nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2012‒12‒15
fifteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. What inventories tell us about aggregate fluctuations -- a tractable approach to (S,s) policies By Yi Pengfei Wang; Wen; Zhiwei Xu
  2. Optimal Fiscal Policy and the Banking Sector By Matthew Schurin
  3. Sequential Monte Carlo sampling for DSGE models By Edward Herbst; Frank Schorfheide
  4. Understanding the distributional impact of long-run inflation By Gabriele Camera; YiLi Chien
  5. Business Cycle Implications of Internal Consumption Habit for New Keynesian Models By Kano, Takashi; Nason, James M.
  6. The performance of simple fiscal policy rules in monetary union By Lukas Vogel; Werner Roeger; Bernhard Herz
  7. Macroprudential policy: its effects and relationship to monetary policy By Hyunduk Suh
  8. Financial Intermediation and Costly Technology Adoption under Uncertainty: A Political Economy Perspective By Ziv Chinzara; Radhika Lahiri
  9. Credit risk and disaster Risk By Francois Gourio
  10. Matching models and housing markets: the role of the zero-profit condition By Gaetano Lisi
  11. Brain Drain and Development Traps By Jean-Pascal Bénassy; Elise S. Brézis
  12. Informal unemployment insurance and labor market dynamics By Kyle F. Herkenhoff
  13. Longevity, pollution and growth By Natacha Raffin; Thomas Seegmuller
  14. Efficient Bailouts? By Javier Bianchi
  15. Analyzing the Effects of Insuring Health Risks: On the Trade-off between Short Run Insurance Benefits vs. Long Run Incentive Costs By Harold L. Cole; Soojin Kim; Dirk Krueger

  1. By: Yi Pengfei Wang; Wen; Zhiwei Xu
    Abstract: We estimate a DSGE model with (S,s) inventory policies. We find that (i) taking inventories into account can significantly improve the empirical fit of DSGE models in matching the standard business-cycle moments (in addition to explaining inventory fluctuations); (ii) (S,s) inventory policies can significantly amplify aggregate output fluctuations, in contrast to the findings of the recent general-equilibrium inventory literature; and (iii) aggregate demand shocks become more important than technol- ogy shocks in explaining the business cycle once inventories are incorporated into the model. An independent contribution of our paper is that we develop a solution method for analytically solving (S,s) inventory policies in general-equilibrium models with het- erogeneous firms and a large aggregate state space, and we illustrate how standard log-linearization methods can be used to solve various versions of our inventory model, generate impulse response functions, and estimate the model’s deep structural para- meters.
    Keywords: Inventories
    Date: 2012
  2. By: Matthew Schurin (University of Connecticut)
    Abstract: What should the government’s fiscal policy be when banks hold significant amounts of public debt and the government can default on its debt obligations? This question is addressed using a dynamic general equilibrium model where banks face constraints on their leverage ratios and adjust lending to satisfy regulatory requirements. In response to adverse real shocks, the government subsidizes banks and accelerates bond repayments to sustain private sector lending. When government consumption exogenously increases, however, the government optimally taxes banks and partially defaults on its debt. Debt issuance is procyclical to ensure equilibrium in the deposit market. With an opening of the economy, the government uses less aggressive tax and default policies. JEL Classification: E32, E62, F41, H21, H63 Key words: Business Fluctuations, Debt, Fiscal Policy, Government Bonds, Ramsey Equilibrium, Optimal Taxation
    Date: 2012–11
  3. By: Edward Herbst; Frank Schorfheide
    Abstract: We develop a sequential Monte Carlo (SMC) algorithm for estimating Bayesian dynamic stochastic general equilibrium (DSGE) models, wherein a particle approximation to the posterior is built iteratively through tempering the likelihood. Using three examples consisting of an artificial state-space model, the Smets and Wouters (2007) model, and Schmitt-Grohe and Uribe's (2012) news shock model we show that the SMC algorithm is better suited for multi-modal and irregular posterior distributions than the widely-used random walk Metropolis-Hastings algorithm. Unlike standard Markov chain Monte Carlo (MCMC) techniques, the SMC algorithm is well suited for parallel computing.
