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Microeconomic Heterogeneity and Macroeconomic Shocks Greg Kaplan University of Chicago Gianluca Violante Princeton University BdF/ECB Conference on HFC In preparation for the Special Issue of JEP on “The State of Macroeconomics” G. Violante, ”Micro Heterogeneity and Macro Shocks” p. 1 /22

Microeconomic Heterogeneity and Macroeconomic Shocks · macroeconomics, in particular for quantitative study of economic fluctuations? 1. To what extent has heterogeneity been incorporated

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Page 1: Microeconomic Heterogeneity and Macroeconomic Shocks · macroeconomics, in particular for quantitative study of economic fluctuations? 1. To what extent has heterogeneity been incorporated

Microeconomic Heterogeneity

and Macroeconomic Shocks

Greg Kaplan

University of Chicago

Gianluca Violante

Princeton University

BdF/ECB Conference on HFC

In preparation for the Special Issue of JEP on “The State of Macroeconomics”

G. Violante, ”Micro Heterogeneity and Macro Shocks” p. 1 /22

Page 2: Microeconomic Heterogeneity and Macroeconomic Shocks · macroeconomics, in particular for quantitative study of economic fluctuations? 1. To what extent has heterogeneity been incorporated

Introduction

• Micro data reveal pervasive household heterogeneity in income,wealth and other dimensions, all salient for economic behavior

• Cross-sectional heterogeneity has changed the theory andpractice of applied microeconomics (Heckman, 2001)

G. Violante, ”Micro Heterogeneity and Macro Shocks” p. 2 /22

Page 3: Microeconomic Heterogeneity and Macroeconomic Shocks · macroeconomics, in particular for quantitative study of economic fluctuations? 1. To what extent has heterogeneity been incorporated

Introduction

• Micro data reveal pervasive household heterogeneity in income,wealth and other dimensions, all salient for economic behavior

• Cross-sectional heterogeneity has changed the theory andpractice of applied microeconomics (Heckman, 2001)

• But, is household heterogeneity equally relevant formacroeconomics, in particular for quantitative study of economicfluctuations?

G. Violante, ”Micro Heterogeneity and Macro Shocks” p. 2 /22

Page 4: Microeconomic Heterogeneity and Macroeconomic Shocks · macroeconomics, in particular for quantitative study of economic fluctuations? 1. To what extent has heterogeneity been incorporated

Introduction

• Micro data reveal pervasive household heterogeneity in income,wealth and other dimensions, all salient for economic behavior

• Cross-sectional heterogeneity has changed the theory andpractice of applied microeconomics (Heckman, 2001)

• But, is household heterogeneity equally relevant formacroeconomics, in particular for quantitative study of economicfluctuations?

1. To what extent has heterogeneity been incorporated intobusiness cycle models, so far?

2. What new insights are emerging from new class of models?

3. Looking ahead, what challenges are these models facing?

G. Violante, ”Micro Heterogeneity and Macro Shocks” p. 2 /22

Page 5: Microeconomic Heterogeneity and Macroeconomic Shocks · macroeconomics, in particular for quantitative study of economic fluctuations? 1. To what extent has heterogeneity been incorporated

Outline of the paper

1. Brief historical account of heterogeneity in macroeconomics

2.a New framework: Heterogeneous Agents + New Keynesian

2.b Role of household heterogeneity in the response of themacroeconomy to aggregate shocks: HANK vs RANK

• Metric to assess equivalence between models and exampleswith canonical shocks (demand, productivity, monetary)

• Fiscal stimulus differs greatly between two models

• Questions where heterogeneity is essential: (i) aggregateshocks that require a distribution; (ii) distributional implicationsof aggregate shocks

3. Shortcoming of current framework and new directions

G. Violante, ”Micro Heterogeneity and Macro Shocks” p. 3 /22

Page 6: Microeconomic Heterogeneity and Macroeconomic Shocks · macroeconomics, in particular for quantitative study of economic fluctuations? 1. To what extent has heterogeneity been incorporated

Modern Macroeconomics

• Common core: DSGE approach with microfoundations

• Two branches that advanced in parallel for past two decades

1. Cross-sectional macroeconomics

• Workhorse: Bewley model (HA + incomplete markets)

