Imply Welfare Losses Research Articles

Optimal fiscal policy under private debt deleveraging

This paper investigates Ramsey-optimal fiscal policy in a closed economy with savers and borrowers in the presence of a private debt deleveraging shock where monetary policy is constrained by the zero lower bound (ZLB). It is shown that monetary policy being constraint by the ZLB implies huge welfare losses. Applying an optimal fiscal policy in this situation is found to be highly effective by eliminating roughly one quarter of the total welfare loss of being at the ZLB. Here, following the optimal fiscal policy imlies a prolonged stay at the ZLB. Moreover, while the relative effectiveness of consumption and wage taxes depends on the presence of government spending as well as on the specific monetary policy conducted, all Ramsey-policies aiming at maximizing economy-wide welfare imply reducing the welfare of savers. Furthermore, it is found that the welfare gains of having government spending as an additional instrument are small compared to the total welfare gains of applying a Ramsey-optimal instead of an exogenous policy. Finally, it is shown that if fiscal policy is set optimally, conducting an inflation-targeting policy instead of an optimal monetary policy need not necessarily imply welfare losses.

Inflation bias and markup shocks in a LAMP model with strategic interaction of monetary and fiscal policy

This paper investigates the effects generated by limited asset market participation on optimal monetary and fiscal policy, where monetary and fiscal authorities are independent and play strategically. It shows that: (i) both the long run and the short run equilibrium require a departure from zero inflation rate; (ii) in response to a markup shock, fiscal policy becomes more aggressive as the fraction of liquidity constrained agents increases and price stability is no longer optimal even under Ramsey; (iii) overall, optimal discretionary policies imply welfare losses for Ricardians, while liquidity constrained consumers experience welfare gains with respect to Ramsey.

Inflation Bias and Markup Shocks in a LAMP Model with Strategic Interaction of Monetary and Fiscal Policy

This paper investigates the effects generated by limited asset market participation on optimal monetary and fiscal policy, where monetary and fiscal authorities are independent and play strategically. It shows that: (i) both the long run and the short run equilibrium require a departure from zero inflation rate; (ii) in response to a markup shock, fiscal policy becomes more aggressive as the fraction of liquidity constrained agents increases and price stability is no longer optimal even under Ramsey; (iii) overall, optimal discretionary policies imply welfare losses for Ricardians, while liquidity constrained consumers experience welfare gains with respect to Ramsey.

Rail access charges and internal competition in high speed trains

This paper develops an ex ante analysis of the introduction of on-track competition in High Speed Rail (HSR) lines. The distinctive elements of our analysis are the consideration of: (i) the vertical structure of the rail sector, (ii) operators that compete in prices and number of services, and (iii) access charges for the use of the rail infrastructure that are endogenous. We provide simulation results for three Spanish HSR routes. The socio-economic viability of entry is found to depend on whether infrastructure and rail operations are integrated or separated, and also on the policy rule to set rail access charges. Firstly, separation without entry is not an appropriate good policy: the reduction in prices is followed by a reduction in the number of services that leads to lower consumer surplus and lower industry profits. Secondly, marginal cost pricing, that would entail losses to the infrastructure manager, would make entry profitable because access charges are much lower; welfare gains would be in the range of 6–9% higher than in the pre-entry scenario. This conclusion holds for large increases in rail traffic. Thirdly, the consideration of a more realistic scenario (where the entry of a new operator would lead to a modest rise in the whole rail traffic), while encouraging entry, would imply welfare losses yet consumer surplus would go up as long as access charges are set to marginal cost pricing.

Pension reform in an OLG model with heterogeneous abilities

AbstractWe study the effects of pension reform on hours worked, human capital, income and welfare in an open economy populated by four overlapping generations: three active generations (the young, the middle aged and the older) and one generation of retired. Within each generation we distinguish individuals with high, medium or low ability to build human capital. Our simulation results prefer a pay-as-you-go pension system with a particular earnings-related linkage above a fully-funded private system. This pay-as-you-go system conditions pension benefits on past individual labor income, with a high weight on labor income earned when older and a low weight on labor income earned when young. Uncorrected, however, such a system implies welfare losses for current low-ability generations and rising inequality. Complementing or replacing it by basic and/or minimum pension components is negative for aggregate employment and welfare. Better is to maintain the tight link between individual labor income and the pension also for low-ability individuals, but to strongly raise their replacement rate. An additional correction improving the welfare of low-ability individuals would be to maintain for these individuals equal weights on past labor income.

