Essays in macroeconomics

Abstract

This thesis studies three essays in macroeconomics. The first study evaluates the welfare effects of trade in a setting with risk averse workers and uncertainty in labour market outcomes. We provide conditions under which a small change in relative prices due to trade reduces welfare in both a static as well as a dynamic economy. Using a dynamic model we quantify the set of prices that result in a welfare loss following trade. We also examine the welfare implications of large price changes due to trade. For a realistic calibration, the gains from trade exist but are smaller than in a world with risk neutral individuals. The second study examines the labour market impacts of an extension of unemployment insurance policy. Unemployment insurance benefits are typically extended during recessions. Existing research shows that this policy increases the unemployment rate, the average duration of unemployment and the long term unemployment rate. But less is known about why these changes occur. I construct a job search model with an endogenous participation decision to quantify the contributions of (i) search effort (ii) job selectivity and (iii) labour market attachment to changes in unemployment outcomes. In a model calibrated to the US economy, I show that following a permanent extension of benefits for 10 weeks the unemployment rate increases by about 0.4 percentage points. I find that increased participation accounts for about 50% of the increase, while reduced search effort and increased selectivity each explain about 25% of the increase. This finding suggests that labour market participation is the most important margin in driving changes in the unemployment rate. In the third study, I examine the relationship between income inequality, sovereign borrowing and default decisions. To this end, I extend the traditional endogenous sovereign default framework proposed by Eaton and Gersovitz (1981) to allow for ex-ante income heterogeneity and a tax/transfer system for income redistribution across households. I show that an increase in income inequality increases incentives of a government to default. An increase in income inequality increases the need for income redistribution. A (utilitarian) government may find it optimal to default in order to transfer more resources to households for consumption. I show that, in equilibrium, in response to an increase in income inequality the government may issue less debt. In turn, the incentives to default decreases. In a simulated economy, I show that for a small increase in income inequality of about 5% relative to the equilibrium, these two forces offset each other and the probability of default remains unchanged. I find that, in a model with no income inequality, the impact of an increased debt dominates and the probability of default increases.