Economic Dynamics Newsletter
Volume 3, Issue 1 (November 2001)
The EconomicDynamics Newsletter is a free supplement to the Review of Economic Dynamics (RED). It is published twice a year in April and November.
In this issue
José-Víctor Ríos-Rull on the Determinants of Inequality
I want to take advantage of this opportunity that the EconomicDynamics Newsletter provides me to discuss some questions that interest me, and some tools that we are developing in addressing those questions.A good part of my research has dealt with the determinants of inequality. A large dose of the effort in public policy is aimed to redistribute resources among persons, and this can only be done effectively if we understand what is it that makes people different in the first place. In this respect, we (Castañeda, Díaz-Gimenez and Ríos-Rull (2000)) have estimated a model with temporary (but autocorrelated) shocks to earnings capabilities that generates a distribution of labor earnings and wealth as well as a set of macromagnitudes and a tax system that is similar to that of the U.S. In this model all agents share the same preferences and they differ in age, wealth and in the realization of the earnings shock. The model essentially estimates the properties of a stochastic process for earnings opportunities. This process has built in some life cycle features and some potential for intergenerational transmission of earnings. Our findings state that most of the differences in earnings potential are already there at the beginning of adulthood. Specifically, our estimates decompose the population into four types according to the realization of the shock. In the beginning of adulthood, the differences in the present value of earnings among these four types are large. If the majority of the population is normalized to one, the other three groups show present values for earnings that are 1.63, 4.66 and a whopping 74.93 (this latter group is very small in size) times bigger. Moreover, these characteristics persist over generations. Households at retirement have expected values for their progenie of 1.00, 2.47, 27.92 and 46.56 respectively.
With very different methods, Keane and Wolpin (1997) points to the fact that differences in the fate of people are determined very early in life. Essentially they find that, utility-wise, cross sectional differences are accounted for mostly (90%) by features already present in agents by age 16 rather than in the actual shocks that the agents receive after age 16. Knowles (2001) argues that the explicit consideration of fertility choice and its associated implication of a negative relation between fertility and parental education, changes the implications of models where agents smooth consumption by holding assets when facing uninsurable shocks. In particular, wealth dispersion is greatly increased.
These findings point out something quite important that most differences in economic performance do not occur in the strict realm of the labor market. On the contrary, they have occurred by the time people enter the labor market.
Inspired by these findings, part of my research is now devoted to the understanding of how the family shapes the economic performance of individuals and of their progenie. This requires the construction of models that explicitly take into account that households and individuals are very different entities (going against the old tradition in economics that treats households as the basic economic unit). These models owe a lot to the work of Gary Becker who brought the family to the realm of economics.
These structures have still to be embedded in models of the macroeconomy that display aggregate characteristics that can be mapped back to aggregate data in order to discipline the research. The discipline comes partly due to the quantitative restrictions imposed by macroeconomic aggregates, and partly from the general equilibrium restrictions that the model imposes (things like the number of males of type x married to females of type y, is equal to the number of type y females married to type x males). The key paper in bringing the family to macroeconomics is Aiyagari, Greenwood and Guner (2000).
The basic structure of aggregate models with families
Let me summarily describe how these models operate. Agents differ typically in age, sex, and other economically relevant characteristics such as education or skill. Agents, upon becoming adults, bump into each other and choose whether to form a household, and/or, in the case of females choose whether to try to have a child. Their decisions depend on who they bump into, their general characteristics (age, marital status, education, skills) and perhaps something that is not shared by others, a personal assessment, love in one word. The decisions depend not only on who they bump, but also on what else is out there, this is on what agents expect to happen in the future. Forming a household provides some advantages beyond the pure joy of being together: there are increasing returns to consumption, opportunities to share income risks, and to take advantage of division of labor between home and market activities, as well as the possibility of jointly raise children over whom they have altruist feelings. Besides the decisions of the agents regarding family formation, there are typically some form of consumption/savings decision either in the form of financial assets or in the form of educational investment in the children.
