Overlapping Generations Framework Research Articles

Investment shocks and inequality dynamics

We explore the dynamics of income and income inequality under asymmetric information in credit markets. Within a stochastic overlapping-generations framework, we study the investment decision of entrepreneurs with heterogeneous abilities. Under information asymmetry, banks do not observe entrepreneurial ability and offer a single pooled loan contract to all entrepreneurs. We show that, following a negative investment shock, the average quality of the entrepreneur pool improves and banks optimally react by lowering the pooled borrowing rate. This reduction in the borrowing rate mitigates the drop in entrepreneurs' income. Consequently, after a negative investment shock, income inequality decreases less compared to the case of full information. Our findings therefore suggest that information asymmetry lessens the fluctuations in income inequality.

Endogenous Preferences for Parenting and Macroeconomic Outcomes

This paper investigates the effects of parenting time on macroeconomic outcomes and welfare when parenting choices are determined by own childhood experience and social norms in an overlapping generations framework. Parenting time and material expenditures on children generate children’s human capital. When the share of parenting time is relatively low and parenting and leisure are complements or weak substitutes the model has two steady-state equilibria with different welfare levels. In the high-welfare equilibrium parents have stronger endogenous taste for parenting and spend more time with children and less in paid work. Higher productivity due to the higher human capital more than compensates for the reduction in working hours, leading to a higher output level, in comparison to the low-welfare equilibrium.

Optimal fiscal policy in a model with inherited aspirations and habit formation

AbstractIn this paper, we analyze optimal fiscal policies in an overlapping generations framework, where preferences exhibit aspirations in consumption and environmental quality as well as habit formation. We focus on the second best policies when the government needs to finance a given stream of public expenditures by using distortionary taxes. We derive necessary and sufficient conditions under which the competitive equilibrium is characterized by levels of capital and environmental quality that are too small and a level of labor supply that is too large. Our numerical simulations show that an optimal fiscal policy can be used as an effective stabilization device and that when consumption taxes are fixed, the planner implements maintenance investment and capital income subsidies while financing public spending through labor and fixed consumption taxes.

Modeling the Internal Revenue Code in a Heterogeneous-Agent Framework: An Application to TCJA

Macroeconomic models routinely abstract from two features of the US federal tax code: the joint taxation of ordinary capital and labor income, and the special taxation of preferential capital income. In this paper we argue that this abstraction omits a `portfolio-effect' mechanism where endogenous changes to the ordinary-preferential composition of households' capital income influence individuals' optimal labor and saving decisions through its impact on their effective marginal tax rates. We demonstrate the quantitative importance of this tax detail by simulating provisions from the recently enacted “Tax Cuts and Jobs Act” using a heterogeneous-agent overlapping generations framework with two production sectors.

Child Care Subsidies with One- and Two-Parent Families

The implementation of child care subsidies has varied widely across countries and states, as well as over time, ranging from universal to poverty-tested eligibility. I study the implications of eligibility rules for child care subsidies in a general equilibrium, overlapping generations framework where altruistic parents invest in child skill. I allow for one- and two-parent families, and endogenize family formation with a marriage market. This explicitly incorporates single mothers, who currently parent 20% of children under 5 in the United States. Using individual-level data from the US Department of Education, I estimate how mother time, father time, and non-parental child care affect child skill for each family structure. These estimates allow me to account for the differential effect of child care subsidies on one- and two-parent families. My general equilibrium framework accounts for the effect of the subsidy on government expenditures as well as the skill distribution and, through that, on endogenous tax rates. I find that universal subsidies yield ex ante welfare gains of 5.9 percentage points, while targeting child care subsidies to one-parent families or poor families yields welfare gains of 2.4 and 2.0 percentage points, respectively. Universal subsidies more fully insure newborns against the risks they face than targeted subsidies, and do not disincentivize skill investment as happens with subsidies to the poor.

Untimely Destruction: Pestilence, War and Accumulation in the Long Run

This paper analyses the effects of disease and war on the accumulation of human and physical capital. We employ an overlapping-generations frame-work in which young adults, confronted with such hazards and motivated by old-age provision and altruism, make decisions about investments in schooling and reproducible capital. A poverty trap exists for a wide range of stationary war losses and premature adult mortality. If parents are altruistic and their sub-utility function for own consumption is more concave than that for the children's human capital, the only possible steady-state growth path involves full education. Otherwise, steady-state paths with incompletely educated children may exist, some of them stationary ones. We also examine, analytically and with numerical examples, a growing economy's robustness in a stochastic environment. The initial boundary conditions have a strong influence on outcomes in response to a limited sequence of destructive shocks.

