Incomplete markets and the output–inflation tradeoff

This paper analyses the effects of money shocks on macroeconomic aggregates in a tractable flexible-price, incomplete-markets environment that generates persistent wealth inequalities amongst agents. In this framework, current inflation redistribute wealth from the cash-rich employed to the cash-poor unemployed and induce the former to increase their labour supply in order to maintain their desired levels of consumption and precautionary savings. If the shocks are persistent, however, they also raise inflation expectations and thus deter the employed from saving and supplying labour. We relate the strength of these two inflation taxes to the underlying parameters of the model and study how they compete in determining the overall sign and slope of the implied ‘output–inflation tradeoff’ relation.     

Monetary policy with heterogeneous agents and borrowing constraints

We show that the long-run neutrality of inflation on capital accumulation obtained in complete market models no longer holds when households face binding credit constraints. Borrowing-constrained households are not able to rebalance their financial portfolio when inflation varies, and thus adjust their money holdings differently compared to unconstrained households. This heterogeneity leads to a new precautionary savings motive, which implies that inflation increases capital accumulation. We quantify the importance of this new channel in an incomplete market model where the traditional redistributive effects of inflation are also introduced. We show that this model provides a quantitative rationale for the observed hump-shaped relationship between inflation and capital accumulation.     

Job Protection: The Macho Hypothesis

This paper shows that the stringency of employment protectionin Mediterranean countries can be partly explained by culturalvalues embedded in religion. Both the security provided by thislegislation and its redistributive effects in favour of themale breadwinner insiders fit into the framework of Mediterraneanreligions. First, international individual surveys allow usto document that Catholics and Muslims are more likely to agreewith traditional gender division of work than Protestants andthe non-religious. Second, we develop a political economy modelpredicting that employment protection should be more stringentin countries where there is a larger share of insiders supportiveof traditional family values. We then show that this predictionis supported by empirical evidence on OECD countries over theperiod 1970–99. Footnotes ¹ E-mail addresses: yann.algan{at}ens.fr; cahuc{at}ensae.fr     

Macroeconomic implications of financial policy

This paper studies the effects of financial policy in a model with heterogeneous agents, incomplete markets and portfolio restrictions. For an economy calibrated to replicate key aspects of the U.S. wealth distribution, we find that the quantitative effects of financial policy are relatively small. The reason is that the households determining aggregate behavior are relatively well insured and can therefore offset the actions of the firm by modifying their portfolio allocations. However, financial policy has important effects on asset prices. Whereas a higher level of debt in the capital structure of the firm introduces more risk into the economy by increasing the volatility of the equity return, it enhances the liquidity of households by increasing the supply of bonds. In an economy with a substantial amount of heterogeneity, this last effect dominates and leverage leads to a decrease in the equity premium. This is in contrast to the findings in representative agent models, in which leverage unambiguously increases the premium through a higher equity return volatility.     

Solving the incomplete markets model with aggregate uncertainty using parameterized cross-sectional distributions

This note describes how the incomplete markets model with aggregate uncertainty in Den Haan et al. [Comparison of solutions to the incomplete markets model with aggregate uncertainty. Journal of Economic Dynamics and Control, this issue] is solved using standard quadrature and projection methods. This is made possible by linking the aggregate state variables to a parameterized density that describes the cross-sectional distribution. A simulation procedure is used to find the best shape of the density within the class of approximating densities considered. This note compares several simulation procedures in which there is—as in the model—no cross-sectional sampling variation.