Other questions that are currently addressed
There are some recent social changes that we are addressing that require models with explicit household formation. They include the actual decrease in married couples that has occurred in the U.S. in the last 25 years and that can be accounted for by the increase of both absolute and relative female wages (Regalia and Ríos-Rull 2001). A similar issue that is currently under study is the formidable increase in female (and not so much male) college attendance that has occurred in the last 25 years. To understand it we have to start understanding why it was that men used to go more to college than women. This is not so clear. In recent work (Ríos-Rull and Sanchez 2001) we found that it is not because of parental preference or of cheaper costs of attendance for males, rather it seems that by attending college males acquire a lot more than just higher wages, they became better parents (in the sense that they are more able to educate their children). A student of mine, Nishiyama (2002) tackles some properties of the wealth distribution and of precautionary savings using models where parents and children coexist and where the parents altruistic feelings generate both bequests and inter-vivos transfers. In this way he can measure to what extend parents have altruistic feelings over their children (note that the two workhorses in macroeconomics the infinitely lived dynastic model and the overlapping generations model assume either that parents care about their children as much as they care about themselves or not at all). He finds that parents care about their children about half as about themselves. In another work (Cubeddu and Ríos-Rull 1998) we explore how divorce operates in pretty much the same way as an uninsurable earnings shock, and a very large one at that. Another student of mine, (Bethencourt 2002) is exploring the changes in living arrangements between adult households and there elderly mothers.
Other questions that I would like to address
The interrelation of quantitatively theoretical economic models (models with explicit utility maximization and with the equilibrium requirement of compatibility between agents decisions that can be explicitly solved and compared with data) with demographics is likely to go forward and be used to address more issues. Central among them is, I think, the issue of differential mortality. Life expectancy differs a lot among groups of people, for example, women live more than men (a feature that could perhaps be imputed to better engineering). But more interesting to economists is that married men, and educated men live longer that their single and uneducated counterparts. To understand why is very important: imagine it is that education or income is it that allows people to access better care, or at least to be informed about healthier life styles, then perhaps well intentioned governments may want to subsidize education or health care or even redistribute income in order to increase life expectancy. If, however, the characteristics that makes people be educated and have high income also make them live longer (such as a higher valuation of the future) then the ability of governments to affect life expectancy is much more limited and redistributive policies and policies that subsidize education and health care lose a lot of their appeal.
New technical challenges that have appeared
Models of the family present numerous challenges that have to be addressed. I will now discuss some of those challenges.First and foremost, the household does not have preferences, the individuals do. Somehow, we have to aggregate from the individuals to the household in order to attain an operational decision rule. One way to do this is to formulate the problem in a such a way that both adult household members agree over the allocations of resources. This is not always easy since they may have different time horizons or because the household may break up. Another way to deal with this is to find the allocation that solves a weighted average of the utilities or even (better) to assume a bargaining process between the household members that yield a specific allocations.
Second, the use of models with families brings to the forefront of quantitative economic theory a set of functional forms and parameters that are new and that cannot be clearly related to other work that we do. Things like the human capital acquisition and evolution, the characteristics of affection between people, the mapping between intent and success of having children and so on and so forth. The old way of mapping models to data in macroeconomics by mere parameter picking shows its shortcomings very clearly now. Therefore, calibrating models with families can only be done as part of an explicit estimation process (something that is also behind other work in macroeconomics, although perhaps not so clearly). An obvious way of calibrating these models is then by specifying a list of statistics that the model has to match, and choosing the parameters that do that in the best possible way. This process is also known as exactly identified method of moments, and it is certainly not the only way to do it, but it has the very nice implication of cleanly separating what the model is restricted to do and what the model can tell us. Using a more general version of GMM estimators has the disadvantage that there is a lack of clear separation between what the model can be used for and what is imposed in the model.
