Overlapping Generations Model Research Articles

The Analysis of the Effects of Labor income and Capital gain tax rates on Macroeconomic Variables: based on Overlapping Generation Models ،(DSGE) approach

The Analysis of the Effects of Labor income and Capital gain tax rates on Macroeconomic Variables: based on Overlapping Generation Models ،(DSGE) approach

Patience and Comparative Development

Abstract This article studies the relationship between patience and comparative development through a combination of reduced-form analyses and model estimations. Based on a globally representative dataset on time preference in 76 countries, we document two sets of stylized facts. First, patience is strongly correlated with per capita income and the accumulation of physical capital, human capital, and productivity. These correlations hold across countries, sub-national regions, and individuals. Second, the magnitude of the patience elasticity strongly increases in the level of aggregation. To provide an interpretive lens for these patterns, we analyse an overlapping generations model in which savings and education decisions are endogenous to patience, aggregate production is characterized by capital-skill complementarities, and productivity implicitly depends on patience through a human capital externality. In our model estimations, general equilibrium effects alone account for a non-trivial share of the observed amplification effects, and an extension to human capital externalities can quantitatively match the empirical evidence.

Risk Sharing, Macro-Prudential Policy and Welfare in an Overlapping Generations Model (OLG) Economy

Risk Sharing, Macro-Prudential Policy and Welfare in an Overlapping Generations Model (OLG) Economy

Macroeconomic Implications of Inequality and Income Risk

<ns3:p>We explore the long-run relationship between income risk, inequality, and the macroeconomy in an overlapping-generations model in which households face uncertain streams of labor income and returns on their savings. To manage those risks, households can apportion their savings to a bond, whose return is safe and identical across households, and a productive asset, whose return is uncertain and can differ persistently across households. We find that greater polarization in households’ labor income and returns on their savings generally accentuates households’ demand for risk-free assets and the compensation they require for bearing risk, leading to higher measured income and wealth inequality, a lower risk-free real interest rate, and higher risk premiums. These findings suggest that the factors behind the observed rise in inequality over the past few decades might have contributed to the observed fall in the risk-free real interest rate and widening gap between the risk-free real interest rate and the rate of return on capital. We also find that the magnitude of the decline in the risk-free real interest rate and offsetting rise in risk premiums depend importantly on the source of income polarization, with the effects being especially large when greater inequality is caused by increased dispersion in returns on risky assets. Thus, the macroeconomic implications not only depend on the amount of inequality, but also the source of this inequality.</ns3:p>

Sustainable and equitable pensions with means testing in aging economies

A means-tested pension system has a distinct feature that tailors the level of pension benefits according to individual economic status. In the context of population aging with widening gaps in life expectancies, we show that this feature generates an automatic mechanism that (i) mitigates the pressing fiscal cost of an old-age public pension program (fiscal stabilization device) and (ii) redistributes pension benefits to those in need with shorter life expectancies (redistributive device). To evaluate this automatic mechanism, we employ an overlapping generations model with population aging. Our results indicate that this novel mechanism plays an important role in containing the adverse effects of population aging on the fiscal costs and enhancing the progressivity of a pension system. More pronounced aging scenarios further strengthen the role of this mechanism. A well-designed means test rule can create a sufficiently strong automatic mechanism to keep public pensions sustainable and progressive under population aging.

On the marginal excess burden of taxation in an overlapping generations model

We extend marginal excess burden (MEB) analysis in public finance literature to a dynamic general equilibrium model with incomplete markets and heterogeneous households. This extension allows us to quantitatively assess efficiency ranking and incidence of taxes. Our results indicate a disparity in welfare cost and distributional consequence of different forms of taxation on capital, labor and consumption. According to our MEB ranking, capital income taxation appears to be least efficient as it results in larger marginal excess burdens, compared to labor income tax and consumption tax. The tax incidence analysis shows variation of tax burdens across households, depending on their age, income type and generation. In particular, older households with higher income bear the highest burden of company income tax; meanwhile, future born households bear the highest burden of personal income tax. Hence, our MEB analysis demonstrates a fruitful approach to better understanding efficiency and incidence of tax reforms in one unified framework.

