Volume 23, Issue 1

In this paper we extend the Hicksian compensating variation welfare measure in two directions. First, we adjust the size of the compensating variation in order to account for the fact that the compensating transfers will result in changes in output, as well as in prices, because labor and, in dynamic models, capital will adjust in response to these transfers. Second, we extend the measure to a dynamic setting with possibly time non-separable preferences. We find that these considerations become more significant for the welfare cost of higher labor income taxes as one moves from static to dynamic models, to models with time non-separable preferences, and finally to models with uncertainty.

This paper investigates the mechanism behind the cyclical movements in the labor income share. We build a dynamic stochastic general equilibrium model with search and matching frictions to examine the counter-cyclicality and overshooting of the labor income share, following a technology innovation. This model features (i) a time-varying output elasticity of labor, generated from the capital–labor complementarity under a constant-elasticity-of-substitution production function, and (ii) an endogenous markup variation, generated from wage/price rigidity. Through the output elasticity and markup channels, the capital–labor complementarity interacts with wage rigidity, which allows us to produce a satisfactory matching of the amplitude of the labor share overshooting observed in the data. The amplitude of the labor share overshooting is more significant when wages (prices) are more (less) sticky, and when the government’s interest rate rule is more (less) responsive to the deviation in the inflation (output) target.

This paper empirically examines the effect of monetary policy on the government spending multiplier when the nominal interest rate is not bound to zero. We estimate a time-varying coefficient vector autoregressive (TVC-VAR) model using 2000:Q1 to 2019:Q3 quarterly data of Korea, whose policy rate is distant from zero. We find a substantial degree of time variation in the medium-run government spending multipliers, which increase over time and become statistically different from zero throughout the 2010s. Yet the reverse pattern is observed in the policy rate responses to government spending shocks, decreasing gradually until 2008–09 and then stagnating for the subsequent period. Decompositions of the policy rate responses reveal that inflation is an important ingredient in determining the responses of the nominal interest rate to government spending shocks, and thus has a critical impact on the size of government spending multipliers. In particular, our finding underscores a substantial role of the monetary policy stance against inflation in shaping government spending multipliers.

We investigate how the economy responds to anticipated (news) shocks to future investment decisions. Using structural vector autoregressions (SVARs), we show that news about the future relative price of residential investment explains a high fraction of the variance of output, aggregate investment and residential investment for Spain. In contrast, for Germany it is the news shocks on business structures and equipment that explain a higher fraction of the variance of output, consumption and non-residential investment. We confront the identified shock with other shocks to provide evidence that our structural interpretation is valid. Then, to address our empirical findings, we propose a stylized two-sector model of the willingness to substitute current consumption for future investment in housing, structures or equipment. The model combines a wealth effect driven by the expectation of rising house prices, with a reduced-form friction in labor reallocation. We find that the model calibrated for Spain displays a response to anticipated house price shocks that stimulate residential investment, whereas for Germany those shocks enhance investment in equipment and structures. The results highlight the propagation mechanism of anticipated shocks to future investment, which is consistent with the housing booms in Spain and their absence in Germany. Such a mechanism complements a view relying on a combination of monetary, financial or housing supply and demand, surprise shocks.

This paper examines the impact of exogenous shocks on sovereign debts in an incomplete monetary union. We assume that financial stability is a public good that sovereign debt shocks can undermine in fragile (peripheral) members. Our model shows that, unlike the common misconception, active monetary policies do not induce the peripheral government to relax its fiscal constraints; on the contrary, these policies tend to incentivize fiscal discipline by reducing the cost of balance consolidation. Active monetary policies, in fact, partially reallocate the stabilization costs from the periphery to the core of the union, preserving the common good and facilitating fiscal discipline in the periphery.

Using a neoclassical model with endogenous growth, this study examines the effects of increasing housing taxation and eliminating the mortgage interest tax deduction on economic growth and household welfare in the United States. The optimal tax policy reduces taxation of income in favor of increased taxation of housing and consumption. This policy increases the growth rate by 0.49 percentage points. In addition, simply shifting the tax burden by reducing the tax rates on productive forms of capital toward housing can increase the growth rate up to 0.18 percentage points. This study also find that eliminating the income tax deduction on mortgage interest and lowering income taxes would increase growth by about 0.016 percentage points. Each of these proposed policies improves household welfare.

