|
on Dynamic General Equilibrium |
| By: | Carlos Ballesteros |
| Abstract: | The paper develops a Dynamic Stochastic General Equilibrium (DSGE) model, which assesses the macroeconomic and labor market effects derived from simulating a positive shock to the stochastic component of the mining-energy sector productivity. Calibrating the model for the Colombian economy, this shock generates a whole increase in formal wages and a raise in tax revenues, expanding total consumption of the household members. These facts increase non-tradable goods prices relative to tradable goods prices, then real exchange rate decreases (appreciation) and occurs a displacement of productive resources from the tradable (manufacturing) sector to the non-tradable sector, followed by an increase in formal GDP and formal job gains. This situation makes the formal sector to absorb workers from the informal sector through the non-tradable formal subsector, which causes informal GDP to go down. As a consequence, in the net consumption falls for informal workers, which leads some members of the household not to offer their labor force in the informal sector but instead they prefer to keep unemployed. Therefore, the final result on the labor market is a decrease in the number of informal workers, of which a part are in the formal sector and the rest are unemployed. |
| Keywords: | Mining and energy boom, dutch disease, formal and informal sectors, unemployment, DSGE model |
| JEL: | E0 E1 E2 E3 |
| Date: | 2016–08–01 |
| URL: | http://d.repec.org/n?u=RePEc:col:000122:015011&r=dge |
| By: | Acikgoz, Omer |
| Abstract: | Aiyagari (1995) showed that long-run optimal fiscal policy features a positive tax rate on capital income in Bewley-type economies with heterogeneous agents and incomplete markets. However, determining the magnitude of the optimal capital income tax rate was considered to be prohibitively difficult due to the need to compute the optimal tax rates along the transition path. Contrary to this view, this paper shows that in this class of models, long-run optimal fiscal policy and the corresponding allocation can be studied independently of the initial conditions and the transition path. Numerical methods based on this finding are used on a Ramsey model calibrated to the U.S. economy. I find that the observed average capital income tax rate in the U.S. is too high, the average labor income tax rate and the debt-to-GDP ratio are too low, compared to the long-run optimal levels. The implications of these findings for existing literature on the optimal quantity of debt and constrained efficiency are also adressed. |
| Keywords: | Optimal Taxation, Ramsey Problem, Incomplete Markets, Heterogeneous Agents |
| JEL: | E2 E21 E25 E6 E62 H3 H6 |
| Date: | 2015–06 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:73380&r=dge |
| By: | Alireza Sepahsalari (Univesrity College London (UCL); Centre for Macroeconomics (CFM)) |
| Abstract: | This paper investigates the importance of credit market frictions on labour market outcomes. I build a tractable search and matching model of the labour market with firm dynamics and hetero-geneity in productivity and size. Firms produce output using labour, which they hire in a frictional market modelled by a directed search approach, and capital which they rent period-by-period. First, I show that the interaction of search and financial frictions slows down the reallocation of labour and capital from low productivity to high productivity firms and therefore prolongs the recession following a financial shock. Second, I find that the credit tightening reduces the net employment of large and productive firms more than small and unproductive firms, consistent with recent empirical findings.Third, I find that the introduction of financial frictions enhances the ability of the model to explain the fluctuation and persistence observed in output and labour market flows during the great recession. In fact, the model can account for 50% of the increase in unemployment during the 2008-2010 recession. |
| Keywords: | Labour market frictions, Collateral constraints, Financial shocks |
| JEL: | E24 E44 |
| Date: | 2016–01 |
| URL: | http://d.repec.org/n?u=RePEc:cfm:wpaper:1624&r=dge |
| By: | Tetsuo Ono (Graduate School of Economics, Osaka University); Yuki Uchida (Graduate School of Economics, Osaka University) |
| Abstract: | This study considers public education policy and its impact on growth and wel- fare across generations. In particular, the study compares two scal perspectives| tax nance and debt nance|and shows that in a competitive equilibrium context, the growth and utility in the debt- nance case could be higher than those in the tax- nance case in the long run. However, the opposite occurs when the policy is shaped by politics. When the degree of parents' altruism is low, they choose debt nance in their voting, despite its long-run worse performance because a current generation can pass the cost of debt repayment to future generations. |
| Keywords: | Economic growth, Human capital, Public debt, Political equilib- rium |
| JEL: | D70 E24 H63 |
| Date: | 2016–01 |
| URL: | http://d.repec.org/n?u=RePEc:osk:wpaper:1601r&r=dge |
| By: | Timothy Kehoe (University of Minnesota); Sewon Hur (University of Pittsburgh); Kim Ruhl (New York University Stern School of Busi); Jose Asturias (Georgetown University) |
