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Macro-economic Implications of Incomplete Markets

Paper Session

Saturday, Jan. 6, 2018 8:00 AM - 10:00 AM

Pennsylvania Convention Center, 201-A
Hosted By: American Economic Association
  • Chair: Ivan Werning, Massachusetts Institute of Technology

Housing Wealth Effects: The Long View

Emi Nakamura
,
Columbia University
Jon Steinsson
,
Columbia University
Alisdair McKay
,
Boston University
Adam Guren
,
Boston University

Abstract

We provide new, time-varying estimates of the housing wealth effect back to the 1980s. We exploit systematic differential city-level exposure to regional house price cycles to construct our estimates. Our main findings are that: 1) Large housing wealth effects are not new: we estimate large effects back to the 1980s; 2) There is no evidence that housing wealth effects were particularly large in the 2000s; if anything, they are larger prior to 2000; and 3) We find no evidence of a boom-bust asymmetry that might arise from households hitting their borrowing constraints. We compare these findings with the implications of a “new canonical model'' of housing wealth effects. This model yields large housing wealth effects. It can also explain why housing wealth effects have not risen over time despite the “great leveraging” of households since the 1980s and, in particular, the sharp increase in leverage associated with the 2006-2009 housing bust.

Incompleteness Schocks

Eduardo Davila
,
New York University
Thomas Philippon
,
New York University

Abstract

This paper studies the effects of shocks to the degree of market completeness. We present a dynamic stochastic economy where agents can trade in complete markets in normal times, but where financial markets can randomly become incomplete. When this happens, agents cannot trade in state contingent assets and cannot re-hedge their risks. Our model formalizes a new type of purely financial shock, which we call an incompleteness shock. Even if we allow our agents to hedge the incompleteness shock itself, we find that these shocks are sufficient to trigger a recession with misallocation of capital, lower aggregate output and consumption.

Unconventional Monetary Policy in HANK

Gianluca Violante
,
Princeton University
Greg Warren Kaplan
,
University of Chicago
Benjamin Moll
,
Princeton University

Abstract

We analyze the effectiveness of forward guidance in HANK. We show that, in contrast to representative-agent economies, the announcement of a future interest rate cut in our baseline economy has a smaller impact on current consumption than an equal-size contemporaneous cut. We explain the role of hand-to-mouth households and fiscal policy in accounting for this finding. In the second part, we study the transmission of a conventional monetary policy shock in an economy where household liquidity is provided by the private sector rather than by the government. Like in our baseline economy, it is also true that indirect general equilibrium effects dominate the direct intertemporal substitution channel for stimulating consumption: lowering the nominal interest rate reduces the cost of funds for firms and induces an investment boom that, in turn, triggers a rise in aggregate labor demand.

Price Theory for Incomplete Markets

Ivan Werning
,
Massachusetts Institute of Technology

Abstract

Demand theory provides restrictions and predictions for behavior, stemming from rational consumers operating within classical Walrasian Price Theory settings. Well-known results such as Slutksy symmetry, homogeneity, budget exhaustion have been usefully invoked to derive results, limit free parameters, or impose or test the restrictions implied by rationality. However, outside classical settings, these results do not necessarily hold. A popular class of models features Walrasian static markets, linked over time by imperfectly and incomplete asset markets, including borrowing constraints and lack of insurance. The goal of this paper is to flesh out the behavioral predictions and restrictions in such settings.
Discussant(s)
Stijn Van Nieuwerburgh
,
New York University
Urban Jerman
,
University of Pennsylvania
David López-Salido
,
Federal Reserve Board
Hanno Lustig
,
Stanford University
JEL Classifications
  • E2 - Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy
  • E4 - Money and Interest Rates