nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2015‒08‒13
28 papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Progressive Taxation as an Automatic Destabilizer under Endogenous Growth By Jang-Ting Guo; Shu-Hua Chen
  2. Optimal Capital and Progressive Labor Income Taxation with Endogenous Schooling Decisions and Intergenerational Transfers By Alexander Ludwig; Dirk Krueger
  3. Human Capital Risk, Contract Enforcement, and the Macroeconomy By Krebs, Tom; Kuhn, Moritz; Wright, Mark L. J.
  4. Cross-border banking and business cycles in asymmetric currency unions By Dräger, Lena; Proaño, Christian R.
  5. Technological Progress, Investment Frictions and Business Cycle: New Insights from a Neoclassical Growth Model By Michael Donadelli; Vahid Mojtahed; Antonio Paradiso
  6. Uncertainty and Fiscal Cliffs By Andrew Foerster; Troy Davig
  7. Aggregate and distributional effects of increasing taxes on top income earners By Brüggemann, Bettina; Yoo, Jinhyuk
  8. The Political Economy of Underfunded Municipal Pension Plans By Holger Sieg; Daniele Coen-Pirani; Jeffrey Brinkman
  9. Rational Inattention Dynamics: Inertia and Delay in Decision-Making By Filip Matejka; Colin Stewart; Jakub Steiner
  10. Macroprudential Policies in a Commodity Exporting Economy By Andrés González; Franz Hamann; Diego Rodríguez
  11. Debt Policy Rules in an Open Economy By Keiichi Morimoto; Takeo Hori; Noritaka Maebayashi; Koichi Futagami
  12. The labor market effect of demographic change: Alleviation for financing social security By Friese, Max
  13. Bank leverage, credit traps and credit policies By Foulis, Angus; Nelson, Benjamin; Tanaka, Misa
  14. Pensions, Education, and Growth: A Positive Analysis By Tetsuo Ono; Yuki Uchida
  15. Optimal tax progressivity: an analytical framework By Jonathan Heathcote; Kjetil Storesletten; Giovanni L. Violante
  16. Economic theory and forecasting: lessons from the literature By Raffaella Giacomini
  17. Macroprudential policy in a Knightian uncertainty model with credit-, risk-, and leverage cycles By Eddie Gerba; Dawid Zochowski
  18. Schumpeterian business cycles By Filip Rozsypal
  19. Clearing Up the Fiscal Multiplier Morass By Eric M. Leeper; Nora Traum; Todd B. Walker
  20. The Impact of Consumer Credit Constraints on Earnings, Sorting, and Job Finding Rates of Displaced Workers By Gordon Phillips; Kyle Herkenhoff
  21. Education, Social Mobility, and Talent Mismatch By Yuki Uchida
  22. What Measure of Inflation Should a Developing Country Central Bank Target? By Anand, Rahul; Prasad, Eswar; Zhang, Boyang
  23. (S)Cars and the Great Recession By Morten Ravn
  24. Exit Strategies and Trade Dynamics in Repo Markets By Aleksander Berentsen; Sébastien Philippe Kraenzlin; Benjamin Müller
  25. Capital Depreciation and Labor Shares Around the World: Measurement and Implications By Brent Neiman; Loukas Karabarbounis
  26. Multidimensional Skills, Sorting, and Human Capital Accumulation By Fabien Postel-Vinay; Jeremy Lise
  27. Cash and Pensions: Have the elderly in England saved optimally for retirement? By Rowena Crawford; Cormac O'Dea
  28. Monetary Shocks in Models with Inattentive Producers By francesco lippi; Luigi Paciello; Fernando Alvarez

  1. By: Jang-Ting Guo (Department of Economics, University of California Riverside); Shu-Hua Chen (National Taipei University)
    Abstract: It has been shown that in an otherwise standard one-sector real business cycle model with an indeterminate steady state under laissez faire, sufficiently progressive income taxation may stabilize the economy against aggregate fluctuations caused by agents' animal spirits. We show that this previous finding can be overturned within an identical model which allows for sustained endogenous growth. Specifically, progressive taxation may operate like an automatic destabilizer that leads to equilibrium indeterminacy and sunspot-driven cyclical fluctuations in an endogenously growing macroeconomy. This instability result is obtained under two tractable progressive tax policy formulations that have been considered in the existing literature.
    Keywords: Progressive Income Taxation, Automatic Stabilizer, Equilibrium Indeterminacy, Endogenous Growth.