Empirical evidence suggests a positive correlation between health and educational outcomes at the aggregate level. However, both inter and intra-country data suggest that these variables may not always be monotonically increasing in income, pointing towards household income as a possible mitigating factor in the relationship between health and education expenditures and outcomes. We develop an overlapping generations model where agents spend their childhood studying, undertake expenditures to educate their offspring and health expenditures to improve their own longevity in adult age, and spend old age in retirement. Our model is characterised by two equilibria. In one equilibrium, longevity enhancing health expenditure is an inferior good, resulting in agents substituting health expenditures in favour of education expenditures on offspring as their income increases. In the other equilibrium, health expenditure is a normal good, but for incomes below a certain level, an increase in income causes agents to raise health expenditures whilst lowering education expenditures on offspring, while for incomes above this level all expenditures are increasing in income. These results suggest that the relationship between parental longevity and offspring’s human capital depends on income and whether agents consider longevity enhancing health expenditure to be an inferior or normal good. Dynamics of the model show that the economy could either achieve unbounded growth or converge towards a lower bound of income in the long run.

We study an equilibrium two-sector occupational choice model – agents can be (formal or informal) entrepreneurs or workers. An informal entrepreneur faces taxation determined by the combination of her capital choice and society’s tolerance of informality. Our model is consistent with many empirical findings regarding the informal sector in Brazil, a developing economy with a large informal sector. With a calibrated version of our model, we show that as society’s tolerance of informality decreases, the informal sector employs less capital and labor, and informality decreases. We conduct several counterfactual exercises. Informality is substantially lower in economies that are less tolerant of informal activities, formal entrepreneurs have more access to financial markets, and taxation of output and labor is lower. We extend the model to consider stochastic taxation of informal activities – a higher (average) informal output taxation and its variability reduce informality.

In this paper, we argue that macroeconomic uncertainty shocks cause a persistent decline in economic activity, investment in R&D, and total factor productivity. After providing empirical evidence, we build a DSGE model with sticky prices and endogenous growth through investment in R&D. In this framework, uncertainty shocks lead to a short-term fall in demand because of precautionary savings and rising markups. The reduction in the utilised aggregate stock of R&D determines a fall in productivity, which causes a long-term reduction in the main macroeconomic aggregates. When households feature Epstein–Zin preferences, they become averse to these long-term risks affecting their consumption process (long-run risk channel), which severely exacerbates the precautionary savings motive and the overall adverse effects of uncertainty shocks.

This paper uses a panel vector autoregressive model to study the differential effects of components of private debt on income growth for a large panel of countries. While household debt growth in a given period generally has a positive impact on income, this effect is much stronger for countries with relatively lower levels of income and household debt-to-GDP ratios. On the other hand, the responsiveness of income growth to an increase in corporate debt varies across countries, with a consistently negative impact in richer and/or more heavily indebted countries. A simple extension of our framework suggests the roles of investment and consumption spending in explaining the varying effects of household and corporate debt on growth. We carry out several exercises to illustrate the robustness of our results.

We revisit three major US recessions through the lens of a standard medium-scale DSGE model (Smets, F., and R. Wouters. 2007. “Shocks and Frictions in US Business Cycles: A Bayesian DSGE Approach.” The American Economic Review 97: 586–606) augmented with financial frictions. We first estimate the DSGE model using a Bayesian approach for three alternative periods, each containing a major US recession: the Great Depression, the Stagflation and the Great Recession. Then, we assess the stability of structural parameters, and analyze what frictions were particularly important and what shocks were the main drivers of aggregate fluctuations in each historical period. This exercise can be understood as a test of the standard New-Keynesian DSGE model with financial accelerator in closed economies. We find that the estimated DSGE model is able to provide a sound explanation of all three recessions by closely relating both estimated structural shocks and frictions with well known economic events.

