Session 6: Macroeconomics and Inequality

We study the effect of monetary and fiscal policy in a heterogeneous-agent model where households have present-biased time preferences and naive beliefs. The model features a liquid asset and illiquid home equity, which households can use as collateral for borrowing. Because present bias substantially increases households' marginal propensity to consume (MPC), present bias increases the impact of fiscal policy. Present bias also amplifies the effect of monetary policy but, at the same time, slows down the speed of monetary transmission. Interest rate cuts incentivize households to conduct cash-out refinances, which become targeted liquidity-injections to high-MPC households. But present bias also introduces a motive for households to procrastinate refinancing their mortgages, which slows down the speed with which this monetary channel operates.

In a textbook New Keynesian model extended to allow for uninsurable household income risk, any path of inflation and output implementable via nominal interest rate policy is also implementable by adjusting uniform lumpsum transfer payments, and vice-versa. The two tools are thus perfect substitutes for a dual mandate policymaker. It follows that conventional fiscal policy using stimulus checks can fully substitute for monetary policy when interest rates are constrained by an effective lower bound. In a quantitative heterogeneous-agent (HANK) model, the mapping between the equivalent fiscal and monetary policies is well-characterized by a small number of measurable sufficient statistics. While macro-equivalent, however, the two tools operate very differently in the cross-section of households: compared to a given rate cut, stimulus checks that deliver the same aggregate stabilization imply strictly lower consumption inequality.

Spatial differences in unemployment rates are large and persistent. Our objective is to develop a quantitative theory of these differences. Considering the local unemployment rate as an (equilibrium) outcome between workers and firms, we document facts on both sides of the labor market. First, we confirm recent findings that differences in separation rates (unemployment inflows) are more important than differences in job-finding rates (unemployment outflows) in accounting for local unemployment differences. Second, we present novel facts on the differences in job-creation and job-filling rates. We document that local labor markets with lower unemployment rates are tighter, have lower vacancy filling rates, and higher average vacancy duration. These facts constitute empirical regularities in the United States, Germany, and the United Kingdom. On the theory side, we demonstrate that a Diamond-Mortensen-Pissarides model with endogenous separations quantitatively accounts for all the documented facts on the geography of job creation and job destruction. Furthermore, we demonstrate that this model not only matches labor market differences across space but also over the business cycle.

We develop a general equilibrium model of frictional labor reallocation across firms and regions and use it to quantify the aggregate and distributional effects of spatial frictions that hinder worker mobility across regions in Germany. The model leverages matched employer-employee data to unpack spatial frictions into different types while isolating them from labor market frictions that operate also within region. The estimated model shows sizable spatial frictions between East and West Germany, especially due to the limited ability of workers to obtain job offers from more distant regions. Despite the large real wage gap between East and West of Germany, removing the spatial frictions leads, in equilibrium, to only a small increase in aggregate productivity and it mostly affects the within-region allocation of labor to firms rather than the between-region allocation. However, spatial frictions have large distributional consequences, as their removal drastically reduces the gap in lifetime earnings between East and West Germans.

How did the largest expansion of unemployment benefits in U.S. history affect household behavior? Using anonymized bank account data covering millions of households, we provide new empirical evidence on the spending and job search responses to benefit changes during the pandemic and compare those responses to the predictions of benchmark structural models. We find that spending responds more than predicted, while job search responds an order of magnitude less than predicted. In sharp contrast to normal times when spending falls after job loss, we show that when expanded benefits are available, spending of the unemployed actually rises after job loss. Using quasi-experimental research designs, we estimate a large marginal propensity to consume out of benefits. Notably, spending responses are large even for households who have built up substantial liquidity through prior receipt of expanded benefits. These large responses contrast with a theoretical prediction that spending responses should shrink with liquidity. Simple job search models predict a sharp decline in search in the wake of a substantial benefit expansion, followed by a sustained rebound when benefits expire. We instead find that the job-finding rate is quite stable. Moreover, we document that recall plays an important role in driving job-finding dynamics throughout the pandemic. A model extended to fit these key features of the data implies small job search distortions from expanded unemployment benefits. Jointly, these spending and job finding facts suggest that benefit expansions during the pandemic were a more effective policy than predicted by standard structural models. Abstracting from general equilibrium effects, we find that overall spending was 2.0-2.6 percent higher and employment only 0.2-0.4 percent lower as a result of the benefit expansions.

We study a design of the optimal tax system in an economy featuring active business owners running closely held, highly profitable businesses--a.k.a. capitalists in the twenty-first century. In line with the current U.S. law, they choose a legal form of firm's organization between a pass-through entity and a C corporation, which determines the way their business income is taxed. The model captures a key trade-off between these forms, C corporations face double taxation of profits but have easier access to external equity and can insure better against investment risk, relative to pass-through entities. Through endogenous selection, our model generates the predominant position of the pass-through business owners in line with the U.S. data. We compute the optimal fiscal policy under two revenue-neutral scenarios. Under the current U.S. legal restrictions, we find that the reform maximizing social welfare of the population cuts corporate income tax by half and decreases the progressivity of the tax code. This implies sizeable switch of economic activity towards C corporations, which improves allocation of capital in the economy but worsens the insurance provision and resource redistribution for workers. Under the uniform tax code for business income, we find that progressivity of the labor tax code should rise, and business income tax should be set to 36 percent. This optimal policy strictly dominates in terms of welfare the optimal policy computed under the current legal framework.  Separation of labor income taxation from business income taxation enables the Ramsey planner to separate distortions of the labor supply margin from the distortions of the productive capital accumulation and the choice of the legal form of business organization margins.