• Questions: inequality, economic mobility, tax reforms,redistribution, etc., but not business cycles

G. Violante, ”Micro Heterogeneity and Macro Shocks” p. 4 /22

Page 7: Microeconomic Heterogeneity and Macroeconomic Shocks · macroeconomics, in particular for quantitative study of economic fluctuations? 1. To what extent has heterogeneity been incorporated

Modern Macroeconomics

• Common core: DSGE approach with microfoundations

• Two branches that advanced in parallel for past two decades

1. Cross-sectional macroeconomics

• Workhorse: Bewley model (HA + incomplete markets)

• Questions: inequality, economic mobility, tax reforms,redistribution, etc., but not business cycles

• Why?

(a) Computational complexity: problem of the distribution as astate variable

(b) Quasi-aggregation has been (mistakenly) interpreted asequivalence with RA model

G. Violante, ”Micro Heterogeneity and Macro Shocks” p. 4 /22

Page 8: Microeconomic Heterogeneity and Macroeconomic Shocks · macroeconomics, in particular for quantitative study of economic fluctuations? 1. To what extent has heterogeneity been incorporated

Modern Macroeconomics

2. Business cycle analysis

• Workhorses: RBC and NK model (RA + complete markets)

• Questions: impulse and propagation mechanism —unable todeal with distributional issues, but never seen as a problem

G. Violante, ”Micro Heterogeneity and Macro Shocks” p. 5 /22

Page 9: Microeconomic Heterogeneity and Macroeconomic Shocks · macroeconomics, in particular for quantitative study of economic fluctuations? 1. To what extent has heterogeneity been incorporated

Modern Macroeconomics

2. Business cycle analysis

• Workhorses: RBC and NK model (RA + complete markets)

• Questions: impulse and propagation mechanism —unable todeal with distributional issues, but never seen as a problem

• Great Recession changed this perception

◮ Key elements: housing equity, credit, liquidity, portfoliocomposition, propensity to spend, labor market risk

◮ Issues one cannot even start debating in a RA model

G. Violante, ”Micro Heterogeneity and Macro Shocks” p. 5 /22

Page 10: Microeconomic Heterogeneity and Macroeconomic Shocks · macroeconomics, in particular for quantitative study of economic fluctuations? 1. To what extent has heterogeneity been incorporated

Modern Macroeconomics

2. Business cycle analysis

• Workhorses: RBC and NK model (RA + complete markets)

• Questions: impulse and propagation mechanism —unable todeal with distributional issues, but never seen as a problem

• Great Recession changed this perception

◮ Key elements: housing equity, credit, liquidity, portfoliocomposition, propensity to spend, labor market risk

◮ Issues one cannot even start debating in a RA model

◮ Importance of aggregate demand effects

G. Violante, ”Micro Heterogeneity and Macro Shocks” p. 5 /22

Page 11: Microeconomic Heterogeneity and Macroeconomic Shocks · macroeconomics, in particular for quantitative study of economic fluctuations? 1. To what extent has heterogeneity been incorporated

Modern Macroeconomics

2. Business cycle analysis

• Workhorses: RBC and NK model (RA + complete markets)

• Questions: impulse and propagation mechanism —unable todeal with distributional issues, but never seen as a problem

• Great Recession changed this perception

◮ Key elements: housing equity, credit, liquidity, portfoliocomposition, propensity to spend, labor market risk

◮ Issues one cannot even start debating in a RA model

◮ Importance of aggregate demand effects

⇒ Emergence of a new macro framework that combinesheterogeneous agents (HA) and New Keynesian (NK) models

G. Violante, ”Micro Heterogeneity and Macro Shocks” p. 5 /22

Page 12: Microeconomic Heterogeneity and Macroeconomic Shocks · macroeconomics, in particular for quantitative study of economic fluctuations? 1. To what extent has heterogeneity been incorporated

HANK Models

• In RANK, household has high sensitivity of C to interest rate(Euler Equation) and small MPC out of transitory income (PIH)

G. Violante, ”Micro Heterogeneity and Macro Shocks” p. 6 /22

Page 13: Microeconomic Heterogeneity and Macroeconomic Shocks · macroeconomics, in particular for quantitative study of economic fluctuations? 1. To what extent has heterogeneity been incorporated

