Engineering a paradox of thrift recession
We build a variation of the neoclassical growth model in which financial shocks to households or wealth shocks (in the sense of wealth destruction) generate recessions. Two standard ingredients that are necessary are (1) the existence of adjustment costs that make the expansion of the tradable goods sector difficult and (2) the existence of some frictions in the labor market that prevent enormous reductions in real wages (Nash bargaining in Mortensen-Pissarides labor markets is enough). We pose a new ingredient that greatly magnifies the recession: a reduction in consumption expenditures ...
Non-linear effects of taxation on growth
We study a model in which the effects of taxation on growth are highly non-linear. Marginal increases in tax rates have a small growth impact when tax rates are low or moderate. When tax rates are high, further tax hikes have a large, negative impact on growth performance. We argue that this non-linearity is consistent with the empirical evidence on the effect of taxation and other disincentives to investment and innovation on economic growth.
Comment on Eggertsson, \"What fiscal policy is effective at zero interest rates?\"
Gauti B. Eggertsson's paper (published in NBER Macroeconomics Annual 2010) represents an important contribution to the analysis of fiscal policy in the New Keynesian model when the zero lower bound on the nominal interest rate is binding. The paper accomplishes a great deal. It analyzes two types of taxes on capital and labor, the investment tax credit, a sales tax, and two types of government spending. It deserves to be an important reference on fiscal policy in a binding zero lower bound. In my discussion, I focus on the subset of Eggertsson's results that initially surprised me and that I ...
Involuntary unemployment and the business cycle
We propose a monetary model in which the unemployed satisfy the official U.S. definition of unemployment: people without jobs who are (1) currently making concrete efforts to find work and (2) willing and able to work. In addition, our model has the property that people searching for jobs are better off if they find a job than if they do not (that is, unemployment is involuntary). We integrate our model of involuntary unemployment into the simple new Keynesian framework with no capital and use the resulting model to discuss the concept of the nonaccelerating inflation rate of unemployment. We ...
A model of the Twin Ds: optimal default and devaluation
This paper characterizes jointly optimal default and exchange-rate policy in a small open economy with limited enforcement of debt contracts and downward nominal wage rigidity. Under optimal policy, default occurs during contractions and is accompanied by large devaluations. The latter inflate away real wages, thereby avoiding massive unemployment. Thus, the Twin Ds phenomenon emerges endogenously as the optimal outcome. In contrast, under fixed exchange rates, optimal default takes place in the context of large involuntary unemployment. Fixed-exchange-rate economies are shown to have ...
Optimal unemployment insurance and cyclical fluctuations
The authors study the design of optimal unemployment insurance in an environment with moral hazard and cyclical fluctuations. The optimal unemployment insurance contract balances the insurance motive to provide consumption for the unemployed with the provision of incentives to search for a job. This balance is affected by aggregate conditions, as recessions are characterized by reductions in job finding rates. We show how benefits should vary with aggregate conditions in an optimal contract. In a special case of the model, the optimal contract can be solved in closed form. We show how this ...
Affine term structure pricing with bond supply as factors
This paper presents a theoretical model for analyzing the effect of the maturity structure of government debt on the yield curve. It is an ATSM (affine term structure model) in which the factors for the yield curve include, in addition to the short rate, the government bond supply for each maturity. The supply shock is not restricted to be perfectly correlated across maturities. The effect on the yield curve of a bond supply shock that is local to a maturity is largest at the maturity. This hump-shaped response of the yield curve persists in spite of the absence of preferred-habitat investors.
The great housing boom of China
China's housing prices have been growing nearly twice as fast as national income in the past decade despite (1) a phenomenal rate of return to capital and (2) an alarmingly high vacancy rate. This paper interprets such a prolonged paradoxical housing boom as a rational bubble that emerges naturally from China's large-scale economic transition, featuring an exceptionally high rate of return to capital driven by massive resource reallocation. Because such primarily resource-reallocation-driven high capital returns are not sustainable in the long run, expectations of high future demand for ...
DSGE models for monetary policy analysis
Monetary DSGE models are widely used because they fit the data well and can be used to address important monetary policy questions. We provide a selective review of these developments. Policy analysis with DSGE models requires using data to assign numerical values to model parameters. The paper describes and implements Bayesian moment matching and impulse response matching procedures for this purpose.
Fiscal stimulus and distortionary taxation
We quantify the fiscal multipliers in response to the American Recovery and Reinvestment Act of 2009. We extend the benchmark Smets-Wouters New Keynesian model (Smets and Wouters, 2007), allowing for credit-constrained households, the zero lower bound, government capital, and distortionary taxation. The posterior yields modestly positive short-run multipliers around 0.52 and modestly negative long-run multipliers around -0.42. The multiplier is sensitive to the fraction of transfers given to credit-constrained households, the duration of the zero lower bound, and the capital. The stimulus ...