Overlapping Generations Model Research Articles

Generational Distribution of Fiscal Burdens: A Positive Analysis

AbstractThis study presents an overlapping generations model to analyze the impact of population aging on fiscal policy and intergenerational fiscal burden. Aging populations incentivize governments to increase capital and labor income tax rates and the public debt‐to‐GDP ratio, consistent with OECD evidence. Our model‐based simulation for Japan and the United States (2000–2070) reveals that Japan will experience higher labor income tax rates, a greater public debt‐to‐GDP ratio, and a lower government expenditure‐to‐GDP ratio compared to the United States. From 2040 onward, Japan is predicted to surpass the United States in terms of the capital tax rate.

Skill choice and dynamic efficiency: The effects of skill subsidies

This paper develops an overlapping generations model with heterogeneous (skilled versus unskilled) agents to analyze skill choice and dynamic efficiency of the steady-state equilibrium. Those adults sacrificing working time for skill training become skilled workers, while those adults not receiving skill training are referred to as unskilled workers. Findings show when there is no government intervention that the steady-state equilibrium is dynamically efficient, and that the ratio of skilled workers to the adult population is lower than it would be under the Golden rule if the depreciation rate of capital is sufficiently low. An elaborate policy to subsidize the costs of skill acquisition can thus be initiated to help the economy choose the right mix of skills while at the same time maintaining the dynamic efficiency of the steady-state equilibrium.

The rate of discount on public investments with future bias in an altruistic overlapping generations model

A typical approach to evaluating public investment projects requires an appropriate rate for discounting future benefits and costs. In many developed countries, the practical discount rate for benefit–cost analysis has been calculated using the Ramsey formula in an optimal growth model, stretched back to the pioneering work presented by Frank Ramsey in 1928. Intergenerational altruism that is widely observed in our society generates future bias. Therefore, elected governments under democracies are future-biased. In such cases, the Ramsey formula is no longer valid. This paper derives a modified Ramsey formula for an appropriate social discount rate to be applied instead of the conventional Ramsey formula. We also examine properties of equilibrium policy. The degree of future bias depends on the political power of young people relative to elderly people. Demographic effects such as population aging negatively affect public investment through decreasing future bias effects. This paper contributes to the optimal theory of public investment for calculating an appropriate social discount rate, both theoretically and practically.

The effects of public sector employment on household savings and labor supply

AbstractIn many countries, the structure of wages and the labor law legislation are completely different for public and private sector employees. In this paper, we develop a general equilibrium overlapping generations model to study the effect of such differences on household savings and labor supply. To conduct our analysis, first we use microdata from two Brazilian household surveys to document that civil servants save and work significantly less than their counterparts in the private sector. Second, we use matched employer–employee microdata from Brazil (RAIS) to document differences between the two sectors in terms of wage and unemployment risk. Then, we calibrate the model to be consistent with micro and macro evidence for Brazil. Our counterfactual exercises show that differences in wages characteristics and labor law legislation account for nearly 70% of the gap in savings between civil servants and private sector workers, and 57% of the gap in labor supply. In addition, we find that eliminating those differences can produce sizable increase on aggregate savings, employment, and welfare.

AD-AS Analysis from the Perspective of Functional Finance Theory and MMT

Abstract Research background In the past few years, MMT (Modern Money Theory or Modern Monetary Theory) has been increasingly discussed in Japan as well as in the U.S. However, both in the U.S. and Japan, analysis using mathematics is lacking and analysis using IS-LM and AD-AS analysis methods in macroeconomics is almost non-existent. Purpose We present an AD-AS analysis from the perspective of Functional Finance Theory and MMT (Modern Monetary Theory). Research methodology Graphical analyses with some mathematical analyses. Mathematical analyses include graphic analysis using AD and AS curves and calculations to derive equations representing them based on models of consumer and firm behavior. Results Using an overlapping generations model under monopolistic competition we show the following results by calculations and graphical analyses. 1. The budget deficit (including interest payments on government bonds) equals an increase in the savings of consumers from period to period. This result means that the debt-GDP ratio would not diverge to infinity, but would remain at a finite value whether the interest rate of government bonds is larger or smaller than the growth rate. 2. We need a budget deficit (including interest payments) to maintain full employment without inflation under economic growth. However, if the interest rate of government bonds is larger than the growth rate, we need a budget surplus (excluding interest payments) to maintain full employment without inflation. 3. A return to full employment from a recession can be achieved by implementing the appropriate fiscal policies through increased government spending or tax cuts. 4. Excessive government expenditure or an insufficient tax under full employment induces inflation. Novelty This is probably the first AD-AS analysis done from the standpoint of Functional Finance Theory and MMT.

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.