HANK Models

• In RANK, household has high sensitivity of C to interest rate(Euler Equation) and small MPC out of transitory income (PIH)

• Both features are vastly at odds with micro evidence

1. Micro data reveal weak sensitivity of C to r

◮ ‘hand-to-mouth’ households (not on EE)

◮ offsetting income and precautionary effects on savers

G. Violante, ”Micro Heterogeneity and Macro Shocks” p. 6 /22

Page 14: Microeconomic Heterogeneity and Macroeconomic Shocks · macroeconomics, in particular for quantitative study of economic fluctuations? 1. To what extent has heterogeneity been incorporated

HANK Models

• In RANK, household has high sensitivity of C to interest rate(Euler Equation) and small MPC out of transitory income (PIH)

• Both features are vastly at odds with micro evidence

1. Micro data reveal weak sensitivity of C to r

◮ ‘hand-to-mouth’ households (not on EE)

◮ offsetting income and precautionary effects on savers

2. Micro data reveal strong MPC out of windfall income

◮ ‘hand-to-mouth’ households

◮ precautionary motive ⇒ concave consumption function

G. Violante, ”Micro Heterogeneity and Macro Shocks” p. 6 /22

Page 15: Microeconomic Heterogeneity and Macroeconomic Shocks · macroeconomics, in particular for quantitative study of economic fluctuations? 1. To what extent has heterogeneity been incorporated

HANK Models

• In RANK, household has high sensitivity of C to interest rate(Euler Equation) and small MPC out of transitory income (PIH)

• Both features are vastly at odds with micro evidence

1. Micro data reveal weak sensitivity of C to r

◮ ‘hand-to-mouth’ households (not on EE)

◮ offsetting income and precautionary effects on savers

2. Micro data reveal strong MPC out of windfall income

◮ ‘hand-to-mouth’ households

◮ precautionary motive ⇒ concave consumption function

• Why do we care? Different transmission mechanism of macroshocks and hence their effect on economy

G. Violante, ”Micro Heterogeneity and Macro Shocks” p. 6 /22

Page 16: Microeconomic Heterogeneity and Macroeconomic Shocks · macroeconomics, in particular for quantitative study of economic fluctuations? 1. To what extent has heterogeneity been incorporated

HANK as in Kaplan-Moll-Violante (2017)

• Continuum of households:

maxct,dt

E0

∫∞

0

e−ρt

[

log ct − φh1+1/ηt

1 + 1/η

]

dt

s.t.

bt = (1− τt)wtztht + rbt (bt)bt + Tt − dt − χ(dt, at)− ct

at = rat at + dt

bt ≥ −b, at ≥ 0

G. Violante, ”Micro Heterogeneity and Macro Shocks” p. 7 /22

Page 17: Microeconomic Heterogeneity and Macroeconomic Shocks · macroeconomics, in particular for quantitative study of economic fluctuations? 1. To what extent has heterogeneity been incorporated

HANK as in Kaplan-Moll-Violante (2017)

• Continuum of households:

maxct,dt

E0

∫∞

0

e−ρt

[

log ct − φh1+1/ηt

1 + 1/η

]

dt

s.t.

bt = (1− τt)wtztht + rbt (bt)bt + Tt − dt − χ(dt, at)− ct

at = rat at + dt

bt ≥ −b, at ≥ 0

• Production: monopolistic interm. goods + competitive final good

• Nominal rigidities: price adjustment cost (à la Rotemberg)

G. Violante, ”Micro Heterogeneity and Macro Shocks” p. 7 /22

Page 18: Microeconomic Heterogeneity and Macroeconomic Shocks · macroeconomics, in particular for quantitative study of economic fluctuations? 1. To what extent has heterogeneity been incorporated

HANK as in Kaplan-Moll-Violante (2017)

• Continuum of households:

maxct,dt

E0

∫∞

0

e−ρt

[

log ct − φh1+1/ηt

1 + 1/η

]

dt

s.t.

bt = (1− τt)wtztht + rbt (bt)bt + Tt − dt − χ(dt, at)− ct

at = rat at + dt

bt ≥ −b, at ≥ 0

• Production: monopolistic interm. goods + competitive final good

• Nominal rigidities: price adjustment cost (à la Rotemberg)

