Category Archives: macroeconomics

Moving back home- Determining the household size!

I am great fan of Greg Kaplan’s paper `Moving Back home’ in which he motivates moving back with parents as an insurance mechanism against labor market risks. I think, apart from explaining consumption and savings responses of low income households, it highlights one of the most important economic determinants of household size for not only the US but also for other countries. When no other insurance mechanisms are available, people tend to huddle up economizing on costs of living and minimizing labor market risk through skill set diversification (much like portfolio diversification!). This explains, for example, why traditional societies like India had joint family systems for a very long period of time to the extent of becoming a defining feature of Indian society. The important thing to realize is that this system may not be here for long. The  general increase in incomes, economic opportunities, and capacity to shield oneself from economic risks will reduce the need for a joint family.  This is already evident in the increasing nuclearization of families across urban India. Moreover, the size of the households also might change over the business cycle!

A recent paper with José-Víctor Ríos-Rull and Sebastin Dryda,  extends the idea of moving back home with parents to build a model of household size determination that is amenable to equilibrium business cycle analysis with aggregate technology shocks. The authors then use this model to explain the discrepancy between the micro evidence on the Frisch elasticities and the ones implied by the macro models. Interesting stuff!

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On Powerful Macroeconomic Concepts: Consumption Smoothing

The idea of consumption smoothing is a very powerful one and seem to underlie a variety of economic as well as social phenomenon. In what follows I discuss a few examples to illustrate this. Consumption smoothing implies that the people prefer a smoother consumption path over a relatively choppy or fluctuating one. The ability to smooth consumption differs across countries and within countries across income classes. For example it has been documented that private consumption expenditure in developed countries is less variable than the real GDP at the business cycle frequencies, while in the developing countries it is more variable than the real GDP. This difference can be explained by differing access to credit markets as well support from governments in terms of welfare spending. You can read more about this here and here.

A couple of research papers on India also highlight how consumption smoothing can help explain patterns of migration and marriage as well as the probability of survival of a girl child in rural India. For example, Rosenweig and Stark (1989) find evidence among rural households in India that marriages are arranged between families that come from areas with different income risks. This allows for inter-household transfers of good and services and helps households to tide through rainfall shocks. Such arrangements are important in the absence of formal agricultural insurance products and difficulties in credit provision. Rainfall shocks are not uniformly distributed over the region and hence such flow of goods and services associated with such marital arrangements helps families smooth consumption in difficult time periods.

In another study on India, Elaina Rose shows that one can explain excess female mortality in rural India with the help of consumption smoothing. Using data from almost 4000 rural households, Rose finds that the ratio of probability that a girl survives until school age  to the probability that a boy survives to this age is related to rainfall shocks in childhood. This ratio shows improvement for a cohort that experiences a positive rainfall shock in the first two years of life.   This means that when there is an increase in income or purchasing power of a household because of good rainfall, the probability of a girl child surviving improves as households can afford to allocate more resources to the girl child. The opposite happens when there is a negative rainfall shock. The general  importance of rainfall shocks in fluctuations in Indian GDP is discussed here.

However dismal these findings, they have important implications for government policy. As Rose argues, becuase excess female mortality in rural India is associated with inability to smooth consumption  through other means, promoting institutions that provide alternative mechanisms to smooth consumption might do far good in improving survival of the girl child than any other policy. In case you doubted the importance of insurance and other financial products that provide a hedge against income fluctuations, you will find som solid argument here!

 

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Filed under current economic issues, indian economy, macroeconomics, social perspectives

To deregulate or not?

An article published at Macroscan on the dilemma of the Indian government about whether to deregulate the price of oil or not, the author argues for not to do so. However, I think he needs more than the analysis he is basing his argument on. The simulation is based on Tinbergen style simultaneous equations model of the Indian economy. So my 5 cents to the debate are as follows:

There are several general equilibrium effects of an oil price shock that have to considered. How are people going to react to the change in price of oil? In the first place, shielding the consumers from oil price shocks has distorted consumer decisions. Combined with shoddy public transportation system, it has lead to a higher demand for private transportation vehicles. If government passes on the oil price changes to the consumer, the consumers might respond to the relative price changes. Over the period of time there will be further demand for efficient public transportation and the reliance on oil for private transportation might actually go down leaving the net effect on GDP close to zero. Also, reduction the oil subsidy will reduce the over fiscal deficit and lower the inflation tax. The government might decide to channel that expenditure somewhere else like better schools or highways! But to account for such kind of changes you will have to simulate a micro-founded general equilibrium model and not a Tinbergen style simultaneous equations one (NIPFP working paper No. 2012-99) which does not allow for equilibrium responses from economic agents (the famous Lucas critique!). I think right assessment of what should be the appropriate policy in the case of oil price deregulation cannot be made till such analysis is undertaken. You still might have a case for not deregulating the price of oil but it would be based on a more robust analysis.