The Debt Multiplier

This paper studies the debt multiplier, that is the effects of a temporary and pure change in government debt on economic activity. Contrary to an infinitely-lived representative agent model, in an overlapping generations (OLG) framework output increases even after a temporary increase in debt due to a lump-sum tax reduction that is totally reversed in the future. When nominal interest rates are positive, the debt multiplier is generally quite small. However, the debt multiplier is much larger when the nominal interest rate is at the zero lower bound. Hence, the call for fiscal consolidation in recession times seems ill-advised. Moreover, the steady state level of debt matters in an OLG framework. Multipliers tend to increase with the level of debt in steady state. A rise in the steady state debt-to-GDP level increases the steady state real interest rate and thus it provides an alternative route to increase the room for manoeuvre for monetary policy facing deflationary shocks.

Beyond rational expectations: The effects of heuristic switching in an Overlapping Generations model

We explore the transitional dynamics in an Overlapping Generations framework with and without heuristic switching. Agents use simple heuristics to forecast the interest rate and the real wage. The fraction of agents using a specific heuristic depends on its relative forecasting performance. In the absence of heuristic switching, the results indicate that there is a lot of variation in the transitional dynamics over different parameter values and heuristics. When agents switch between heuristics, however, the variation in the transitional dynamics decreases significantly. We show that heuristic switching has a stabilising effect on transitional dynamics that would otherwise exhibit permanent oscillations.

Dynamic adjustment of fiscal policy under a debt crisis

In an overlapping generations framework that allows for the presence of a debt crisis scenario (debt bubbles), we introduce productive government expenditures, and endogenous deficits through a dynamic fiscal rule that combines fiscal stimulus and fiscal consolidation. We formally argue that a fiscal rule must be pro-cyclical to output for government investment financing and simultaneously has to control for the level of debt adjusting taxation for a policy aiming to escape a situation of exploding debt and low economic activity. Then, when the economy becomes sustainable (or in an economy’s high initial private capital), the same rule, has to endogenously adapt to the actual level of debt and income in order to stimulate private investment through lower taxes. We provide a numerical example for our theoretical results and show that in economies with sufficiently low levels of capital and high levels of debt, the tax rate has to adjust non-monotonically during the recover process, reflecting the two counter-balancing properties of the examined fiscal policy rule. However, under a threshold level of initial capital stock, taxes must adjust monotonically (negatively) to boost private investment activity, and in turn, alleviating the volume of debt though a higher tax base.

Energy and Physical Capital: A Case of Non-classical Dynamics

We study the importance of considering different energy requirements for physical capital and final good production in an overlapping generations (OLG) resource economy. In contrast to the standard OLG framework, but consistently with the empirical evidence, we assume that the accumulation of physical capital requires more energy than the production of consumption goods. Focusing on exhaustible energy resources, we find that OLG equilibria can exhibit “non-classical dynamics”: the economy generates complex dynamics where, differing from the response predicted by the standard approach, resource prices may not increase monotonically. This result illustrates that the technological assumptions behind the energy inputs should be taken with caution, in particular on dynamic analyses involving exhaustible energy resources.

Dynamic Scoring: An Assessment of Fiscal Closing Assumptions

Analysis of fiscal policy changes using general equilibrium models with forward-looking agents typically requires the modeler to assume a counterfactual adjustment to some fiscal instrument in order to achieve the debt sustainability implied by the government's intertemporal budget constraint. Since the fiscal instrument chosen to close the model can induce economic behavior unrelated to the policy change in models where Ricardian Equivalence does not hold, noise may be introduced into the analysis. In this paper we use such an overlapping generations framework to examine the impact of alternative fiscal closing assumptions on projected changes to economic aggregates over the ten-year 'budget window' following a change in tax policy, assessing the extent to which the noise associated with a particular fiscal instrument can be mitigated. We find that while quantitative differences in projected macroeconomic activity can be observed across alternative fiscal instruments, these differences tend to shrink as the date that fiscal instruments begin to adjust is delayed into the future. Since the particular fiscal instrument chosen to achieve debt sustainability can then become relatively unimportant, the reliability of policy analysis obtained using this class of models may be improved.

MYOPIC MISERY: MATERNAL DEPRESSION, CHILD INVESTMENTS, AND THE NEUROBIOLOGICAL POVERTY TRAP

In this paper, I explore in an overlapping generations framework, a mechanism motivating a neurobiological poverty trap. Poverty causes stress and depression in individuals susceptible to depression. Poor and depressed individuals discount the future at a higher rate and invest less in the human capital of their children than mentally healthy or rich individuals. This gene–environment interaction generates a vicious cycle in which poor individuals inherit not only susceptibility to depression, but also stress and poverty. I show that a successful one-time intervention has the power to permanently eliminate the neurobiological poverty trap.