• Government: supplies liquid assets and follows Taylor rule

• Market clearing: goods, labor, liquid, and illiquid assets (K)

G. Violante, ”Micro Heterogeneity and Macro Shocks” p. 7 /22

Page 19: Microeconomic Heterogeneity and Macroeconomic Shocks · macroeconomics, in particular for quantitative study of economic fluctuations? 1. To what extent has heterogeneity been incorporated

HANK as in Kaplan-Moll-Violante (2017)

• Continuum of households:

maxct,dt

E0

∫∞

0

e−ρt

[

log ct − φh1+1/ηt

1 + 1/η

]

dt

s.t.

bt = (1− τt)wtztht + rbt (bt)bt + Tt − dt − χ(dt, at)− ct

at = rat at + dt

bt ≥ −b, at ≥ 0

• Production: monopolistic interm. goods + competitive final good

• Nominal rigidities: price adjustment cost (à la Rotemberg)

• Government: supplies liquid assets and follows Taylor rule

• Market clearing: goods, labor, liquid, and illiquid assets (K)

RANK: RA counterpart (same 2-asset structure)

G. Violante, ”Micro Heterogeneity and Macro Shocks” p. 7 /22

Page 20: Microeconomic Heterogeneity and Macroeconomic Shocks · macroeconomics, in particular for quantitative study of economic fluctuations? 1. To what extent has heterogeneity been incorporated

Model liquid and illiquid wealth distributions

• Top: very skewed wealth distribution

• Bottom: share of hand-to-mouth households as in the data (≈1/3)

G. Violante, ”Micro Heterogeneity and Macro Shocks” p. 8 /22

Page 21: Microeconomic Heterogeneity and Macroeconomic Shocks · macroeconomics, in particular for quantitative study of economic fluctuations? 1. To what extent has heterogeneity been incorporated

Model distribution of quarterly MPCs out of $500

0400

0.05

0.1

300 20

0.15

0.2

10200

0.25

0.3

0100-10

0

• RANK: 0.5% HANK-1: 5% HANK-2: 15% DATA: 20%

G. Violante, ”Micro Heterogeneity and Macro Shocks” p. 9 /22

Page 22: Microeconomic Heterogeneity and Macroeconomic Shocks · macroeconomics, in particular for quantitative study of economic fluctuations? 1. To what extent has heterogeneity been incorporated

HANK vs RANK

Equivalence of the two models wrt a specific aggregate shock

G. Violante, ”Micro Heterogeneity and Macro Shocks” p. 10 /22

Page 23: Microeconomic Heterogeneity and Macroeconomic Shocks · macroeconomics, in particular for quantitative study of economic fluctuations? 1. To what extent has heterogeneity been incorporated

HANK vs RANK

Equivalence of the two models wrt a specific aggregate shock

• Strong equivalence:

1. Same Impulse Response Function

2. Same transmission mechanism

3. Both discrepancies are zero:

CHA−CRA = CHA(pHA)− CHA(pRA)︸ ︷︷ ︸

GE component

+ CHA(pRA)− CRA(pRA)︸ ︷︷ ︸

PE component

4. Ricardian neutrality ‘holds’ also in HANK

G. Violante, ”Micro Heterogeneity and Macro Shocks” p. 10 /22

Page 24: Microeconomic Heterogeneity and Macroeconomic Shocks · macroeconomics, in particular for quantitative study of economic fluctuations? 1. To what extent has heterogeneity been incorporated

HANK vs RANK

Equivalence of the two models wrt a specific aggregate shock

• Strong equivalence:

1. Same Impulse Response Function

2. Same transmission mechanism

3. Both discrepancies are zero:

CHA−CRA = CHA(pHA)− CHA(pRA)︸ ︷︷ ︸

GE component

+ CHA(pRA)− CRA(pRA)︸ ︷︷ ︸

PE component

4. Ricardian neutrality ‘holds’ also in HANK

• Weak equivalence: (1) holds, but not others

• Non-equivalence: (1) does not hold

G. Violante, ”Micro Heterogeneity and Macro Shocks” p. 10 /22

Page 25: Microeconomic Heterogeneity and Macroeconomic Shocks · macroeconomics, in particular for quantitative study of economic fluctuations? 1. To what extent has heterogeneity been incorporated