Third, related to the previous point, there is now a new set of statistics that can be used as calibration targets, or more generally, to compare model and data. Of course, we still use the same aggregate statistics that allow us to relate to the whole economy and that impose a tremendous amount of discipline such as consumption to output ratio, wealth to output ratio and others. Understanding inequality implies understanding the cross-sectional distribution of wages, hours worked, consumption, education and wealth. But now, these statistics can be looked at in a new light. The data for those variables is collected sometimes at household level and sometimes at person level. Models that explicitly incorporate families allow us to look simultaneously at the joint distribution of all those statistics. This is particularly important because hours and wages of spouses are now part of the information set of the same household.
The role of new computational tools
In the discussion of the last few paragraphs, I have emphasized the calibration process as a formal process of restricting the model by imposing that some of its statistics have certain desired values (typically their data counterparts). Implementing this is only possible if we are able to compute the equilibrium of the models that we use and its statistics very cheaply. Until very recently, computing the equilibrium of a simple economy was a feat. Now the complications arise from two different angles: we want to compute equilibria of complicated economies (economies with many agents that differ in various dimensions) and we want to compute equilibria many times so we can choose the right parameterizations.We all know that there have been enormous improvements in hardware and some in software to do the required calculations. Recently, the power of supercomputers has started to trickle down to the average economist in the form of parallel processing via cheap Beowulf clusters. Here at Penn we just have acquired two of these clusters with a total of 15 processors that we expect will allow us to improve our ability to deal with increasingly more sophisticated models and more stringent estimation procedures. Ellen McGrattan in the Minneapolis Fed was the first one to have one of these machines, and her generous support to help others learn has made their use a lot easier. Parallel processing is particularly appropriate for problems that are intensive in things like value function iteration (and other iterative methods to solve dynamic programming problems), that is, problems where calculations need not be simultaneous. This is exactly the type of problem that is pervasive in quantitative economic theory.
Bethencourt, C. 2002.
Castañeda, A. & Díaz-Gimenez, J. & Ríos-Rull, J.-V. 2000. “Accounting for Earnings and Wealth Inequality“. University of Pennsylvania, mimeo.
Cubeddu, L., and Ríos-Rull, J.-V. 1997. “Marital risk and capital accumulation“, Federal Reserve Bank of Minneapolis Staff Report 235.
Keane, M. P., and Wolpin, K. I. 1997. “The Career Decisions of Young Men“, Journal of Political Economy, 105, 473-522.
Knowles, J. 1999. “Can Parental Decisions Explain U.S. Income Ineqality?“, University of Pennsylvania, mimeo.
Nishiyama, S. 2002. “Bequests, Inter Vivos Transfers, and Wealth Distribution,” Review of Economic Dynamics, vol. 5(4), pages 892-931
Regalia, F., and Ríos-Rull, J.-V. 2001. “What Accounts for the Increase in the Number of Single Households?“, University of Pennsylvania, mimeo.
Ríos-Rull, J.-V., and Sanchez-Marcos, V. 2002. “College Attainment of Women,” Review of Economic Dynamics, vol. 5(4), pages 965-998.
Q&A: Mehmet Yorukoglu on Economic Revolutions
- EconomicDynamics: In “Engines of Liberation”, you argue with Jeremy Greenwood and Ananth Seshadri that the increase in female labor market participation is due to the introduction of significant technology improvements in the household sector. Would you therefore say that the various movements fighting to liberate women were not a factor in their access to the labor market?