    Keywords: Bayesian statistical decision theory
    Date: 2012
  4. By: Gabriele Camera; YiLi Chien
    Abstract: The impact of fully anticipated inflation is systematically studied in heterogeneous agent economies with an endogenous labor supply and portfolio choices. In stationary equilibrium, inflation nonlinearly alters the endogenous distributions of income, wealth, and consumption. Small departures from zero inflation have the strongest impact. Three features determine how inflation impacts distributions and welfare: financial structure, shock persistence, and labor supply elasticity. When agents can self-insure only with money, inflation reduces wealth inequality but may raise consumption inequality. Otherwise, inflation reduces consumption inequality but may raise wealth inequality. Given persistent shocks and an inelastic labor supply, inflation may raise average welfare.
    Keywords: Inflation (Finance)
    Date: 2012
  5. By: Kano, Takashi; Nason, James M.
    Abstract: We study the implications of internal consumption habit for new Keynesian dynamic stochastic general equilibrium (NKDSGE) models. Bayesian Monte Carlo methods are employed to evaluate NKDSGE model fit. Simulation experiments show that internal consumption habit often improves the ability of NKDSGE models to match the spectra of output and consumption growth. Nonetheless, the fit of NKDSGE models with internal consumption habit is susceptible to the sources of nominal rigidity, to spectra identified by permanent productivity shocks, to the choice of monetary policy rule, and to the frequencies used for evaluation. These vulnerabilities indicate that the specification of NKDSGE models is fragile.
    Keywords: Consumption Habit, New Keynesian, Propagation, Monetary Transmission, Posterior Predictive Analysis, Bayesian Monte Carlo
    JEL: E10 E20 E32
    Date: 2012–11
  6. By: Lukas Vogel; Werner Roeger; Bernhard Herz
    Abstract: The paper analyses the stabilising potential of simple fiscal policy rules for a small open economy in monetary union in a 2-region DSGE model with nominal and real rigidities. We consider simple fiscal instrument rules for government purchases, transfers, and consumption, labour and capital taxes in analogy to interest rate rules in monetary policy. The paper finds a dichotomy in the welfare effects of fiscal policy for liquidity-constrained and intertemporal optimising households, i.e. policies enhancing the welfare of one group tend to reduce the welfare of the other one. Moderate average welfare gains from optimal policy contrast with large losses from non-optimal policy. Fiscal rules that respond to employment fluctuations may be preferred to rules responding to indicators of price competitiveness, because optimal policy in the former corresponds more closely to the idea of countercyclical stabilisation. The paper also emphasises the strong impact of the budgetary closure rule on the welfare effects of business cycle stabilisation.
    JEL: E37 E62 F41
    Date: 2012–11
  7. By: Hyunduk Suh
    Abstract: This paper examines the interactions of macroprudential policy and monetary policy in a New Keynesian DSGE model with financial frictions. Macroprudential policy can stabilize credit cycles. However, a macroprudential instrument that aims to stabilize a specific segment of the credit market can cause regulatory arbitrage, that is, a reallocation of credit to a less regulated part of the market. Within this model, welfare-maximizing monetary policy aims to stabilize only inflation and macroprudential policy only stabilizes credit. Two aspects of the model account for this dichotomy. First, credit stabilization is welfare improving because lower volatility is compensated by higher mean equilibrium credit and capital. Second, monetary policy is sub-optimal for credit stabilization. The reason is that it operates on the decisions of borrowers and savers, while macroprudential policy operates only on the decisions of borrowers.