    JEL: E62 O41
    Date: 2015–07
  2. By: Alexander Ludwig (Goethe University Frankfurt); Dirk Krueger (University of Pennsylvania)
    Abstract: In this paper we characterize quantitatively the optimal mix of progressive labor income and capital income taxes as well as and education subsidies in a model with endogenous human capital formation, borrowing constraints, income risk. and incomplete financial markets. Progressive labor income taxes provide social insurance against idiosyncratic income risk and redistributes after tax income among ex-ante heterogeneous households. In addition to the standard distortions of labor supply progressive taxes also impede the incentives to acquire higher education, generating a non-trivial trade-off for the benevolent utilitarian government. The latter distortion can potentially be mitigated by an education subsidy. We find that the welfare-maximizing fiscal policy is indeed characterized by a substantially progressive labor income tax code and a positive subsidy for college education. The optimal degree of the education subsidy is larger than in the current U.S. status quo.
    Date: 2015
  3. By: Krebs, Tom (University of Mannheim); Kuhn, Moritz (University of Bonn); Wright, Mark L. J. (Federal Reserve Bank of Chicago)
    Abstract: We use data from the Survey of Consumer Finance and Survey of Income Program Participation to show that young households with children are under-insured against the risk that an adult member of the household dies. We develop a tractable macroeconomic model with human capital risk, age-dependent returns to human capital investment, and endogenous borrowing constraints due to the limited pledgeability of human capital. We show analytically that, consistent with the life insurance data, in equilibrium young households are borrowing constrained and under-insured. A calibrated version of the model can quantitatively account for the life-cycle variation of life-insurance holdings, financial wealth, earnings, and consumption inequality observed in the US data. Our analysis implies that a reform that makes consumer bankruptcy more costly, like the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, leads to a substantial increase in the volume of both credit and insurance.
    Keywords: human capital risk, limited enforcement, life insurance
    JEL: E21 E24 D52 J24
    Date: 2015–07
  4. By: Dräger, Lena; Proaño, Christian R.
    Abstract: Against the background of the recent housing boom and bust in countries such as Spain and Ireland, we investigate in this paper the macroeconomic consequences of cross-border banking in monetary unions such as the euro area. For this purpose, we incorporate in an otherwise standard two-region monetary union DSGE model a banking sector module along the lines of Gerali et al. (2010), accounting for borrowing constraints of entrepreneurs and an internal constraint on the bank's leverage ratio. We illustrate in particular how different lending standards within the monetary union can translate into destabilizing spill-over effects between the regions, which can in turn result in a higher macroeconomic volatility. This mechanism is modeled by letting the loanto-value (LTV) ratio that banks demand of entrepreneurs depend on either regional productivity shocks or on the productivity shock from one dominating region. Thereby, we demonstrate a channel through which the financial sector may have exacerbated the emergence of macroeconomic imbalances within the euro area. Additionally, we show the effects of a monetary policy rule augmented by the loan rate spread as in Cúrdia and Woodford (2010) in a two-country monetary union context.
    Keywords: cross-border banking,euro area,monetary unions,DSGE,monetary policy
    JEL: F41 F34 E52
    Date: 2015
  5. By: Michael Donadelli; Vahid Mojtahed; Antonio Paradiso
    Abstract: This paper examines whether there is direct link between investment frictions and technological progress. An augmented version of a standard stochastic Solow model is presented. In this novel version the TFP is a function of a set of “ad hoc” variables in deviation from their equilibrium trend: (i) relative price of investment goods with respect to consumption goods (i.e. investment frictions); (ii) human capital index and (iii) trade openness. Empirical results show that investment frictions have an important role in influencing productivity growth. This finding may help in solving an important puzzle raised by the recent business cycle accounting literature, which points out that frictions have a marginal role in driving business cycles. The continuous fluctuations around the long-run trend of exogenous variables entering as driving forces in the technological progress implies that productivity shocks are state dependent. In other words, the true effect on the stock of knowledge and output depends on the exogenous variables’ cyclical phase. This provides novel, realistic and country-specific policy implications.