The political (in)stability of funded social security

We analyze the political stability of funded social security. Using a stylized theoretical framework we study the mechanisms behind governments capturing social security assets in order to lower current taxes. The results and the driving mechanisms carry over to a fully-fledged and carefully calibrated overlapping generations model with an aging population. Funding is efficient in a Kaldor-Hicks sense. We demonstrate that, even though we can rationalize the actual introduction of a two-pillar defined-contribution scheme with funding through a majority vote, a new vote to curtail the funded pillar through asset capture or permanent diversion of contributions to the pay-as-you-go pillar always receives majority support. For those alive and thus allowed to vote, the temporary reduction in taxes outweighs the reduction in retirement benefits. This result is robust to substantial intra-cohort heterogeneity and other extensions, and only overturned with a sufficient degree of altruism. Our analysis rationalizes the experience of Central and Eastern European countries, who rolled back their funded pension pillars soon after setting them up.

POSTPONING RETIREMENT AND SOCIAL SECURITY IN A TWO-SECTOR MODEL

Pay-as-you-go social security schemes in the Organisation for Economic Co-operation and Development countries are facing solvency problems, as people are living longer and birth rates have declined. Postponing the full retirement age (FRA), when retirees are entitled to full pension, has been proposed as a solution. This effectively lowers the payroll tax rate since pension is paid only in the post-FRA period. In a two-period two-sector overlapping generations model, I show that this shift lowers savings (because a part of the expected old-age income is consumed in the first period), as employment increases. In the transition to the new steady state, capital is decumulated and the wage rate falls. Contrast this with a reduction of the payroll tax rate where the initial old suffer reduced consumption, but the young have higher post-tax income and this spurs capital accumulation.

Capital requirements, risk-taking and welfare in a growing economy

The effects of capital requirements on risk-taking and welfare are studied in an overlapping generations model of endogenous growth with banking, limited liability, and government guarantees. Capital producers face a choice between a safe technology and a risky, more productive but socially inefficient, technology. Bank risk-taking is endogenous. As a result of a skin in the game effect—motivated either as an aggregate externality, or as the outcome of the optimal choice of monitoring effort by individual banks—default risk is inversely related to the capital adequacy ratio. Numerical simulations show that in an equilibrium where banks extend both safe and risky loans, the skin in the game effect must be sufficiently strong for a welfare-maximizing regulatory policy to exist. These results remain qualitatively similar with endogenous monitoring costs and a strong effect of monitoring on entrepreneurial moral hazard. However, numerical experiments also suggest that the optimal capital adequacy ratio may be too high in practice and may require concomitantly a broadening of the perimeter of regulation and a strengthening of financial supervision to prevent disintermediation and distortions in financial markets.

Business Cycles in a Two-Sided Altruism Model

This study demonstrates that business cycles with complex periodic fluctuations may arise in an overlapping generations model with two-sided altruism. The structure of an equilibrium dynamical system strongly depends on the degree of altruism in the model. If either altruism of a generation to the parent or the child disappears, the study also demonstrates that complex periodic fluctuations never occur. In this sense, two-sided altruism is essential for a complex business cycle.

Wealth distribution and skills generation under public and private education systems

