NEP-DGE Blog

By Daan Steenkamp, Roy Havemann and Hylton Hollander

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This paper quantifies the effect of fiscal transfers on the trade-off between social relief and debt accumulation, and discusses the economic growth and fiscal implications of different combinations of expanded social support and funding choices. Given South Africa’s already high level of public debt, the opportunity to fund a basic income grant through higher debt is limited. Using a general equilibrium model, the paper shows that extending the social relief of distress grant could be fiscally feasible provided taxes rise to fund such a programme. Implementing such a policy would, however, have a contractionary impact on the economy. A larger basic income grant (even at the level of the food poverty line) would threaten fiscal sustainability as it would require large tax increases that would crowd-out consumption and investment. The model results show that sustainably expanding social transfers requires structurally higher growth, which necessitates growth-enhancing reforms that crowd-in the private sector through, for example, relieving the energy constraint, increasing government infrastructure investment and expanding employment programmes.

This is the thoroughest analysis of a basic income program I have seen so far. The results are not surprising: any program that lacks targeting is prohibitively expensive whichever way you finance it. I tried to address a similar question and came to the same conclusion, though using a much lower unemployment rate that was is usual in South Africa.

By James Lennox

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Transport infrastructure is costly to build and very long-lived. Major projects are expected to enhance accessibility, which over time, is likely to affect the distribution of population and employment. In a Dynamic Spatial Equilibrium (DSE) model, the timing and location of a project’s direct costs and benefits can be explicitly represented. Effects of both construction and operational phases are captured in a forward-looking spatial general equilibrium with costly adjustment. Not only are dynamic responses of direct interest to policymakers, but they have crucial implications for welfare analysis. In this paper, we present a flexible DSE model incorporating dynamics of internal migration and occupation choice, and intra- period spatial linkages via commuting and trade flows. We calibrate the framework to Australian data and illustrate its application by modelling a hypothetical fast express rail service in South-East Queensland. In analysing the results, we highlight the roles of general equilibrium effects within and between periods. These are important both to overall welfare benefits and to their distribution. Transport cost changes are exogenous inputs to our simulation. However, we also discuss the potential to link a DSE model to a four-step strategic transport model to enable fully dynamic Land Use-Transport Interactions (LUTI) simulations.

Is this the next dimension into which DSGE models will evolve? I highlights a few space models before, which had direct relevance to topics that DSGE modelers cared about. Here, we are venturing further away, a area that space modelers are familiar with but now using some DSGE techniques.

By Lorenzo Burlon, Carlos Montes-Galdón, Manuel Muñoz and Frank Smets

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We provide evidence on the estimated effects of digital euro news on bank valuations and lending and find that they depend on deposit reliance and design features aimed at calibrating the quantity of CBDC. Then, we develop a quantitative DSGE model that replicates such evidence and incorporates key selected mechanisms through which CBDC issuance could affect bank intermediation and the economy. Under empirically-relevant assumptions (i.e., central bank collateral requirements and imperfect substitutability across CBDC, cash and deposits), the issuance of CBDC yields non-trivial trade-offs and effects through an expansion of the central bank balance sheet and profits. The issuance of CBDC exerts a smoothing effect on lending and real GDP by stabilizing deposit holdings. Such “stabilization effect” improves the well-known liquidity services/disintermediation trade-off induced by CBDC and permits to rank different types of CBDC rules according to individual and social preferences. Welfare-maximizing CBDC policy rules are effective in mitigating the risk of bank disintermediation and induce significant welfare gains.

Central Bank Digital Currencies (CBDC) are often presented as a response of central banks to cryptocurrencies. That is wrong. First CBDC do not need to be on a blockchain, as the central bank manages its ownership. Second, its value can be managed by monetary policy. This means that it has many commonalities with non-digital money, but, as this paper shows, CBDC also has a few properties that make it a valuable addition to the portfolio of assets the public can use.