    Keywords: technological progress, macroeconomic fluctuations, investment frictions, trade openness, education
    JEL: E32 C32 O47
    Date: 2015
  6. By: Andrew Foerster (Federal Reserve Bank of Kansas City); Troy Davig (Federal Reserve Bank of Kansas City)
    Abstract: Motivated by the US Fiscal Cliff in 2012, this paper considers the short- and longer-term impact of uncertainty generated by fiscal policy. Empirical evidence shows increases in economic policy uncertainty lower investment and employment. Investment that is longer-lived and subject to a longer planning horizon responds to policy uncertainty with a lag, while capital that depreciates more quickly and can be installed with few costs falls immediately. A DSGE model incorporating uncertainty over future tax regimes produces responses to fiscal uncertainty that match key features of the data. The model features uncertainty over the average tax rate and rational expectations about the resolution of uncertainty with specific outcomes and timing. Uncertainty injects noise into the economy and lowers the level of economic activity
    Date: 2015
  7. By: Brüggemann, Bettina; Yoo, Jinhyuk
    Abstract: We analyze the macroeconomic implications of increasing the top marginal income tax rate using a dynamic general equilibrium framework with heterogeneous agents and a fiscal structure resembling the actual US tax system. The wealth and income distributions generated by our model replicate the empirical ones. In two policy experiments, we increase the statutory top marginal tax rate from 35 to 70 percent and redistribute the additional tax revenue among households, either by decreasing all other marginal tax rates or by paying out a lump-sum transfer to all households. We find that increasing the top marginal tax rate decreases inequality in both wealth and income but also leads to a contraction of the aggregate economy. This is primarily driven by the negative effects that the tax change has on top income earners. The aggregate gain in welfare is sizable in both experiments mainly due to a higher degree of distributional equality.
    Keywords: Top Income Taxation,Heterogeneous Agents,Incomplete Markets,Income and Wealth Inequality
    JEL: E21 E62 H21 H24
    Date: 2015
  8. By: Holger Sieg (University of Pennsylvania); Daniele Coen-Pirani (University of Pittsburgh); Jeffrey Brinkman (Federal Reserve Bank of Philadelphia)
    Abstract: The purpose of this paper is to provide an explanation of the political and economic determinants of underfunding of municipal pension funds. We develop a new dynamic politico-economic model within an overlapping generations framework. The key insight of the model is that underfunding can result in equilibrium even if individuals are fully informed, perfectly rational, and forward looking, and policies are capitalized in housing or land prices. Funding policies matter if housing also serves as collateral for households that are potentially credit constrained. The model suggests that differences in funding levels are systematically related to differences in economic fundamentals such as wage levels, the size of the public sector in a city, and the compensation of public sector workers measured by the current wage and retirement benefiÂÂ…ts. Finally, our analysis has some important policy implications. A policy intervention that mandates higher funding rates for municipalities than those adopted in equilibrium improves household welfare.
    Date: 2015
  9. By: Filip Matejka (CERGE-EI); Colin Stewart (University of Toronto); Jakub Steiner (Cerge-ei)
    Abstract: We solve a general class of dynamic rational-inattention problems in which an agent repeatedly acquires costly information about an evolving state and selects actions. The solution resembles the choice rule in a dynamic logit model, but it is biased towards an optimal default rule that does not depend on the realized state. We apply the general solution to the study of (i) the sunk-cost fallacy; (ii) inertia in actions leading to lagged adjustments to shocks; and (iii) the tradeoff between accuracy and delay in decision-making.
    Date: 2015
  10. By: Andrés González; Franz Hamann; Diego Rodríguez
    Abstract: Colombia is a small open and commodity exporter economy, sensitive to international commodity price fluctuations. During the surge in commodity prices, as income from the resource sector increases total credit expands, boosting demand for tradable and nontradable goods, appreciating the currency and shifting resources from the tradable sector to the nontradable. Although this adjustment is efficient, the presence of financial frictions in the economy exacerbates the resource allocation process through credit. In this phase, as total credit expands, the appreciation erodes the net worth of the tradable sector and boosts the nontradable one, and thus credit gets concentrated in that sector. A sudden reversal of commodity prices causes a rapid adjustment of resources in the opposite direction. However, the ability of the tradable sector to absorb the freed resources is limited by its financial capacity. In this scenario, macroprudential policies may help to restrain aggregate credit dynamics and thus prevent or act prudently in anticipation to the effects of large oil price shock reversals. In this work we write a model that accounts for these facts and quantify the role of three policy instruments: short term interest rate, FX intervention and financial regulation. We explore this issues in a DSGE model estimated for the Colombian economy and find that both FX intervention and regulation policies complement the short-term interest rates in smoothing the business cycle by restraining credit, raising market interest rates and smoothing economic activity. However, these additional instruments have undesirable sectoral implications. In particular, the use of these policies implies that credit to the tradable sector dries and becomes more expensive, weakening its financial position, which in turn implies a sharper fall of this sector during the price reversal and a longer recovery. These effects, nonetheless, appear to be quantitatively small according to the estimated model.