Purpose This paper aims to understand the differing impacts of wealth distribution on human capital accumulation and skilled-unskilled labour generation under three educational paradigms as follows: private, public and a system of mixed education. Design/methodology/approach The authors use an overlapping generations model. Findings The wealth dynamics show that both in the private education system and public education system, there are two possible outcomes- stagnation and steady growth depending on the efficiency of the education system, skill premium and other parameters. The choice of the education system through voting is discussed. It is found that skilled workers would always vote for private education whilst unskilled workers vote for private education if public education expenditure of the economy is low. Research limitations/implications The study is subject to several limitations. This paper considers the rate of interest and wage rate to be exogenously given, and thus ignores the general equilibrium effects. The authors do not consider the labour-leisure choice. The introduction of labour leisure choice in the model would alter many of the results. The authors do not consider heterogeneous ability across individuals. The analysis of the differential efficiency of the different education systems needs further, rigorous research. Also, this paper does not consider other occupations such as entrepreneurship and self-employment. This paper considers the labour demand function to be perfectly elastic, and hence, does not consider any demand constraint. What happens if bequests are taxed? What happens if parents are not altruistic? These questions may be addressed in future research. Social implications If the proportion of tax paying skilled labour is low in any country, pure public education may not be able to generate sustained human capital growth. For countries with a sufficiently large proportion of skilled labour, the public education system would be successful. On the other hand, if skill premium is low or the education system is poorly managed private education system may fail too. Originality/value Whilst investigating the effects of public vs private education on growth and development in the presence of unequal wealth distribution, The authors have tried to address a few questions. First, why the public education system has been successful in skill accumulation in developed countries whilst it has failed to do so in less developed countries? Second, why do some countries with mostly privately run educational institutions perform much better in human capital production whilst others do not? Third, in an economy with unequal wealth distribution, what are the factors that result in public or private education as a voting equilibrium outcome?

How Long does a Generation Last? Assessing the Relationship Between Infinite and Finite Horizon Dynamic Models*

This note aims at assessing the temporal relationship that exists between the time reference of dynamic models with infinite and finite horizon. Specifically, comparing the optimal inter‐temporal plans arising from an infinite horizon model and a 2‐period overlapping generations model in their stationary equilibria, I suggest way to assess the number of time periods of the former that form a time unit of the latter. Relying on an argument grounded on consumption smoothing, I show that the theoretical length of a generation is an increasing function of the discount factor of the optimising agent. Moreover, from an empirical point of view, I give evidence that this analysis corroborates the well‐documented nexus that links demographic developments and the path of interest rates, and it offers interesting insights for the calibration of discount rates in computational models.

Involuntary Unemployment as a Nash Equilibrium and Fiscal Policy for Full Employment

This study aimed to provide a game-theoretic interpretation of the analyses of involuntary unemployment by deficiency of aggregate demand and fiscal policy to achieve full employment using an overlapping generations model. We showed that involuntary unemployment is in a Nash equilibrium of a game with a firm and consumers. Moreover, we showed that full employment can be achieved through fiscal policies that create budget deficits in recessionary conditions with involuntary unemployment. Once full employment is achieved, it can be sustained without a budget deficit.

Optimal taxes on capital in the OLG model with uninsurable idiosyncratic income risk

We characterize the optimal linear tax on capital in an Overlapping Generations model with two period lived households facing uninsurable idiosyncratic labor income risk. The Ramsey government internalizes the general equilibrium effects of private precautionary saving on factor prices and taxes capital unless the weight on future generations in the social welfare function is sufficiently high. For logarithmic utility a complete analytical solution of the Ramsey problem exhibits an optimal aggregate saving rate that is independent of income risk, whereas the optimal time-invariant tax on capital implementing this saving rate is increasing in income risk. The optimal saving rate is constant along the transition and its sign depends on the magnitude of risk and on the Pareto weight of future generations. If the Ramsey tax rate that maximizes steady state utility is positive, then implementing this tax rate permanently induces a Pareto-improving transition even if the initial equilibrium capital stock is below the golden rule.

Demographics and the natural real interest Rate: historical and projected paths for the euro area

This paper employs a large-scale overlapping generation model quantifying that demographics account for a decrease in the natural real interest rate of about 1.4 percentage points in the euro area compared with the average for the 1980s to 2030 (roughly at its trough), under the baseline calibration. Two channels prevail in providing the downward impact: the increasing scarcity of effective labor input and the growing willingness of individuals to save due to longer life expectancy. Mitigating factors are: greater substitutability between labor and capital, higher intertemporal elasticity of substitution in consumption, higher productivity and participation by older individuals and, to a lesser extent, a higher retirement age. Absent pay-as-you-go pension systems, the natural rate would stand at a lower level of about 0.5 percentage points by 2030. The simulated paths of the natural real interest rate and output growth are consistent with econometric estimates.