Myopic Misery: Maternal Depression, Child Investments, and the Neurobiological Poverty Trap

In this paper, I explore in an overlapping generations framework, a mechanism motivating a neurobiological poverty trap. Poverty causes stress and depression in individuals susceptible to depression. Poor and depressed individuals discount the future at a higher rate and invest less in the human capital of their children than mentally healthy or rich individuals. This gene-environment interaction generates a vicious cycle in which poor individuals inherit not only susceptibility to depression but also stress and poverty. I show that a successful one-time intervention has the power to permanently eliminate the neurobiological poverty trap.

AkiraYakitaPopulation Aging, Fertility and Social SecuritySpringer International, 2017. xvii + 237 p. $129.00.

Readers should not be misled by the straightforward title of this book into expecting a broadly accessible discussion of problems of social support in aging, low-fertility societies. Some of those issues are taken up, but the treatment throughout is at a purely abstract level. Indeed, the book is remarkable in sustaining this high level of formality throughout. In this respect it is comparable to but even more purist than David de la Croix's Fertility, Education, Growth, and Sustainability (Cambridge, 2013—see PDR 39, no. 4). The starting point of most chapters is the classic Samuelson consumption–loan model formulation, a two-period, one-sex, overlapping-generations framework. In the first period, individuals work and have and bring up children; in the second, if they survive into it, they are retired. They choose a lifetime consumption profile and level of childbearing to maximize (expected) lifetime utility, subject to their budget constraint. A longer life expectancy induces them to save more for retirement and have fewer children, thus promoting economic growth and fertility transition. Introducing an unfunded PAYG pension scheme leads to lower savings. If age of retirement is left to individual choice, those with higher earning capacity tend to have more children and work further into old age. Other complications in the fertility calculus come from adding a market in childcare services. Individuals who have fewer children than are needed on average to support PAYG pensions can be seen as free-riders—and doubly benefit by forgoing less income in childcare time or expense. A fuller treatment of age structure and human capital requires expanding to a three-period model, the first period now devoted to education. Youth dependency is found mostly to be inversely related to growth in total factor productivity (the demographic dividend argument), but at very low incomes the returns to educational investment can be sufficiently high to crowd out investment in technological innovation, yielding falling productivity—a poverty trap, or even, in Yakita's term, a rat hole. Topics touched on in other chapters include the effects of population aging on public investment and on the sustainable stock of renewable resources. A concluding chapter restates the results seriatim. The analytical prowess on display is undeniable. Tractability imposes some limitations: most of the analysis is confined to steady states, leaving aside transitional situations, and the economies in all but one chapter are closed, abstracting from international factor and product flows; gender differences, ex hypothesi, are ruled out. What is most lacking, however, is any serious discussion of how the modeling relates to the real world—to what degree the particular features of the economy and demography captured in the successive model variants are those that are in fact salient in governing outcomes or that shed light on what is actually going on behind the scenes. The author is content to point out where his findings agree with or differ from those of other theorists (whose work is extensively cited), and to express satisfaction when he qualitatively reproduces an accepted empirical observation or stylized fact. The book exemplifies a well-established genre of formal economic demography and public economics familiar in the pages of the Journal of Population Economics and other theoretically inclined economics journals—where many of the chapters in fact originated. But in those journals there is more than a sprinkling of empirical material to balance the contents; here there is not. The author is an economist at Nanzan University, Nagoya. Chapter bibliographies.

Education Financing and Student Lending

As the cost of education rises and student debt reaches new highs, more research has focused on financing the acquisition of human capital. Most research has had a positive focus, examining the effect of debt on student choices and outcomes. However, because education financing involves many public policy choices, normative questions have become more prominent. We discuss the trade-offs involved in these choices and propose simple models to help shape these questions. We first develop an overlapping generations framework of student debt to examine the macroeconomic impact of shifting from a parent-funded to a student debt–based financing system. We then consider a framework that includes the supply-side response to different funding regimes; that is, how do enrollment and tuition decisions of schools respond to changes in education financing? We show that shifting from parent-based funding to a student loan program can lower aggregate savings, although welfare still improves if education has a higher return than physical capital investment. A public student loan program also tends to promote enrollment at the cost of higher tuition at for-profit schools and deteriorating loan performance, paid for by taxpayers. Alternative contract designs, with school participation in the lending program, tend to ameliorate these issues.