| Abstract: | Using plant-level data from Chile and Korea, we find that, during episodes of rapid growth, most of the aggregate productivity growth is due to the entry and exit of firms while, during episodes of slower growth, it is mostly due to growth within and across existing firms. Studies for other countries suggest that this is an empirical regularity. We develop a dynamic general equilibrium model based on Hopenhayn (1992) which incorporates the theory of economic growth proposed by Parente and Prescott (1994) and Kehoe and Prescott (2002). In this model, new firms enter every period with productivities drawn from a distribution whose mean grows over time. After entering, a firm’s productivity grows, but not as rapidly as new firms’ productivity distribution. In a version of the model calibrated to U.S. plant-level data, we simulate two sets of reforms: a decrease in new firms’ costs of entry and a reduction in the barriers to technology adoption for new firms. The model reproduces the regularity that we observe in the data, and confirm that entry and exit of firms is crucial for reforms to generate rapid growth. |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed016:573&r=dge |
| By: | Ruben Gaetani (Northwestern University); Matthias Doepke (Northwestern University) |
| Abstract: | Since the 1980s, the United States economy has experienced a sharp rise in education premia in the labor market, with the college premium going up by more than 30 percent. In contrast, most European economies witnessed a much smaller rise in the return to education, and in Germany, Italy, and Spain the college premium actually fell. In this paper, we argue that differences in employment protection can account for a substantial part of these diverging trends. We consider an environment where firms can invest in technologies that are complementary to experienced workers with long tenure, and workers can make corresponding investments in firm-specific skills. The incentive to undertake such investments interact with employment protection. Incentives are particularly strong if employment protection favors older workers and workers with long tenure, as is the case in the European countries where the college premium fell. We use a calibrated dynamic model that allows for different education levels, labor-market search, and investment in relationship-specific capital and skills to quantify the ability of this affect to account for diverging inequality trend in the United States and Europe. |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed016:539&r=dge |
| By: | Hao Jin (Wang Yanan Institute for Studies in Economics (WISE) and Department of International Economics and Trade, School of Economics, Xiamen University) |
| Abstract: | This paper examines the interactions between fiscal policy and the open economy macroeconomic policy trilemma in a small open economy dynamic stochastic general equilibrium model. I show that the trilemma policy regime choices require fiscal accommodation. Otherwise, when future budget fail to stabilize government liabilities, fiscal imbalance generates exchange rate depreciation, regardless of monetary and capital account policy regimes. In this active fiscal policy regime, fiscal and monetary policy interact to determine the magnitude of exchange rate depreciation, while monetary policy and capital controls manage the timing of the depreciation. |
| Keywords: | Trilemma, Fiscal Policy, Capital Account Policy, Exchange Rate Stability, Monetary Policy |
| Date: | 2016–08 |
| URL: | http://d.repec.org/n?u=RePEc:inu:caeprp:2016003&r=dge |
| By: | Carlos Carvalho (Pontificia Universidade Catolica do Rio de Janeiro); Fernanda Nechio (Federal Reserve Bank of San Francisco) |
| Abstract: | Online appendix for the Review of Economic Dynamics article |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:red:append:15-199&r=dge |
| By: | Arifovic, J. (Simon Fraser University); Hommes, C.H. (University of Amsterdam); Salle, I. (University of Amsterdam; University of Amsterdam) |
| Abstract: | We set up a laboratory experiment within the overlapping-generations model of Grandmont (1985). Under perfect foresight this model displays infinitely many equilibria: a steady state, periodic as well as chaotic equilibria. Moreover, there exists some learning theory predicting convergence to each of these equilibria. We use experimental evidence as an equilibrium selection device in this complex OLG economy, and investigate on which outcomes subjects most likely coordinate. We use two alternative experimental designs: learning-to-forecast, in which subjects predict the future price of the good, and learning-to-optimize, in which subjects make savings decision. We find that coordination on a steady state or 2-cycle are the only outcomes in this complex environment. In the learning-to-forecast design, coordination on a 2-cycle occurs frequently, even in the chaotic parameter range. Simulations of a behavioral heuristic switching model result in initial coordination on a simple AR(1) rule though sample autocorrelation learning, with subsequent coordination on a simple second-order adaptive rule once the up-and-down pattern of prices has been learned. |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:ams:ndfwpp:16-06&r=dge |