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Game Thoery and Macroeconomics

The increasing emphasis on micro-foundations in macroeconomics seems to have lead to modeling efforts incorporating strategic decision making at the individual level in a general equilibrium setting yielding interesting insights on important questions.  A couple of days at a workshop organized by the Center for Game Theory at the scenic Stony Brook university on the use of game theory in macroeconomics was indeed an enjoyable experience in this regard. Here is a peek at a few interesting papers from the workshop.

1. B Ravikumar et al, Unemployment Insurance Fraud and Optimal Monitoring:

How do you address the problem that the unemployment benefits overpaid because of fraud are more than ten times the overpayments due to insufficient search?  Ravikumar and his coauthors  study optimal monitoring of fraudulent behavior in a model of unemployment insurance and suggest an interesting optimal monitoring mechanism to avoid the overpayment .

2. Harold Cole et.al, Why does technology not flow to developing countries?

A very interesting approach to answering the question asked originally by Robert Lucas in his 1990 AER paper.  Cole and his coauthors concentrate on efficiency of financial system of a country as the factor determining technology adoption. They conduct a comparative analysis of technology adoption in the US, Mexico and India to help shed light on the question. They propose that “the ability of an intermediary to monitor and control the cash ‡flows of a fi…rm plays an important role in a fi…rm’s decision to adopt a technology“. This is where the efficiency of the financial system comes into play.  Based on this hypothesis, they develop a costly state verification model of venture capital where the position of a firm wishing to adopt a particular technology on the technology ladder is private information. An intermediary financing the adoption of technology for  such a firm has to incur positive costs for monitoring and where it cannot monitor, it has to develop incentive schemes to ensure successful running of the venture.  The model is then embedded in a general equilibrium framework and calibrated to the US, Mexico and Indian data for applied analysis.

3. Perri Fabrizio and Vincenzo Quadrini, International Recessions.

The recession following the recent financial crisis in the US is different than the ones before in many respects. One of them is that this recession seems to be internationally synchronized at least for the developed countries. How do we explain this synchronization? Perri develops a two-country model with financial market frictions where a credit tightening can emerge as a self-fulling equilibrium caused by pessimistic but fully rational expectations. As a result of the credit tightening, countries experience large and endogenously synchronized declines in asset prices and economic activity (international recessions). The model suggests that these recessions are more severe if they happen after a prolonged period of credit expansion.

4. Xavier Mateos-Planas and Victor Rios Rull, Credit Lines.

An interesting analysis of unsecured credit arising out of use of credit cards:

This paper develops a new quantitative theory of long-term unsecured credit contracts. Households can default and can switch credit lines. Banks can change the credit limit at any time, but must commit to the interest rate or not depending on the regulatory setting. Without commitment, the distribution of households over interest rates, credit limits and wealth matches observed patterns. We study the new regulatory rules in the U.S.credit card market which require a stronger commitment from banks not to raise interest rates discretionally. This results in tighter limits but lower interest rates, reduced indebtedness and lower default.

Overall it was a good food for thought and a much needed intellectual refreshment!

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Factor shares in India’s National Income

The business cycle properties of data in the US says that consumption is much less volatile than the GDP. This suggests that households do engage into consumption smoothing and hence looking at consumption distribution is not a good gauge for what is happening to income distribution. A similar argument can also be made for India and hence the debate on effects of liberalization policies would do better if based on income distribution than just on consumption distribution. C.P. Chandrashekhar and Jayati Ghosh make this point quite well in their recent column in The Hindu Business Line.

