts that risk averse banks accumulate substantial holdings of excess reserves in response to large, low-probability shocks to the risk on loans. Our findings support the hypothesis that risk aversion led banks to build-up excess reserves within the US banking system in September of 2008 following news about the failure of Lehman Brothers and the credit downgrade of AIG. Moreover, our model also explains the magnitude of excess reserve fluctuations observed in the US over typical business cycles.

Foreign official holdings of US treasuries, stock effect and the economy: a DSGE approach

Abstract: Previous studies focus on quantifying the effect of foreign official holdings of long-term U.S Treasuries (FOHL) on the long-term interest rate. The consensus is that FOHL has a large and negative effect on the long-term interest rate. The long-term interest rate matters in determining aggregate demand, (Andres et al., 2004). However, these studies discount the macroeconomic implications of FOHL on the U.S economy. This paper extends the literature and studies the macroeconomic implications of FOHL shocks through their impact on the long-term interest rate in a dynamic stochastic general equilibrium (DSGE) model. The model treats short and long-term government bonds as imperfect substitutes through endogenous portfolio adjustment frictions(costs). Three main findings emerge from the baseline model: (1) A positive shock to FOHL impacts the long-term interest rate negatively through a stock effect channel-defined as persistent changes in interest rate as a result of movement along the Treasury demand curve. This result is consistent with the empirical literature; (2) The decline in the long-term interest rate creates favorable economic conditions that feed back into the economy and increases consumption, output and inflation through an endogenous term structure implied by the model and; (3) Monetary authority responds to the increase in inflation and output by raising the short-term interest rate. The simultaneous increase in the short-term interest rate and fall in the long-term interest rate causes the term spread to fall. This last result sheds light on the decoupling of interest rates observed between 2004-2006, a phenomenon known as the ``Greenspan Conundrum". The findings from the DSGE model are supported by impulse response functions obtained from a structural near-Vector Auto-regression(near-VAR) model.

Liquidity constraints, international trade, and optimal monetary policy

Abstract: The availability of liquidity matters for an economy’s production and trade as firms need working capital to finance their operations. This paper studies the interaction between trade and capital flows operating through the liquidity allocations in the financial markets using a small-open-economy, overlapping-generations model. Working capital requirements distort the intratemporal consumption allocations. International capital inflows help easing liquidity in the domestic credit market, facilitating trade and improving the intratemporal allocation, while distorting the intertemporal allocation of the economy. We show how the government can use the Friedman rule and differentiated consumption taxes to address the tradeoff between the intratemporal and intertemporal distortions and achieve the second best optimum. Imposing a higher tax rate on imports can reduce the international borrowing to imports ratio and enhance the efficiency in using capital inflows to facilitate trade flows.

Technology and the two margins of labor adjustment: a New Keynesian perspective

Abstract: Canova et al. [Canova, F., J. D. Lopez-Salido, and C. Michelacci. 2010. “The Effects of Technology Shocks on Hours and Output: A Robustness Analysis.” Journal of Applied Econometrics 25: 755–773; Canova, F., J. D. Lopez-Salido, and C. Michelacci. 2012. “The Ins and Outs of Unemployment: An Analysis Conditional on Technology Shocks.” The Economic Journal 123: 515–539] estimate the dynamic response of labor market variables to technological shocks. They show that investment-specific shocks imply predominantly an adjustment along the intensive margin (i.e., hours per worker), whereas for neutral shocks the largest share of the adjustment takes place along the extensive margin (i.e., employment). In this paper we develop a New Keynesian model featuring capital accumulation, two margins of labor adjustment and a hiring cost. The model is used to analyze a novel economic mechanism to explain that evidence.

Optimal monetary policy in a model of vertical production and trade with reference currency

Abstract: This paper examines optimal monetary policy rules in a model of vertical production and trade with reference currency. As evidenced by empirical findings, we assume that final-goods prices are sticky, but intermediate-goods prices are flexible. We find that even if intermediate-goods prices are flexible, monetary authorities need to respond to the shocks at the stage of intermediate-goods production. We also find that, when a shock occurs at the stage of final-goods production, monetary responses are independent of the expenditure share of final-goods producers on intermediate goods. For the first time in the literature, our model gives a condition under which both countries are willing to participate in monetary cooperation. Thus the gains from cooperation are real. In addition, we compare the volatility of the nominal exchange rate in Nash case with that in cooperative case, and compare the volatility of the nominal exchange rate in our model with that in a model without vertical production and trade as well. We also extend the model to consider a case of dual price stickiness. We find that the change in solution methods completely alters the conclusions of the model.

Middlemen: A Directed Search Equilibrium Approach

Abstract: This paper studies an intermediated market for a homogeneous good with middlemen who hold inventories of the good. Using a directed search approach, I investigate a steady state equilibrium. Under market frictions and competition, the ask price of middlemen includes a retail premium for the immediacy service to buyers and the bid price includes a wholesale premium charged to sellers for guaranteed sale. It is shown that the middlemen enhance the economy-wide eciency, and that the bid-ask spread can be non-monotone in the middlemen’s inventory capacity. The simple model provided here has wide applicability and oers economic insights into many empirically relevant forms of middlemen, especially in the context of financial intermediaries, international trade and retail stores.

Dynamic effects of consumption tax reforms with durable consumption

Abstract: This paper introduces durables into a dynamic general equilibrium overlapping generation model with idiosyncratic income shocks and endogenous borrowing constraints, which depend on durables. The aim of this paper is to evaluate the welfare effects of consumption tax reforms in a richer model that captures the difference between nondurable and durable consumption. When durables are considered, the standard results that a shift to consumption taxes is welfare improving are overturned. The mechanism of this opposing result is that consumption tax makes durable consumption more expensive without relaxing the borrowing constraint. The inability of borrowing to insure against income risk deviates the economy further away from market completeness and particularly hurts young and poor households. As a result, welfare decreases, coupled with negative redistribution.

Monitoring and coordination for essentiality of money

Abstract: For money to be essential, environments have been considered in which there is imperfect monitoring of past actions and in which it is difficult to coordinate among economic agents. This paper provides an environment in which there is no monitoring of past actions while coordination is difficult. In this environment, we show that the first best allocation is achieved without money, and hence, money is not essential. The implication is that, for money to be essential, no monitoring is not enough but coordination must also be free.

International Trade and Productivity after Apartheid

Abstract: International trade fell in South Africa from the 1970s to the mid-1990s, and climbed fast thereafter, coinciding with the imposition and later removal of apartheid sanctions. Productivity followed suit. This paper explores the extent to which the increase in trade can account for the increase in productivity after apartheid. I use a model of international trade with innovation and calibrate it to match key macroeconomic variables. Non-tariff barriers, mostly related to apartheid sanctions, account for over half the changes in aggregate productivity. Tariffs play a very minor role, in line with existing studies.

Ramsey income taxation in a small open economy with trade in capital goods

Abstract: In this paper, the optimal taxation problem in a small open economy with international trade in capital or investment goods is investigated. The monopolistic power of a small open economy over the terms of trade causes distortions in consumption and investment. The results suggest that due to the external distortion in investment, the long-run optimal capital income tax could be positive under the baseline calibration, and it is increasing in the degree of investment openness and decreasing in the elasticity of substitution between domestic and foreign goods. The long-run optimal labor income tax exhibits the opposite relationships with the openness and elasticity parameters. During the course of business cycles, the fluctuations in the external distortions cause the optimal labor income tax to be more volatile and the optimal capital income tax to be less volatile than their closed-economy counterparts.

Prospect Theory and sentiment-driven fluctuations

Abstract: In this paper we aim to present a novel channel through which the volatility of the monetary/financial sector affects the instability of the real macroeconomic variables originated by self-fulfilling market sentiments. To this aim, we insert some elements of Prospect Theory in the preferences of agents living in an overlapping generations economy where consumers’ heterogeneity and firms’ imperfect information on the level of aggregate demand allow market sentiments to affect the equilibrium path of the economy under rational expectations. In this environment, greater heterogeneity in the household’s narrow framing parameter and in the degree of competition in goods markets favor the emergence of self-fulfilling equilibria by exacerbating the coordination problem generated by a pair-wise matching process taking place in the labor market. Furthermore, the more dispersed are agents’ deviations from standard rationality the higher is the volatility of the economy due to sentiment fluctuations. Finally, a higher volatility of the money/financial market, by increasing the effect of Prospect Theory on households’ choices under risk, increases the noise of the signal upon which firms make their hiring decisions; this, in its turn, generates greater variability in market sentiments and hence in real economic activity.

