Has Public Debt Been too High in Canada and the U.S.? A Quantitative Assessment (R&R at the Canadian Journal of Economics, previous working paper version).
I quantify the welfare effects of changing the long-run value of public debt using a two-region OLG model with rich income dynamics over the life-cycle, incomplete insurance, and an integrated asset market. I consider two model calibrations, one for Canada and one for the US. In the former case, I find that changes in public debt cause small interest rate effects. To validate the model, I conduct a formal empirical analysis, which does not reject the two-region theoretical framework. The quantitative model is used to perform a welfare analysis of counterfactual debt policies. In the long-run, for both Canada and the US, I find that negative quantities of public debt involve considerable welfare gains. For the US economy, when taking into account the welfare costs of the transitional dynamics, the result is reversed. However, imposing the empirical correlation between changes in public debt and changes in public expenditure found in the OECD data restores the finding that moving to equilibria with public wealth leads to welfare gains.
JEL Classification Codes: D52, E21, E62, H63.
Keywords: Public Debt, Incomplete Markets, Welfare.
A vast experimental literature in both psychology and economics documents that individuals exhibit rank-dependent probability weighting in economic decisions characterized by risk. I incorporate this well-known behavioral bias in a Rank-Dependent Expected Utility (RDEU) macroeconomic model. I develop a dynamic general equilibrium model with heterogeneous agents, labor market risk, and aggregate fluctuations, featuring households that are RDEU maximizers in an environment characterized by realistic labor market dynamics. I use the model to quantify the importance of RDEU for a number of macroeconomic outcomes. In a calibration of the model based on U.S. data, I find that RDEU plays an important role for the amount of aggregate wealth. Compared to the complete-markets EU benchmark, the long-run average of the capital stock rises by up to 12.6%. This large change is determined by the increased importance of precautionary saving, driven by the volatile labor market dynamics combined with the employed workers' pessimism. As for the outcomes routinely studied in the analysis of business-cycles, such as the volatility of both consumption and investment (relative to income), I find that RDEU improves the fit of the model. Overall, in terms of the discrepancy between model-generated business-cycle statistics and data, the RDEU models attain lower root mean squared errors than the EU one.
JEL Classification Codes: C63, D15, D52, D58, D90, E32, E71, J64.
Keywords: Rank-dependent Probability Weighting, Rank-dependent Expected Utility, Heterogeneous Agents, Incomplete Markets, Labor Market Risk, Business Cycles..
This paper characterizes quantitatively the optimal capital income tax rate in an OLG economy with uninsurable income risk, incomplete markets and endogenous Schumpeterian growth. Contrary to the most recent literature, it is found that it is virtually never optimal to tax capital: under the optimal scheme, in a series of cases, the highest proportional tax rate on capital is found to be less than 0.2%. The reason for this result lies in the reduced GDP (and wage) growth rate stemming from a higher capital tax rate. In General Equilibrium, the interest rate rises, and the increased cost of capital reduces the endogenous rate of innovation, leading to a negative response of the growth rate. Although the equilibrium effect on the growth rate is found to be quantitatively modest (approximately half a percentage point), it still has a first order consequence on welfare. The results show that moving to the optimal income tax schedule entails large welfare gains, approximately 5% in consumption equivalent. The results are robust along a number of dimensions, including the specification of preferences. An alternative formulation of the utility function, taken from a class consistent with a Balanced Growth Path, is calibrated to obtain an empirically plausible value for the Frisch elasticity of 0.5, and confirms all the results, both qualitatively and quantitatively.
JEL Classification Codes: E13, H21, H24, H25.
Keywords: Capital and Income Taxation, Heterogeneous Agents, Incomplete Markets, Endogenous Growth, Welfare.
Public Funding of Research and Grant Proposals in the Social Sciences: Empirical Evidence from Canada (under submission, previous working paper version).
I use Social Sciences and Humanities Research Council data to analyze some of the elements shaping the decision of researchers affiliated with Canadian institutions to apply for public research grants. Relying on panel data methods, I find that researchers show an aversion to the instability of funding, hence, to the uncertainty in the policy environment. In particular, both the volatility of the resources granted and the volatility of the funding probability deter researchers from submitting proposals. I then speculate on the possible consequences of the current funding scheme and on the chances for some recent worrisome trends to revert in the near future.
JEL Classification Codes: H50, I23, I28.
Keywords: Academic Research Funding, Public Policy, Social Sciences.
Heterogeneity in Macroeconomics and the Minimal Econometric Interpretation for Model Comparison (R&R at the Journal of Applied Econometrics).
I formally compare the fit of various versions of the incomplete markets model with aggregate uncertainty relying on the Minimal Econometric Interpretation, which is a computationally tractable Bayesian empirical framework. The models differ in the degree of household heterogeneity, with a focus on the role of preferences. For every specification, empirically motivated priors for the parameters are postulated to obtain the models' predictive distributions, which are interpreted as being distributions of population moments. These are in turn compared to the posterior distributions of the same moments obtained from an a-theoretical Bayesian econometric model. I show that aggregate data on consumption and income contain valuable information to determine which models are more likely to have generated the data. The two models featuring risk aversion heterogeneity have the highest marginal likelihoods, showing that this element is quantitatively important also for the study of aggregate outcomes. I also extend the framework to include the fit of the wealth Gini index, but the ranking of the models is only marginally affected.
JEL Classification Codes: C63, C68, E21, E32, D52, D58.
Keywords: Heterogeneous Agents, Incomplete Markets, Unemployment Risk, Business Cycles, Calibration, Bayesian Methods, Minimal Econometric Interpretation, Model Comparison.