Endogenous longevity and optimal tax progressivity

We study the impact of endogenous longevity on optimal tax progressivity and inequality in an overlapping generations model with skill heterogeneity. Higher tax progressivity decreases both the longevity gap and net income inequality, but at the expense of lower average lifetime and income. We find that the welfare-maximizing income tax is less progressive in our model with endogenous longevity than in our model with exogenous longevity. In a highly stylized calibration of the US economy, we show that optimal tax progressivity is less than what prevails under the current US tax system. Our results are robust to the range of empirical labor supply elasticity and the assumptions of missing annuity markets and stochastic health. Our conclusion for the optimal progressivity of the US tax system can be altered by the adoption of a more egalitarian welfare function or by increases in prevailing levels of wage inequality.

Environmental regulation and economic growth: A new perspective based on technical level and healthy human capital

Environmental regulation provides new constraints and opportunities for economic growth. Based on OLG (Overlapping Generation) model, this paper re-characterizes the relationship between the intensity of environmental regulations and economic growth rate from two perspectives: technical level and healthy human capital. By using the panel data of 31 provinces and cities in China from 2004 to 2017, empirical tests were conducted through the mediation effect method and the contrast groups of OLS (Ordinary Least Squares) regression experiment to support the theoretical part. The results show that: (1) The non-linear relationship between environmental regulations and economic growth rate shows an “inverted U-shaped” curve, where the economic growth rate displays a correlation with the intensity of environmental regulations from positive to negative; (2) The internal action path of environmental regulations on economic growth shows the differentiated characteristics according to different industrial types. Specifically, under the established intensity of environmental regulation, the effect of regulatory policies on labor-intensive enterprises is more based on the technological level, while it is more inclined to the path of healthy human capital for capital-intensive enterprises. This paper enriches the theoretical system of economic growth under environmental regulations, which has important reference significance for promoting green development and ecological civilization construction.

Financial openness, capital rents and income inequality

This study presents an institutional analysis using a dynamic overlapping generations model with capital rents and technological change to assess the impact of financial reforms on income inequality. We contribute to the growing research by examining the hypothesis in which capital rents are the underlying cause of income inequality resulting from financial openness, through changing the relative market power of capital and financial market structure, which affects investment activities. We find that i) in a closed economy, income inequality rises as capital rents decrease; ii) in a small open economy, income inequality falls when the capital rent ratio between entrepreneurs and investors increases; and (iii) financial openness can amplify the effect of technological changes on income inequality, although the ultimate effect is nonlinear. These findings provide valuable insights for further research and for policymakers to adjust capital rents in the interest of reducing income inequality.

Pension Reforms, Population Aging, and Retirement Decision of the Elderly in a Neoclassical Growth Model

AbstractThis study explores the linkage between the labor force participation of the elderly and the long-run performance of the economy in the context of a two-period-lived overlapping generations model. We assume that the old agents are heterogeneous in their labor efficiency and they continue working if their income exceeds the pension that can be received in the case of full retirement. We first inspect the key factors that determine the retirement decision of the elderly. We then examine analytically as well as numerically the long-run impact of labor participation of the elderly on capital accumulation and income distribution.

Revisited: Monopoly and Long-Run Capital Accumulation in Two-Sector Overlapping Generation Model

In this paper, we investigate if an increasing competition in an oligopolistic market will enhance the real incomes and consumer surplus in the long run. For this purpose, we apply a two-sector overlapping generation model in which members of the young generation own the oligopolistic firms. We show that increasing competition in the oligopolistic market leads to ambiguous outcomes regarding the real income and consumer surplus in the long run. However, we show that the distribution of income will become fairer if the competition increases, but it is possible that the price for a fairer distribution is a lower income for all members of the economy.