    Keywords: credit, leverage, financial accelerator, business cycle, monetary policy, macro-prudential policies, Colombia
    Date: 2015–07
  11. By: Keiichi Morimoto (Department of Economics, Meisei University); Takeo Hori (College of Economics, Aoyama Gakuin University); Noritaka Maebayashi (Faculty of Economics and Business Administration, The University of Kitakyushu); Koichi Futagami (Graduate School of Economics, Osaka University)
    Abstract: In a small open economy model of endogenous growth with public capital accu- mulation, we examine the effects of a debt policy rule under which the government must reduce its debt-GDP ratio if it exceeds the criterion level. To sustain public debt at a finite level, the government should adjust public spending rather than the income tax rate. The long run debt-GDP ratio should be kept sufficiently low to avoid equilibrium indeterminacy. Under sustainability and determinacy, a tighter (looser) debt rule brings welfare gains when the world interest rate is relatively high (low).
    Keywords: Fiscal policy, Public debt, Welfare, Small open economy, Indeterminacy, Limit cycles
    JEL: E62 H54 H63
    Date: 2013–05
  12. By: Friese, Max
    Abstract: The paper shows the effect of demographic change on per capita burden of financing a PAYG social security system in the standard OLG model with frictional labor markets. Rising longevity and decreasing fertility both induce a rise in the employment level via increased capital accumulation and job openings. Simulations of the theoretical model show that this labor market effect indirectly crowds out part of the initial demographic shock's direct impact on per capita financing burden. This holds true for the generation at the period of impact as well as for the following generations.
    Keywords: OLG,demographic change,frictional labor market,PAYG social security,tax burden
    JEL: E24 E62 H55
    Date: 2015
  13. By: Foulis, Angus (Bank of England); Nelson, Benjamin (Bank of England); Tanaka, Misa (Bank of England)
    Abstract: We construct an overlapping generations macroeconomic model with which to study the causes, consequences and remedies to ‘credit traps’ — prolonged periods of stagnant real activity accompanied by low productivity, financial sector undercapitalisation, and the misallocation of credit. In our model, credit traps arise when shocks to bank equity capital tighten banks’ borrowing constraints, causing them to allocate credit to easily collateralisable but low productivity projects. Low productivity weakens bank capital generation, reinforcing tight borrowing constraints, sustaining the credit trap steady state. We use the model to study policy options, both ex ante(avoiding credit traps) and ex post (escaping them). Ex ante, restrictions on bank leverage can help to enhance the economy’s resilience to the shocks that can cause credit traps. Further, a policymaker focused on maximising the economy’s resilience to credit traps would set leverage countercyclically, allowing an expansion of leverage in minor downturns and reducing leverage in upswings. However, ex post, relaxing a leverage cap will not help escape the trap. Instead, a range of unconventional policies are needed. We study publicly intermediated lending, discount window lending, and recapitalisation, and compare the efficacy of these policies under different conditions.
    Keywords: Unconventional credit policy; leverage regulation; financial intermediation; financial crisis.
    JEL: E58 G01 G21
    Date: 2015–07–31
  14. By: Tetsuo Ono (Graduate School of Economics, Osaka University); Yuki Uchida (Graduate School of Economics, Osaka University)
    Abstract: This study presents an overlapping generations model to capture the nature of the competition between generations regarding two redistribution policies, public education and public pensions. From a political economy viewpoint, we investigate the effects of population aging on these policies and economic growth. We show that greater longevity results in a higher pension-to-GDP ratio. However, an increase in longevity produces an initial increase followed by a decrease in the public education- to-GDP ratio. This, in turn, results in a hump-shaped pattern of the growth rate.
