Mini Course on ”Policy in Models with Heterogeneous Agents” Bank of Portugal, June 15-19, 2015 Professor Gianluca Violante • Lectures: Classes are held every day at 10:30-12:00 and 2:00-3:30. In the afternoon, the students are encouraged to review the material and do the assigned readings to keep up with the class pace which will be quite intense. • Goals: The primary goal of the course is for the student to learn how to develop heterogeneous agents models for quantitative policy analysis. The course will try to give an exhaustive overview of the literature, from classic contributions to state-of-the-art research in this area. While the main focus of the course is on fiscal policy, the last lecture will discuss frameworks amenable to the study of monetary policy as well. A parallel objective of the course is to equip students with the numerical and computational tools necessary to solve for the equilibrium of this class of models. • Prerequisites: Students are expected to have taken at least the first year of a graduate macroeconomics sequence. They should be familiar with the main economic insights present in dynamic representative-agent macroeconomic models, and they should know how to compute the equilibrium in these models with the use of local (e.g., linearization, linear-quadratic, or perturbation techniques) or, even better, global solution methods. • Background readings: To become familiar with the language of this class of models, before the course students are encouraged to read: 1. Gianluca Violante. Lecture notes on aggregation, the PIH, precautionary saving, and the income fluctuation problem. 2. Jonathan Heathcote, Kjetil Storesletten, and Gianluca Violante (2009). Quantitative Macroeconomics with Heterogeneous Households, Annual Review of Economics 3. Fatih Guvenen (2012). Macroeconomics with Heterogeneity: A Practical Guide, Richmond Fed Quarterly Review 4. Vincenzo Quadrini and Jose-Victor Rios-Rull (2014). Inequality in Macroeconomics, Handbook of Income Distribution, chapter 15.

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Course Outline Day 1: Introduction to the basic heterogeneous-agents incomplete markets model Part I: The Aiyagari model. Characterization of stationary equilibrium and comparative statics. Optimal quantity of government debt and optimal redistribution (pure steady-state comparison). Constrained efficiency in the Aiyagari model. Part II: Numerical methods to solve for the decision rules and the equilibrium invariant distribution.

Day 2: Transitional dynamics and life-cycle economies Part I: Transitional dynamics between steady states. Computational details and application to a tax reform. Welfare decomposition. Part II: Life-cycle economies. Optimal degree of progressivity of the tax code and optimal capital income taxation.

Day 3: Some more insights, and models with aggregate fluctuations Part I: An analytical framework to gain more intuition about the key economic trade-offs faced by a policymaker in this class of economies. Part II: Fiscal policy in heterogeneous agents model with aggregate shocks. Computation of equilibrium.

Day 4: Redistributive and macro effects of fiscal stimulus policies Part I: The effect of fiscal stimulus (especially targeted transfers) on the macroeconomy in the one-asset version of the model. Quantitative analysis of deviations from Ricardian neutrality. Part II: The two-asset version of the incomplete-markets model. The wealthy hand-to-mouth households and their significance for policy analysis

Day 5: Monetary policy Part I: Heterogeneous Agents New Keynesian (HANK) models Part II: Effects of conventional and unconventional monetary policy in this class of models 2

References Day 1 A IYAGARI , S. R.,

AND

E. R. M C G RATTAN (1998): “The optimum quantity of debt,” Journal of

Monetary Economics, 42(3), 447–469. C ARROLL , C. D., J. S LACALEK ,

AND

K. TOKUOKA (2014): “The Distribution of Wealth and the

Marginal Propensity to Consume,” ECB Mimeo. D AVILA , J., J. H. H ONG , P. K RUSELL ,

AND

J.-V. R´I OS -R ULL (2012): “Constrained efficiency in

the neoclassical growth model with uninsurable idiosyncratic shocks,” Econometrica, 80(6), 2431–2467. F LODEN , M.,

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J. L IND E´ (2001): “Idiosyncratic risk in the United States and Sweden: Is there

a role for government insurance?,” Review of Economic Dynamics, 4(2), 406–437. H UGGETT, M. (1993):

“The risk-free rate in heterogeneous-agent incomplete-insurance

economies,” Journal of Economic Dynamics and Control, 17(5), 953–969. R´I OS -R ULL , J.V. (1995): “Models with Heterogeneous Agents,” in Frontiers of Business Cycles Research, ed. by T. F. Cooley, pp. 98–125. Princeton University Press.

