This paper tests the optimality of consumption decisions at the aggregate level, taking into account popular deviations from the canonical constant-relative-risk-aversion (CRRA) utility function model—rule of thumb and habit. First, we provide extensive empirical evidence of the inappropriateness of linearization and testing strategies using Euler equations for consumption—a drawback for standard rule-of-thumb tests. Second, we propose a novel approach to testing for consumption optimality in this context: nonlinear estimation coupled with return aggregation, where rule-of-thumb behavior and habit are special cases of an all-encompassing model. We estimated 48 Euler equations using GMM. At the 5% level, we only rejected optimality twice out of 48 times. Moreover, out of 24 regressions, we found the rule-of-thumb parameter to be statistically significant only twice. Hence, lack of optimality in consumption decisions represent the exception, not the rule. Finally, we found the habit parameter to be statistically significant on four occasions out of 24.

Financial crises lead to substantial declines in output and consumption in emerging markets. The fact that fiscal policy is procyclical in these countries shows that the effects of a crisis are exacerbated by spending cuts and tax increases, which are usually attributed to borrowing constraints they face in bad times. This paper quantitatively analyzes the costs of reduced borrowing during crises by studying the effects of expansionary fiscal policies that would have been possible to implement, had the government been able to borrow more. The model shows that a 25% reduction of taxes on labor income, capital income, and consumption during the 1997 Korean crisis would have required an additional borrowing of 4.10% of GDP, while increasing output and consumption by 5.23 and 5.92 percentage points, respectively. When the effects of each tax rate are analyzed separately, labor tax reduction turns out to be more effective than the other policies.

Coefficient drivers are observable variables that feed into time-varying coefficients (TVCs) and explain at least part of their movement. To implement the TVC approach, the drivers are split into two subsets, one of which is correlated with the bias-free coefficient that we want to estimate and the other with the misspecification in the model. This split, however, can appear to be arbitrary. We provide a way of splitting the drivers that takes account of any nonlinearity that may be present in the data, with the aim of removing the arbitrary element in driver selection. We also provide an example of the practical use of our method by applying it to modeling the effect of ratings on sovereign-bond spreads.

This paper investigates, in the case of the euro area, the standard assumption that the liquidity trap steady state, which arises from the existence of the zero lower bound on the nominal interest rate, is locally unstable. We show that the policy function of the European Central Bank (ECB) is described by a nonlinear Taylor rule. Then, using our estimations, we show that around the liquidity trap steady state the equilibrium is locally determinate for most plausible parameter values. Finally, we find that an inflation shock is more efficient than a demand shock to escape the liquidity trap steady state.

This paper focuses on the macroeconomic and wealth effects of unconventional monetary policy. To this end, we estimate a Bayesian structural vector autoregression (B-SVAR) using U.S. monthly data for the post-Lehman Brothers' collapse period. We show that a positive shock to the growth rate of central bank reserves does not have a substantial impact on industrial production or consumer prices. However, it also gives a strong boost to asset prices, which is larger in magnitude for stock prices than for housing prices. Thus, unconventional monetary policy typically operates via portfolio-rebalancing effects. A VAR counterfactual exercise confirms the role of the shocks to the growth rate of central bank reserves in explaining the dynamics of the variables included in the system, especially in the case of asset prices. Finally, additional empirical assessments uncover an important change in the conduct of monetary policy from “standard” to “exceptional” times and the suitability of our model to capture such a structural transformation.

Replacing the pay-as-you-go defined benefit (PAYG DB) system with an at least partially funded defined contribution (DC) system generates fiscal costs that need financing. The fiscal closures at hand differ by the channel and the extent of distortions. The main contribution of this paper is a thorough comparison of the welfare effects of the various fiscal closures of the pension system reform. In addition, we decompose the welfare effects to the parts attributable to changing the way pensions are financed (PAYG ⇒ prefunding) and to changing the way pensions are computed (DB ⇒ DC). We show that depending on the fiscal closure, the welfare effects differ substantially for the same pension system reform. The financing of the the pension system gap with public debt allows more intergenerational redistribution.