    Keywords: Ratio analysis
    Date: 2012
  8. By: Ziv Chinzara (QUT); Radhika Lahiri (QUT)
    Abstract: We develop a stochastic political economy model to explain the trade-off between growth and inequality during the process of technology adoption. In the model endogenous growth occurs through physical and human capital deepening. Agents can adopt either of the two risky high-return technologies, one of which is only available to those who can afford the entry cost associated with financial intermediation. We assume that this entry cost depends on the proportion of government revenue that is allocated towards cost-reducing financial development expenditure, and that agents decide on this proportion through a voting mechanism. The results show that certain interest groups comprising of both the poorest and the richest agents block the policies that are aimed at allocating resources towards costreducing financial development expenditure in the early stages of the economy’s development. However, as redistribution continues from generation to generation, the middle of the distribution successively becomes thicker and consequently the majority of agents start supporting reallocation in the form of cost-reducing financial development expenditure. In the transition to the steady state, inequality patterns show recurring ‘Kuznets-like curves’. Furthermore, high initial inequality tends to hasten the pace at which growth and inequality converge towards the steady state paths, while low inequality result in more fluctuations in transitional growth and inequality. Finally, our results show that although the political outcomes do not coincide with the welfare maximisation outcomes in the early and the transitional stages of the economy, the two outcomes eventually converge in the long-run.
    Keywords: political economy, overlapping generations model, growth and inequality, technology adoption, redistribution
    JEL: O1 O3
    Date: 2012–11–26
  9. By: Francois Gourio
    Abstract: Credit spreads are large, volatile and countercyclical, and recent empirical work suggests that risk premia, not expected credit losses, are responsible for these features. Building on the idea that corporate debt, while safe in ordinary recessions, is exposed to economic depressions, this paper embeds a trade-off theory of capital structure into a real business cycle model with a small, exogenously time-varying risk of economic disaster. The model replicates the level, volatility and cyclicality of credit spreads, and variation in the corporate bond risk premium amplifies macroeconomic fluctuations in investment, employment and GDP.
    Keywords: Risk - Mathematical models ; Credit ; Debt
    Date: 2012
  10. By: Gaetano Lisi
    Abstract: The recent and growing literature which has extended the use of search and matching models even to the housing market does not use the free entry or zero-profit assumption as a key condition for solving the equilibrium of the model. This is because a straightforward adaptation of the basic matching model to the housing market seems impossible. However, this paper shows that the zero-profit condition can be easily reformulated to take the distinctive features of the housing market into account. Indeed, it helps to provide a theoretical explanation for well-known empirical regularities in the housing markets.
    Keywords: trust (in) and power (of) tax authorities, tax compliance, tax evasion macroeconomics variables.
    JEL: A12 A13 E26 H26 K34 K42
    Date: 2012–11–22
  11. By: Jean-Pascal Bénassy; Elise S. Brézis (Bar-Ilan University)
    Abstract: This paper links the two fields of “development traps” and “brain drain”. We construct a model which integrates endogenous international migration into a simple growth model. As a result the dynamics of the economy can feature some underdevelopment traps: an economy starting with a low level of human capital can be caught in a vicious circle where low level of human capital leads to low wages, and low wages leads to emigration of valuable human capital. We also show that our model displays a rich array of different dynamic regimes, including the above traps, but other regimes as well, and we link explicitly the nature of the regimes to technology and policy parameters.
    Keywords: brain drain; development traps; human capital; migration.
    JEL: F22 J61 O11 O15
    Date: 2012–01
  12. By: Kyle F. Herkenhoff
    Abstract: How do job losers use default -- a phenomenon 6x more prevalent than bankruptcy --as a type of “informal" unemployment insurance, and more importantly, what are the social costs and benefits of this behavior? To this end, I establish several new facts: (i) job loss is the main reason for default, not negative equity (ii) people default because they are credit constrained and cannot borrow more, and (iii) the value of debt payments is a significant fraction of a defaulter's earnings. Using these facts, I calibrate a general equilibrium model with a frictional labor market similar to Burdett and Mortensen (1998) and Menzio and Shi (2009, 2011) and individually priced debt along the lines of Eaton and Gersovitz (1981) and Chatterjee et al. (2007). After proving the existence of a Block Recursive Equilibrium, I find that the extra self- insurance job losers obtain by defaulting outweighs the subsequent increase in the cost of credit, and as a result, protectionist policies such as the Mortgage Servicer Settlement of 2012 or the CARD Act of 2009 improve overall welfare by .1%. The side effect of the policies, however, is a .2-.5% higher unemployment rate during recessions that persists throughout the recovery.
