nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2013‒07‒05
ten papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Mismatch shocks and unemployment during the Great Recession By Francesco Furlanetto; Nicolas Groshenny
  2. Generational Risk – Is It a Big Deal?: Simulating an 80-Period OLG Model with Aggregate Shocks By Jasmina Hasanhodzic; Laurence J. Kotlikoff
  3. International Business Cycles with Complete Markets By Alexandre Dmitriev; Ivan Roberts
  4. Liquidity effects on asset prices, financial stability and economic resilience By Dimitrios Tsomocos; Juan Francisco Martinez Sepulveda
  5. Debt dilution and sovereign default risk By Leonardo Martinez; Cesar Sosa Padilla; Juan Hatchondo
  6. The Joint Impact of Social Security and Medicaid on Incentives and Welfare By Tatyana Koreshkova; Karen Kopecky
  7. Signaling Effects of Monetary Policy By Leonardo Melosi
  8. Mixed frequency structural models: estimation, and policy analysis By Claudia Foroni; Massimiliano Marcellino
  9. Bailouts, Time Inconsistency, and Optimal Regulation By V.V. Chari; Patrick J. Kehoe
  10. Emancipation Through Education By Michelle Rendall; Fatih Guvenen

  1. By: Francesco Furlanetto (Norges Bank (Central Bank of Norway)); Nicolas Groshenny (University of Adelaide, School of Economics)
    Abstract: We investigate the macroeconomic consequences of .uctuations in the effectiveness of the labor-market matching process with a focus on the Great Recession. We conduct our analysis in the context of an estimated medium-scale DSGE model with sticky prices and equilibrium search unemployment that features a shock to the matching efficiency (or mismatch shock). We find that this shock is almost irrelevant for unemployment fluctuations in normal times. However, it plays a somewhat larger role during the Great Recession when it contributes to raise the actual unemployment rate by 1.25 percentage points and the natural rate by 2 percentage points. Moreover, it is the only shock that generates a positive conditional correlation between unemployment and vacancies.
    Keywords: Search and marketing frictions, Unemployment, Natural rates
    JEL: E32 C51 C52
    Date: 2013–06–28
  2. By: Jasmina Hasanhodzic; Laurence J. Kotlikoff
    Abstract: The theoretical literature on generational risk assumes that this risk is large and that the government can effectively share it. To assess these assumptions, this paper calibrates and simulates 80-period, 40-period, and 20-period overlapping generations (OLG) life-cycle models with aggregate productivity shocks. Previous solution methods could not handle large-scale OLG models such as ours due to the well-known curse of dimensionality. The prior state of the art uses sparse-grid methods to handle 10 to 30 periods depending on the model's realism. Other methods used to solve large-scale, multi- period life-cycle models rely on either local approximations or summary statistics of state variables. We employ and extend a recent algorithm by Judd, Maliar, and Maliar (2009, 2011), which restricts the state space to the model's ergodic set. This limits the required computation and effectively banishes the dimensionality curse in models like ours. We find that intrinsic generational risk is quite small, that government policies can produce generational risk, and that bond markets can help share generational risk. We also show that a bond market can mitigate risk-inducing government policy. Our simulations produce very small equity premia for three reasons. First, there is relatively little intrinsic generational risk. Second, aggregate shocks hit both the young and the old in similar ways. And third, artificially inducing risk between the young and the old via government policy elicits more net supply as well as more net demand for bonds, by the young and the old respectively, leaving the risk premium essentially unchanged. Our results hold even in the presence of rare disasters, very high risk aversion, persistent productivity shocks, and stochastic depreciation. They echo other findings in the literature suggesting that macroeconomic fluctuations are too small to have major microeconomic consequences.
    JEL: E0
    Date: 2013–06
  3. By: Alexandre Dmitriev (University of Tasmania); Ivan Roberts (Reserve Bank of Australia)
    Abstract: Kehoe and Perri (2002) show that a two-country business cycle model with endogenously incomplete markets helps to resolve the 'international co-movement puzzle' (Baxter 1995) and the 'quantity anomaly' (Backus, Kehoe and Kydland 1992, 1995). We claim that a similar performance can be achieved without resorting to market incompleteness. We show that a model with complete markets driven by productivity shocks alone can account for the 'international co-movement puzzle'. Our model features time non-separable preferences that allow arbitrarily small changes in wealth to affect the supply of labour. It matches the data by predicting (i) positive cross-country correlations of investment and hours worked; and (ii) realistic cross-country correlations of consumption. It reduces the gap between international correlations of output and consumption, but fails to change their order. Unlike models with restricted international markets, ours shows little sensitivity to the parameterisation of the forcing process.
    Keywords: time non-separable preferences; wealth effects; international business cycles
    JEL: E32 F41 G15
    Date: 2013–06
  4. By: Dimitrios Tsomocos (University of Oxford); Juan Francisco Martinez Sepulveda (University of Oxford)
    Abstract: This paper analyzes the different channels of shock transmission in an economy affected by financial frictions. We distinguish between the liquidity and default effects on asset prices. Furthermore, we develop a framework in which we can assess financial stability policy under financial frictions. We introduce a simplified model of trade and financial intermediation that captures the effects of shocks on financial and real variables of the economy. Our results suggest that financial stability and economic resilience to adverse shocks should take into account default in the credit market as well as the liquidity of goods traded in the commodity market.