U.S. banks countercyclically vary the ratio of charge-offs to defaulted loans (COD) and the standard deviation of COD is roughly 15 times that of GDP. We show that canonical financial accelerator models cannot explain these facts, but introducing stochastic default costs and stochastic risk can potentially resolve the discrepancy. Estimating the augmented model and including both surprise and news shocks reveals that default cost news shocks account for most of the variance of COD. Also, in the many model specifications we work with, default cost news shocks always account for at least 20 percent of the variance of investment, while risk news shocks account for a significant portion of the variation in the credit spread, and around 10 percent of the variation in investment growth. Both news shocks also account for a material amount of the variance of hours and output growth.

This paper evaluates the ability of the trend-cycle decomposition approach of Hamilton (2018. “Why You Should Never Use the Hodrick-Prescott Filter.” The Review of Economics and Statistics 100 (5): 831–43) to adequately characterize linear and (a)symmetric nonlinear business cycles fluctuations that are known to be persistent. This ability is contrasted to that of the Hodrick–Prescott filter. By means of Monte Carlo simulations, the results indicate that neither filter is able to preserve the cyclical properties of the data-generating process nor reproduce U.S. business cycles features, although this inability is exacerbated for the decomposition of Hamilton (2018. “Why You Should Never Use the Hodrick–Prescott Filter.” The Review of Economics and Statistics 100 (5): 831–43). Based on these findings, caution is called into question when this approach is applied to linear or nonlinear processes that are thought to exhibit persistence.

This paper sheds light on the role of population aging in convergence of household credit. Using data from 32 economies over the period of 1995–2015, it shows that household credit tends to converge across countries over time, but aging populations hinder this convergence process. The result is also robust to controlling for various country-specific factors. Focusing on a further breakdown of credit to households, population aging weakens the convergence process in the case of housing loans, while it does not have a pronounced role in convergence of consumer credit. These findings can have implications for macroeconomic and financial policies, given the potential effects of household credit on economic growth and stability.

This paper studies robustly optimal monetary policy with myopic agents in a behavioral New Keynesian model. The central bank is assumed to have Knightian uncertainty about the degree of myopia and the degree of price stickiness. We show that, under uncertainty about myopia, the Brainard’s attenuation principle holds under commitment and discretion, while, under uncertainty on price stickiness, alone or in addition to myopia, monetary policy becomes more aggressive. Welfare evaluation shows significant gains from a robust conduct of monetary policy when the model is distorted.

Housing markets are closely related to monetary policy. This paper studies the link between housing frictions and the effectiveness of forward guidance. A housing collateral constraint and forward guidance shocks are incorporated into a standard medium-scale New Keynesian Dynamic Stochastic General Equilibrium (DSGE) model. Our main results produce a number of important implications. First, financial frictions emanating from the housing market dampen the effectiveness of forward guidance on the economy. Second, forward guidance shocks generate welfare gains, though the magnitude of these gains declines when housing frictions increase. Housing frictions also attenuate the effect of forward guidance at the zero lower bound. Finally, this article provides a solution to “forward guidance puzzle” of Del Negro, M., M. P. Giannoni, and C. Patterson (2012. “The Forward Guidance Puzzle.” In FRB of New York Staff Report , 574). Thus, policymakers should consider housing frictions when examining the effects of forward guidance on the economy.

Family support in the form of intergenerational transfers could serve as a substitute for the public transfer system, especially when the public safety net is weak. These intergenerational transfers could be impacted by changes in public insurance. Conversely, induced changes in family transfers could also impact the effectiveness of a public insurance program. What is the impact of social insurance reform on household welfare in the context of intergenerational transfers? This paper investigates this question by using an overlapping generations general equilibrium model where parents and their children are linked by intergenerational transfers. In the model, individuals differ in earnings ability and face idiosyncratic uninsurable income risk, health risk, and mortality risk. This paper calibrates the model to key features in the urban Chinese economy. Using this calibrated model, this paper finds that households on average experience a welfare gain from an increase in the social insurance benefits but that this effect differs across households conditional on their economic status. This paper then provides a decomposition of these welfare changes into three channels: a direct policy channel, an intergenerational-transfers channel, and a general equilibrium channel.