    Keywords: Unemployment ; Insurance ; Labor market
    Date: 2012
  13. By: Natacha Raffin; Thomas Seegmuller
    Abstract: We analyze the interplay between longevity, pollution and growth. We develop an OLG model where longevity, pollution and growth are endogenous. The authorities may provide two types of public services, public health and environmental maintenance, that participate to increase agents’ life expectancy and to sustain growth in the long term. We show that global dynamics might be featured by a high growth rate equilibrium, associated with longer life expectancy and a environmental poverty trap. We examine changes in public policies: increasing public intervention on health or environmental maintenance display opposite effects on global dynamics, i.e. on the size of the trap and on the level of the stable balanced growth path. On the contrary, each type of public policy induces a negative leverage on the long run rate of growth.
    Keywords: Life expectancy; Pollution; Health; Growth
    JEL: I15 O44 Q56
    Date: 2012
  14. By: Javier Bianchi
    Abstract: This paper develops a non-linear DSGE model to assess the interaction between ex-post interventions in credit markets and the build-up of risk ex ante. During a systemic crisis, bailouts relax balance sheet constraints and mitigate the severity of the recession. Ex ante, the anticipation of such bailouts leads to an increase in risk-taking, making the economy more vulnerable to a financial crisis. The optimal policy requires, in general, a mix of ex-post intervention and ex-ante prudential policy. We also analyze the effects of bailouts on financial stability and welfare in the absence of ex-ante prudential policy. Our results show that the moral hazard effects of bailouts are significantly mitigated by making bailouts contingent on the occurrence of a systemic financial crisis.
    JEL: E2 E20 E3 E32 E44 E6 F40
    Date: 2012–12
  15. By: Harold L. Cole; Soojin Kim; Dirk Krueger
    Abstract: This paper constructs a dynamic model of health insurance to evaluate the short- and long run effects of policies that prevent firms from conditioning wages on health conditions of their workers, and that prevent health insurance companies from charging individuals with adverse health conditions higher insurance premia. Our study is motivated by recent US legislation that has tightened regulations on wage discrimination against workers with poorer health status (Americans with Disability Act of 2009, ADA, and ADA Amendments Act of 2008, ADAAA) and that will prohibit health insurance companies from charging different premiums for workers of different health status starting in 2014 (Patient Protection and Affordable Care Act, PPACA). In the model, a trade-off arises between the static gains from better insurance against poor health induced by these policies and their adverse dynamic incentive effects on household efforts to lead a healthy life. Using household panel data from the PSID we estimate and calibrate the model and then use it to evaluate the static and dynamic consequences of no-wage discrimination and no-prior conditions laws for the evolution of the cross-sectional health and consumption distribution of a cohort of households, as well as ex-ante lifetime utility of a typical member of this cohort. In our quantitative analysis we find that although a combination of both policies is effective in providing full consumption insurance period by period, it is suboptimal to introduce both policies jointly since such policy innovation induces a more rapid deterioration of the cohort health distribution over time. This is due to the fact that combination of both laws severely undermines the incentives to lead healthier lives. The resulting negative effects on health outcomes in society more than offset the static gains from better consumption insurance so that expected discounted lifetime utility is lower under both policies, relative to only implementing wage nondiscrimination legislation.
    JEL: E61 H31 I18
    Date: 2012–11

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