    Date: 2012
  5. By: Leonardo Martinez (International Monetary Fund); Cesar Sosa Padilla (University of Maryland); Juan Hatchondo (Federal Reserve Bank of Richmond)
    Abstract: We measure the effects of debt dilution on sovereign default risk and show how these effects can be mitigated with debt contracts promising borrowing-contingent payments. First, we calibrate a baseline model `a la Eaton and Gersovitz (1981) to match features of the data. In this model, bondsâ values can be diluted. Second, we present a model in which sovereign bonds contain a covenant promising that after each time the government borrows it it pays to the holder of each bond issued in previous periods the difference between the bond market price that would have been observed absent current-period borrowing and the observed market price. This covenant eliminates debt dilution by making the value of each bond independent from future borrowing decisions. We quantify the effects of dilution by comparing the simulations of the model with and without borrowing-contingent payments. We find that dilution accounts for 84% of the default risk in the baseline economy. Similar default risk reductions can be obtained with borrowing-contingent payments that depend only on the bond market price. Using borrowing-contingent payments is welfare enhancing because it reduces the frequency of default episodes.
    Date: 2012
  6. By: Tatyana Koreshkova (Concordia University); Karen Kopecky (Federal Reserve Bank of Atlanta)
    Abstract: We evaluate the joint effects of social security and Medicaid on labor supply, savings, economic inequality, and welfare in an environment with idiosyncratic risk in labor earnings, health expenses, and survival. The model features households consisting males and females; a progressive social security system which provides insurance against lifetime earnings, health expense, survival and spousal death risks; and a means-tested social insurance system that proxies for the US Medicaid program. We show that the annuity role of social security benefits entails important welfare gains in the presence of health expense risk and Medicaid.
    Date: 2012
  7. By: Leonardo Melosi (Federal Reserve Bank of Chicago)
    Abstract: We develop a DSGE model in which the policy rate signals to price setters the central bank’s view about macroeconomic developments. The model is estimated with likelihood methods on a U.S. data set that includes the Survey of Professional Forecasters as a measure of price setters’ inflation expectations. We find that the model fits the data better than a prototypical New Keynesian DSGE model because the signaling effects of monetary policy help the model account for the run-up in inflation expectations in the 1970s. The estimated model with signaling effects delivers large and persistent real effects of monetary disturbances even though the average duration of price contracts is fairly short. While the signaling effects do not substantially alter the transmission of technology shocks, they bring about deflationary pressures in the aftermath of positive demand shocks. The signaling effects of monetary policy have contributed (i ) to heightening inflation expectations in the 1970s, (ii ) to raising inflation and to exacerbating the recession during the first years of Volcker’s monetary tightening, and (iii ) to subduing inflation and to stimulating economic activity from 1991 through 2007.
    Keywords: Bayesian econometrics; price puzzle; persistent real effects of nominal shocks; imperfect common knowledge; public signal; heterogeneous beliefs
    JEL: E52 C11 C52 D83
    Date: 2013–03–01
  8. By: Claudia Foroni (Norges Bank (Central Bank of Norway)); Massimiliano Marcellino (European University Institute, Bocconi University and CEPR)
    Abstract: In this paper we show analytically, with simulation experiments and with actual data that a mismatch between the time scale of a DSGE model and that of the time series data used for its estimation generally creates identfication problems, introduces estimation bias and distorts the results of policy analysis. On the constructive side, we prove that the use of mixed frequency data, combined with a proper estimation approach, can alleviate the temporal aggregation bias, mitigate the identfication issues, and yield more reliable policy conclusions. The problems and possible remedy are illustrated in the context of standard structural monetary policy models.
    Keywords: Structural VAR, DSGE models, temporal aggregation, mixed frequency data, estimation. policy analysis
    JEL: C32 C43 E32
    Date: 2013–06–11
  9. By: V.V. Chari; Patrick J. Kehoe
    Abstract: We develop a model in which, in order to provide managerial incentives, it is optimal to have costly bankruptcy. If benevolent governments can commit to their policies, it is optimal not to interfere with private contracts. Such policies are time inconsistent in the sense that, without commitment, governments have incentives to bail out firms by buying up the debt of distressed firms and renegotiating their contracts with managers. From an ex ante perspective, however, such bailouts are costly because they worsen incentives and thereby reduce welfare. We show that regulation in the form of limits on the debt-to-value ratio of firms mitigates the time-inconsistency problem by eliminating the incentives of governments to undertake bailouts. In terms of the cyclical properties of regulation, we show that regulation should be tightest in aggregate states in which resources lost to bankruptcy in the equilibrium without a government are largest.
    JEL: E0 E44 E6 E61
    Date: 2013–06
  10. By: Michelle Rendall (University of Zurich); Fatih Guvenen (University of Minnesota)
    Abstract: This paper investigates the role of education in the evolution of women's role in the society---specifically, in the labor market and in the marriage market. In particular, it attempts to understand a set of socio-economic trends since the 1950s, such as (i) the falling marriage rate and the rising divorce rate, (ii) the rising educational attainment of women, which now exceeds that of men's (iii) the rising average earnings of women relative to men (i.e., the gender wage gap), and (iv) the substantial rise in the labor force participation (and labor supply) of married women. These trends have potentially profound effects on the society and raise several interesting questions to study. We build a plausible model with education, marriage/divorce, and labor supply decisions in which these different trends are intimately related to each other. We focus on education because divorce laws typically allow spouses to keep a much larger fraction of the returns from their human capital upon divorce compared to their physical assets, making education a good insurance against divorce risk. The proposed framework generates a number of powerful amplification mechanisms, which lead to large rises in divorce rates and college enrollment of women and a fall in marriage rates from relatively modest exogenous driving forces.
    Date: 2012

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