    Keywords: economic growth; population aging; public education; public pen-sions
    JEL: D78 E24 H55
    Date: 2014–12
  15. By: Jonathan Heathcote (Institute for Fiscal Studies); Kjetil Storesletten (Institute for Fiscal Studies and University of Oslo); Giovanni L. Violante (Institute for Fiscal Studies)
    Abstract: What shapes the optimal degree of progressivity of the tax and transfer system? On the one hand, a progressive tax system can counteract inequality in initial conditions and substitute for imperfect private insurance against idiosyncratic earnings risk. At the same time, progressivity reduces incentives to work and to invest in skills, and aggravates the externality associated with valued public expenditures. We develop a tractable equilibrium model that features all of these trade-offs. The analytical expressions we derive for social welfare deliver a transparent understanding of how preferences, technology, and market structure parameters influence the optimal degree of progressivity. A calibration for the U.S. economy indicates that endogenous skill investment, flexible labor supply, and the externality linked to valued government purchases play quantitatively similar roles in limiting desired progressivity.
    Date: 2014–10
  16. By: Raffaella Giacomini (Institute for Fiscal Studies and cemmap and UCL)
    Abstract: Does economic theory help in forecasting key macroeconomic variables? This article aims to provide some insight into the question by drawing lessons from the literature. The definition of "economic theory" includes a broad range of examples, such as accounting identities, disaggregation and spatial restrictions when forecasting aggregate variables, cointegration and forecasting with Dynamic Stochastic General Equilibrium (DSGE) models. We group the lessons into three themes. The first discusses the importance of using the correct econometric tools when answering the question. The second presents examples of theory-based forecasting that have not proven useful, such as theory-driven variable selection and some popular DSGE models. The third set of lessons discusses types of theoretical restrictions that have shown some usefulness in forecasting, such as accounting identities, disaggregation and spatial restrictions, and cointegrating relationships. We conclude by suggesting that economic theory might help in overcoming the widespread instability that affects the forecasting performance of econometric models by guiding the search for stable relationships that could be usefully exploited for forecasting.
    Date: 2014–09
  17. By: Eddie Gerba; Dawid Zochowski
    Abstract: We study the impact of uncertainty on financial stability and the business cycle. We extend the work of Boz and Mendoza (2014) by endogenizing credit production, modifying learning mechanism into an adaptive set-up, as well as including financial and monetary policies. In our model households are (intrinsically) rational but take economic decisions under incomplete information. The incompleteness is not caused by their cognitive limitations, as in rational inattention theory (Sims, 2003). Households `learn by doing' and once a sufficient number of realizations of the state variable have materialized, and the incomplete information set is completed. This learning set-up is incorporated into a New Keynesian model with credit market frictions, extended to include uncertainty, where a share of households needs external financing to consume. Because of limited enforceability of financial contracts, households are required to provide collateral for their loans, and so the relationship between the bank and household is tightened for many periods ahead. We find in our framework the build up of risk, leverage, increase in consumption and price of collateral takes longer than in other DSGEs with standard financial friction models. We also find that both the frequency and the amplitude of expansions and contractions are asymmetric - recessions are less frequent and deeper than expansions. Moreover, we find that boom-bust cycles occur as rare events. Using the Cogley and Sargant's (2008) definition of a severe(or systemic) crisis, we find on average two such events per century. We also find that, different from standard boom-bust cycles, a systemic crisis can be followed by a sequence of subsequent contractions, as it makes the economy more unstable. The result is asymmetric distributions of key macroeconomic and financial variables, with high skewness and fat tails. Lastly, we also find that, by reducing the amount of borrowing and leverage in upturns, the LTV-ratio regulation is effective in smoothing the cycles and reducing the effects of a deep contraction on the real-financial variables. We also discuss the role of macroprudential policy in reducing information incompleteness by generating information that helps the agent learn faster the new environment, or provide a smoother transition to the new economic environment.
    Keywords: uncertainty; financial engeneering; deregulation; leverage forecasting; macroprudential policy
    JEL: E44 E58 G14 G21 G32
    Date: 2015
  18. By: Filip Rozsypal (University of Cambridge)
    Abstract: This paper presents an economy where business cycles and long term growth are both endogenously generated by the same type of iid shocks. I embed a multi-sector real business cycle model into an endogenous growth framework where innovating firms replace incumbent production firms. The only source of uncertainty is the imperfectly observed quality of innovation projects. As long as the goods are complements, a successful innovation in one sector increases demand for the output of other sectors. Higher profits motivate higher innovation efforts in the other sectors. The increase in productivity in one sector is thus followed by increases in productivity in the other sectors and the initial innovation generates persistent movement in aggregate productivity.