| By: | Diego Perez (New York University); Pablo Ottonello (University of Michigan) |
| Abstract: | The currency composition of sovereign external debt in emerging market economies is tilted towards foreign currency and the share of debt denominated in local currency is highly pro-cyclical. We study these facts through the lens of a quantitative model of optimal currency-composition of sovereign debt when the government lacks commitment regarding monetary policy. High levels of debt in local currency give rise to incentives to dilute debt repayment through nominal currency depreciation. Governments tilt the currency-composition of debt towards foreign currency to avoid the inflationary costs associated with currency depreciation. This is done at the expense of foregoing the hedging properties of debt in local currency. The cyclicality of the currency-composition of sovereign debt responds to the cyclical properties of the benefits associated to debt dilution, which are higher in recessions. Inflation-linked bonds do not eliminate the time inconsistency problem of monetary policy. |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed016:596&r=dge |
| By: | Sniekers, F. (University of Amsterdam) |
| Abstract: | This paper explains the cyclical behavior of the fluctuations in unemployment and vacancies by demand externalities. Adding such externalities to an otherwise standard search and matching model reduces the need for exogenous shocks in explaining these fluctuations. Under plausible parameter values, the equilibrium dynamics include a stable limit cycle that resembles the empirically observed counterclockwise cycles around the Beveridge curve. Calibrated to the duration of the business cycle, these endogenous `Beveridge cycles' are as persistent as the data, without losing any of the ampli cation of the standard model. |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:ams:ndfwpp:16-05&r=dge |
| By: | Alisdair McKay |
| Abstract: | This paper shows how the empirical implications of incomplete markets models can be assessed using the same full-information methods that are commonly used for representative agent models. It then asks what features of the microeconomic insurance arrangement are important for understanding the dynamics of aggregate consumption as it relates to aggregate labor income and employment conditions. A model with a low level of insurance against unemployment risk and an intermediate level of insurance against individual skill shocks provides the best fit of the aggregate data. A model that matches the strong consumption responses to fiscal stimulus payments does not improve the overall fit to the aggregate data. |
| URL: | http://d.repec.org/n?u=RePEc:bos:wpaper:wp2013-013&r=dge |
| By: | Malamud, Semyon |
| Abstract: | I develop a dynamic general equilibrium model of exchange traded funds (ETFs) that accounts for the two-tier ETF market structure with both a centralized exchange (secondary market) and a creation/redemption mechanism (primary market) operating through market-making firms known as Authorized Participants (APs). The model is tractable and allows for any number of ETFs and basket securities. I show that the creation/redemption mechanism serves as a shock propagation channel through which temporary demand shocks may have long-lasting impacts on future prices. In particular, they may lead to a momentum in asset returns and a persistent ETF pricing gap. Improving liquidity in the primary market stimulates creation/redemption and therefore strengthens the shock propagation channel. As a result, it may amplify the volatility of both the underlying assets and the ETF pricing gap. At the same time, introducing new ETFs may reduce both the volatility and co-movement in the returns and may improve the liquidity of the underlying securities. |
| Keywords: | exchange traded funds; Limits to Arbitrage; liquidity |
| JEL: | G10 G12 G23 |
| Date: | 2016–08 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:11469&r=dge |
| By: | Johanna Wallenius (Stockholm School of Economics); Tobias Laun (Uppsala university) |
| Abstract: | Sweden boasts high fertility and high female employment. Notably, also women with young children work. However, part-time employment is very prevalent. There is a notable gender gap in both wages and earnings, which widens substantially after women have children. In this paper we study the effect of family policies on female employment, fertility and the gender wage gap. We are particularly interested in understanding why part-time employment is so prevalent in Sweden, despite heavily subsidized daycare, and the effect of this on the widening of the gender wage gap. We are also interested in understanding the role of home production, particularly the unequal division of home work across genders, in shaping women’s career paths. To this end, we develop a structural, life cycle model of heterogenous households which features endogenous labor supply, endogenous human capital accumulation, endogenous fertility and home production. |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed016:518&r=dge |
| By: | Seneca, Martin (Bank of England) |
