CER-ETH Research Seminar, Fall Term 2009

Everyone who is interested is cordially invited!

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Speakers

Matti Liski: Energy demand change under uncertainty

We consider a model of capital replacement under uncertainty of conventional energy costs. Adjustment delays in the replacement of energy-intensive capital follow from two fundamentals in the problem: uncertainty and Ricardian rents of the existing capital structure. They imply a simple dichotomy, where short-run output contracts but the long-run output recovers and generally expands above the initial output, despite the increasing energy costs. To provide a quantitative assessment of the consumer price increase needed for the replacement, adjustment delays, and policies expediting the change, the model is calibrated using electricity market data. We find that a market-driven large scale entry of green energy requires unprecedented energy cost and consumer price increases mainly due to rents of the existing capital. Subsidies to green energy can greatly benefit the consumer side.

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Tony Venables: Absorbing a Windfall of Foreign Exchange

The short run response of an economy to a windfall of foreign exchange (be it aid or natural resource revenues) is often constrained by the absorptive capacity of the economy. We provide a micro-founded analysis of absorption constraints, based on the idea that expanding the economy's capital stock (in aggregate or sectorally) requires non-trade inputs, the supply of which is constrained by the initial capital stock. Given this constraint, the economy will manifest 'Dutch disease' symptoms, although many of them are temporary. On impact there is sharp appreciation of the real exchange rate, which will then depreciate back to its equilibrium level. In contrast to the permanent income hypothesis, real consumption jumps part of the way to its new long run level, and then continues to rise. The economy will run a current account surplus in early years as it 'parks' some of its windfall while absorption constraints are relaxing.

Pierre Lasserre: A Real Option Approach to the Protection of a Habitat Dependent Endangered Species

We use a real option approach to determine optimally when a social planner has to stop or resume logging in situations where an endangered species relies on forest habitat for its survival, and that habitat evolves stochastically. The model incorporates economic, ecological and social features, and is calibrated to generate an optimal forest management rule that balances the benefits from commercial forest exploitation with the risks of extinction facing the endangered species. For the reasonable parameters used in our application to the Rangifer tarandus caribou, an endangered species in Central Labrador (Canada), the policy of banning logging temporarily is quite attractive as it does not require long banning periods while it drastically reduces the extinction risk and increases forest value.

Hyun Shin: Illiquidity Component of Credit Risk (joint with Stephen Morris)

We describe and contrast three different measures of an institution's credit risk. "Insolvency risk" is the conditional probability of default due to deterioration of asset quality if there is no run by short term creditors. "Total credit risk" is the unconditional probability of default, either because of a (short term) creditor run or (long run) asset insolvency. "Illiquidity risk" is the difference between the two, i.e., the probability of a default due to a run when the institution would otherwise have been solvent. We discuss how the three kinds of risk vary with balance sheet composition. We provide a formula for illiquidity risk and show that it is (i) decreasing in the "liquidity ratio" - the ratio of realizable cash on the balance sheet to short term liabilities; (ii) increasing in the "outside option ratio" - a measure of the opportunity cost of the funds used to roll over short term liabilities; and (iii) increasing in the "fundamental risk ratio" - a measure of ex post variance of the asset portfolio.

Dirk Niepelt: Sovereign Debt-Maturity without Commitment

I analyze how lack of commitment affects the maturity structure of sovereign debt. Governments balance benefits of default induced redistribution and costs due to income losses in the wake of a default. Their choice of short versus long-term debt affects default and rollover decisions by subsequent policy makers. The equilibrium maturity structure is shaped by revenue losses on inframarginal units of debt that reflect the price impact of these decisions. The model predicts an interior maturity structure with positive gross positions and a shortening of the maturity structure when debt issuance is high, output low, or a cross default more likely. These predictions are consistent with empirical evidence.

Stefan Ambec: Fair intergenerational sharing of a natural resource

In this article, overlapping generations are extracting a natural resource over an infinite future. We examine the fair allocation of resource and compensations among generations. Fairness is defined by core lower bounds and aspiration upper bounds. The core lower bounds require that every coalition of generations obtains at least what it could achieve by itself. The aspiration upper bounds require that no coalition of generations enjoys a higher welfare than it would achieve if nobody else extracted the resource. We show that, upon existence, the allocation that satisfies the two fairness criteria is unique and assigns to each generation its marginal contribution to the preceding generation. Finally, we describe the dynamics of such an allocation.

Holger Strulik: Patience and Prosperity

This paper introduces wealth-dependent time preference into a simple model of endogenous growth. The model generates adjustment dynamics in line with the historical facts on savings and economic growth in Europe from the High Middle Ages to today. Along a virtuous cycle of development more wealth leads to more patience, which leads to more savings and even higher wealth. Savings rates and income growth rates are thus jointly increasing during the process of develop ment until they converge towards constants along a balanced growth path. During the transition to modern growth an economy in which the association of wealth and patience is stronger overtakes an otherwise identical economy and generates temporarily diverging growth rates. It is shown how wealth-dependent time preference can explain the existence of a locally stable poverty trap as well as the phenomenon of simultaneously falling interest rates and rising growth rates.