Further Comments On The Apparent Limitations Of Olg Models

This article is a brusk response to the article Sam together with Janet become to College, yesteryear Professor Roger Farmer. The master copy impetus for that article was to response to comments I made earlier. I accept looked at the papers he suggested, together with I am all the same circling dorsum to roughly where I was before alongside regards to overlapping generations (OLG) models. I all the same accept non establish whatever OLG models which run across my fairly potent criteria for what constitutes a useful economical model for analysing financial policy. I explicate those criteria here, every bit I did non desire to spam his website alongside a yard news comment. Since the literature is huge, together with I do non accept access to an academic library, that does non hateful such models do non exist. I am but unaware of them. But they are for certain good hidden from the populace domain. Moreover, I accept my doubts nigh the analytical tractability of such models.


I desire to travel on my comments hither tightly focussed, every bit this could easily degenerate into a much wider combat nigh Dynamic Stochastic General Equilibrium (DGSE) models.

I seek to avoid the combat nigh "debt burdens"; the job is that a "debt burden" is non a real good defined concept. Instead, I volition precisely aspect at a to a greater extent than limited, yet interested problem: could an OLG model tell us anything useful nigh how the economic scheme volition evolve every bit the "baby boom" generation moves into retirement (under electrical current policy settings, or nether option settings)? If a model offering a description of this evolution, which is of crucial importance for financial dynamics, I am difficult pressed to consider how the model tin offering insights to fifty-fifty to a greater extent than abstract problems.

Professor Farmer helpfully lists around articles to read, also every bit around books. Since I currently accept a backlog of things to read, I alone looked at the articles. I accept read other DSGE textbooks, together with each 1 alone covers OLG models where households alive for 2 or iii periods. I explicate elsewhere why I turn down the usefulness of such models, alongside their real long fourth dimension increments.

Blanchard Paper

Olivier Blanchard's Debt, Deficits together with Infinite Horizons (1984) is described inwards that article as:

Olivier Blanchard, the inquiry managing director of the IMF, developed an elegant version of the OLG model inwards which people accept long lives, but they decease each menses alongside around probability.

I accept already sketched out a longer give-and-take of this paper. I would non depict this article every bit existence an OLG model, every bit all households are akin to J.R.R. Tolkien's elves: they do non decease of quondam age, but they tin decease for other reasons (accidents, orcs). Mathematically, all living households accept the same finite expected life span. Even alongside the improver of declining incomes, this does non stand upward for the longevity profile of a existent the world population; inwards exceptional the issues associated alongside the "baby boom" generation.

Since I am non interested inwards the fate of private model households, rather the aggregate economy, this model looks to me precisely similar the Ramsey models used yesteryear key banks, but alongside a modified consumption function. Once nosotros unopen the model alongside a key banking concern reaction function, it looks to me similar the final result of financial policy volition live the same every bit inwards the Ramsey model away from the null bound: nothing. This raises a lot of issues that are a distraction relative to the subject of this article.

This is an interesting paper, but I would live difficult pressed to consider why this model would live whatever easier to stand upward for to the demographic profile of the babe blast generation than the Ramsey model. But since I would non consider this a truthful OLG model, it does non contradict my before statements nigh them.

Kehoe together with Levine [1985]

I alone glanced at the paper Comparative Statics together with Perfect Foresight inwards Infinite Horizon Economies, by Timothy J. Kehoe together with David K. Levine (Econometrica, 1985). The OLG component of the newspaper had households that were alone inside the model for 2 periods. Whatever merits this newspaper has, it does non address my concerns nigh long fourth dimension increments.

Auerbach, Gokhale together with Kotlikoff

The newspaper Generational Accounts: Influenza A virus subtype H5N1 Meaningful Alternative to Deficit Accounting, by Auerbach, Gokhale together with Kotlikoff, develops a detailed breakdown of cyberspace spending over time, including unlike scenarios. Their objective is to demonstrate whether unlike generations are existence treated fairly relative to each other.

I volition non address their logic, other than to say that I discovery it highly questionable. I volition instead whether their piece of work constitutes an "economic model". I would characterise their piece of work every bit "an accounting framework", together with non a model. There is no assay to model variables such every bit inflation together with unemployment. These are critical for the decision of the financial balance, together with are subject upon financial policy choices.

In other word, the trajectory of the economic scheme is exogenous to the accounting framework. I imagine that this practise could live extended yesteryear "dynamic scoring", but without an actual model, how do nosotros do the "scoring"?

The CBO does this form of accounting framework, together with they were famously worried nigh the U.S. Treasury debt disappearing a few years back. This mightiness non accept happened if they used an actual economic scheme model which includes feedback effects betwixt unlike sectors.

More generally, I accept seen other OLG models alongside a fine-grained fourth dimension increment (for example, annual) applied to things similar retirement savings. These were closer to truthful economical models, alongside optimising households trading assets alongside each other. However, these models were alone able to imitate around component of the economic scheme (for example, financial markets), together with all of the interesting economical variables were largely exogenous.

Lacking a agency of calculating those exogenous variables agency that these accounting exercises are alone of express usefulness to policymakers. All they tin do is reproduce the effects of the exogenously determined variables, together with nosotros accept no way of determining whether those exogenous variables are internally consistent alongside policy settings. 

Concluding Remarks

Leaving aside the inquiry of whether the Blanchard model is an OLG model, I all the same accept non seen an OLG model framework that could live applied to the next problem.

• Time increments no longer than a year.
• Simulation of the historic menses profile together with longevity of the babe blast generation.
• Private together with populace pensions.
• Tax rates are laid yesteryear policy makers together with thus the financial residual is endogenous. 
• Unemployment together with inflation rates determined inside the model (although 1 mightiness assume inflation is ever at the inflation target).
• Capital stock determined inside the model.

Additionally, it would live prissy to handle:

• private sector financial assets;
• different savings profiles based on wealth cohort;
• external sector, including the final result of the large holdings of the U.S. financial assets yesteryear foreigners. 

This is plainly a fairly impressive wishing list. I dubiety that a model could teach a real accurate fit. But nosotros volition demand to capture these effects inwards lodge to at to the lowest degree sympathise what the trade-offs are for financial policy choices.

And this is non an impossible task, every bit long every bit nosotros drib the unusual insistence upon model-consistent rational expectations. A stock-flow consistent modelling framework could live adapted to this problem; all that needs to live done is to dis-aggregate the menage sector into annual cohorts. (As an aside, it's a projection which I am slow working on.)

(c) Brian Romanchuk 2015