Creator: Kehoe, Patrick J. and Perri, Fabrizio Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 265 Abstract:
Backus, Kehoe and Kydland (1992), Baxter and Crucini (1995) and Stockman and Tesar (1995) find two major discrepancies between standard international business cycle models with complete markets and the data: In the models, cross-country correlations are much higher for consumption than for output, while in the data the opposite is true; and cross-country correlations of employment and investment are negative, while in the data they are positive. This paper introduces a friction into a standard model that helps resolve these anomalies. The friction is that international loans are imperfectly enforceable; any country can renege on its debts and suffer the consequences for future borrowing. To solve for equilibrium in this economy with endogenous incomplete markets, the methods of Marcet and Marimon (1999) are extended. Incorporating the friction helps resolve the anomalies more than does exogenously restricting the assets that can be traded.
Keyword: Credit constraints and Debt constraints Subject (JEL): F21 - International Investment; Long-term Capital Movements, F32 - Current Account Adjustment; Short-term Capital Movements, and F41 - Open Economy Macroeconomics
Creator: İmrohoroǧlu, Selahattin Series: Macroeconomics with heterogenous agents, incomplete markets, liquidity constraints, and transaction costs Abstract:
This paper investigates the optimal tax structure in an overlapping generations model in which individuals face idiosyncratic income risk, borrowing constraints and lifetime uncertainty. The calibrated model economy produces some quantitative results that differ significantly from the findings of the previous research. The main finding in this imperfect insurance setup is that moving away from capital income taxation toward higher labor income taxation yields a (steady-state) welfare benefit of 1% of aggregate consumption compared with the 6% figure Lucas (1990) finds in an infinite-horizon, complete markets model. This is because replacing the tax on capital income with a higher tax on labor income redistributes resources away from the young working years during which borrowing constraints are more likely to bind. Furthermore, when the individuals have access to a private annuity market to insure against uncertain lifetimes, it becomes optimal to tax capital. When a consumption tax is made available, it is optimal to switch to consumption taxation. The welfare benefit from implementing this optimal plan is on the order of 1.5-3.2% of GNP.
Subject (JEL): H21 - Taxation, subsidies and revenue - Efficiency ; Optimal taxation and D52 - General equilibrium and disequilibrium - Incomplete markets
Creator: Den Haan, Wouter J., 1962- Series: Macroeconomics with heterogenous agents, incomplete markets, liquidity constraints, and transaction costs Abstract:
This paper is part of a project to model the interaction between heterogeneous agents in intertemporal stochastic models and to develop numerical algorithms to solve these kind of models. It is well-known that solving dynamic heterogeneous agent models is a challenging problem, since in these models the distribution of wealth and other characteristics evolve endogenously over time. Existing dynamic models in the literature contain therefore just two agents or other simplifying assumptions to limit the heterogeneity.
Subject (JEL): D52 - General equilibrium and disequilibrium - Incomplete markets and C63 - Mathematical methods and programming - Computational techniques ; Simulation modeling
Creator: Cole, Harold Linh, 1957- and Kocherlakota, Narayana Rao, 1963- Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 577 Abstract:
We consider a simple environment in which individuals receive income shocks that are unobservable to others and can privately store resources. We show that this ability to privately store can undercut the ability to shift resources across individuals to the extent that the efficient allocation only involves consumption smoothing over time, as opposed to insurance (consumption smoothing over states) if the rate of return on savings is not too far below the rate of time preference, or, alternatively, if the worst possible outcome is sufficiently dire. We also show that unlike environments without unobservable storage, the symmetric efficient allocation is decentralizable through a competitive asset market in which individuals trade risk-free bonds among themselves.
Creator: Aiyagari, S. Rao Series: Quarterly review (Federal Reserve Bank of Minneapolis. Research Department) Number: Vol. 17, No. 1 Abstract:
In this article, I suggest that incomplete markets and transaction costs are crucial for explaining the high equity premium and the low risk-free rate. I first demonstrate the failure of the complete frictionless markets model in explaining these return puzzles and then show how introducing incomplete markets and transaction costs can lead to success. Additionally, I explain how these features lead to predictions concerning individual consumptions, wealths, portfolios, and asset market transactions that are in better agreement with the facts than the predictions of the complete frictionless markets model.
Creator: Aiyagari, S. Rao Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 508 Abstract:
For a wide class of dynamic models, Chamley (1986) has shown that the optimal capital income tax rate is zero in the long run. Lucas (1990) has argued that for the U.S. economy there is a significant welfare gain from switching to this policy. We show that for the Bewley (1986) class of models with heterogeneous agents and incomplete markets (due to uninsured idiosyncratic shocks), and borrowing constraints the optimal tax rate on capital income is positive even in the long run. Quantitative analysis of a parametric version of such a model suggests that one cannot dismiss the possibility that the observed tax rates on capital and labor income for the U.S. economy are fairly close to being (long run) optimal. We also provide an existence proof for the dynamic Ramsey optimal tax problem in this environment.
Creator: Kocherlakota, Narayana Rao, 1963- Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 393 Abstract:
This paper considers four models in which immortal agents face idiosyncratic shocks and trade only a single risk-free asset over time. The four models specify this single asset to be private bonds, public bonds, public money, or private money respectively. I prove that, given an equilibrium in one of these economies, it is possible to pick the exogenous elements in the other three economies so that there is an outcome-equivalent equilibrium in each of them. (The term “exogenous variables” refers to the limits on private issue of money or bonds, or the supplies of publicly issued bonds or money.)
Keyword: Incomplete markets and Money bonds Subject (JEL): E40 - Money and Interest Rates: General and E51 - Money Supply; Credit; Money Multipliers
Creator: Aiyagari, S. Rao Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 518 Abstract:
This paper is about a useful way of taking account of frictions in asset pricing and macroeconomics. I start by noting that complete frictionless markets models have a number of empirical deficiencies. Then I suggest an alternative class of models with incomplete markets and heterogenous agents which can also accommodate a variety of other frictions. These models are quantitatively attractive and computationally feasible and have the potential to overcome many or all of the empirical deficiencies of complete frictionless markets models. The incomplete markets model can also differ significantly from the complete frictionless markets model on some important policy questions.
Keyword: Macroeconomics, Incomplete markets, Frictionless market model, Asset pricing, and Friction Subject (JEL): G12 - Asset Pricing; Trading Volume; Bond Interest Rates and E13 - General Aggregative Models: Neoclassical