Assessing the macroeconomic impact of alternative macroprudential policies

This article assesses effects on the wider economy and overall costs and benefits of two alternative macroprudential policies - loan-to-value ratios on mortgage lending and variable bank capital adequacy targets. It also traces the potential effects of such policies if introduced prior to the subprime crisis. The work is performed within the National Institute Global Econometric Model, with a focus on Germany, Italy and the UK. Detailed banking sectors and addition of a macroprudential block to our model enable effects of policies to be captured. A systemic risk index tracks the likelihood of the occurrence of a banking crisis and establishes thresholds at which macroprudential policies should be activated by the authorities. Capital adequacy impacts the economy by acting on the spread between borrowing and lending of corporates and households, while loan-to-value transmits through its impact on the housing market. We find generally loan-to-value policy has a lesser effect than capital adequacy on crisis probabilities and net benefits, but there is considerable cross country variation. We show that the introduction of macroprudential policy prior to the crisis would have led to improvement in a number of key macroeconomic measures and might thus have reduced the incidence of the crisis.     

Countercyclical capital rules for small open economies

The growing literature on macroprudential regulation focuses on how a combination of monetary and macroprudential policies can boost macroeconomic and financial stability. We contribute to this literature by developing a DSGE model that assesses the effectiveness of countercyclical capital regulation in small open economies, in monetary unions or with exchange rate pegs, where policymakers do not have full control over traditional stabilisation instruments such as nominal interest and exchange rates. In such economies, macroprudential policy could potentially play an even more relevant role in mitigating the adverse effects of macro-financial feedback loops. To validate the model’s ability to replicate the stylised facts of financial crises, we calibrate using data for the Irish economy, the scene of a recent housing crash. Our results demonstrate that the pro-active use of countercyclical capital regulation – in the form of Basel III-type rules – can help attenuate boom-bust cycles driven by over-optimistic expectations. We also find that more aggressive action by regulators during the release phase can bolster the economy’s ability to absorb a negative shock.     

Capital controls and welfare

This paper computes welfare levels under different degree of capital controls and compares them with the welfare level under perfect capital mobility by using the methodology of Schmitt-Grohé and Uribe (2007). We show that perfect capital mobility is not always optimal and that capital controls may enhance an economy’s welfare level. There exists an optimal degree of capital-account restriction that achieves a higher level of welfare than that under perfect capital mobility, if the economy has costly financial intermediaries. The results of our analysis imply that as the domestic financial intermediaries are less efficient, the government should impose stricter capital controls in the form of a tax on foreign borrowing.     

Reconsidering the Impact of the Environment on Long-run Growth when Pollution Influences Health and Agents have a Finite-lifetime

Using an overlapping generation model à la Blanchard (1985, J Polit Econ 93:223–247) with human capital accumulation, we demonstrate that the influence of the environment on optimal growth in the long-run may be explained by the detrimental effect of pollution on life expectancy. We also show that, in such a case, greener preferences are growth- and welfare-improving in the long-run even if the ability of the agents to learn is independent of pollution and utility is additively separable. Finally, we establish that a minimum environmental policy is required to obtain a sustainable equilibrium in the market economy and that it is possible to implement a win–win environmental policy.     

Physical and human capital,fertility, and childcare services

We shed light on a nexus between fertility transitions and economic growth patterns. We construct a two-sector overlapping generations (OLG) model with endogenous fertility, physical capital, and human capital, where one sector produces goods, and another produces childcare services. If the elasticity of fertility for expenditure on childcare services is zero, the economy experiences endogenous growth, and fertility does not depend on physical and human capital, but it increases with parental child-rearing time. On the other hand, if elasticity is positive, the economy converges to a steady state, and the number of children becomes the homogenous function of degree of elasticity (less than one). In other words, fertility is the decreasing-return-to-scale function of physical and human capital. We show that a subsidy policy for education is more desirable than a subsidy for childcare services.     

