Gary D. Hansen

The Role of Unemployment Insurance in an Economy with Liquidity Constraints and Moral Hazard

The potential welfare benefits of unemployment insurance, along with the optimal replacement ratio, are studied using a quantitative dynamic general equilibrium model. To provide a role for unemployment insurance, agents in our economy face exogenous idiosyncratic employment shocks and are unable to borrow or insure themselves through private markets. In the absence of moral hazard, replacement ratios as high as .65 are optimal and the welfare benefits of unemployment insurance are quite large. However, if there is moral hazard and the replacement ratio is not set optimally, but is instead set to an empirically plausible value, the economy can be much worse off than it would be without unemployment insurance.

Tax distortions in a neoclassical monetary economy

In this paper we use the common perspective provided by the neoclassical growth model to evaluate the size of the distortions associated with different monetary and fiscal policies designed to finance a given sequence of government expenditures. We construct an artificial monetary economy incorporating the cash-in-advance framework of Lucas and Stokey (1983), calibrate it to match important features of the U.S. economy, and simulate it to provide a quantitative assessment of the welfare costs associated with government policies involving different combinations of taxes on capital and labor income, consumption, and holdings of money. In particular, we evaluate the welfare gains from tax reforms that are designed to replace taxes on capital or labor income with other forms of taxation. Our results suggest that the welfare costs of financing a given sequence of government expenditures are slightly lower in economies that substitute inflation or consumption taxes for the tax on labor income, but dramatically lower for economies that substitute any of these taxes for the tax on capital income. Replacing the capital tax with a consumption tax, for example, eliminates 81 percent of the welfare cost arising from distorting taxation. In addition, we show that these welfare costs can be reduced further by eliminating the capital tax with a nonstationary policy that involves a transition to a temporary policy followed by a new steady state policy rather than an immediate change to a new steady state policy.

Technical progress and aggregate fluctuations

Abstract We compare the cyclical fluctuations exhibited by a stochastic growth model under various stochastic processes governing technical change, all of which are highly autocorrelated. The results obtained are quite sensitive to the precise form of this stochastic process. In particular, the results depend on whether growth is deterministic or stochastic and, in each case, are quite sensitive to the persistence of an innovation. The model does a relatively poor job of accounting for features of observed business cycles when technical change is difference-stationary and does a better job when technical change is trend-stationary but highly autocorrelated.

Equilibrium business cycles with idle resources and variable capacity utilization

SummaryA real business cycle economy is studied in which some capital is idle each period and the fraction of capital left idle varies in response to technology shocks. Previous equilibrium business cycle models have the characteristic that the entire stock of capital is used for production in each period. Our objective is to determine whether incorporating idle resources, something regularly observed in actual economies, significantly affects the cyclical properties of the model and hence changes our views about the importance of technology shocks for aggregate fluctuations. In our analysis we do not assume an aggregate production function, but instead model production as taking place at individual plants that are subject to idiosyncratic technology shocks. Each period the plant manager must choose whether to operate the plant or to let the plant remain idle. We find that the cyclical properties of this model are surprisingly similar to those of a standard real business cycle economy. One difference is that the model displays variation in factor shares while the standard models does not.

The Role of Monetary Shocks in Equilibrium Business Cycle Theory: Three Examples

This paper analyzes three equilibrium business cycle models that differ according to the mechanism through which monetary growth shocks affect the economy. These include models with inflation tax effects [as in Cooley and Hansen (1989, 1995)], with staggered nominal wage contracts [as in Cho and Cooley (1995)], and with unanticipated inflation effects [as in Lucas (1975) and Cooley and Hansen (1997)]. We review the most important monetary features of business cycles in post-war U.S. data and compare these with the same features of the artificial economies. Our goal is to identify characteristics of the business cycle that each mechanism helps to explain, the features that remain puzzling, and to describe how the form of the mechanism matters.

Unanticipated Money Growth and the Business Cycle Reconsidered

The role of unanticipated changes in money growth for aggregate fluctuations is reexamined using the methods of quantitative equilibrium business cycle theory. A stochastic growth model with money is constructed in which production and trade take place in spatially separated markets (islands). Following Robert E. Lucas (1972, 1975), individuals only observe prices in their own local market, causing them to confuse changes in the average price level with changes in market specific relative prices. The authors show that this mechanism can lead to large fluctuations in real economic activity. Some aspects of the statistical properties of these fluctuations, however, differ significantly from those describing U.S. business cycles. Copyright 1997 by Ohio State University Press.

Health insurance reform: The impact of a Medicare buy-in

The steady-state general equilibrium and welfare consequences of a Medicare buy-in program, optional for those aged 55–64, is evaluated in a calibrated life-cycle economy with incomplete markets. Incomplete markets and adverse selection create a potential welfare improving role for health insurance reform. We find that adverse selection eliminates any market for a Medicare buy-in if it is offered as an unsubsidized option to individual private health insurance. The subsidy needed to bring the number of uninsured to less than 5 percent of the target population could be financed by an increase in the labor income tax rate of just 0.03–0.18 percent depending on how the program is implemented.