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References Day 2 C ONESA , J. C., S. K ITAO ,

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D. K RUEGER (2009): “Taxing Capital? Not a Bad Idea After All!,”

American Economic Review, 99(1), 25–48. C ONESA , J. C., AND D. K RUEGER (2006): “On the optimal progressivity of the income tax code,” Journal of Monetary Economics, 53(7), 1425–1450. D OMEIJ , D.,

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J. H EATHCOTE (2004): “On the distributional effects of reducing capital

taxes,” International Economic Review, 45(2), 523–554. F LODEN , M. (2001): “The effectiveness of government debt and transfers as insurance,” Journal of Monetary Economics, 48(1), 81–108. G OUVEIA , M.,

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R. P. S TRAUSS (1994): “Effective federal individual income tax functions:

An exploratory empirical analysis,” National Tax Journal, pp. 317–339. H UGGETT, M. (1996): “Wealth Distribution in Life-Cycle Economies,” Journal of Monetary Economics, 38(3), 469–494. K APLAN , G.,

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G. V IOLANTE (2010): “How Much Consumption Insurance Beyond Self-

Insurance?,” American Economic Journals: Macroeconomics, 2(4), 53–87. N ISHIYAMA , S., AND K. S METTERS (2013): “Analyzing Fiscal Policies in a Heterogeneous-Agent Overlapping-Generations Economy,” Handbook of Computational Economics, 3, 117.

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References Day 3 A LGAN , Y., O. A LLAIS , W. D EN H AAN ,

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P. R ENDAHL (2014): “Solving and simulating

models with heterogeneous agents and aggregate uncertainty,” Handbook of Computational Economics. C ARROLL , C. D., J. S LACALEK ,

AND

K. TOKUOKA (2014): “The Distribution of Wealth and the

Marginal Propensity to Consume,” ECB Mimeo. H EATHCOTE , J., K. S TORESLETTEN ,

AND

G. L. V IOLANTE (2014a): “Consumption and labor

supply with partial insurance: An analytical framework,” The American Economic Review, 104(7), 2075–2126. (2014b): “Optimal tax progressivity: An analytical framework,” Discussion paper, National Bureau of Economic Research. K RUEGER , D., K. M ITMAN ,

AND

F. P ERRI (2015): “Macroeconomics and Heterogeneity, Includ-

ing Inequality,” . K RUSELL , P.,

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A. S MITH (1997): “Income and Wealth Heterogeneity, Portfolio Choice, and

Equilibrium Asset Returns,” Macroeconomic Dynamics, 1(02), 387–422. (1998): “Income and Wealth Heterogeneity in the Macroeconomy,” Journal of Political Economy, 106(5), 867–896. K RUSELL , P.,

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A. A. S MITH (2006): “Quantitative Macroeconomic Models with Heteroge-

neous Agents,” Econometric Society Monographs, 41, 298.

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References Day 4 ¨ B AYER , C., R. L UTTICKE , L. P HAM -D AO ,

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V. T JADEN (2014): “Precautionary Savings, Illiq-

uid Assets, and the Aggregate Consequences of Shocks to Household Income Risk,” Mimeo, University of Bonn. B ILBIIE , F. O., T. M ONACELLI ,

AND

R. P EROTTI (2013): “Public debt and redistribution with

borrowing constraints,” The Economic Journal, 123(566), F64–F98. C AMPBELL , J. Y.,

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N. G. M ANKIW (1989): “Consumption, Income and Interest Rates: Rein-

terpreting the Time Series Evidence,” in NBER Macroeconomics Annual 1989, Volume 4, NBER Chapters, pp. 185–246. National Bureau of Economic Research, Inc. C OENEN , G., C. J. E RCEG , C. F REEDMAN , D. F URCERI , M. K UMHOF, R. L ALONDE , D. L AX TON ,

J. L IND E´ , A. M OUROUGANE , D. M UIR ,

ET AL .