By Andrew Atkeson, Jonathan Heathcote and Fabrizio Perri

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The US net foreign asset position has deteriorated sharply since 2007 and is currently negative 65 percent of US GDP. This deterioration primarily reflects changes in the relative values of large gross international equity positions, as opposed to net new borrowing. In particular, a sharp increase in equity prices that has been US-specific has inflated the value of US foreign liabilities. We develop an international macro finance model to interpret these trends, and we argue that the rise in equity prices in the United States likely reflects rising profitability of domestic firms rather than a substantial accumulation of unmeasured capital by those firms. Under that interpretation, the revaluation effects that have driven down the US net foreign asset position are associated with large, unanticipated transfers of US output to foreign investors.

This is a fascinating paper with very interesting results. However, I am afraid that some may draw the wrong policy lessons from it, for example limiting access of foreign investors to US markets. While it would likely “improve” the net foreign asset position, it would also restrict investment into the productive capacity of the US, and this is what matters in the end. A better policy would be to look into why the profits are so high and how that is welfare worsening.

By Catalina Granda-Carvajal, Franz Hamann and Cesar Tamayo

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In this paper we build an incomplete-markets model with heterogeneous households and firms to study the aggregate effects of saving constraints and credit constraints in general equilibrium. We calibrate the model using survey data from Colombia, a developing country in which informal saving and credit frictions are pervasive. Our quantitative results suggest that reducing savings costs increases selection into formal saving, but the effect on aggregate outcomes and welfare is dwarfed by that of a policy which ameliorates borrowing constraints. Such a policy improves resource allocation and increases returns to capital and labor, resulting in higher savings and welfare gains for both households and firms.

In other words, it is very nice to get unbanked people into formal banks, but the real impact is by getting access to formal credit. At least for the aspects considered by the paper. Being unbanked has other consequences, such as the risk of losing savings kept in cash in your home and more difficult payments, in particular online. That is unlikely (my guess) to be more important that what this paper highlights, though.

By Pietro Cova, Alessandro Notarpietro, Patrizio Pagano and Massimiliano Pisani

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We assess the transmission of a monetary policy shock in a two-country New Keynesian model featuring a global private stablecoin and a central bank digital currency (CBDC). In the model, cash and digital currencies are imperfect substitutes that differ as to the liquidity services they provide. We find that in a digital-currency economy, where the stablecoin is a significant means of payment, the domestic and international macroeconomic effects of a monetary policy shock can be smaller or larger than in a (benchmark) mainly-cash economy, depending on how the assets backing the stablecoin supply respond to the shock. The benchmark transmission of the monetary policy shock can nonetheless substantially be restored in the digital-currency economy 1) if the stablecoin is fully backed by cash or 2) if the CBDC is a relevant means of payment.

I guess I need to be educated as to what the value of a fully-backed stablecoin is in the presence of a CBDC. To me they look identical. And it does not look like monetary policy would differ either, even compared to a world without either of them. It all boils down to the fact that imperfectly substitutable goods leads to the same responses if they always move together, and thus for policy purposes they are perfectly substitutable.

By Ryuichiro Hashimoto and Nao Sudo

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This paper quantitatively assesses the indirect effect of floods on the real economy and financial intermediation in Japan by estimating a dynamic stochastic general equilibrium (DSGE) model that incorporates a mechanism through which floods cause the capital stock and the public infrastructure to depreciate exogenously, using the data on flood damage recorded in the Flood Statistics released by the Japanese government. The result of the analysis is twofold. First, flood shocks dampen GDP from the supply side by reducing the capital stock inputs. The decline in GDP then impairs the balance sheets of firms and financial intermediaries, resulting in disruptions to financial intermediation and thus dampening GDP further from the demand side. Even when the direct damage due to floods is fully covered by insurance, the downward pressure on GDP endogenously deteriorates the balance sheets of these sectors, causing the same mechanism to operate. Second, the quantitative impacts of flood shocks on GDP up to now have been minor compared to the standard structural shocks that are considered important in existing macroeconomic studies, including shocks to total factor productivity (TFP) and the subjective discount factor. According to the estimates that use the relationship between the key variables in our model together with climate change scenarios published by an external organization, the impacts of these shocks could become somewhat larger in the future.

