Abstract: This paper analyses the optimal saving behaviour of a risk-averse and prudent consumer who faces two sources of income risk: risk as described by a given probability distribution and risk in the distribution itself. The latter is captured by the randomness in the parameters underlying the probability distribution and is referred to as distributional risk. Stochastic volatility, which generally refers to the randomness in the variance, can be viewed as a form of distributional risk. Necessary and sufficient conditions by which an increase in distributional risk will induce the consumer to save more are derived under two specifications of preferences: expected utility preferences and Selden/Kreps-Porteus preferences. The connection (or lack of) between these conditions and stochastic volatility is addressed. The additional conditions under which a prudent consumer will save more under greater volatility risk are identified.
Abstract: Is a more heterogeneous population conducive or detrimental to capital accumulation and economic growth? This paper addresses this question using a dynamic general equilibrium model with ex ante heterogeneous consumers and progressive taxation. We show that the answer depends crucially on the shape of the marginal tax function. If this function is concave, then a more heterogeneous population will have a lower average marginal tax rate and a higher level of capital accumulation. The opposite is true when the marginal tax function is convex. These results are robust in a variety of models with either exogenous or endogenous economic growth.
Abstract: This paper examines quantitatively the effects of R&D subsidy and government-financed basic research on U.S. economic growth and consumer welfare. To achieve this, we develop an endogenous growth model which takes into account both public and private research investment, and the differences between basic and non-basic research. A calibrated version of the model is able to replicate some important features of the U.S. economy over the period 1953-2009. Our model suggests that government spending on basic research is an effective policy instrument to promote economic growth. Subsidizing private R&D, on the other hand, has no effect on economic growth.
Abstract: This paper examines the theoretical foundations of precautionary saving behavior in a canonical life-cycle model where consumers face uninsurable idiosyncratic labor income risk and borrowing constraints. We begin by characterizing the consumption function of individual consumers. We show that the consumption function is concave when the utility function has strictly positive third derivative and the inverse of absolute prudence is a concave function. These conditions encompass all HARA utility functions with strictly positive third derivative as special cases. We then show that when consumption function is concave, a mean-preserving increase in income risks would encourage wealth accumulation at both the individual and aggregate levels.
* This paper was previously circulated under the title "Concave Consumption Function under Borrowing Constraints."
Abstract: Since 1950, the U.S. has experienced a significant expansion in health care spending and longevity. In this paper, we quantify the importance of medical technology improvements and rising incomes in explaining these changes. To achieve this, we develop a dynamic general equilibrium model in which consumers face idiosyncratic uncertainty in health. Both health care spending and life expectancy are endogenously determined. According to our model, medical technology improvements and rising incomes can explain all of the increase in health care spending and more than 60% of the increase in life expectancy at age 25 in the United States between 1950 and 2001.
Abstract: This short paper examines the effects of asset bubbles in an overlapping generations model with endogenous labor supply. We derive a set of conditions under which asset bubbles will lead to an expansion in steady-state capital, investment, employment and output. We also provide a specific numerical example to illustrate these results.
Abstract: This paper examines the connection between time preference heterogeneity and economic inequality in a deterministic environment. Specifically, we extend the standard neoclassical growth model to allow for (i) heterogeneity in consumers' discount rates, (ii) direct preferences for wealth, and (iii) human capital formation. The second feature prevents the wealth distribution from collapsing into a degenerate distribution. The third feature generates a strong positive correlation between earnings and capital income across consumers. A calibrated version of the model is able to generate patterns of wealth and income inequality that are very similar to those observed in the United States.
Abstract: Suburbanization in the U.S. between 1910 and 1970 was concurrent with the rapid diffusion of the automobile. A circular city model is developed in order to access quantitatively the contribution of automobiles and rising incomes to suburbanization. The model incorporates a number of driving forces of suburbanization and car adoption, including falling automobile prices, rising real incomes, changing costs of traveling by car and with public transportation, and urban population growth. According to the model, 60 percent of postwar (1940-1970) suburbanization can be explained by these factors. Rising real incomes and falling automobile prices are shown to be the key drivers of suburbanization.
*This paper was previously circulated with the title “Suburbanization and the Automobile.”
Abstract: The Rouwenhorst method of approximating stationary AR(1) processes has been overlooked by much of the literature despite having many desirable properties unmatched by other methods. In particular, we prove that it can match the conditional and unconditional mean and variance, and the first-order autocorrelation of any stationary AR(1) process. These properties make the Rouwenhorst method more reliable than others in approximating highly persistent processes and generating accurate model solutions. To illustrate this, we compare the performances of the Rouwenhorst method and four others in solving the stochastic growth model and an income fluctuation problem. We find that (i) the choice of approximation method can have a large impact on the computed model solutions, and (ii) the Rouwenhorst method is more robust than others with respect to variation in the persistence of the process, the number of points used in the discrete approximation and the procedure used to generate model statistics.