- Mehmet Yorukoglu: There is an underappreciated relationship between social norms and economic (usually technological) constraints. Individuals and societies may have tastes over social norms and they can certainly develop these tastes. Therefore, one must recognize that social norms have to be in the utility function but it is always subject to economic and technological constraints. Social ideals and movements are like seeds which need appropriate environment for their cultivation. This environment is usually determined by technology. To me, arguing that social norms solely determine social equilibrium is a bit like arguing that automobiles are invented because suddenly people developed a taste for faster travel.Take democracy for instance. That ideal was around at least since Ancient Greeks. The city-state of ancient Athens was a direct democracy between 500 BC and 320 BC. Although only around 15% of the population was eligible to vote, important public affairs were decided according to citizens’ votes. But democracy then was so time consuming and slow that voting about one issue usually took a day before thousands of people filling large amphitheaters voted. This of course proved to be a disadvantage for Athens when some fast decision were necessary for a vital issue. Some historians argue that this inability of Athens in fast action prepared its end. It took millenniums for a successful application of democracy to prevail. Social ideals usually remain as utopias until economics and technology favor their successful application. The same arguments can be made for prohibition of slavery, and other social changes.
In “Engines of Liberation”, we argue that before the technological improvements in the household sector, the economic environment was in an equilibrium where women specialized in household production and men specialized in market work. This specialization had social outcomes far beyond itself (allocation of power and decision making in the house and in the market). This equilibrium continued until technological improvements in the household sector freed up female labor allowing it to participate in the market production. Actually, there is some evidence that during that period public opinion about female work did not change significantly. For instance, after reviewing public opinion poll evidence, Oppenheimer (1970) concludes “it seems unlikely that we can attribute much of the enormous postwar increases in married women’s labor force participation to a change in attitudes about the propriety of their working.”
Therefore, I think although social movements definitely catalyzed the increase in female labor force participation, the engine that removed the bottleneck still resides on the technology side.
- ED: In “1974”, you argue with Jeremy Greenwood that the introduction of a new technology leads to a sudden increase in a stock prices, followed by higher growth rates. Are you still convinced by your model and story seeing the recent developments in stock prices, in particular for the IT sector?
- MY: In “1974”, IT revolution is modeled in the following way. Until the date of technological breakthrough the economy is assumed to be on a balanced growth path where individuals solve their problems assuming that the economy will be on this path forever. But suddenly, and unexpectedly, the technological breakthrough occurs creating a change in individuals’ expectations. They suddenly become aware of the technological breakthrough and they have perfect foresight about the future of the economy from then on. Therefore, at the date of breakthrough the stock value of firms jump up and converges to a higher balanced growth path. This setup of expectations is not realistic in at least two ways. First, in reality, both technological improvements and people’s understanding and expectations about these improvements change only gradually. Second, people do not have perfect foresight about the future of a new technology.Also diffusion of a new product can create cycles in economic activity and in the value of the firms producing the new product. In a study with Jeremy Greenwood titled “From Model T to Great Depression: Automobilization and Suburbanization of US”, we model the diffusion of automobiles and the suburbanization wave in US during the first part of the 20th century. After Henry Ford’s genius application of assembly lines to automobile production (Model T), the US experienced an era of fast diffusion of automobiles across households. By 1929, more than 30 million cars had already been produced, more than half of households in US had at least one car–a figure which would not increase much until the end of the WWII. We show that diffusion of new goods can create cycles in output and values of new good producing firms. The faster is the diffusion of the new good, the larger can be the cycles. Therefore, one can suspect that fast diffusion of IT related products can also lead to similar cycles in output and stock value. The automobile diffusion data also shows that the producers of a new product can make big expectational mistakes since forecasting future technological progress and demand for a new product is a hard task. The data shows that the large automobile producers like Ford and GM made very large investments just before the depression. Now, they couldn’t forecast the depression, no big deal, nobody did. But it seems like by the end 1929 demand for automobiles entered into a temporary saturation point separate from the depression itself. Because of the fast diffusion of cars, before the early adopters wanted to replace their cars, most of the households who were willing to buy one at a reasonable price already bought one. Similar expectational mistakes on the firms’ side are also possible for IT related new products.
Additionally, I think one important point which was not realized early on is that IT improvements increase consumer surplus more than they increase firms’ profits. With cheaper information available to consumers, competition among firms become fiercer, driving down profits. Increasing variety of products in the market, and increased customization of products to individual consumers improve their utility without benefiting firms’ bottom lines much.
