Overlapping Generations Model Research Articles

Don’t worry about the debt-GDP Ratio

I will show that if the propensity to consume from savings satisfies appropriate conditions, the debt-GDP ratio will not grow infinitely large and fiscal collapse will not occur. Using a basic macroeconomic model, with an overlapping generations model in mind, we show the following results: 1) The budget deficit including interest payments on the government bonds equals an increase in the savings from a period to the next period. 2) If the savings in the first period is positive, we need budget deficit to maintain full employment under constant prices or inflation in the later periods. 3) Under an appropriate assumption about the propensity to consume from savings, the debt-GDP ratio converges to a finite value. It does not diverge to infinity. The larger the propensity to consume from savings, the smaller the budget deficit required to achieve full employment. The larger the propensity to consume from savings, the less likely it is that the debt-GDP ratio will become large.

Public investment, national debt, and economic growth: The role of debt finance under dynamic inefficiency

Public investment is a central issue in the dynamic analyses of fiscal policy and economic growth. Debt financing for public investment and its effects have recently received great attention because interest rates have been low, almost invariably remaining below economic growth rates. This paper presents examination of the effects of debt-financed public investment subject to a simple fiscal rule in an overlapping generations model with public capital. This topic includes capital budgeting and the debt–deficit criterion of the Maastricht treaty. We show herein that debt financing for public investment enhances economic growth if an economy is dynamically inefficient and if public capital has a sufficiently large productivity effect. Moreover, it reduces economic growth rates in a dynamically efficient economy. Debt and growth can have a monotonic or non-monotonic relation, depending on the steady-state interest rate, growth rate, and productivity effect of public investment. The findings indicate that debt–growth relations match with controversial empirical evidence. Furthermore, existing generations choose perfect debt finance if dynamic inefficiency exists. In contrast, a balanced budget is preferred in a dynamically efficient economy with low productivity effects of public capital. However, an economy with high productivity effects of public capital might cho ose debt financing. This paper contributes to the elucidation of currently emphasized issues of public investment.

Universal basic income, time inconsistency and saving regret

We investigate whether a universal basic income (UBI) programme should replace New Zealand’s public pension system. A UBI programme would increase the number of social benefit recipients and hence increase tax rates. Not only the basic income itself but also its accompanying tax rate hikes would influence intra- and inter-temporal choices of households. We use an overlapping generations model and show that households’ preferences would be time-inconsistent—in hindsight, households regret having saved too little. There are three major findings of this study. First, the public pension system would be preferred to a UBI programme increasing the tax rate of income. Second, a UBI programme increasing the consumption tax rate would be preferred to the public pension system by households at most ages, but they would reverse the preference later in their lives. Third, a decrease in the population growth rate would make the reversal of the preference more noticeable.

Public pension policy and the equity–efficiency trade‐off∗

AbstractThis paper illustrates that the equity–efficiency trade‐off between a redistributive, Beveridgean, pension system and an earnings‐based, Bismarckian, scheme can collapse when accounting for labor supply effects on the extensive margins. I introduce a general equilibrium overlapping generations model with endogenous savings, human capital formation, and labor supply. The model is calibrated to an average OECD economy. The results suggest that allocating funds towards a Bismarckian pension system always reduces earnings inequality – and, in some cases, lifetime inequality – when compared with a Beveridgean scheme. However, the Bismarckian scheme crowds out more human capital in the economy following a higher steady‐state interest rate.

Green technology policies versus carbon pricing: An intergenerational perspective

Technology policy is the most widespread form of climate policy and is often preferred over seemingly efficient carbon pricing. We propose a new explanation for this observation: gains that predominantly accrue to households with large capital assets and that influence majority decisions in favor of technology policy. We study climate policy choices in an overlapping generations model with heterogeneous energy technologies and distortionary income taxation. Compared to carbon pricing, green technology policy leads to a pronounced capital subsidy effect that benefits most of the current generations but burdens future generations. Based on majority voting which disregards future generations, green technology policies are favored over a carbon tax. Smart “polluter-pays” financing of green technology policies enables obtaining the support of current generations while realizing efficiency gains for future generations.

The redistributive effects of monetary policy in an overlapping generations model

I study the redistributive effects of monetary policy with attention to a wealth effect for savers generated by a cut in interest rates. To this end, I build a full-fledged overlapping generations New Keynesian model (OLGNK) that features marginal propensity to consume (MPC) heterogeneity, financial frictions, and precautionary saving behavior. The model is calibrated to match the U.S. demographic structure and yields empirically realistic MPCs and inequality among households. I find that a negative wealth effect resulting from an interest rate cut for savers is substantial, which dampens the impulse responses of aggregate output relative to those in a representative agent New Keynesian (RANK) model. This finding is in contrast to a heterogeneous agent New Keynesian (HANK) model, in which there is amplification of monetary policy relative to RANK.