Credit policies,macroeconomic stability and welfare: The case of China

Using a new Keynesian DSGE model with credit constraints, we study the impact on macroeconomic volatility of a macroprudential credit policy of the type implemented by the Central Bank of China. We find that the countercyclical credit policy plays a non-negligible role in stabilizing the real economy, and that this effect is distinctly more pronounced when credit conditions are looser. By means of a second-order approximation method, we show that the macroprudential credit policy can significantly boost welfare, benefiting the entrepreneurial sector more than the household sector. The results can yield insights for the institutional and policy setting of China and other emerging countries.     

Financial innovation,economic growth,and the consequences of macroprudential policies

We leverage a ‘catch-all’ measure of financial innovation—research and development spending in the financial sector—to assess the net relationship between financial innovation and economic growth and evaluate the influence of macroprudential policy on this relationship. Using a panel of 23 countries over the period of 1996–2014, our results demonstrate a net-positive relationship between financial innovation and gross capital formation. We find no evidence of a net-negative impact of financial innovation on economic growth, challenging the popular and political stigma surrounding financial innovation. We also find little robust evidence of macroprudential policy influencing the relationship between financial innovation and economic growth. Our results support a functional approach to the regulation of financial innovation, which improves the intermediation process, leading to increased capital formation.     

Inflation, Welfare, and Public Goods

In this article we study the welfare effects of monetary policy in a simple overlapping generation economy in which agents voluntarily contribute to a public good. Inflation has two effects at equilibrium: it increases voluntary contributions and it misallocates private consumption across time. We show that the aggregate effect is welfare-improving for "not too large" inflation rates. Moreover, there exists an optimal inflation rate.     

The effects of elections on macroprudential policy

We provide evidence for a specific challenge in the design of macroprudential policy, namely political interference. Using panel data from 80 countries over the period of 1990–2016, we uncover the electoral cycles in macroprudential policy. We show that a loosening in macroprudential policy becomes more likely in the pre-election year, especially in countries with lower institutional quality. There is no evidence for the reversal of such actions in the post-election year. We also find that capital account openness, the history of macroprudential policy actions and inflation matter in determining the strength of electoral cycles in macroprudential policy, in addition to institutional quality. The electoral cycles are found to be stronger in countries that are financially less open, that relied less on macroprudential policy in the past, and that have lower inflation.     

Growth and optimal policies in an R&D-growth model with imperfect international capital mobility

In this paper, we examine the effects of international capital mobility on innovation, growth, and optimal growth policies in a small open economy with R&D-driven growth. Households can borrow funds from an imperfect international capital market to finance their investment in R&D firms. We show that the economy can reach a higher growth rate if international capital is more mobile. This result is consistent with recent empirical findings. Moreover, we show that the common growth-enhancing policies, such as patent protection and the R&D subsidies, have an additional negative welfare effect when households can access the international capital market. Accordingly, the optimal patent protection and R&D subsidy should be smaller when the degree of international capital mobility is higher.     

Optimal Tax Policy, Market Imperfections, and Environmental Externalities in a Dynamic Optimizing Macro Model

This paper develops a dynamic real business cycle model that highlights pollution externalities (on welfare and production) and market imperfections and uses it to determine the socially optimal tax policy that encompasses labor income, capital income, and emission taxes. We show that the optimal tax on capital and labor income only addresses the production inefficiency (and is time-invariant), while the tax on the environmental externalities affects both the production inefficiency and the environmental spillovers (and is time-varying). More interestingly, the socially optimal emission tax will be characterized by a Keynesian-like stabilizer that is designed to mitigate business cycle fluctuations, i.e., that will stimulate the economy with a lower emission tax during recessions. In a positive analysis, we show that the beneficial effects arising from pollution taxation will become larger the greater is the degree of the firms' monopoly power. In addition, a triple dividend in terms of improving environmental quality and increasing employment and firms' profit can be simultaneously realized if the environmental production externality is more significant and if the elasticity of intertemporal substitution in consumption is relatively small.     