| Abstract: | Large risk shocks give rise to cost-push effects in the canonical New Keynesian model. At the same time, monetary policy becomes less effective. Therefore, stochastic volatility introduces occasional trade-offs for monetary policy between inflation and output gap stabilisation. The cost-push effects operate through expectational responses to the interaction between shock volatility and the zero lower bound (ZLB) on interest rates. Optimal monetary policy calls for potentially sharp reductions in the interest rate when risk is elevated, even if this risk never materialises. Close to the ZLB, small risk shocks become ‘large’ in this sense. If policy is initially constrained by the ZLB, lift-off is optimally delayed when risk increases. |
| Keywords: | Risk shocks; uncertainty; zero lower bound on interest rates; optimal monetary policy |
| JEL: | E52 E58 |
| Date: | 2016–08–11 |
| URL: | http://d.repec.org/n?u=RePEc:boe:boeewp:0606&r=dge |
| By: | Richard Dennis (University of Glasgow (E-mail: richard.dennis@glasgow.ac.uk)) |
| Abstract: | Many central banks in developed countries have had very low policy rates for quite some time. A growing number are experimenting with official rates that are negative. We develop a New Keynesian model in which the zero lower bound (ZLB) on nominal interest rates is imposed as an occasionally binding constraint and use this model to examine the duration of ZLB episodes. In addition, we show that capital accumulation and capital adjustment costs can raise significantly the length of time an economy spends at the ZLB, as does the conduct of monetary policy. We identify anticipation effects that make the ZLB more likely to bind and we show that allowing negative nominal interest rates shortens average durations, but only by about one quarter. |
| Keywords: | Monetary policy, zero lower bound, New Keynesian |
| JEL: | E3 E4 E5 |
| Date: | 2016–08 |
| URL: | http://d.repec.org/n?u=RePEc:ime:imedps:16-e-11&r=dge |
| By: | Tatyana Koreshkova (Concordia University); Karen Kopecky (Federal Reserve Bank of Atlanta); R. Anton Braun (Federal Reserve Bank of Atlanta) |
| Abstract: | A protracted stay in a nursing home towards the end of life is one of the biggest risks faced by individuals. The annual cost of a nursing home stay in 2010 was $84,000. At age of 50, the probability of a nursing home stay ranges from 50 to 59 percent and among those who have a stay, 20 percent spend more 3 years. Yet, only about 10 percent of U.S. retirees purchase private long-term-care (LTC) insurance. Previous research has emphasized that Medicaid crowds out the demand for private LTC insurance. However, rejection rates are also high. Nearly 40 percent of the potential pool of purchasers would be rejected if they applied for private LTC insurance using current screening guidelines. We explore the possibility that high rejection rates are due to adverse selection. We propose a model which features agents who have private information about their risk exposure, a private LTC insurer and a government who provides public insurance (Medicaid). Our model accounts for low coverage rates and high rejection rates of private LTC insurance and is used to consider welfare-enhancing reforms of private and public provision of LTC insurance. |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed016:515&r=dge |
| By: | Garriga, Carlos (Federal Reserve Bank of St. Louis); Kydland, Finn E. (University of California–Santa Barbara and NBER); Sustek, Roman (Queen Mary University of London) |
| Abstract: | Standard models used for monetary policy analysis rely on sticky prices. Recently, the literature started to explore also nominal debt contracts. Focusing on mortgages, this paper compares the two channels of transmission within a common framework. The sticky price channel is dominant when shocks to the policy interest rate are temporary, the mortgage channel is important when the shocks are persistent. The first channel has significant aggregate effects but small redistributive effects. The opposite holds for the second channel. Using yield curve data decomposed into temporary and persistent components, the redistributive and aggregate consequences are found to be quantitatively comparable. |
| Keywords: | Mortgage contracts; sticky prices; monetary policy; yield curve; redistributive vs. aggregate effects. |
| JEL: | E32 E52 G21 R21 |
| Date: | 2016–08–23 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2016-017&r=dge |
| By: | Rigas Oikonomou; Albert Marcet (Institut d'Anà lisi Econòmica CSIC, BGS); Elisa Faraglia (Cambridge University) |
| Abstract: | We study how the issuance of long bonds affects optimal fiscal policy. Long bonds are usually modelled as having two features that are not found in the data: a) zero coupons and b) previously issued bonds are repurchased each period regardless of their time to maturity. The literature has found that under a) and b) issuing long bonds provides fiscal insurance. We show that these assumptions are not innocuous. Specifically we find that long bonds may not complete the markets even in the absence of uncertainty and under certain assumptions long bonds introduce additional tax volatility that offsets the attractiveness they provide through fiscal insurance. We find that introducing coupons helps alleviate the additional tax volatility but does so by reducing the ability of long bonds to provide insurance. Under full commitment the government promises future tax changes in order to reduce current funding costs. This introduces additional tax volatility. If we remove assumptions a) and b) interest rate twisting takes a very different form, showing again that those assumptions matter. |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed016:565&r=dge |