    Date: 2015
  19. By: Eric M. Leeper (Indiana University); Nora Traum (North Carolina State University); Todd B. Walker (Indiana University)
    Abstract: We use Bayesian prior and posterior analysis of a monetary DSGE model, extended to include fiscal details and two distinct monetary-fiscal policy regimes, to quantify government spending multipliers in U.S. data. The combination of model specification, observable data, and relatively diffuse priors for some parameters lands posterior estimates in regions of the parameter space that yield fresh perspectives on the transmission mechanisms that underlie government spending multipliers. Posterior mean estimates of short-run output multipliers are comparable across regimes—about 1.4 on impact—but much larger after 10 years under passive money/active fiscal than under active money/passive fiscal—means of 1.9 versus 0.7 in present value.
    Keywords: government spending; monetary-fiscal interactions; prior predictive analysis; Bayesian estimation
    Date: 2015–07
  20. By: Gordon Phillips (University of Southern California); Kyle Herkenhoff (University of Minnesota)
    Abstract: Earnings losses after layoff are severe on average and differ significantly across individuals (Jacobson et al. [1993], Jacobson et al. [2005], Couch and Placzek [2010], Davis and von Wachter [2011]). While much is known empirically and theoretically about the impact of unemployment benefits on earnings losses (Ljungqvist and Sargent [1998], Saporta-Eksten [2013]), little is known about the role consumer credit plays in the earnings losses of displaced workers, their job finding rates, and the subsequent quality of jobs they take. To answer this question, we merged confidential, quarterly, individual employment records from the Census with proprietary individual credit reports based on social security numbers. Our first contribution is to use this new administrative panel dataset to measure the impact of consumer credit access on job finding rates and re-employment earnings of displaced workers. We find that credit constrained workers have earnings losses that are [X]% greater than unconstrained households, and that the job finding rates of credit constrained workers are [X]% greater then unconstrained households. To understand the impact of credit access on sorting, employment, output, and productivity, we introduce risk aversion into a model with heterogeneous workers and firms, building on the influential prior work by Eeckhout and Kircher [2010], Eeckhout and Kircher [2011] and Hagedorn et al. [2012]. In our model, heterogeneous credit-constrained workers accumulate human capital while working and direct their search for jobs among heterogeneous credit-constrained firms while unemployed. We find that an increase in credit limits equal to [X]% of GDP (decreases or) increases employment by [X]%, increases output by [X]%, and increases productivity by [X]%. The mechanism is that credit access acts as a safety net, allowing workers to sort into better matches with firms.
    Date: 2015
  21. By: Yuki Uchida (Graduate School of Economics, Osaka University)
    Abstract: This study presents a two-class, overlapping-generation model featuring social mobility inhibited by the mismatch of talents. Mobility decreases as the private education gap between the two classes widens, whereas it increases with an increased public education spending. Within this framework, we consider the redistributive politics of public education and show that the private education gap provides the government with an incentive to increase public education. We also show that social mobility reveals a cyclical motion across generations when the political power of the poor is weak.
    Keywords: Social mobility; Public education; Redistribution; Voting
    JEL: H20 I24 J62
    Date: 2015–08
  22. By: Anand, Rahul (International Monetary Fund); Prasad, Eswar (Cornell University); Zhang, Boyang (Cornell University)
    Abstract: In closed or open economy models with complete markets, targeting core inflation enables monetary policy to maximize welfare by replicating the flexible price equilibrium. We analyze this result in the context of developing economies, where a large proportion of households are credit constrained and the share of food expenditures in total consumption expenditures is high. We develop an open economy model with incomplete financial markets to show that headline inflation targeting improves welfare outcomes. We also compute the optimal price index, which includes a positive weight on food prices but, unlike headline inflation, assigns zero weight to import prices.
    Keywords: inflation targeting, monetary policy framework, core inflation, headline inflation, financial frictions
    JEL: E31 E52 E61
    Date: 2015–07
  23. By: Morten Ravn (University College London)
    Abstract: In this paper we consider how car purchases behaviour changes at the onset and during a recession. In particular, by using the rich information available in the Consumer Expenditure Survey, we look both at the number of individuals buying a car, and at the size of the car they buy. We show that the behaviour during the great recession of 2008-2010 is remarkably different from previous recessions. We interpret the evidence through the prism of a life cycle model where individuals receive idiosyncratic uninsurable income as well as aggregate income shocks and stochastic borrowing constraints. Households allocate their resources between cars and non durable consumption. Cars are large and costly to transact but can be financed through car loans. This implies an (S,s) type of durables adjustment. We show that, because of their salience and the transaction costs, cars are particularly sensitive to changes in the perception of future expected in come and its variability. We show that persistent common income shocks explain the consumption data better than changes in borrowing constraints and idiosyncratic income shocks.
