Macroeconomic Shocks and Banking Regulation

The recent crisis has brought to the fore the cyclical properties of banking regulation. Countercyclical buffers and enhanced capital requirements meant to stabilize banks’ balance sheets across the cycle are not costless, and a delicate balance needs to be reached between providing incentives to generate value and discouraging excessive risk taking. The paper develops a model in which, in contrast with Modigliani–Miller, outside equity and capital requirements matter. It analyses banking regulation in the presence of macroeconomic shocks and studies the desirability of self‐insurance mechanisms such as countercyclical capital buffers or dynamic provisioning, as well as “macro‐hedges” such as CoCos and capital insurance.     

Macroeconomic Effects of Government Spending: The Great Recession was (Really) Different

We estimate the effect of government spending shocks on the U.S. economy with a time‐varying parameter vector autoregression. The recent Great Recession period appears to be characterized by uniquely large impulse responses of output to fiscal shocks. Moreover, the particularity of this period is underlined by highly unusual responses of several other variables. The pattern of fiscal shock responses neither completely fits the predictions of the New Keynesian model of an economy subject to the zero lower bound on nominal interest rates, nor does it suggest regular variation of fiscal policy effects depending on the state of the business cycle. Rather, the Great Recession period seems special in that government spending shocks had a strongly negative effect on the spread between corporate and government bond yields and a strongly positive effect on consumer confidence and private consumption spending.     

Income Redistribution,Consumer Credit,and Keeping Up with the Riches

In this study, we set up a dynamic stochastic general equilibrium (DSGE) model with upward looking consumption comparison and show that consumption externalities are an important driver of consumer credit dynamics. Our model economy is populated by two different household types. Investors, who hold the economy's capital stock, own the firms and supply credit, and workers, who supply labor and demand credit to finance consumption. Furthermore, workers condition their consumption choice on the investors' level of consumption. We estimate the model and find a significant keeping up mechanism by matching business cycle statistics. In reproducing credit moments, our proposed model significantly outperforms a model version in which we abstract from consumption externalities.     

Make Trade Not War?

This paper analyses theoretically and empirically the relationship between military conflicts and trade. We show that the conventional wisdom that trade promotes peace is only partially true even in a model where trade is economically beneficial, military conflicts reduce trade, and leaders are rational. When war can occur because of the presence of asymmetric information, the probability of escalation is lower for countries that trade more bilaterally because of the opportunity cost associated with the loss of trade gains. However, countries more open to global trade have a higher probability of war because multilateral trade openness decreases bilateral dependence to any given country and the cost of a bilateral conflict. We test our predictions on a large data set of military conflicts on the 1950–2000 period. Using different strategies to solve the endogeneity issues, including instrumental variables, we find robust evidence for the contrasting effects of bilateral and multilateral trade openness. For proximate countries, we find that trade has had a surprisingly large effect on their probability of military conflict.     

The Design of Pension Pay Out Options When the Health Status during Retirement Is Uncertain

This paper examines the optimal design of pension plans when the health status during retirement is uncertain. Assuming that the health status affects both life expectancy and the marginal utility of consumption, choice between a lump-sum payment and an annuity can be welfare-enhancing if the health status is not observable by pension plan providers. This result holds if the marginal utility of consumption and life expectancy are negatively correlated. On equity grounds, a lump-sum option can be justified even if the marginal utility of consumption is independent of life expectancy.     

The Consumption–Income Ratio,Entrepreneurial Risk,and the U.S. Stock Market

The owners of small noncorporate businesses face substantial and largely uninsurable entrepreneurial risk. They are also an important group of stock owners. This paper explores the role of entrepreneurial risk in explaining time variation in expected U.S. stock returns in the period 1952–2010. It proposes an entrepreneurial distress factor that is based on a cointegrating relationship between aggregate consumption and income from proprietary and nonproprietary wealth. This factor, referred to here as the cpy residual, signals when entrepreneurial income is low in relation to aggregate consumption and other forms of income in the economy. It is highly correlated with cross‐sectional measures of idiosyncratic entrepreneurial and default risk, and it has considerable forecasting power for the expected equity premium. However, the correlation between cpy and the stock market started to decline at the beginning of the 1980s. The decline in this correlation can be associated with increased stock market participation and with the progress of U.S. state‐level bank deregulation. This pattern is consistent with the view that entrepreneurial risk became more easily diversifiable in the wake of U.S. state‐level bank deregulation.     

Austerity and Private Debt

This study provides empirical evidence that the costs of austerity crucially depend on the level of private indebtedness. In particular, fiscal consolidations lead to severe contractions when implemented in high private‐debt states. Contrary, fiscal consolidations have no significant effect on economic activity when private debt is low. These results are robust to alternative definitions of private‐debt overhang, the composition of fiscal consolidations, and controlling for the state of the business cycle and government debt overhang. I show that deterioration in household balance sheets is important to understand private debt‐dependent effects of austerity.     

Optimal Redistributive Taxation in a Search Equilibrium Model

This paper characterizes optimal non-linear income taxation in an economy with a continuum of unobservable productivity levels and endogenous involuntary unemployment due to frictions in the labour markets. Redistributive taxation distorts labour demand and wages. Compared to their efficient values, gross wages, unemployment, and participation are lower. Average tax rates are increasing. Marginal tax rates are positive, even at the top. Finally, numerical simulations suggest that redistribution is much more important in our setting than in a comparable Mirrlees-type setting.