| By: | Hashmat U. Khan (Department of Economics, Carleton University); Jean-François Rouillard (Département d'économique, Université de Sherbrooke) |
| Abstract: | Why does residential investment lead output in the US and Canada but it is coincident in eurozone countries? In this paper we explore the role of home-equity loans used to boost consumption as a channel that affects residential investment. We consider a multi-agent model where some home-owning households face borrowing constraints that reflect home-equity loans or refinancing constraints. The main contribution of our paper is to highlight that the severity of the households' borrowing constraints in an economy can generate both stylized facts of residential investment dynamics. In US and Canada, a greater proportion of households rely on home-equity loans relative to eurozone countries. This difference matters for the distinct residential investment dynamics observed across countries. |
| Keywords: | Home-Equity Loans, Borrowing Constraints, Residential Investment, Business Cycles. |
| JEL: | E22 E32 R21 R31 |
| Date: | 2016–08 |
| URL: | http://d.repec.org/n?u=RePEc:shr:wpaper:16-04&r=dge |
| By: | Simeon Alder (Notre Dame University); Guillermo Ordonez (University of Pennsylvania) |
| Abstract: | Online appendix for the Review of Economic Dynamics article |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:red:append:14-175&r=dge |
| By: | Thomas Winberry (University of Chicago); Pablo Ottonello (University of Michigan) |
| Abstract: | Aggregate investment is central to the conduct of monetary both empirically and theoretically. However, existing studies largely ignore the extensive micro-level heterogeneity in investment behavior across firms. In this paper, we reassess the investment channel of monetary policy in the presence of this heterogeneity by empirically studying the response of micro-level investment to monetary shocks, and using these estimates to build a quantitative heterogeneous firm model for policy analysis. Our empirical analysis combines firm-level Compustat investment data with a high-frequency identification of monetary policy shocks. We will then build a quantitative general equilibrium model incorporating the relevant sources of heterogeneity identified in the data. We will use the model to study two broad issues. First, we will compute the average aggregate effect of monetary policy shocks, and compare the results to the estimated VAR literature. Second, we will study how the distribution of underlying heterogeneity shapes the response to monetary shocks at different points in time. How does the aggregate effect of monetary policy depend on the distribution of productivity, capital, or net worth? Does it vary substantially over the cycle? What does all this imply for the design of monetary policy going forward? |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed016:585&r=dge |
| By: | Corsetti, G.; Mavroeidi, E.; Thwaites, G.; Wolf, M. |
| Abstract: | We study how small open economies can engineer an escape from deflation and unemployment in a global secular stagnation. Building on the framework of Eggertsson et al. (2016), we show that the transition to full employment requires a dynamic depreciation of the exchange rate, without prejudice for domestic inflation targeting. However, if depreciation has strong income and valuation effects, the escape can be beggar thy self, raising employment but actually lowering welfare. We show that, while a relaxation in the Effective Lower Bound (ELB) can work as a means of raising employment and inflation in financially closed economies, it may have exactly the opposite effect when economies are financially open. |
| Keywords: | Small open economy, secular stagnation, capital controls, optimal policy, zero lower bound |
| JEL: | F41 E62 |
| Date: | 2016–08–15 |
| URL: | http://d.repec.org/n?u=RePEc:cam:camdae:1645&r=dge |
| By: | Christian vom Lehn (Brigham Young University); Aspen Gorry (Utah State University); Eric Fisher (California Polytechnic State University) |
| Abstract: | Between 1948 and 2000, hours worked per man in the United States fell by twenty percent. Using a life cycle model of labor supply with intensive and extensive margins, we assess how much of this decline can be accounted for by changes in tax and transfer policies. We use policy measures from the generational accounting literature, capturing the lifetime fiscal bur- dens faced by each birth-year cohort. Changes in age demographics and fiscal policy together account for roughly half of the decline in hours worked. Policy alone explains approximately thirty percent, both in the aggregate and for different age groups. |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed016:536&r=dge |
| By: | Fernando Alvarez (University of Chicago); Francesco Lippi (Einaudi Institute (EIEF)) |
