Intertemporal substitution and the liquidity effect in a sticky price model

The liquidity effect, defined as a decrease in nominal interest rates in response to a monetary expansion, is a major stylized fact of the business cycle. This paper first confirms that, with separable preferences, a low degree of intertemporal substitution in consumption is a necessary condition for the existence of the liquidity effect. In contrast to this result, in a model with non-separable preferences and capital accumulation it takes an implausibly high elasticity of intertemporal substitution to produce a liquidity effect. The robustness of these results to alternative degrees of nominal rigidities, capital adjustment costs and stochastic monetary processes is also analysed. We conclude that price stickiness, by itself, does not guarantee the existence of a liquidity effect.     

On-the-job human capital accumulation in a real business cycle model: Implications for intertemporal substitution elasticity and labor hoarding

A substantial fraction of a worker's time at work goes to acquiring human capital. This paper explicitly considers on-the-job human capital accumulation from the perspective of time invested for acquiring skills and learning by doing in an RBC model and shows that the inability to account for human capital accumulation leads to a substantial bias in conventional estimates of intertemporal substitution elasticity.Our main results are based on the standard intuition that the opportunity cost of time invested in acquiring human capital moves procyclically, so that on-the-job time invested in acquiring human capital is “counter-cyclical.” Furthermore, the true wage rate becomes less procyclical, while production hours become more procyclical than total hours at work. The overall results can be viewed as providing a micro foundation for labor hoarding models without adjustment costs.     

Epstein–Zin Utility,Asset Prices,and the Business Cycle Revisited

This paper discusses the advantages of Epstein and Zin (1989) (EZ) preferences when building dynamic stochastic general equilibrium (DSGE) models that are consistent with well‐known stylized facts of both the business cycle and asset markets. To this end, we combine EZ preferences with several building blocks from the DSGE literature that has tried to solve the equity premium puzzle and to replicate characteristic statistics of the labor market. Our goal is to guide researchers in this area to useful modeling devices and to discuss EZ preferences vis‐a‐vis the standard time‐additive expected utility function. EZ preferences separate the attitude toward risk from the attitude toward intertemporal substitution. We demonstrate that this additional degree of freedom allows us to closely match the empirical facts already in a frictionless production economy with endogenous labor supply. Our study follows Heer and Maußner (2013). We examine models that consider adjustment costs of capital accumulation, consumption habits, and frictions in the allocation of labor. Our empirical targets are estimated from German data.     

Balanced‐Budget Rules,Elasticity of Substitution,and Macroeconomic (In)Stability

This paper examines the relation between factor substitution and (local) stability of equilibria in a one‐sector real business cycle model under balanced‐budget rules. We show that under non‐unitary elasticity of factor substitution, the Schmitt‐Grohé‐Uribe indeterminacy result can be altered. Using the two‐step normalization procedure, we highlight two opposing effects of factor substitution, namely, the efficiency effect and the distribution effect, on aggregate stability. With endogenous distortionary taxes and gross substitutability between capital and labor, the existing literature overlooks the distribution effect and finds that balanced‐budget rules are likely to deliver indeterminacy. However, if capital stock is relatively more abundant, a higher elasticity of substitution generates a source of stability due to the distribution effect. Our calibration shows that the distribution effect is always the dominating force.     

THE RISK‐FREE RATE IN A FINITE HORIZON MODEL WITH BEQUESTS

This paper studies the risk‐free rate in an overlapping generations economy with bequests. It is shown that the risk‐free rate depends on risk aversion, the elasticity of intertemporal substitution, the share of wealth invested in human wealth, life expectancy, and the preference for bequests. In a standard life‐cycle context, mortality increases the subjective time rate of discount, and thus increases the compensation required to postpone consumption. This latter effect is offset in a bequest‐driven model of the type considered here, leading to much more powerful income effects. In this sense, the model provides a bequest‐motive explanation for the risk‐free rate puzzle put forward by Weil in 1989.     

Business cycle fluctuations and the life cycle: How important is on-the-job skill accumulation?

We study the effects of on-the-job skill accumulation on average hours worked by age and the volatility of hours over the life cycle in a calibrated general equilibrium model. Two forms of skill accumulation are considered: learning by doing and on-the-job training. In our economy with learning by doing, individuals supply more labor early in the life cycle and less as they approach retirement than they do in an economy without this feature. The impact of this feature on the volatility of hours over the life cycle depends on the value of the intertemporal elasticity of labor supply. When individuals accumulate skills by on-the-job training, there are only weak effects on both the steady-state labor supply and its volatility over the life cycle.     