Financing Climate Justice Through Climate Bonds

Climate control needs have reached momentum. While scientists call for stabilizing climate and regulators structure climate change mitigation and adaptation efforts around the globe, economists are concerned with finding proper and fair financing mechanisms. In an overlapping-generations framework, Sachs (2014) solves the climate change predicament that seems to pit today’s against future generations. Sachs (2014) proposes that the current generation mitigates climate change financed through bonds to remain financially as well off as without mitigation while improving environmental well-being of future generations through ensured climate stability. This intergenerational tax-and-transfer policy turns climate change mitigation into a Pareto improving strategy. Sachs’ (2014) discrete model is integrated in contemporary growth and resource theories. The following article analyzes how climate bonds can be phased in, in a model for a socially optimal solution and a laissez-faire economy. Optimal trajectories are derived partially analytically (e.g. by using the Pontryagin maximum principle to define the optimal equilibrium), partially data driven (e.g., by the use of modern big market data) and partially by using novel cutting-edge methods – e.g., nonlinear model predictive control (NMPC), which solves complex dynamic optimization problems with different nonlinearities for infinite and finite decision horizons. NMPC will be programmed with terminal condition in order to determine appropriate numeric solutions converging to some optimal equilibria. The analysis tests if the climate change debt adjusted growth model stays within the bounds of a sustainable fiscal policy by employing nonlinear model predictive control (NMPC), which solves complex dynamic systems with different nonlinearities.

Microeconomic shocks and macroeconomic fluctuations in a dynamic network economy

The distribution of firm-sizes in the U.S. – or at least its upper tail – appears to be well-described by a Pareto distribution with infinite variance. This fact forms the basis of the granular hypothesis proposed by Gabaix in his paper “The Granular Origins of Aggregate Fluctuations” (Econometrica, (2011)). The granular hypothesis provides a mechanism whereby independent firm-level shocks are capable of generating macroeconomic fluctuations. This paper considers the granular hypothesis in a new framework. It develops a DSGE model by superimposing a stochastic overlapping generations framework on a network. Idiosyncratic output shocks to individual firms are transmitted across the economy through income–expenditure channels. Specifically, firms represent vertices of the network, and a firm x is linked to another firm y if x employs one or more workers who purchase commodities produced by y. The paper’s findings agree closely with results first discovered by Gabaix: if firm-sizes in an economy are described by a Pareto distribution, then independent firm-level shocks can generate macroeconomic fluctuations in accordance with the granular hypothesis. Furthermore, the model is capable of generating aggregate volatility of the same order of magnitude as occurs in reality. Thus the paper describes a new general equilibrium framework where macroeconomic fluctuations can arise as the consequence of independent firm-level shocks.

Invest-as-You-Go: Public Health Investment, Long-Term Care and Welfare

Better health not only boosts longevity in itself, it also postpones the initial onset of disability and chronic infirmity to a later age. In this paper we examine the effects of such "compression of morbidity" on pensions, and introduce a health-dependent dimension to the standard pay-as-you-go (PAYG) pension scheme. Studying the implications of this "long-term care augmented" system in an overlapping generations framework, public health investment is analytically shown to boost savings and capital accumulation in the long run. Because of this multiplier effect, a partially health-dependent PAYG scheme will outperform a regular PAYG system in terms of lifetime welfare, as indicated by our numerical calculations.

Young, Old, Conservative, and Bold: The Implications of Heterogeneity and Finite Lives for Asset Pricing

We study the implications of preference heterogeneity for asset pricing. We use recursive preferences in order to separate heterogeneity in risk aversion from heterogeneity in the intertemporal elasticity of substitution, and an overlapping-generations framework to obtain a non-degenerate stationary equilibrium. We solve the model explicitly up to the solutions of ordinary differential equations, and highlight the effects of overlapping generations and each dimension of preference heterogeneity on the market price of risk, interest rates, and the volatility of stock returns. We find that separating IES and risk aversion heterogeneity can have a substantive impact on the model's (qualitative and quantitative) ability to address some key asset pricing issues.

Factor shares, inequality, and capital flows

I present an endogenous growth model where innovations are factor saving and model the choice of technologies in an Overlapping Generations framework. Markets are competitive and factor prices are determined by marginal productivity of factors; therefore, the income share of reproducible factors increases with the stage of development. Beyond the standard results of this type of model I find that (i) without bequests long‐run growth is not possible, (ii) if the economy presents long‐run growth then intrageneration inequality may last forever but if the economy does not present long‐run growth then in steady state, there is no intrageneration inequality, (iii) when the economy is open, the pattern of capital flows depends not only on the relative abundance of factors but also on the technologies and, for this reason, capital may not flow from rich to poor economies, and (iv) consistently, capital flows may not help to break poverty traps.