A policy model to analyze macroprudential regulations and monetary policy

We construct a small‐open‐economy, new Keynesian dynamic stochastic general‐equilibrium model with real financial linkages to analyze the effects of financial shocks and macroprudential policies on the Canadian economy. The model incorporates rich interactions between the balance sheets of households, firms and banks, long‐term household and business debt, macroprudential policy instruments and nominal and real rigidities and is calibrated to match dynamics in Canadian macroeconomic and financial data. We study the transmission of monetary policy and financial and real shocks in the model economy and analyze the effectiveness of various policies in simultaneously achieving macroeconomic and financial stability. We find that, in terms of reducing household debt, more targeted tools such as loan‐to‐value regulations are the most effective and least costly, followed by bank capital regulations and monetary policy, respectively.     

Pension Reform, Capital Markets and the Rate of Return

Abstract. This paper discusses the consequences of population aging and a fundamental pension reform – that is, a shift towards more pre‐funding – for capital markets in Germany. We use a stylized closed‐economy, overlapping‐generations model to compare the effects of the recent German pension reform with those of a more decisive reform that would freeze the current pay‐as‐you‐go contribution rate and thus result in a larger funded component of the pension system. We predict rates of return to capital under both reform scenarios over a long horizon, taking demographic projections as given. Our main finding is that the future decrease in the rate of return is much smaller than often claimed in the public debate. Our simulations show that the capital stock will decrease once the baby‐boom generations enter retirement, even if there were no fundamental pension reform. The corresponding decrease in the rate of return, the direct effect of population aging, is around 0.7 percentage points. While the capital market effects of the recent German pension reform are marginal, the rate of return to capital would decrease by an additional 0.5 percentage points under the more decisive reform proposal.     

Global banking and the conduct of macroprudential policy in a monetary union

This paper questions the role of cross-border lending in the definition of national macroprudential policies in the European Monetary Union. We build and estimate a two-country DSGE model with corporate and interbank cross-border loans, Core-Periphery diverging financial cycles and a national implementation of coordinated macroprudential measures based on Countercyclical Capital Buffers. We get three main results. First, targeting a national credit-to-GDP ratio should be favored to federal averages as this rule induces better stabilizing performances in front of important divergences in credit cycles between core and peripheral countries. Second, policies reacting to the evolution of national credit supply should be favored as the transmission channel of macroprudential policy directly impacts the marginal cost of loan production and, by so, financial intermediaries. Third, the interest of lifting up macroprudential policymaking to the supra-national level remains questionable for admissible value of international lending between Eurozone countries. Indeed, national capital buffers reacting to the union-wide loan-to-GDP ratio only lead to the same stabilization results than the one obtained under the national reaction if cross-border lending reaches 45%. However, even if cross-border linkages are high enough to justify the implementation of a federal adjusted solution, the reaction to national lending conditions remains remarkably optimal.     

Capital controls and welfare with cross-border bank capital flows

This performance of time-varying capital controls on cross-border bank borrowing is studied in an open-economy, dynamic stochastic general equilibrium model with financial frictions and imperfect capital mobility. The model is parameterized for a middle-income country and replicates the stylized facts associated with a drop in world interest rates—capital inflows, real appreciation, credit boom, asset price pressures, and output expansion. A capital controls rule, which is fundamentally macroprudential in nature, is defined in terms of changes in bank foreign borrowing. The welfare-maximizing rule is established numerically and compared to the Ramsey policy. The analysis is then extended to solve jointly for optimal countercyclical reserve requirements and capital controls rules. The results show that the implementation of a countercyclical credit-based reserve requirement rule induces less reliance on capital controls. Thus, these two instruments are partial substitutes in maximizing welfare.     

On the optimality of a minimum wage: New insights from optimal tax theory

We build a theoretical model to study whether a minimum wage can be welfare-improving if it is implemented in conjunction with an optimized nonlinear income tax. We consider this issue in a framework where search frictions on the labor market generate unemployment. Workers differ in productivity. The government does not observe workers' productivity but only their wages. Hence, the redistributive policy solves an adverse selection problem. We show that a minimum wage is optimal if the bargaining power of the workers is relatively low. However, if the government controls the bargaining power, then it is preferable to set a sufficiently high bargaining power.     