Demand shock: strong equivalence

5 10 15 20-0.8

-0.6

-0.4

-0.2

0

0.2

5 10 15 20-0.8

-0.6

-0.4

-0.2

0

0.2

5 10 15 20-0.8

-0.6

-0.4

-0.2

0

0.2

5 10 15 20-0.4

-0.2

0

0.2

0.4

0.6

5 10 15 20-0.4

-0.2

0

0.2

0.4

0.6

5 10 15 20-0.8

-0.6

-0.4

-0.2

0

0.2

G. Violante, ”Micro Heterogeneity and Macro Shocks” p. 11 /22

Page 26: Microeconomic Heterogeneity and Macroeconomic Shocks · macroeconomics, in particular for quantitative study of economic fluctuations? 1. To what extent has heterogeneity been incorporated

TFP shock: weak equivalence

5 10 15 20

-0.8

-0.6

-0.4

-0.2

0

5 10 15 20

-0.8

-0.6

-0.4

-0.2

0

5 10 15 20

-0.8

-0.6

-0.4

-0.2

0

5 10 15 20-0.4

-0.2

0

0.2

0.4

0.6

5 10 15 20-0.4

-0.2

0

0.2

0.4

0.6

5 10 15 20

-0.8

-0.6

-0.4

-0.2

0

G. Violante, ”Micro Heterogeneity and Macro Shocks” p. 12 /22

Page 27: Microeconomic Heterogeneity and Macroeconomic Shocks · macroeconomics, in particular for quantitative study of economic fluctuations? 1. To what extent has heterogeneity been incorporated

Monetary shock: non equivalence

5 10 15 20

-0.8

-0.6

-0.4

-0.2

0

5 10 15 20

-0.8

-0.6

-0.4

-0.2

0

5 10 15 20

-0.8

-0.6

-0.4

-0.2

0

5 10 15 20-0.4

-0.2

0

0.2

0.4

0.6

5 10 15 20-0.4

-0.2

0

0.2

0.4

0.6

5 10 15 20

-0.8

-0.6

-0.4

-0.2

0

G. Violante, ”Micro Heterogeneity and Macro Shocks” p. 13 /22

Page 28: Microeconomic Heterogeneity and Macroeconomic Shocks · macroeconomics, in particular for quantitative study of economic fluctuations? 1. To what extent has heterogeneity been incorporated

Fiscal stimulus

Fiscal stimulus differs greatly between HANK and RANK

1. Expansion of G expenditures

• Larger output multiplier (weaker crowding out) in HANK

2. Expansion of lump-sum transfers

• Positive effects in HANK (zero in RANK due to RicardianNeutrality)

• Nonlinearities and sign-asymmetries

G. Violante, ”Micro Heterogeneity and Macro Shocks” p. 14 /22

Page 29: Microeconomic Heterogeneity and Macroeconomic Shocks · macroeconomics, in particular for quantitative study of economic fluctuations? 1. To what extent has heterogeneity been incorporated

Fiscal stimulus: G

5 10 15 20

0

0.2

0.4

0.6

0.8

1

5 10 15 20-0.3

-0.2

-0.1

0

0.1

0.2

5 10 15 20-0.3

-0.2

-0.1

0

0.1

0.2

5 10 15 20-0.3

-0.2

-0.1

0

0.1

0.2

• Weaker crowding out in HANK due to strong GE effects fromhigher labor demand

G. Violante, ”Micro Heterogeneity and Macro Shocks” p. 15 /22

Page 30: Microeconomic Heterogeneity and Macroeconomic Shocks · macroeconomics, in particular for quantitative study of economic fluctuations? 1. To what extent has heterogeneity been incorporated

Fiscal stimulus: Transfer

5 10 15 204.5

5

5.5

6

6.5

7

7.5

8

8.5

5 10 15 20-0.6

-0.4

-0.2

0

0.2

0.4

0.6

0.8

5 10 15 20-0.6

-0.4

-0.2

0

0.2

0.4

0.6

0.8

5 10 15 20-0.6

-0.4

-0.2

0

0.2

0.4

0.6

0.8

• Stronger stimulus with sticky prices: rb has to rise less to inducehouseholds to buy govt. bonds, as rise in labor income is stronger