The U.S. spends non trivially on non-medical transfers for its working-age population in a wide range of programs that support low and middle-income households. How valuable are these programs for U.S. households? Are there simpler, welfare-improving ways to transfer resources that are supported by a majority? What are the macroeconomic effects of such alternatives? We answer these questions in an equilibrium, life-cycle model with single and married households who face idiosyncratic productivity risk, in the presence of costly children and potential skill losses of females associated with non-participation. Our findings show that a potential revenue-neutral elimination of the welfare state generates large welfare losses in the aggregate. Yet, most households support eliminating current transfers since losses are concentrated among a small group. We find that a Universal Basic Income program does not improve upon the current system. If instead per-person transfers are implemented alongside a proportional tax, a Negative Income Tax experiment, there are transfer levels and associated tax rates that improve upon the current system. Providing per-person transfers to all households is quite costly, and reducing tax distortions helps to provide for additional resources to expand redistribution.

If the average worker attributes distinct values to the intrinsic qualities of different occupations, benefitting from those values constitutes part of one's labor compensation. Based on responses in the General Social Survey (GSS), we construct an index that aggregates positive qualities such as respect, learning, and work hazards, controlling for respondent income and tenure. Using the PSID and NLSY data, we document that children of richer US parents are more likely to select into occupations that rank higher in terms of this index. We rationalize this fact when we introduce occupational choice with preferences over the intrinsic qualities of occupations into a standard theory of intergenerational mobility. Estimating the model allows us to infer the size of compensation each worker receives from their choice of occupation. When earnings are adjusted to reflect this additional compensation, we find substantially larger persistence of income from parents to children. Applying this adjustment, our model further predicts that the trends in the composition of labor demand in the US over the past three decades may have decreased intergenerational persistence, while also leading to higher growth in the welfare of the average worker.

Factor-biased technical change is at the core of the US labor market dynamics in the post-war era. Concurrently, workers' occupations have become a key dimension for the anatomy of labor reallocation and inequality. This paper furthers our understanding of the heterogeneity in factor-biased technical change across occupations by providing the first direct measures of capital-embodied technical change (CETC) as well as of the elasticity of substitution between labor and capital at the occupational level. We nd that CETC and capital-labor ratios vary substantially across occupations and over time, but it is the heterogeneity in the elasticity of substitution that fuels differences in workers' exposure to technical change and ultimately sets the direction of the labor reallocation triggered by CETC. We evaluate the impact of CETC in a general equilibrium model of endogenous sorting of workers across occupations of different CETC and substitutability between capital and labor. CETC explains 87% of labor reallocation in the US between 1984 and 2015. In an economy with a common elasticity of substitution between capital and labor, measured differences in CETC can only explain 14.5% of the observed labor reallocation.

Should the government intervene in the automation process? We study this question in a heterogeneous agent model where displaced workers reallocate slowly and face borrowing constraints. We first show that automation is inefficient. Firms are effectively too patient when they automate, and (partly) overlook the time it takes for labor to reallocate and for the benefits of automation to materialize. We then analyze a second best problem where the government indirectly controls automation and reallocation, but is unable to directly redistribute income between workers. The equilibrium is (constrained) inefficient—automation and reallocation impose pecuniary externalities on workers. The government should curb automation on efficiency grounds, even when it does not value equity. Finally, we use a quantitative version of our model to assess the importance of these distorsions and evaluate the welfare gains from slowing down automation.

Using a dynamic panel approach, we provide empirical evidence that negative health shocks reduce earnings. The effect is primarily driven by the participation margin and is concentrated in less educated and poor health individuals. We build a dynamic, general equilibrium, lifecycle model that is consistent with these findings. In the model, individuals, whose health is risky and heterogeneous, choose to either work, or not work and apply for social security disability insurance (SSDI). Health impacts individuals' productivity, SSDI access, disutility from work, mortality, and medical expenses. Calibrating the model to the United States, we nd that health inequality is an important source of lifetime earnings inequality: nearly 29 percent of the variation in lifetime earnings at age 65 is due to the fact that Americans face risky and heterogeneous lifecycle health proles. A decomposition exercise reveals that the primary reason why individuals in the United States in poor health have low lifetime earnings is because they have a high probability of obtaining SSDI benefits. In other words, the SSDI program is an important contributor to lifetime earnings inequality. Despite this, we show that it is ex ante welfare improving and, if anything, should be expanded.

We characterize how welfare responds to changes in budget set and technology when preferences are non-homothetic or subject to shocks, in both partial and general equilibrium. We generalize Hulten’s theorem, the basis for constructing aggregate quantity indices, to this context. We show that calculating changes in welfare in response to a shock only requires knowledge of expenditure shares and elasticities of substitution and (given these elasticities) not of income elasticities and taste shocks. We also characterize the gap between changes in welfare and changes in chained indices. We apply our results to long-run and short-run phenomena. In the long-run, we show that structural transformation, if caused by income effects or changes in tastes, is roughly twice as important for welfare than what is implied by standard measures of Baumol’s cost disease. In the short-run, we provide evidence that chain-weighted price indices for non-durable consumer goods understate welfare-relevant inflation because product-level demand shocks are positively correlated with price changes. Finally, using the Covid-19 crisis we illustrate the differences between partial and general equilibrium notions of welfare, and we show that real consumption and real GDP are unreliable metrics for measuring welfare or production.