    Date: 2015
  24. By: Aleksander Berentsen; Sébastien Philippe Kraenzlin; Benjamin Müller
    Abstract: How can a central bank control interest rates in an environment with large excess reserves? In this paper, we develop a dynamic general equilibrium model of a secured money market and calibrate it to the Swiss franc repo market to study this question. The theoretical model allows us to identify the factors that determine demand and supply of central bank reserves, the money market rate and trading activity in the money market. In addition, we simulate various instruments that a central bank can use to exit from unconventional monetary policy. These instruments are assessed with respect to the central bank's ability to control the money market rate, their impact on the trading activity and the operational costs of an exit. All exit instruments allow central banks to attain an interest rate target. However, the trading activity differs significantly among the instruments and central bank bills and reverse repos are the most cost-effective.
    Keywords: exit strategies, money market, repo, monetary policy, interest rates
    JEL: E40 E50 D83
    Date: 2015
  25. By: Brent Neiman (University of Chicago); Loukas Karabarbounis (University of Chicago)
    Abstract: The labor share is typically measured as compensation to labor relative to gross value added ("gross labor share"), in part because gross value added is more directly measured than net value added. Labor compensation relative to net value added ("net labor share") may be more important in some settings, however, because depreciation is not consumed. In this paper we make three contributions. First, we document that gross and net labor shares generally declined together in most countries around the world over the past four decades. Second, we use a simple economic environment to show that declines in the price of capital necessarily cause gross and net labor shares to move in the same direction, whereas other shocks such as a decline in the real interest rate may cause the net labor share to rise when the gross labor share falls. Third, we illustrate that whether the gross or the net labor share is a more useful proxy for inequality during an economy's transition depends sensitively on the nature of the underlying shocks that hit the economy.
    Date: 2015
  26. By: Fabien Postel-Vinay (UCL); Jeremy Lise (UCL)
    Abstract: We construct a structural model of on-the-job search in which workers differ in skills along several dimensions (cognitive, manual, interpersonal) and sort themselves into jobs with heterogeneous skill requirements along those same dimensions. We further allow for skills to be accumulated when used, and eroded away when not used. We estimate the model using occupation-level measures of skill requirements based on O*NET data, combined with a worker-level panel from the NLSY79. We use the estimated model to shed light on the origins and costs of mismatch along the cognitive, manual, and interpersonal skill dimensions. Our results clearly suggest that those three types of skills are very different productive attributes.
    Date: 2015
  27. By: Rowena Crawford (Institute for Fiscal Studies); Cormac O'Dea (Institute for Fiscal Studies and Institute for Fiscal Studies)
    Abstract: Using a model where households can save in either a safe asset or in an illiquid, tax-advantaged pension, we assess the extent to which those who recently reached the state pension age in the UK have saved optimally for retirement. The policy environment specified closely matches that prevailing in the UK. Using the model and administrative data linked with survey data from the English Longitudinal Study of Ageing, an optimal level of wealth is calculated for each household. This is compared to the levels of wealth observed in the data. Our results show that, for those born in the 1940s, the vast majority of households have wealth levels far greater than necessary to maintain their living standards into and through retirement.
    Date: 2014–09
  28. By: francesco lippi (University of Sassari); Luigi Paciello (Einaudi Institute (EIEF)); Fernando Alvarez (University of Chicago)
    Abstract: We study models where prices respond slowly to shocks because firms are rationally inattentive. Producers must pay a cost to observe the determinants of the current profit maximizing price, and hence observe them infrequently. To generate large real effects of monetary shocks in such a model the time between observations must be long and/or highly volatile. Previous work on rational inattentiveness has allowed for observation intervals which are either constant-but-long (e.g. Caballero (1989) or Reis (2006)) or volatile-but-short (e.g. Reis's (2006) example where observation costs are negligible), but not both. In these models, the real effects of monetary policy are small for realistic values of the average time between observations. We show that non-negligible observation costs produce both these effects: intervals between observations are both infrequent and volatile. This generates large real effects of monetary policy for realistic values of the average time between observations.
    Date: 2015

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