Are the Liquidity and Collateral Roles of Asset Bubbles Different?

AbstractSeveral papers explain why asset bubbles are observed when growth is large. These papers differ in the role of the bubble, used to provide liquidities or as collateral in a borrowing constraint. We compare the liquidity and collateral roles of bubbles in an overlapping generations model. When the bubble is deterministic, the equilibrium is identical under these two roles, implying that the same mechanism explains the crowding‐in effect of the bubble on growth. With stochastic bubbles, growth is larger when bubbles play the liquidity role, because the burst of a bubble used for liquidity is less damaging to capital investors.

Unexpected longevity, intergenerational policies, and fertility

This paper studies the dynamic effects of longevity on intergenerational policies and fertility, distinguishing between effects of expected and unexpected longevity gains. Old agents become poorer from unexpected longevity gains than from expected gains, as they cannot prepare (save) for the former in advance. In an overlapping-generations model with means-tested pay-as-you-go social security, we show that young agents reduce their fertility when longevity increases because they need to save more for their old age (“life-cycle effect”), and in the unexpected case, they also need to pay taxes to support the impoverished elderly (“policy effect”). Using cross-country panel data on mortality rates and social expenditure, we find that an unexpected increase in life expectancy at age 65 lowers total fertility rate growth and government family-related spending growth while raising government old-age spending growth.

Demographic change and the rate of return in pay-as-you-go pension systems

The ongoing demographic change in most developed countries consists of two coinciding independent developments that differ in structure and persistence: A slow, monotonic and (presumably) permanent longevity effect caused by an increasing life expectancy; and a more rapidly changing, non-monotonic and less permanent cohort effect caused by fluctuations in the size of cohorts. This paper shows the longevity effect has a positive impact on the rates of return households generate within a pay-as-you-go (PAYG) pension system. The cohort effect, by contrast, results in winners and losers in PAYG systems. The paper additionally shows that the type of PAYG pension system alters the results significantly. Taking the remarkable demographic change in Germany as an example, a large-scale overlapping generation model quantifies rates of return within the PAYG pension system for every cohort. The results show that the two effects combined cause return differentials of almost 1.3 percentage points between generations.

Myopic fiscal objectives and long-Run monetary efficiency

Is the pursuit of myopic fiscal objectives, such as short-run redistribution or public spending, a threat to long-run monetary efficiency? We answer this question in the context of a textbook overlapping generations model where we introduce a sequence of one-period fiscal authorities that can tax endowments and trade money. Each authority is myopic in that it cares only about current agents’ utility and its own consumption, without any concern about the future. Nonetheless, we show that the sequence of fiscally-backed money purchases that maximize the current authority’s objective also selects a unique equilibrium – one in which money is traded at the efficient intertemporal price – as a by-product. In fact, myopic redistribution policies ensure equality in marginal utilities making up for incomplete markets, without interfering with the efficiency of private intertemporal choices. Multiplicity and sub-optimality emerge as fiscal capacity is bounded, inducing authorities to use money trades to generate resources for public consumption.

Rethinking fiscal rules

The Covid 19 pandemic has caused both a decrease in tax revenues and an increase in public spending, forcing governments to increase fiscal deficits to unprecedented levels. Given these circumstances, it is foreseeable that fiscal rules will play a predominant role in the design of many countries’ recovery policies. We develop a general equilibrium, overlapping generations model for a small, open economy in order to study the impact of several fiscal rules upon welfare, public expenditures and growth. We calibrate the model to the Peruvian economy. In this economy, fiscal rules have been widely used and, unlike in other Latin American countries, they have been relatively successful. We find that fiscal rules will generate better results in terms of output if, in addition to maintaining control over the fiscal result, they also preserve public investment. We also find that the performance of economies that implement structural rules tends to be better than the performance of economies that implement rules based on realized budget balance.

Human Capital, Female Employment, and Electricity: Evidence from the Early 20th-Century United States

Abstract This paper revisits the link between electrification and the rise in female labour force participation (LFP), and presents theoretical and empirical evidence showing that electrification triggered a rise in female LFP by increasing market opportunities for skilled women. I formalize my theory in an overlapping generations model and find that my mechanism explains one quarter of the rise in female LFP during the rollout of electricity in the U.S. (1880–1940), and matches the slow decline in female home production hours during this period. I then present micro-evidence supporting my theory using newly digitized data on the early electrification of the U.S.