The financial accelerator and marketable debt: the prolongation channel

Abstract: This paper investigates the effects of mark-to-market accounting for risky liabilities on the business cycle. While marking assets to market results in an amplification of the business cycle, as is well-known from the financial accelerator model a la Bernanke, Gertler, and Gilchrist [Bernanke, B. S., M. Gertler, and S. Gilchrist. 1999. “The Financial Accelerator in a Quantitative Business Cycle Framework.” In Handbook of Macroeconomics, edited by J. Taylor and M. Woodford, Elsevier.], allowing for debt with a specific maturity priced at market value generates ambiguous effects. Changes in the market price of debt affects firms’ net worth since the accounting principle takes the perspective of repurchasing debt. This is called the prolongation channel of debt. Real economic activity is attenuated as long as asset and debt prices move in the same direction, whereas the response of debt prices is stronger. This happens for a monetary policy shock or a shock to total factor productivity. Amplification occurs if both prices move in opposite directions, as is the case for a demand shock. The implications for the business cycle eventually depend on the occurrence of shocks. Implementing mark-to-market accounting for liabilities in a model for the US yields a higher volatility of the business cycle.

Robust learning in the foreign exchange market

Abstract: This paper studies risk premia in the foreign exchange market when investors entertain multiple models for consumption growth. Investors confront two sources of uncertainty: (1) individual models might be misspecified, and (2) it is not known which of these potentially misspecified models is the best approximation to the actual data-generating process. Following Hansen and Sargent (Hansen, L. P., and T. J. Sargent. 2010. “Fragile Beliefs and the Price of Uncertainty.” Quantitative Economics 1 (1): 129–162.), agents formulate “robust” portfolio policies. These policies are implemented by applying two risk-sensitivity operators. One is forward-looking, and pessimistically distorts the state dynamics of each individual model. The other is backward-looking, and pessimistically distorts the probability weights assigned to each model. A robust learner assigns higher weights to worst-case models that yield lower continuation values. The magnitude of this distortion evolves over time in response to realized consumption growth. It is shown that robust learning not only explains unconditional risk premia in the foreign exchange market, it can also explain the dynamics of risk premia. In particular, an empirically plausible concern for model misspecification and model uncertainty generates a stochastic discount factor that uniformly satisfies the spectral Hansen-Jagannathan bound of Otrok et al. (Otrok, C., B. Ravikumar, and C. H. Whiteman. 2007. “A Generalized Volatility Bound for Dynamic Economies.” Journal of Monetary Economics 54 (8): 2269–2290.).

Is Unemployment on Steroids in Advanced Economies

Abstract: Conventional macroeconomic theory is based on the idea that demand shocks can only have temporary effects on unemployment, however several European economies display highly persistent unemployment dynamics. The theory of hysteresis points out that, under certain conditions, demand disturbances can have permanent effects. We find strong evidence of unemployment hysteresis in advanced economies since the 1990s. Relying on an identification scheme instigated by an insider/outsider model, we exploit the heterogeneity in impulse responses to demand shocks to investigate what labor institutions soften or amplify these responses. Our results indicate that strengthening labor institutions that promote a faster adjustment of real wages, removing disincentives for firms to hire and for workers to be employed, and improving the matching between labor supply and demand can lessen the effects of adverse demand shocks and lead to a faster reversion of unemployment rates to pre-shock levels.

Agency Costs and the Monetary Transmission Mechanism

Abstract: Once New Keynesian (NK) theory (see, e.g., Woodford 2003) is combined with a standard model of investment (see, e.g., Thomas 2002), the resulting framework loses its ability to generate a realistic monetary transmission mechanism. This is the puzzle uncovered in Reiter et al. (2013). The simple economic reason behind it is the unrealistically large interest rate elasticity of investment, as implied by standard investment theory. In order to address this puzzle we develop a NK model featuring fully flexible investment combined with a financial friction in the spirit of Carlstrom and Fuerst (1997). This model is used to isolate the quantitative importance of the financial friction for the monetary transmission mechanism.

Collateral and Development

Abstract: This paper presents a model economy with endogenous credit constraints a la Kiyotaki-Moore and endogenous growth a la Uzawa-Lucas, in which agents face a trade-off between investing resources to improve the pledgeability of collateral assets and the accumulation of human capital. The model generates both growth miracles and stagnant economies.