Superneutrality, indeterminacy and endogenous growth

In this paper, we explore the possibility of having money as a source of indeterminacy in endogenous growth models. We adopt the simple Ak model of endogenous growth to be the main analytical vehicle whose balanced growth paths do not display local indeterminacy. Money is introduced via either a general cash-in-advance (CIA) constraint or a pecuniary transactions costs (PTC) technology. It is shown that local indeterminacy of the dynamics is due to the presence of an intertemporal substitution effect on capital accumulation that works against and dominates the conventional inflation effect of Tobin [1965, Money and economical growth. Econometrica 33(4), Part 2, 671]. If money is growth-rate superneutral, then the intertemporal substitution effect is absent so that local indeterminacy cannot occur. Finally, the strength of the intertemporal substitution effect depends positively on the intertemporal elasticity of substitution in consumption.     

Income and wealth distribution in a simple model of growth

Summary. This paper studies a deterministic one-sector growth model with a constant returns to scale production function and endogenous labor supply. It is shown that the distribution of capital among the agents has an effect on the level of per-capita output. There exists a continuum of stationary equilibria with different levels of per-capita output. If the elasticity of intertemporal substitution is large, a higher output level can be achieved when income inequality is great, that is, when the income distribution is strongly dispersed. If the elasticity of intertemporal substitution is low, the reverse relation holds. The paper shows that countries with identical production technologies and identical preferences may have different GDP levels because wealth is distributed differently among their inhabitants. Received: January 29, 1999; revised version: October 4, 1999     

50 is the new 30—long-run trends of schooling and retirement explained by human aging

Workers in the US and other developed countries retire no later than a century ago and spend a significantly longer part of their life in school, implying that they stay less years in the work force. The facts of longer schooling and simultaneously shorter working life are seemingly hard to square with the rationality of the standard economic life cycle model. In this paper we propose a novel theory, based on health and aging, that explains these long-run trends. Workers optimally respond to a longer stay in a healthy state of high productivity by obtaining more education and supplying less labor. Better health increases productivity and amplifies the return on education. The health accelerator allows workers to finance educational efforts with less forgone labor supply than in the previous state of shorter healthy life expectancy. When both life-span and healthy life expectancy increase, the health effect is dominating and the working life gets shorter if the intertemporal elasticity of substitution for leisure is sufficiently small or the return on education is sufficiently large. We calibrate the model and show that it is able to predict the historical trends of schooling and retirement.     

ESTIMATING TEMPTATION AND COMMITMENT OVER THE LIFE CYCLE

This article estimates the importance of temptation for consumption smoothing and asset accumulation in a life‐cycle model. We use two complementary estimation strategies: first, we estimate the model‐implied Euler equation; second, we match liquid and illiquid wealth accumulation using the method of simulated moments. In both cases, we find that the utility cost of temptation is one‐quarter of the utility benefit of consumption. Further, temptation is crucial for correctly estimating the elasticity of intertemporal substitution (EIS): EIS estimates are biased downward when ignoring temptation. Finally, the model only matches the share of illiquid wealth if temptation is in the preference specification.     

Sunspot Fluctuations in Two-sector Economies with Heterogeneous Agents

We study a two-sector model with heterogeneous agents and borrowing constraint on labor income. We show that the relative capital intensity difference across sectors is crucial for the conditions required to get indeterminacy and endogenous fluctuations. The main result shows that when the consumption good is sufficiently capital intensive, local indeterminacy arises while the elasticities of capital–labor substitution in both sectors are slightly greater than unity and the elasticity of the offer curve is low enough. Locally indeterminate equilibria are thus compatible with a low elasticity of intertemporal substitution in consumption and a low elasticity of the labor supply. As recently shown in empirical analysis, these conditions appear to be in accordance with macroeconomic evidences. We would like to thank R. Becker, J.P. Drugeon and an anonymous referee for useful comments and suggestions. The current version also benefited from a presentation at the conference “Public Economic Theory 04”, Beijing, August 2004.     

Can consumption habit spillovers be a source of equilibrium indeterminacy?

This paper investigates whether the external consumption habit can be a source of indeterminacy in a one-sector growth model when the labor supply is elastic. When there is a proper habit effect with a positive intertemporal elasticity of substitution, we find that the model exhibits indeterminacy if the coefficient of the habit formation is sufficiently large that allows for a substantial impact of current consumption on the habit. Indeterminacy arises even though the elasticity of the Frisch labor supply is positive and the elasticity of the labor demand in negative. In a calibrated version, we find that indeterminacy is empirically plausible when the habit effect is negative that features the “catching up with the Joneses” effect. Under given “catching up with the Joneses” effects, the external consumption habit can be a source of indeterminacy even if more than a half of the external consumption habit comes from past average consumption.     