| Abstract: | Transitory price changes are prominent in the data but do not fit neatly in standard sticky price models. We present a model where a firm chooses a “price plan†, namely a set of 2 prices each of which can be freely posted at each moment. While price changes between prices within the plan are free, the plan can be changed only subject to a fixed menu cost. This setup generates a persistent “reference†price level and short lived deviations from it, as in many datasets and a decreasing hazard function for price changes. We analytically solve for the optimal policy and for the cumulative impulse response function of output to a monetary shock. We compare the economy with the 2-price plan to a menu-cost economy (i.e. a plan with 1 price) featuring the same number of persistent price changes. We show that, for a small monetary shock, the introduction of a plan with 2 prices yields a cumulative output response that is 1/3 of the one produced by the menu cost economy. The smaller real effect is due to the flexibility delivered by the temporary price changes that are used by firms to respond to the shock. |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed016:549&r=dge |
| By: | Tommaso Porzio (Yale University) |
| Abstract: | This paper develops a matching model - in which heterogeneous individuals form production teams and choose an appropriate technology - to study how the technological environment changes the pattern of matching and the production structure of an economy. I show that if technology improvements are expensive, teams bring high and low skilled individuals together and all teams choose similar technologies. In contrast, if improvements are inexpensive, talent concentrates in teams that choose the most advanced technologies, leading to larger dispersion of economic activity. Then, I apply the theory to study cross-country differences in the allocation of talent. Since relatively poor countries can make cheap and large improvements through technology adoption, the theory predicts that they should have stronger concentration of talent than relatively rich ones. I derive an empirical measure of the concentration of talent from the model to validate this prediction using micro data from several countries; in the cross-section, using a sample of 63 countries, and in the time-series, comparing the growth experiences of South Korea and United States. Finally, a dynamic extension of the theoretical framework demonstrates that endogenous allocation of talent coupled with localized technological progress may prevent cross-country convergence even in the absence of exogenous barriers. |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed016:569&r=dge |
| By: | Romain Ranciere (Paris School of Economics); Aaron Tornell (UCLA); Yannick Kalantzis (Banque de France) |
| Abstract: | Should a Central Bank (CB) aim at smoothing out all asset price volatility in crisis times? We consider an economy where leverage is endogenously determined by the CB asset price support policy during crises. By keeping the price of distressed assets above a critical level, the CB can induce a high-leverage equilibrium with high output but with infrequent financial crises. The optimal CB policy depends on whether the interventions necessary to support the high-leverage equilibrium are costly or not. If the CB does not require any net wealth to credibly promise the minimal intervention that will keep asset prices above the critical level, it is optimal to commit all its wealth to intervention. In contrast, if interventions are costly, there is a trade-off between enjoying higher leverage and output now, but withstanding a lower number of crises before falling into a low-leverage low-output trap, and a more prudent policy that can keep the economy longer in the high-leverage equilibrium. We find that more prudent policies tend to be optimal when leverage is more socially valuable or the Central Bank has more wealth. |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed016:508&r=dge |
| By: | Giorgia Piacentino (Olin Business School at Washington Unive); Anjan Thakor (olin school of business); Jason Donaldson (Washington University in St Louis) |
| Abstract: | This paper develops a theory of banking that is rooted in the evolution of banks from warehouses of commodities and precious goods, which occurred even before the invention of coinage or fiat money. The theory helps to explain why modern banks offer warehousing (custodial and deposit-taking) services within the same institutions that provides lending services and how banks create funding liquidity by creating private money. In our model, the warehouse endogenously becomes a bank because its superior storage technology allows it to enforce loan repayment most effectively. The warehouse makes loans by issuing “fake†warehouse receipts—those not backed by actual deposits— rather than by lending out deposited goods. The model provides a rationale for banks that take deposits, make loans, and have circulating liabilities, even in an environment without risk or asymmetric information. Our analysis provides new perspectives on narrow banking, liquidity ratios and reserves requirements, capital regulation, and monetary policy. |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed016:588&r=dge |