Public investment,national debt,and economic growth: The role of debt finance under dynamic inefficiency

Public investment is a central issue in the dynamic analyses of fiscal policy and economic growth. Debt financing for public investment and its effects have recently received great attention because interest rates have been low, almost invariably remaining below economic growth rates. This paper presents examination of the effects of debt-financed public investment subject to a simple fiscal rule in an overlapping generations model with public capital. This topic includes capital budgeting and the debt–deficit criterion of the Maastricht treaty. We show herein that debt financing for public investment enhances economic growth if an economy is dynamically inefficient and if public capital has a sufficiently large productivity effect. Moreover, it reduces economic growth rates in a dynamically efficient economy. Debt and growth can have a monotonic or non-monotonic relation, depending on the steady-state interest rate, growth rate, and productivity effect of public investment. The findings indicate that debt–growth relations match with controversial empirical evidence. Furthermore, existing generations choose perfect debt finance if dynamic inefficiency exists. In contrast, a balanced budget is preferred in a dynamically efficient economy with low productivity effects of public capital. However, an economy with high productivity effects of public capital might cho ose debt financing. This paper contributes to the elucidation of currently emphasized issues of public investment.     

放弃成本、政府偏好与资本控制:一个审慎的机会主义汇率制度选择模型

本文在Obstfeld(1 996)第二代货币危机模型的基础上 ,建立了一个考虑经济结构、供给冲击以及金融风险的多因素汇率制度选择模型 ,以成本分析为工具解释了资本控制、各类成本和政府偏好对均衡的影响以及对汇率制度选择的影响。研究表明 :(1 )资本控制可以通过多种途径对均衡产生影响 ,在一定条件下可以利用资本控制措施使经济避免多重均衡 ;(2 )放弃成本对汇率制度选择发挥关键作用 ;(3 )较大的政府偏好促使政府选择固定汇率制度 ,在放弃成本不足够大的条件下 ,决策者也可以通过提高政府偏好或者实施资本控制措施来保护本国固定汇率制度 ;(4)对人民币现行汇率制度的放弃成本的估计表明 ,当前人民币汇率制度放弃成本正处于中间水平 ,因此有必要增大政府对固定汇率制度的偏好并且对资本帐户实施适度管理以保持人民币汇率的稳定 ,防范金融风险。至于未来人民币汇率波动幅度的扩大、资本项目自由化的进程以及人民币汇率制度何时回归真正的“管理浮动” ,应主要取决于人民币汇率制度放弃成本的有效降低     

Envy and Inequality*

We present an overlapping generations economy, populated by heterogeneous agents who care about both consumption relative to others and the bequest they leave to their offspring. We show that saving and bequest rates vary across the income distribution, and we obtain several interesting results. First, envy reduces the steady‐state capital stock and increases the degree of inequality in consumption, capital ownership, and bequests. Second, if the bequest motive is sufficiently strong the equalizing effect of bequests disappears. Third, income inequality for a given cohort increases with age. Fourth, the distribution of inherited wealth becomes more unequal than that of wealth in general. Fifth, economic position becomes more persistent across generations.     

Public capital,deficit financing,and economic growth in a stochastic economy

This paper examines the relationship among deficit-financing fiscal policy, risk and economic growth in a stochastic endogenous growth model with private and public capital. We show that there are positive balanced-growth rate and a debt-to-GDP ratio that depend on deep parameters such as the income tax rate and the standard deviation of the growth rate of private and public capital. Investment and fiscal shocks influence the mean and variance of the growth rate and the debt dependency rate through portfolio changes and capital accumulation. In particular, an increase in the risk of private investment destabilizes the economy and reduces the mean growth rate if the portfolio change is drastic, and this increase in risk increases the debt-to-GDP ratio. In contrast, an increase in the income tax rate stabilizes the economy, increases the mean growth rate, and has a positive or negative effect on the debt-to-GDP ratio according to the ratio of public to private capital if the income tax rate is sufficiently small.