- ED: One recurring result in your research is that faster growth leads to a more unequal distribution of income or assets. Yet, the literature is not so clear cut. What distinguishes your models form the rest in this respect?
- MY: In “1974”, faster technological progress increases income inequality because skilled individuals facilitate the adoption of the new technologies. When new technologies really bring breakthroughs, meaning that they are very different from the existing ones, there is much more to learn about them and the demand for skilled individuals and the premium that they enjoy increases. This argument is, in general, true for all technological breakthroughs. There is nothing specific to the nature of IT in it.However, I think the new economy, driven by IT, has strong inequality creating mechanisms far beyond what the technological breakthrough model presented in “1974” provides. The new economy is becoming more and more information based. One can categorize the goods in the market according to their information intensity. With information becoming cheaper, information intensity of the goods increase. One thing that is key for information is that once it is produced it can be reused at an insignificantly small marginal cost. This makes the markets for information intensive goods very concentrated with only few producers. This is a very strong inequality creating mechanism. As the goods get more information intensive, very productive top few producers capture the whole market. Asymptotically, as the good becomes totally an information good, a small difference in human capital (productivity) of producers creates an infinite amount of difference in their output. Broader implications of such an economy are studied in “The New Economy: Some Macroeconomic Implications of An Information Age” which is joint work with Thomas F. Cooley.
Greenwood, J., and Yorukoglu, M. 1997. “1974”, Carnegie-Rochester Conference Series on Public Policy, 46, 49-95.
Greenwood, J. and Yorukoglu, M. 2001. “From Model T to Great Depression: Automobilization and Suburbanization of US”, University of Rochester, mimeo.
Greenwood, J., Seshadri, A., and Yorukoglu, M. 2001. “Engines of Liberation“, University of Rochester, mimeo.
Oppenheimer, V. K. 1970. The Female Labor Force in the United States: Demographic and Economic Factors Governing its Growth and Changing Composition, Institute of International Studies, Berkeley.
Yorukoglu, M. 1998. “The Information Technology Productivity Paradox“, Review of Economic Dynamics, 2, 551-592.
It is once again time for my annual invitation to continue your support of the Society for Economic Dynamics by paying the annual membership dues, submitting your research and subscribing to the Review of Economic Dynamics, and participating in our annual conference. This year the Society has continued its extraordinary growth. Our membership is at an all-time high and participation in our annual conference set new records.
This past year our conference was held in Stockholm Sweden at the Stockholm School of Economics. It was a spectacular success. David Domeij and Martin Floden of the Stockholm School of Economics were the organizers and Ellen McGrattan was the program chair. It was our most successful conference yet in every dimension. The local arrangements, including the weather, were wonderful and the conference program was impressive.
The 2002 conference will be held on June 28-30th in New York City. The meetings will be held at the Stern School of Business at New York University. Our planning for this conference was set back by the tragic events of September 11th, but we are now well along and New York City is returning to normal and is as exciting as ever. You can look forward to an interesting conference and a fun stay in the city. June is a great time to visit New York. Narayana Kocherlakota of the University of Minnesota and Fabrizio Perri of New York University are organizing the program. The plenary speakers will be Orazio Attanasio, Lee Ohanian, and Wolfgang Pesendorfer. The call for papers is at http://www.minneapolisfed.org/sed/. Plan on participating – you won’t want to miss it.
This year for the first time the SED sponsored another small research conference jointly with the C.V. Starr Center at New York University. The topic of the conference was “Macroeconomic Perspectives on Families and Inequality.” It was organized jointly by Raquel Fernández, Jeremy Greenwood, and Víctor Ríos-Rull. We heard nine papers over one and a half days and these will appear in the spring of 2002 as a special issue of the Review of Economic Dynamics. The conference was so successful that we will have another next year at about the same time. Sydney Ludvigson, Ellen McGrattan, and John Heaton are organizing it. The call for papers is on the SED web site and enclosed with this newsletter.
