6. Heterogeneity and Redistribution¶
In this chapter, we take baby steps to start thinking about fiscal and monetary policy (again) from the point of view of a model environment with agent heterogeneity. We’ll use the famous overlapping generations (OLG) model. In contrast to our earlier studies of more “reduced-form” Keynesian theories of macroeconomic policy, now the economic insights are more profound as we can relate equilibrium outcomes to underlying taste, technology and policy features of the model environment. As a consequence our policy conclusions are more nuanced.
The OLG model is a natural metaphor for an economy where agents may behave differently as a function of their heterogeneous types. It is also a useful simple prototype to help us think about the problem of missing (i.e., incomplete) markets, whereby government policy intervention may have a welfare-improving and redistributive role to play.
In this course, we only focus on the dimension of heterogeneity that is age. The purpose of our study here is not to immediately have models that have empirical and quantitative policy impact.
To get there, one has to banish that impatience and the lust for instant gratification. Instead, one must be long suffering and slowly appreciate the art of model building and scientific analysis along the way to being able to work with or develop fully-fledged quantitative theory models.
The simple models here will allow us to draw some qualitative and more nuanced insights into whether particular fiscal policies help restore economic efficiency, and if so, how they might do so. (More complex and computational versions of such models are used in academia and policy to not only think about age-dependent policies, but also wealth- and health-dependent tax/transfer schemes.)
Also, we’ll use a version of the framework to also think about why money exists. In our monetary OLG setting, the lessons are somewhat more metaphorical, although the OLG model sets up the stage for later generations of deep monetary theory (a.k.a. New Monetarism) models that are more transparent about the connection between information/contractual frictions in the exchange process and the rise of money and/or other liquid financial assets. In many New Keynesian and the faddish behavioral/agent-based (or post-Keynesian) models, the underlying reasons for why governments should tax or control inflation, or regulate financial markets are often not precisely modelled. If they are, they are often modelled by free parameters. One ought to be very suspicious of economists who purvey policy salves for problems that they have not bothered to model and rationalize, but instead have conjured up from a free parameter.