Risk Aversion Heterogeneity, Risky Jobs and the Distribution of Wealth (R&R at the International Economic Review).
This paper considers the macroeconomic implications of a set of empirical studies finding a high degree of dispersion in preferences for risk. It develops a model with risk aversion heterogeneity, uninsurable idiosyncratic income risk, and (with or without) self-selection into risky jobs to quantify their effects on the distribution of wealth. The results show that the role of risk aversion heterogeneity is quantitatively important. When estimating the risk aversion distribution with the appropriate PSID data on income lotteries, the model matches the observed degree of wealth inequality in the U.S., accounting for both the wealth Gini index and other key features of the wealth distribution. It is also shown that neglecting risk preference heterogeneity has a first order effect on the aggregate allocations.
Social Security Reforms: a Simple Bayesian Quantitative Analysis
This paper characterizes numerically the welfare maximizing pension benefits scheme when two competing specifications for the stochastic income process govern the extent of labor market risk. The analysis embeds elements of both Bayesian empirical methods and robust social security reform. A quantitative Macroeconomic model with heterogeneous agents is exploited to address both which stochastic income process is more likely to have generated the data, and to compute the optimal benefits function for the social security system in an economy with rich labor income dynamics. Under the Minimal Econometric Interpretation of the economic model, proposed by Geweke (2010), the predictive distributions of a set of population moments for the two models, the autocorrelations of earnings and hours worked, are compared to the posterior distributions of the same moments, obtained with an a-theoretical Bayesian Panel VAR. Preliminary results seem to give more weight to the model of wage dynamics with slope heterogeneity, but not overwhelmingly so, as the Bayes Factor is approximately 3:1. Moreover, the optimal replacement rate of the social security system is found to depend heavily on the nature of labor income risk. Finally, the optimal replacement rate with either specification of wage risk is found to be higher than what is typically obtained in similar studies.
JEL Classification Codes: C52, C54, C68, D52, E21, E62, H55.
Keywords: Social Security Reforms, Heterogeneous Agents, Incomplete Markets, Ex-ante Policy Evaluation, Welfare, Bayesian Methods.
This paper studies the effects of both labor market conditions and asset poverty on the property crimes involvement of American males. Since the mid 60's the property crimes arrest rate has been four times higher for black males if compared to white ones. Another set of stylised facts show for the first demographic group lower educational levels and worse labor market outcomes, with the African Americans supplying less hours of labor, gaining lower wages, experiencing both higher unemployment duration and rates. At the same time, more than 30% of black households had a negative net worth. A dynamic general equilibrium model is developed, exploiting these facts to quantitatively assess the race crime gap, that is the difference in crime explained by the difference in observables. The model is calibrated relying on US data and solved numerically. The model captures well relevant dimensions of the crime phenomenon, such as the inmates composition by race, employment status and education. Simulation results show that the observed poverty and labor market outcomes account for as much as 90% of the arrest rates ratio. Finally the model is used to compare two alternative policy experiments aimed at reducing the aggregate crime rate: increasing the expenditure on police seems to be cost effective, when compared to an equally expensive lump-sum subsidy targeted to the high school dropouts.
JEL Classification Codes: K42, D58, D52, D99, J15.
Keywords: Property crimes, Incomplete Markets, Race, Unemployment, Wealth Inequality.
Hard Drugs Addiction, Drug Violations and Property Crimes in the US (New version coming soon.)
This paper studies the effects of hard drugs addiction on both property crimes and hard drugs selling in the US. It specifies and estimates a dynamic equilibrium model to quantify how much of the observed property crime rate is accounted for by hard drugs addiction. Framed in both a rational addiction and a rational crime participation environment, the model exploits information on drug use in the American population, expenditure on hard drugs, number of property crimes and drug abuse violations, obtained from the National Household Survey on Drug Abuse, the Surveys of Inmates and the Uniform Crime Reports of the FBI, respectively. The equilibrium features of the model allow to pin down both the response of hard drug consumers to changes in prices and to compute the revenues from drug selling, variables which are not available in the existing data. Moreover, the equilibrium framework allows to exploit data asked exclusively to inmates: by taking explicitly into account the selection problem, the model can predict moments which are representative of the whole population. The results show that a substantial part of property crimes, about 26%, is accounted for by predatory crime to finance hard drugs addiction. The estimated model is in turn used to perform counterfactual simulations, quantifying a) the economic consequences of a compulsory drug treatment scheme for all arrested felons, and b) the effects of a legalisation policy. The first policy would imply a decrease in the property crime rate by 11%, while under the new legal regime the property crime rate would decrease by 18%.
JEL Classification Codes: K42, I12, D58, D52.
Keywords: Property crimes, Drug Selling, Hard Drugs, Rational Addiction, Incomplete Markets.
Work In Progress:
- An Empirical Investigation of GDP Fluctuations in Canada and its Provinces.
- The Optimal Quantity of Public Debt with Temptation and Self-control.
- An Assessment of Risk Aversion Heterogeneity and its Implications for the Optimal Quantity of Public Debt.
- Minimum Wages: a Welfare Analysis for the UK.
- The Consumption Response to Predictable Income Changes: how Important are Heterogeneous Risk Preferences?
Older Projects:
- Optimal Corporate Taxation, Aggregate Productivity and the Size Distribution of Firms.
- Quantifying the Lucas Critique in a Human Capital Accumulation Model.
- Ability, Job Separations and Job Finding Probabilities (joint with Mike Barber, Queen's).