Please join again in support of the Society for Economic Dynamics. Information about how to pay your 2002 dues and your subscription to RED are available on the SED website
I look forward to seeing you in June in New York.
Thomas F. Cooley, President
Society for Economic Dynamics
Society for Economic Dynamics: Call for Papers, 2002 Meetings
The 2002 meetings of the Society for Economic Dynamics will be held June 28-June 30, 2002, on the campus of New York University. The program co-chairs are Narayana Kocherlakota and Fabrizio Perri. The plenary speakers for the conference are Orazio Attanasio, Lee Ohanian, and Wolfgang Pesendorfer.
The Society for Economic Dynamics solicits applications in all areas of dynamic economics to be presented at this conference. Members and non-members are invited to participate. The deadline for submissions is February 1, 2002. Please use our standardized form available at http://www.minneapolisfed.org/sed/ to submit an abstract, and include the name, affiliation, address, and e-mail address of the author interested in presenting the paper. This form is required for all applicants. Submission of the paper is optional and should be done by submitting a URL via the standardized form or by mailing a hardcopy to: SED Conference, ATTN: Narayana Kocherlakota, Department of Economics, University of Minnesota, 1035 Heller Hall, 271 19th Avenue South, Minneapolis, MN 55455. Fax transmissions will not be considered.
1. Lucas and Kocherlakota join RED Editorial Board
Some notable changes are about to be made to the Editorial Board of the Review of Economic Dynamics. Robert E. Lucas, Jr. (University of Chicago, 1995 Nobel Laureate) has agreed to serve as an Editor and Narayana Kocherlakota (University of Minnesota) will serve as an Associate Editor. We are extremely pleased that these very distinguished economists will be joining us and helping us to insure that RED’s initial success will continue to be strengthened and expanded. David K. Levine (UCLA), who has served as an Editor since the journal was started, will be stepping down. Levine has been very important in helping to establish RED as high quality publication outlet. His work for RED has included co-editing the Special Issue on Dynamic Games that appeared in April 2000.
2. Web Based SED Membership and Journal Subscription Form
Academic Press has been preparing an interactive web site that we will be introducing shortly so that people can apply for 2002 membership in the Society for Economic Dynamics and to subscribe to RED. The price will be $88 and includes both SED membership and a one-year subscription to the Society’s journal. Links to this website will be provided on the Society’s website, as well on the registration pages for the 2002 SED Meetings in New York. Our hope is that this website will improve the efficiency and accuracy with which journal subscriptions for members of the Society are maintained.
3. 2002 will be a “Special” year
We have three special issues planned for 2002 (this is backlog, not steady state). The January issue (Vol. 5 No. 1), which is now available, is on Great Depressions of the Twentieth Century. Timothy J. Kehoe and Edward C. Prescott edited this issue. The 2002 Ely Lecture given by Ed Prescott at the ASSA Meetings in Atlanta was based substantially on material from this volume.
The April 2002 issue, edited by Boyan Jovanovic, will be on the “New Economy.” This issue will feature papers presented at a conference held this past November at the Federal Reserve Bank of New York on “Productivity Growth: A New Era?” as well as a selection of other related papers.
Finally, the July 2002 issue will be on “Macroeconomic Perspectives on Families and Inequality,” and will contain a selection of papers presented at a conference on this topic held at New York University last October. This conference is the first of an annual series of conferences to be sponsored by the Review of Economic Dynamics and the C.V. Starr Center at NYU. Jeremy Greenwood, Raquel Fernández and José-Víctor Ríos-Rull organized the conference and are editing the special issue of RED.
4. RED is Indexed
Effective with Volume 4, Number 1, the Review of Economic Dynamics has been selected for coverage in ISI (Institute for Scientific Information) indexing services. The journal is now indexed in the Social Sciences Citation Index, ISI Alerting Services, Current Contents/Social and Behavioral Sciences, as well as other ISI outlets and RePEc. Many people have asked us about this, so we are happy to report that RED’s inclusion in these services is now official.