Health Risk, Insurance, and Optimal Progressive Income Taxation

Abstract We study the optimal progressivity of personal income taxes in a general equilibrium overlapping generations model where individuals are exposed to idiosyncratic shocks to labor productivity and health status over the lifecycle. Our results—based on a calibration to the US economy—indicate that both, the presence of health risk and the available insurance institutions, have a strong effect on the optimal level of tax progressivity. Given the fragmented and non-universal health insurance system in the US, a welfare maximizing income tax system is substantially more progressive than the current US income tax. The higher progressivity provides additional redistribution and social insurance, especially for unhealthy low income individuals who have limited access to health insurance. When exposure to health risk is removed or reduced by introducing more comprehensive health insurance systems, we observe large decreases in the optimal level of income tax progressivity, and the optimal tax system resembles findings from the previous literature. These findings highlight the importance of accounting for the unique characteristics of health risk and the design of the health insurance system when characterizing optimal income taxes.

Optimality in an OLG model with nonsmooth preferences

AbstractIt is a well‐known observation that, in the overlapping generations (OLG) model with the complete market, we can judge optimality of an equilibrium allocation by examining the associated equilibrium price. Motivated by recent development in decision theory under ambiguity, this study reexamines the above observation in a stochastic OLG model with convex but not necessarily smooth preferences. It is shown that optimality of an equilibrium allocation depends on the set of possible supporting prices, not necessarily on the associated equilibrium price itself. Therefore, observations of an equilibrium price do not necessarily tell us precise information on optimality of the equilibrium allocation.

Income-Based Affirmative Action in College Admissions

Abstract We study whether college admissions should implement quotas for lower-income applicants. We develop an overlapping-generation model and calibrate it to data from Brazil, where such a policy is widely implemented. In our model, parents choose how much to invest in their child’s education, thereby increasing both human capital and likelihood of college admission. We find that, in the long run, the optimal income-based affirmative action increases welfare and aggregate output. It improves the pool of admitted students, but distorts pre-college educational investments. The welfare-maximising policy benefits lower- to middle-income applicants with income-based quotas, while higher-income applicants face fiercer competition in college admissions. The optimal policy reduces intergenerational persistence of earnings by 5.7% and makes nearly 80% of households better off.

Longevity, Fertility, and the Real Exchange Rate

AbstractWe build a simple overlapping generation model to investigate the effect of life expectancy on the real exchange rate where fertility is chosen endogenously. The model reveals that, although the overall effect of life expectancy on the real exchange rate is not certain, longer life expectancy tends to cause the real exchange rate to depreciate by reducing fertility. Fertility thus serves as a mediator in the effect of life expectancy on the real exchange rate. Evidence from 148 economies (1980–2018) shows a statistically significant and robust negative relationship between life expectancy and the real exchange rate. It is estimated that a 1 year increase in life expectancy is associated with a 1.5 percent depreciation in the real exchange rate. The evidence also confirms the mediated effect of fertility. The mediated effect that fertility exerts accounts for 30 percent to 50 percent of the total effect, depending on the real exchange rate index used.

Elderly long-term care policy and sandwich caregivers’ time allocation between child-rearing and market labor

Using an overlapping generations model, we present analyses of public long-term care provision effects on fertility and time allocation decisions of sandwich caregivers, those caring for young children and old parents simultaneously. If the public long-term care level runs short of the necessary level, then working children must compensate for the difference by spending their time. Reportedly, about a third of university students’ parents are sandwich caregivers in Japan, although Japan has a Long-Term Care Insurance system, which is a mandatory system with universal coverage. With a rapidly aging population, demand for long-term care is predicted to increase, thereby affecting family time allocation, e.g., fertility decisions, in Japan. Results show that if public long-term care production is costly relative to family care provision, then increases in public care provision lower the fertility rate. If labor productivity in the public long-term care sector improves, then it increases the fertility rate by freeing caregivers’ time from family care provision. It will also increase social welfare. The effects on labor employment in the goods production sector are generally ambiguous because the increased public care provision requires more labor.

Social security, economic growth, and social welfare in an overlapping generation model with idiosyncratic TFP shock and heterogeneous workers

Social security, economic growth, and social welfare in an overlapping generation model with idiosyncratic TFP shock and heterogeneous workers

Optimal Nonlinear Income Taxes in an Overlapping Generations Model

Optimal Nonlinear Income Taxes in an Overlapping Generations Model

Capital Market Power and Economic Growth in an Overlapping-Generations Model with Rational Expectations

Capital Market Power and Economic Growth in an Overlapping-Generations Model with Rational Expectations