G. Violante, ”Micro Heterogeneity and Macro Shocks” p. 16 /22

Page 31: Microeconomic Heterogeneity and Macroeconomic Shocks · macroeconomics, in particular for quantitative study of economic fluctuations? 1. To what extent has heterogeneity been incorporated

Transfers: nonlinearities and asymmetries

-2 -1 0 1 2 3 4 5-5

0

5

10

15

20

25

30

35

• Response falls with size of T and is stronger for negative transfers

• GE amplifies T stimulus, until inflationary effects (↑ rb) dominate

G. Violante, ”Micro Heterogeneity and Macro Shocks” p. 17 /22

Page 32: Microeconomic Heterogeneity and Macroeconomic Shocks · macroeconomics, in particular for quantitative study of economic fluctuations? 1. To what extent has heterogeneity been incorporated

Questions that require heterogeneity

1. Microfoundation for demand/preference shock in RANK

• Shock to credit limits (e.g., Guerrieri-Lorenzoni)

• Rise in uninsurable risk (e.g., Den Haan-Rendahl-Riegler)

2. Transmission mechanism of shock across distribution

• Useful to compare model with micro data

3. Distributional implications of aggregate shocks

• Welfare consequences across households

G. Violante, ”Micro Heterogeneity and Macro Shocks” p. 18 /22

Page 33: Microeconomic Heterogeneity and Macroeconomic Shocks · macroeconomics, in particular for quantitative study of economic fluctuations? 1. To what extent has heterogeneity been incorporated

Microfoundation for negative demand shock in RANK

Consumption rb and i

TIGHTER CREDIT LIMITS

5 10 15 20-0.5

0

0.5

5 10 15 20-0.5

0

0.5

1

1.5

2

HIGHER UNINSURABLE RISK

5 10 15 20-0.5

0

0.5

5 10 15 20-2

-1.5

-1

-0.5

0

0.5

1

1.5

2

G. Violante, ”Micro Heterogeneity and Macro Shocks” p. 19 /22

Page 34: Microeconomic Heterogeneity and Macroeconomic Shocks · macroeconomics, in particular for quantitative study of economic fluctuations? 1. To what extent has heterogeneity been incorporated

Transmission mechanism across the distribution

Demand shock Monetary shock

-20 0 20 40 60 80 100 120 1400

0.01

0.02

0.03

0.04

0.05

0.06

0.07

0.08

0.09

0.1

-20 0 20 40 60 80 100 120 140-0.2

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

-20 0 20 40 60 80 100 120 1400

0.01

0.02

0.03

0.04

0.05

0.06

0.07

0.08

0.09

0.1

-20 0 20 40 60 80 100 120 140-0.2

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

• Demand shock: uniform across distribution (all direct effect)

• Monetary shock: indirect effects for HtM, direct for others

G. Violante, ”Micro Heterogeneity and Macro Shocks” p. 20 /22

Page 35: Microeconomic Heterogeneity and Macroeconomic Shocks · macroeconomics, in particular for quantitative study of economic fluctuations? 1. To what extent has heterogeneity been incorporated

Distributional implications of negative monetary shock

2 4 6 8 10 12 14 16 18 20-0.7

-0.6

-0.5

-0.4

-0.3

-0.2

-0.1

0

0.1

Devia

tion (

%)

• Rich households: positive direct income effect (higher rb)

• Poor households: negative indirect effect (lower w)

• Consistent with Coibion et al. (2015): ↑ rb ⇒↑ Gini, but tiny effect

G. Violante, ”Micro Heterogeneity and Macro Shocks” p. 21 /22

Page 36: Microeconomic Heterogeneity and Macroeconomic Shocks · macroeconomics, in particular for quantitative study of economic fluctuations? 1. To what extent has heterogeneity been incorporated

Looking ahead

Some directions where HANK models should be extended:

1. Gross and nominal asset positions: Fischer effect

2. Labor market frictions: endogenize cost-push shocks with OJS

3. Alternative sources of AD effects: search in product markets

4. Time-varying risk premia: asset price dynamics

5. Financial sector: link between bank balance sheets and credit

6. Optimal stabilization policy: redistribution implications

G. Violante, ”Micro Heterogeneity and Macro Shocks” p. 22 /22