The effects of alternative fiscal policies on the intertemporal government budget constraint

This article presents the effects of alternative fiscal policies on the intertemporal government budget constraint when the time horizon of the policy maker varies. I show that the wealth effect associated with cuts in the skill-adjusted labor income tax rate improves the intertemporal budget balance, whereas the intertemporal substitution effect associated with the physical capital income tax rate deteriorates the intertemporal budget. Under plausible parameter values, the tax rate on skill-adjusted labor income cannot by itself balance the intertemporal budget at all horizons.     

A Fiscal Stimulus and Jobless Recovery

We analyze the effects of a government‐spending expansion in a dynamic stochastic general equilibrium model with Mortensen–Pissarides labor‐market frictions, deep habits in private and public consumption, investment adjustment costs, a constant elasticity of substitution (CES) production function, and adjustments in employment at both intensive and extensive margins. The combination of deep habits and CES technology is crucial. The presence of deep habits magnifies the responses of macroeconomic variables to a fiscal stimulus, while an elasticity of substitution between capital and labor in the range of available estimates allows the model to produce a scenario compatible with the observed jobless recovery.     

The trade balance and the terms of trade in a two-country two-sector OLG economy

We consider a two-country, two-sector OLG model. It is shown that the trade balance and the relative price of exports are always positively related when exports are labor intensive regardless of the elasticity of intertemporal substitution in consumption. A large response of savings to future prices becomes a sufficient condition for an inverse relation between these variables only if exports are capital intensive. In this case, a rise in the terms of trade can be followed by a trade balance decline if consumption goods are capital intensive and the income effect implied on savings is negative and large.     

Having It All? Employment,Earnings, and Children*

We study the effect of family policies on female employment, fertility, and the gender wage gap. We develop a life‐cycle model of heterogeneous households featuring endogenous labor supply, human capital accumulation, fertility, and home production. Our results suggest that human capital accumulation is important in accounting for the widening of the gender wage gap following children. We find that, in aggregate, childcare subsidies promote maternal employment and fertility, although the effects are heterogeneous across couples. A subsidy on home goods increases female employment, but primarily later in life. Thus, it does not dampen the widening of the gender gap.     

Public Debt,Productive Public Spending and Endogenous Growth

We analyse the effects of public debt in a basic endogenous growth model with productive public spending. We demonstrate that a discretionary policy in general violates the intertemporal government budget constraint along a balanced growth path. A balanced government budget gives a unique saddle point stable growth path. With a rule‐based policy, two saddle point stable balanced growth paths can occur, depending on the intertemporal elasticity of substitution of consumption and on the primary surplus policy. Higher debt goes along with smaller long‐run growth and we derive a condition such that a deficit‐financed increase in public spending raises the growth rate.     

AGE‐DEPENDENT TAXES WITH ENDOGENOUS HUMAN CAPITAL FORMATION

We assess the gains attained by the introduction of age‐dependent labor income taxes in an overlapping generations economy where individuals live a meaningful life cycle and endogenously accumulate human capital. The model is sufficiently rich to isolate the role of general equilibrium effects, credit market imperfections, and different forms of human capital accumulation. The large welfare gains we obtain cannot be attained without age dependence, nor can they be attained with age‐dependent taxes if progressivity of labor income taxes and capital income tax rates are not suitably adjusted to profit from the complementarity of these instruments.     

LUXURY AND WEALTH*

I develop a dynamic theory of luxury consumption, particularly emphasizing the causal effect that pursuit of luxury goods has on wealth accumulation. A quasi‐luxury is defined as a good whose marginal rate of substitution is increasing in a utility index. Under certain conditions, it is indeed a luxury good. When current wealth holding falls short of (exceeds) long‐run needs, luxury consumption is postponed more (less) easily than necessity consumption, due to a lower (higher) time preference for luxury and/or a higher intertemporal elasticity of substitution thereof. Preferences for quasi‐luxuries lead to a higher steady‐state value of wealth or capital.

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Robots and humans – complements or substitutes?

The effect of the spread of Artificial Intelligence (AI) on wages depends on both the form of aggregate production relationships and the elasticity of substitution between human and robotic labor. With a conventional production function involving labor, robots, and ordinary capital, an increase in robotic labor can have either a positive or a negative effect on wages. Alternatively, it is possible to estimate the aggregate production relationship without measuring capital or other fixed factors explicitly, using the procedure developed by Houthakker in the 1950s. Houthakker's method is based on the probability distribution of the productivity of the variable factor. Fitting different distributions to cross-sectional data on U.S. productivity, it is shown that if the elasticity of substitution between human and robotic labor is greater than about 1.9, the burgeoning of AI technologies will cause a decline in aggregate wages, other things equal. For the manufacturing sector, an even smaller human-robot elasticity of substitution is likely to result in declining wages of industrial workers as robots proliferate.