Budgetary-Neutral Fiscal Policy Rules and External Adjustment

Large external imbalances and fragile fiscal positions have emerged as major policy challenges for the euro area in the financial crisis. The paper analyses whether shifting government purchases between tradable and non-tradable goods could help reduce external fluctuations without large swings in the overall fiscal stance. The policy rules considered are budgetary-neutral in the sense that the overall level of government expenditure is kept constant. We compare the policy rules to fiscal devaluation as a strategy to reduce external imbalances and find that state-dependent changes in the composition of government purchases between tradables and non-tradables can stabilise excessive fluctuations in the event of economy-wide supply and demand shocks. Contrary to fiscal devaluation, the expenditure-shifting rule faces a trade-off between stabilising domestic activity and enhancing household welfare, on the one hand, and reducing excessive fluctuations in external positions, on the other hand. The excess volatility of domestic variables associated less volatility in the external position implies welfare losses for standard specifications of household utility. The adverse welfare effect is absent in the case of fiscal devaluation.

Rent control and vacancies in Sweden

PurposeThe purpose of this paper is to analyze the effects of Swedish rent controls on observed vacancy rates for rental housing.Design/methodology/approachHousing vacancy rates are unevenly distributed among Swedish municipalities. In large expansive municipalities, such as Malmö, Göteborg and Stockholm, vacancy rates are very low, while in declining or smaller municipalities such as those in the northern and interior parts of Sweden, vacancy rates are considerably higher. This implies welfare losses not only in growing municipalities with queues for rental apartments but also in municipalities that are shrinking since the controlled rents there are higher than market rents and cause higher vacancy rates than with market rents. The authors estimate the influences of various determining factors, such as population growth, population size, rent levels, construction, demolition and market orientation of rents, on the observed vacancy rates.FindingsThe authors find that that these factors affect the vacancy rates differently depending on whether a municipality is large or small, growing or shrinking. Population growth, in percent per year, plays an important role in explaining the observed vacancy rates in declining regions.Research limitations/implicationsA research task that remains to be done is to calculate the welfare losses due to rent higher than the market rent for municipalities in contraction.Practical implicationsTo reduce the welfare losses of rent control, both in expanding and contracting municipalities, economists' straightforward recommendation to deregulate the rent control should, in principle, be carried out.Originality/valueIn many countries, rent control regulations are limited to cities, such as New York City. The paper shows that the Swedish rent control system however, applies nationwide, except for annual rent increases, which are set locally through negotiation.

THE WELFARE GAINS OF TRADE INTEGRATION IN THE EUROPEAN MONETARY UNION

This paper evaluates the welfare gains arising from deeper trade integration in the European Monetary Union. To do this, the European Monetary Union is represented in a realistic way by an intertemporal general equilibrium model with incomplete financial markets, sticky prices, and home bias in production. The model is estimated and not rejected by the data. Two main results emerge: (i) an increase in vertical trade (occuring at the early stage of the production process) implies welfare gains whereas (ii) an increase in horizontal trade (occuring at the late stage of the production process) implies welfare losses.

Should Central Banks Care about Investment?

We ask how including endogenous capital formation into a New-Keynesian model affects optimal monetary policy. We find that the response of Ramsey optimal policy to a persistent cost-pushing shock is unconventional: In response to the shock, the central bank persistently reduces the nominal interest rate below its steady state. We find that this is due to a decrease in the natural interest rate and does not reflect a desire to choose a systematically different point on the policy frontier. However, the central bank’s tradeoff is affected in the sense that inflation stabilization can become more costly: When analyzing optimal simple rules, we find that these can imply welfare losses which substantially exceed those of Ramsey optimal policy. The reason is that active interest rate policy magnifies output fluctuations by destabilizing the capital stock. When introducing adjustment cost, our results return to standard: First, Ramsey optimal policy increases the interest rate as a response to a cost-pushing shock. Second, active policy becomes more successful in mimicking the allocation a Ramsey planner would choose.

The Welfare Gains of Trade Integration in the European Monetary Union

This paper evaluates the welfare gains arising from a deeper trade integration in the European Monetary Union. To do this, the European Monetary Union is represented in a realistic way by an intertemporal general equilibrium model with incomplete financial markets, sticky prices and home bias both in private consumption and production. The model is estimated and globally not rejected by the data. Two main results emerge: (i) an increase in vertical (intermediate goods) trade implies welfare gains while (ii) an increase in horizontal trade implies welfare losses.

Stabilization policy in an open economy

The scope for an active demand management policy is considered for a small open economy. Business cycle fluctuations generated by supply and demand shocks are shown to imply welfare losses when agents are risk averse and the capital market incomplete. Public demand for non-tradeables has real effects and there is a welfare case for pursuing a demand management policy which stabilizes consumption. It is argued that this type of stabilization can be attained via automatic stabilizers based on nominal budgeting rules.

Distortions and static negative marginal gains from trade

In this paper, the method of input-output analysis is used for the case of Korea to demonstrate that the promotion of certain exports can result in static inefficiency to the economy. It appears that Korea lost a significant amount of both capital and labor via trade in competitive goods during 1970/1972. Although the simple existence of static losses at any specific point in time does not necessarily imply welfare losses to the economy over the long term, the fact that we can observe such losses implies that we should at least try to justify their existence in terms of dynamic gains.