Review of Economic Dynamics
Society for Economic Dynamics: Call for Papers, 2002 CV Starr/RED Conference on Finance and the Macroeconomy
On October 11-12, 2002, the C.V. Starr Center of New York University and the Society for Economic Dynamics will host the second annual CV Starr/RED conference. This year’s topic is on Finance and the Macroeconomy. A combination of invited and submitted papers will be chosen for the program. Selected papers will be considered for publication in a special issue of the Review of Economic Dynamics. The program will be devoted to state-of-the-art research in the nexus between finance and macroeconomics. Any high quality research in this area will be considered for inclusion on the program. Examples of suitable topics include but are not limited to:
- Heterogeneity: The impact of heterogeneity on asset prices. This could include but is not limited to investigations of differential financial market participation, the role of the wealth distribution in understanding savings and securities prices, the effects of preference heterogeneity, and the importance of human capital in understanding financial markets.
- Institutional and Demographic Developments: Investigations of institutional or demographic changes that affect aggregate real activity and financial markets. Examples include social security reform, pension reform, changes in regulations of asset markets, changes in demographic characteristics of the population, changes in taxation, and changes in the costs of transacting.
- Asset Pricing and the Macroeconomy: Empirical and theoretical investigations of the macroeconomic sources of systematic risk underlying asset returns, in both a cross-sectional and a time-series setting; macroeconomic explanations for conditional volatility and predictability of equity index returns; implications of time-varying discount rates for real macroeconomic variables.
Submissions will be reviewed by a selection committee consisting of John Heaton (University of Chicago), Sydney Ludvigson (New York University) and Ellen McGrattan (Federal Reserve Bank of Minneapolis). Papers received will be considered submissions to both the conference and the special issue. Papers selected for the conference will be refereed and must meet the high academic standards of the Review. As such, they are to constitute original and unique research that will not published in similar form elsewhere. The program committee will edit the special issue.
The deadline for submissions is April 8, 2002. Only authors of accepted papers will be notified. This will be done by April 30, 2002. Please email a PDF file for your paper–or a detailed proposal–to email@example.com.
Kotlikoff’s Essays on Saving, Bequests, Altruism, and Life-Cycle Planning
Laurence J. Kotlikoff is now well known for his work on intergenerational issues. 14 of his essays, 5 not previously published, on this general topic have been reunited in a book that offers the various facets of his work. Three fields are covered. First, 3 essays on savings and bequests documents that the life-cycle theory is capable of explaining the secular decline in the U.S. savings rate with the massive redistribution between generations introduced after WWII in which older people receive annuities that reduce incentives to save. This increased wealth inequality and reduced the wealth equalizing effect of unintentional bequests.
The next five essays tackle voluntary bequests. Kotlikoff and coauthors show that intergenerational altruism is largely absent from the data: the distribution of average within-cohort consumption changes depends on that of average within-cohort resource changes, the same applying within extended families, and families with transfers have only small and insignificant voluntary transfers compared to the forced ones. Barro’s Ricardian Equivalence then looses credence not only empirically, but theoretically as well as two essays show: strategic transfer behavior between parents and children are altered by exogenous redistribution, and asymmetric information prevents parents from enforcing efficient effort of their children.
The last 6 essays pertain to life-cycle planning, already the subject of a recent book by Kotlikoff. Here, some the new book present some older evidence that households do not optimize intertemporally, namely that consumption does not only depend on new information, household over-discount future earnings, both in experiments and in empirical data, households are largely financially illiterate and often poorly advised. Then a financial planning tool is introduced and used to show how people close to retirement are under-saving, except for low-income households who can rely on social security.
Any student of life-cycle behavior and savings should have this collection of essays on his/her bookshelf. It provides several challenges to current modelling of intertemporal household behavior that should keep researchers (and practitioners) busy for quite a while.
“Essays on Saving, Bequests, Altruism, and Life-Cycle Planning” is published at MIT Press.