(2010): “Effects of fiscal stimulus in

structural models,” Mimeo, Stanford University. ´ G AL´I , J., J. D. L OPEZ -S ALIDO ,

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J. VALL E´ S (2007): “Understanding the Effects of Govern-

ment Spending on Consumption,” Journal of the European Economic Association, 5(1), 227–270. G IAMBATTISTA , E.,

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S. P ENNINGS (2013): “When is the government transfer multiplier

large,” Unpublished manuscript, New York University. H EATHCOTE , J. (2005): “Fiscal policy with heterogeneous agents and incomplete markets,” The Review of Economic Studies, 72(1), 161–188. J OHNSON , D., J. PARKER ,

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N. S OULELES (2006): “Household Expenditure and the Income

Tax Rebates of 2001,” The American Economic Review, 96(5), 1589–1610. K APLAN , G.,

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G. V IOLANTE (2014a): “A Model of the Consumption Response to Fiscal

Stimulus Payments,” Econometrica, forthcoming. (2014b): “A Tale of Two Stimulus Payments: 2001 vs 2008,” American Economic Review (Papers and Proceedings), 104(5). K APLAN , G., G. V IOLANTE ,

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J. W EIDNER (2014): “The Wealthy Hand-to-Mouth,” Brookings

papers on economic activity, 1(4), 77–153.

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M ALAFRY, P. K.,

ET AL .

(2014): “Fiscal Multipliers in the 21st Century,” Discussion paper,

European University Institute (EUI), Robert Schuman Centre of Advanced Studies (RSCAS). M C K AY, A.,

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R. R EIS (2013): “The role of automatic stabilizers in the US business cycle,”

Discussion paper, National Bureau of Economic Research. M EHROTRA , N. R. (2014): “Fiscal Policy Stabilization: Purchases or Transfers?,” Available at SSRN 2482349. M ISRA , K.,

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P. S URICO (2013): “Consumption, Income Changes and Heterogeneity: Evi-

dence from Two Fiscal Stimulus Programmes,” (9530). N AVARRO , G.,

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A. F ERRIERE (2014): “The Heterogeneous Effects of Government Pur-

chases,” Mimeo NYU. O H , H.,

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R. R EIS (2012): “Targeted transfers and the fiscal response to the great recession,”

Journal of Monetary Economics, 59, S50–S64.

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References Day 5 A UCLERT, A. (2014): “Monetary Policy and the Redistribution Channel,” Discussion paper, MIT mimeo. C HALLE , E., J. M ATHERON , X. R AGOT,

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J. F. R UBIO -R AMIREZ (2015): “Precautionary Sav-

ing and Aggregate Demand,” Banque de France Working Paper. C OIBION , O., Y. G ORODNICHENKO , L. K UENG ,

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J. S ILVIA (2012): “Innocent bystanders?

Monetary policy and inequality in the US,” Discussion paper, NBER Working Paper. D OEPKE , M.,

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M. S CHNEIDER (2006): “Inflation and the redistribution of nominal wealth,”

Journal of Political Economy, 114(6), 1069–1097. E ROSA , A.,

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G. V ENTURA (2002): “On Inflation as a Regressive Consumption Tax,” Journal

of Monetary Economics, 49(4), 761–795. G ORNEMANN , N., K. K UESTER ,

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M. N AKAJIMA (2012): “Monetary Policy with Heteroge-

neous Agents,” Discussion paper, FRB of Philadelphia Working Paper. ˘ , A. (1992): “The welfare cost of inflation under imperfect insurance,” Journal of I˙ MROHORO GLU Economic Dynamics and Control, 16(1), 79–91. K APLAN , G., B. M OLL ,

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G. L. V IOLANTE (2015): “The Macroeconomy According to

HANK,” mimeo, NYU. M C K AY, A., E. N AKAMURA ,

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J. S TEINSSON (2014): “The Power of Forward Guidance Re-

visited,” Discussion paper, Columbia University, mimeo. M EH , C. A., J.-V. R´I OS -R ULL ,

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Y. T ERAJIMA (2010): “Aggregate and welfare effects of redis-

tribution of wealth under inflation and price-level targeting,” Journal of Monetary Economics, 57(6), 637–652.

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