According to their analysis the share of wages and salaries in the national income of India has shown a decline since 1991. This decline is evident both as a share of total NDP as well as of Organized sector NDP. It was roughly around 70% for a decade preceding the economic reforms and has declined since to 50% in the year 2009. This might seem surprising given that in the US (and probably most of the developed world ) the share of compensation of employees in national income has remained between 60-70% for last 50 years or so.

The authors suggest this as an evidence for rising income inequality after the economic reforms and I don’t necessarily disagree with that interpretation.This issue is certainly important to look into and might suggests a role for policy intervention.

However, the contrast with the US suggests that there might be some other factors at play causing the shares to settle at different values in both these countries. One reason for this contrast is that the factor shares could reflect the relative factor scarcity. Capital being relatively scarce in developing countries compared to the developed ones, higher overall returns for it might be expected. The other reason might be the declining importance and presence of unions in the Indian organized sector after reforms than before. If one admits that most of the growth of the organized sector has been because of the rising service sector, then this does makes sense. In addition, the continuing rigidity of labor laws might also mean a lower opportunity cost for ones time further reducing the bargaining power of the workers.

Overall, these empirical regularities and differences in factor shares across countries are definitely worth investigating more.

Update- January 24, 2014: The recent issue of QJE has a paper on this issue. Looks like declining labor share is not just an Indian phenomenon. The authors surmise that the relative decline in price of investment goods explains this trend. You can read it here.

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Modeling the economist modeling the economy!

Saint-Paul Gilles of Toulouse School in Paris is one of those economists whom, you cannot afford not to read. If he writes it, you read it period. He has come up with a very interesting paper on the political economy of macroeconomic thinking- again a must read! you can find it here.

A few months back, I came across an interesting presentation by him titled “Endogenous Indoctrination“. He uses interesting techniques to see how indoctrination can evolve in a society and influence voter attitudes where teachers have a certain attitude towards the market system.

Enjoy!

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Networks and Macroeconomics

No other field challenges your beliefs like macroeconomics. It will just not allow you to rest unless you decide to give up and fall into the trap of what Ricardo Cabellaro calls ‘the pretense of knowledge’. In a very convincingly argued case against the pitfalls of reading too much into the precision and addictiveness of the Dynamic Stochastic General Equilibrium Modelling framework, he introduces us to some interesting, alternative ways of looking at the macroeconomy.

These models try to capture the nature of economic complexity that is easily eschewed by the DSGE framework in favor of precision and neat quantitative results. According to Caballero, “ the nodes of such economic models are special for they contain agents with frontal lobes who can both strategize and panic”. Networks are important and such agents introduce much of unpredictability in the linkages.

Do agents always understand the complete networks and linkages? Apparently not. In fact  “the importance of this lack of understanding is at its most extreme level during financial crises when seemingly irrelevant and distant linkages are perceived to be relevant”.  Novelty and uncertainty play an important role in determining the size of reaction as well.

He also introduces us to literature that deals with developing a policy framework which is robust to small mistakes from the policy maker. Hansen and Sargent’s extremely readable “Robustness” is an important contribution to this literature.

I don’t really have the expertise to comment on what this means for the fate of the whole DSGE world and whether grad students can get away with not learning it. However, I am definitely convinced that the research cited by Cabellaro certainly offers a fresh perspective of linking individual behavior to macro behavior. Randomly browsing the net for his cited references, I came across a course on networks offered by Daron Acemoglu of MIT. The introduction in his course syllabus is worth reproducing here:

Networks are ubiquitous in our modern society. The World Wide Web that links us to and enables information flows with the rest of the world is the most visible example. But it is only one of many networks within which we are situated. Our social life is organized around networks of friends and colleagues. These networks determine our information, influence our opinions, and shape our political attitudes. They also link us, often through important but weak ties, to everybody else in the United States and in the world. Economic and financial markets also look much more like networks than anonymous marketplaces. Firms interact with the same suppliers and customers and use web-like supply chains. Financial linkages, both among banks and between consumers, companies and banks, also form a network over which funds flow and risks are shared. Systemic risk in financial markets often results from the counterparty risks created within this financial network. Food chains, interacting biological systems and the spread and containment of epidemics are some of the other natural and social phenomena that exhibit a marked networked structure.

So, while working on the dissertation, when I was just starting to think that I finally might have made it at least somewhat near the frontier, here comes a group of very intelligent economists pushing it even further!

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