Given that we are recovering from flooding in St. Louis, this hit a nerve. Of course, if you destroy some capital, the economy suffers. But there is this persistent myth that a natural disaster is good because it provides jobs for the recovery. I wonder whether this class of models could say something in this regard when there is under-employment or when a geographically limited area is hit (leading to reallocations).

By Arianna Garofalo

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Over the past three decades, the drop in fertility rates has been accompanied by high rates of migration in several developing countries. We argue that migration affects fertility negatively in the countries of origin. To analyze the effect of migration we build a fertility choice model, based on De La Croix (2014), with endogenous migration decisions. In this framework, when a member of the household migrates abroad, income increases due to remittances but at the same time, individuals left at home face a much higher opportunity cost time. This means that household members have less time to devote to taking care of the children and the consequence is a decrease in fertility. We calibrate the model to match the migration rates and to quantify the effect of migration on the fertility rate in those countries. To this end, we first show that the model can replicate the high rate of migrations in several developing countries. Then we perform two counterfactual exercises to address the effect of our mechanism. In the first exercise, we keep the migration constant as in the benchmark model while we give a higher value to the time cost of migration. The result is an increase in fertility. In the second exercise, we quantify how the differences in the time cost of migration affect the differences in fertility. We found that the time cost of migration accounts for 53% of the fall in the fertility of the developing countries in our sample between 1990 and 2017.

Open migration is the solution to several global problems. This paper shows that it can also contribute is important ways to reducing population growth, at least if the children members remain in the origin country and thus rely on remittances.

By Adam Gulan, Esa Jokivuolle and Fabio Verona

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The optimal level of banks’ capital requirements has been a key research topic since at least the introduction of the Basel rules in the late 1980s. In this paper, we review the literature, focusing on recent findings from quantitative structural macroeconomic models. While dynamic stochastic general equilibrium models capture second-round (general equilibrium) effects such as the feedback effects from macroeconomic outcomes back to financial intermediation and the dynamic evolution of the economy following regulatory changes, they suffer from tractability issues, including treatment of nonlinear effects, that typically force modeling simplifications. Additionally, studies tend to be concerned with determining the optimal level of fixed capital requirements. Only a handful offer estimates of the optimal size of the dynamic buffers. Since optimal dynamic macroprudential policies depend heavily on the nature of the underlying shocks, questions arise regarding the robustness and potential side effects of such plicies. Despite progress, the optimal level of bank capital requirements – in either fixed or dynamic form – remains largely an open research question.

Having tried myself many moons ago to address the question of optimal capital requirements and then facing big difficulties in modelling this properly and then having to come up with unique solution procedures, I can only emphasize how this is an important, and yet very difficult, question this is. With the recent progress in solving highly non-linear heterogeneous agent models more people should tackle this!

By Chris Papageorgiou, Giovanni Melina, Alessandro Cantelmo and Nikos Fatouros

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This paper analyzes monetary policy regimes in emerging and developing economies where climate-related natural disasters are major macroeconomic shocks. A narrative analysis of IMF reports published around the occurrence of natural disasters documents their impact on important macroeconomic variables and monetary policy responses. While countries with at least some degree of monetary policy independence typically react by tightening the monetary policy stance, in a sizable number of cases monetary policy was accommodated. Given the lack of consensus on best practices in these circumstances, a small-open-economy New-Keynesian model with disaster shocks is leveraged to evaluate welfare under alternative monetary policy rules. Results suggest that responding to inflation while allowing temporary deviations from its target is the welfare maximizing policy. Alternative regimes such as strict inflation targeting, exchange rate pegs, or Taylor rules explicitly responding to economic activity or the exchange rate would be welfare-detrimental. With climate change projected to expand the list of disaster-prone countries, these findings are likely to be soon relevant also for richer or larger economies.

I wonder why this analysis would be limited to emerging and developing economies. Developed economies also suffer major shocks. Covid-19 was in many ways like a natural disaster shock (sudden unavailability of staff, supply disruptions, liquidity needs) leading to major price changes.