Policy Analysis With Large Scale OLG Models

Paper Session

Saturday, Jan. 7, 2017 10:15 AM – 12:15 PM

Hyatt Regency Chicago, Soldier Field
Hosted By: Society for Computational Economics
  • Chair: Edward C. Prescott, Arizona State University

Learning to Believe in Simple Equilibria in a Complex OLG Economy - Evidence from the Lab

Jasmina Arifovic
,
Simon Fraser University
Cars Hommes
,
University of Amsterdam and Tinbergen Institute
Isabelle Salle
,
University of Amsterdam and Tinbergen Institute

Abstract

We set up a laboratory experiment within the overlapping-generations model of Grandmont (1985). Under perfect foresight, this model displays infinitely many equilibria, a steady state, periodic, as well as chaotic equilibria. Moreover, “anything goes” in the sense that for any of these equilibria there exists some learning theory predicting convergence to that equilibrium. We use experimental evidence as an equilibrium selection device in this complex OLG economy, and investigate on which outcomes subjects most likely coordinate. We use two alternative experimental designs: learning-to-forecast, in which subjects predict the future price of the good, and learning-to-optimize, in which subjects make savings decision. We find that coordination on a steady state or 2-cycle are the only outcomes in this complex environment. In the learning-to-forecast design, coordination on a 2-cycle occurs frequently, even in the chaotic parameter range. This is the first experiment where coordination on a 2-cycle by a group of individuals has been observed. Simulations of a heuristic switching model, where agents switch between different forecasting rules based upon their relative success, provide a behavioral explanation of these experimental results. Initially subjects coordinate on a simple AR (1), through sample autocorrelation (SAC-)learning, and subsequently coordination on a simple second-order adaptive rule arises once the up-and-down pattern of prices has been recognized and coordination locks in onto a 2-cycle.

Valuing Government Obligations When Markets are Incomplete

Jasmina Hasanhodzic
,
Babson College
Laurence J. Kotlikoff
,
Boston University

Abstract

Valuing future government spending commitments and tax receipts, whether they are sure or risky, is critical to assessing the sustainability of fiscal policy. If markets were complete it would be an easy matter to determine if the present value of projected spending exceeded the present value of projected receipts. But such markets don’t exist for numerous reasons including the inability of the living to trade with the unborn. The approach taken here posits and simulates a ten-period overlapping generations model and uses it to determine the immediate payments—the compensating variations—agents would require to forego promised government future net payments. “Agents” include future generations who are assumed to discount their utility while alive for the number of years it will take for them to be born. Our metric for pricing the compensating variations is agents’ expected utility functions. The sum total of compensating differentials represents a risk-adjusted fiscal gap—the present value of what the government has promised to pay current and future generations in transfer payments net of what it has promised to take from them in taxes. We find that the appropriate fiscal discount rates to be applied to promises of sure future payments depend on the agent’s age (which, as indicated, can be negative) and the state of the economy. They also depend on the size of the payments and whether the promises incorporate the general equilibrium effects of the promised payments. For infinitesimal payments, which have no general equilibrium feedback effects, the discount rates are, surprisingly, remarkably close to the economy’s prevailing safe short-term rate of return. This finding provides some support for standard government practice of discounting firmly promised future benefits and taxes, such as those associated with the U.S. Social Security system, at a fixed rate.

Housing, Saving and Global Imbalances

Luis Franjo Garcia
,
Swiss Federal Institute of Technology-Lausanne
Luisa Lambertini
,
Swiss Federal Institute of Technology-Lausanne
Serhiy Stepanchuk
,
Swiss Federal Institute of Technology-Lausanne

Abstract

In the two decades leading to the Great Recession, the United States experienced current account deficits and rising house prices while Japan, one of its major trading partner, experienced surpluses and falling house prices. During the same time period China, also a major trading partner of the United States, had large current account surpluses together with rapid house price growth. We develop a two-country life-cycle model in which each economy is populated by agents living for three periods (young, middle-aged, and old); young households need to borrow to buy houses but can do so up to a maximum Loan-to-Value (LTV) ratio. We allow for asymmetries across countries in terms of productivity growth and the tightness of the borrowing constraint. We calibrate the model to the United States and China and show that temporarily higher productivity in China and financial integration replicate the pattern of current account balances and growth of house prices observed by the two economies. Likewise, a temporary productivity slowdown in Japan leads to surpluses and falling house prices in Japan and deficits and rising house prices in the United States. Growth differentials among trading partners are key to the relationship between the interest rate, the current account, house prices and the real exchange rate. Moreover, we find that house prices act as an amplification mechanism behind global imbalances.

An Aggregate Model for Policy Analysis with Demographic Change

Ellen McGratten
,
University of Minnesota
Edward C. Prescott
,
Arizona State University

Abstract

Many countries are facing challenging fiscal financing issues as their populations age and the number of workers per retiree fall. Policymakers need transparent and robust analyses of alternative policies to deal with the demographic changes. In this paper, we propose a simple framework that can be matched easily to aggregate data from the national accounts. We demonstrate the usefulness of our framework by comparing quantitative results for our aggregate model to those of a related model that includes more micro details such as within age-cohort heterogeneity. When we assess proposals to switch from the current tax and transfer system in the United States to a mandatory saving-for-retirement system with no payroll taxation, we find that the aggregate predictions for the two models are close.

The Long-Term Implications of Aging Population in the Macroeconomy

Seung Lee
,
University of California-Santa Cruz
Lilia Maliar
,
Stanford University
Serguei Maliar
,
Santa Clara University

Abstract

The life expectancy in the US economy experienced a dramatic increase from about 65 to nearly 80 years over the last three decades. As the economy ages, more and more resources need to be allocated to a growing segment of population that is not productive. This puts the US social security system at risk of bankruptcy and raises important social, political and economic concerns. In the paper, we produce careful forecasts about the long-term consequences of aging population for the US economy. First, we document evidence on aging population using the US economy household data and construct projections. Second, we develop and calibrate a general equilibrium overlapping generation (OLG) model to reproduce the key demographic and economic trends in the aggregate US economy data. Finally, we explore how several policy recommendations in demand (such as an increase in the retirement age, a decrease in the social security benefits etc.) can affect consumption, savings and labor decisions of different age cohort, as well as the macroeconomy as a whole.
Discussant(s)
Luisa Lambertini
,
Swiss Federal Institute of Technology-Lausanne
Viktor Tsyrennikov
,
International Monetary Fund
Richard W. Evans
,
University of Chicago
Serguei Maliar
,
Santa Clara University
Laurence J. Kotlikoff
,
Boston University
JEL Classifications
  • C6 - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling
  • E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook