nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2013‒07‒20
thirteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Wealth Inequality and the Losses from Financial Frictions By Joaquin Blaum
  2. A Life-Cycle Model with Ambiguous Survival Beliefs By Groneck, Max; Ludwig, Alexander; Zimper, Alexander
  3. Should Unemployment Insurance Be Asset-Tested? By Koehne, Sebastian; Kuhn, Moritz
  4. Should monetary policy lean against the wind? An analysis based on a DSGE model with banking By Leonardo Gambacorta; Federico M. Signoretti
  5. Collateral monetary equilibrium with liquidity constraints in an infinite horizon economy. By Ngoc-Sang Pham
  6. Precautionary Saving over the Business Cycle By Edouard Challe; Xavier Ragot
  7. Large Scale Asset Purchases with Segmented Mortgage and Corporate Loan Markets By Meixing Dai; Frédéric Dufourt; Qiao Zhang
  8. Parameter Uncertainty and the Fiscal Multiplier By Jamie Murray
  9. A Total Factor Productivity-Capital Accumulation Hypothesis of India’s Growth Transitions By Kevin S. Nell
  10. Incomplete markets, liquidation risk, and the term structure of interest rates By Edouard Challe; François Le Grand; Xavier Ragot
  11. Entrepreneurial Taxation with Endogenous Entry By Florian Scheuer
  12. Slow Moving Debt Crises By Guido Lorenzoni; Ivan Werning
  13. Transformation Method for Solving Hamilton-Jacobi-Bellman Equation for Constrained Dynamic Stochastic Optimal Allocation Problem By Sona Kilianova; Daniel Sevcovic

  1. By: Joaquin Blaum (MIT)
    Abstract: Does wealth inequality exacerbate or alleviate the degree of misallocation in an economy where financial markets are imperfect? To address this question, I exploit the idea that inequality should have a different effect across sectors. Using a difference-in-difference strategy, I show that sectors that are more in need of external finance are relatively smaller in countries with higher income inequality. To rationalize this fact, I build a model in which sectors differ in their fixed cost requirement, agents face collateral constraints, and production is subject to decreasing returns. The model features key elements from the literature on financial frictions and economic development. I calibrate the model to match standard moments of the US economy. The calibrated model is consistent with the documented facts on inequality and cross-sector outcomes. At the calibrated parameters, wealth inequality exacerbates the effect of financial frictions on the economy. Quantitatively, an increase in wealth inequality that is consistent with an increase in income inequality of 15 points in Gini generates losses of 46 percent of per capita income.
    Date: 2012
  2. By: Groneck, Max; Ludwig, Alexander; Zimper, Alexander (Munich Center for the Economics of Aging (MEA))
    Abstract: On average, "young" people underestimate whereas "old" people overestimate their chances to survive into the future. We adopt a Bayesian learning model of ambiguous survival beliefs which replicates these patterns. The model is embedded within a non-expected utility model of life-cycle consumption and saving. Our analysis shows that agents with ambiguous survival beliefs (i) save less than originally planned, (ii) exhibit undersaving at younger ages, and (iii) hold longer on to their assets than their rational expectations counterparts who correctly assess survival probabilities. Our ambiguity-driven model therefore simultaneously accounts for three important empirical fi…ndings on household saving behavior.
    JEL: D91 D83 E21
    Date: 2013–07–02
  3. By: Koehne, Sebastian (IIES, Stockholm University); Kuhn, Moritz (University of Bonn)
    Abstract: We study asset-tested unemployment insurance in an incomplete markets model with moral hazard during job search. Asset testing has two counteracting effects on welfare. On the one hand, it improves consumption insurance by introducing state contingent transfers to agents most in need. On the other hand, it worsens the moral hazard problem, since workers have a reduced incentive to save and fewer private resources are used for consumption smoothing during unemployment. Our results show that in a realistically calibrated model of the U.S. economy the two effects nearly offset each other – the optimal rate of asset-testing is approximately zero. This finding is robust to several alternative specifications of the model, including a case with heterogeneous time-discount factors. We conclude that the current U.S. unemployment insurance system is approximately optimal.
    Keywords: unemployment insurance, asset-testing, incomplete markets, consumption and saving
    JEL: E21 E24 J65
    Date: 2013–07
  4. By: Leonardo Gambacorta (Bank for International Settlements); Federico M. Signoretti (Bank of Italy)
    Abstract: The global financial crisis has reaffirmed the importance of financial factors for macroeconomic fluctuations. Recent work has shown how the conventional pre-crisis prescription that monetary policy should pay no attention to financial variables over and above their effects on inflation may no longer be valid in models that consider frictions in financial intermediation (Cúrdia and Woodford, 2009). This paper analyzes whether Taylor rules augmented with asset prices and credit can improve upon a standard rule in terms of macroeconomic stabilization in a DSGE with both a firms' balance-sheet channel and a bank-lending channel and in which the spread between lending and policy rates endogenously depends on banks' leverage. The main result is that, even in a model in which financial stability does not represent a distinctive policy objective, leaning-against-the-wind policies are desirable in the case of supply-side shocks whenever the central bank is concerned with output stabilization, while both strict inflation targeting and a standard rule are less effective. The gains are amplified if the economy is characterized by high private sector indebtedness.
    Keywords: DSGE, monetary policy, asset prices, credit channel, Taylor rule, leaning-against-the-wind
    JEL: E30 E44 E50
    Date: 2013–07
  5. By: Ngoc-Sang Pham (Centre d'Economie de la Sorbonne)
    Abstract: This paper considers an infinite-horizon monetary economy with collateralized assets. A Central BanK lends money to households by creating short- and long-term loans. Households can deposit or borrow money on both short- and long-term maturity loans. If households want to sell a financial asset, they are required to hold certain commodities as collateral. They face a cash-in-advance constraints when buying commodities and financial assets. Under Uniform or Sequential Gains to Trade Hypothesis, the existence of collateral monetary equilibrium is ensured. I also provide some properties of equilibria, including the liquidity trap.
    Keywords: Monetary economy, liquidity constraint, collateralized asset, infinite horizon, liquidity trap.
    JEL: D52 E5 C62
    Date: 2013–07
  6. By: Edouard Challe (Department of Economics, Ecole Polytechnique - CNRS : UMR7176 - Polytechnique - X, CREST - Centre de Recherche en Économie et Statistique - INSEE - École Nationale de la Statistique et de l'Administration Économique); Xavier Ragot (Centre de recherche de la Banque de France - Banque de France, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris, PSE - Paris-Jourdan Sciences Economiques - CNRS : UMR8545 - École des Hautes Études en Sciences Sociales [EHESS] - Ecole des Ponts ParisTech - Ecole normale supérieure de Paris - ENS Paris - Institut national de la recherche agronomique (INRA))
    Abstract: We study the macroeconomic implications of time-varying precautionary saving within a general equilibrium model with borrowing constraint and both aggregate shocks and uninsurable idiosyncratic unemployement risk. Our framework generates limited cross-sectional household heterogeneity as an equilibrium outcome, thereby making it possible to analyse the role of precautionary saving over the business cycle in an analytically tractable way. The time-series behaviour of aggregate consumption generated by our model is much closer to the data than that implied by the comparable hand-to-mouth and representative-agent models, and comparable to that produced by the(intractable) Krusell-Smith (1998) model.
    Date: 2013–07–10
  7. By: Meixing Dai (BETA - Bureau d'économie théorique et appliquée - CNRS : UMR7522 - Université Louis Pasteur - Strasbourg I); Frédéric Dufourt (AMSE - Aix-Marseille School of Economics - Aix-Marseille Univ. - Centre national de la recherche scientifique (CNRS) - École des Hautes Études en Sciences Sociales [EHESS] - Ecole Centrale Marseille (ECM)); Qiao Zhang (BETA - Bureau d'économie théorique et appliquée - CNRS : UMR7522 - Université Louis Pasteur - Strasbourg I)
    Abstract: We introduce Large Scale Asset Purchases (LSAPs) in a New-Keynesian DSGE model that features distinct mortgage and corporate loan markets. We show that following a significant disruption of financial intermediation, central-bank purchases of mortgage-backed securities (MBS) are uniformly less effective at easing credit market conditions and stabilizing economic activity than outright purchases of corporate bonds. Moreover, the size of the effects crucially depends on the extent to which credit markets are segmented, i.e. to which a "portfolio balance channel" is at work in the economy. More segmented credit markets imply larger, but more local effects of particular asset purchases. With strongly segmented credit markets, large scale purchases of MBS are useful to stabilize the housing market but do little to mitigate the contractionary effect of the crisis on employment and output.
    Keywords: financial frictions; mortgage-backed securities (MBS); corporate bonds; unconventional monetary policy; large scale asset purchases (LSAPs); portfolio balance channel; credit spreads
    Date: 2013–06
  8. By: Jamie Murray (The Treasury)
    Abstract: I present a simple estimated model of the New Zealand economy which is used to assess the sensitivity of the impact multiplier and output losses associated with fiscal consolidations to uncertainty over model parameters. I find that, in normal times, the fiscal multiplier can be expected to lie between 0.1 and 0.5, with a central estimate of 0.3. Uncertainty over the output effects of fiscal tightening can be attributed to several model parameters and it is found that a bad outcome is likely to be worse than a good outcome is to be better – output risks are skewed to the downside. Sensitivity analysis reveals that if monetary policy in New Zealand were to be constrained by the zero-lower bound, the fiscal impact multiplier would rise substantially, consistent with the empirical evidence for other OECD countries in that position.
    Keywords: Fiscal impact multiplier; Ricardian equivalence; DSGE; SVAR; consolidation; monetary policy; uncertainty; lower bound
    JEL: E62 E43 E32 F33 F41
    Date: 2013–07
  9. By: Kevin S. Nell (Center for Economics and Finance, Faculty of Economics, University of Porto)
    Abstract: This paper re-examines the role of physical capital accumulation in the Indian economy over the period 1953-2010. As an alternative to the orthodox total factor productivity (TFP) view, the paper develops a combined TFP-capital accumulation hypothesis of growth transitions. The results show that the first phase of India’s faster-growing regime during 1980-2002 was mainly TFP driven. However, the large increase in uninvested profits accumulated during the first phase together with evidence of a sharp rise in the productivity of capital and an exogenous saving/investment rate implies that India had a significant amount of untapped long-run growth potential. Consistent with the prediction of the model, the growth surge experienced during 2003-2007 reflects the capital accumulation-driven part of the growth transition. Despite the turbulent years of the global financial crisis since 2008, the analysis suggests that physical capital accumulation will continue to be a driving force of India’s future growth performance.
    Keywords: physical capital accumulation, total factor productivity, Solow model, learning by doing model, growth, India, technical progress function
    JEL: C22 O4 O5 O41 O53
    Date: 2013–07
  10. By: Edouard Challe (Department of Economics, Ecole Polytechnique - CNRS : UMR7176 - Polytechnique - X, CREST - Centre de Recherche en Économie et Statistique - INSEE - École Nationale de la Statistique et de l'Administration Économique, Banque de France - -); François Le Grand (EMLYON Business school - EMLYON Business School, ETH Zurich - [-]); Xavier Ragot (Centre de recherche de la Banque de France - Banque de France, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris, PSE - Paris-Jourdan Sciences Economiques - CNRS : UMR8545 - École des Hautes Études en Sciences Sociales [EHESS] - Ecole des Ponts ParisTech - Ecole normale supérieure de Paris - ENS Paris - Institut national de la recherche agronomique (INRA))
    Abstract: We analyse the term structure of interest rates in a general equilibrium model with incomplete markets, borrowing constraint, and positive net supply of government bonds. Uninsured idiosyncratic shocks generate bond trades, while aggregate shocks cause uctuations in the trading price of bonds. Long bonds command a liquidation risk premium over short bonds, because they may have to be liquidated before maturity following a bad idiosyncratic shock precisely when their resale value is low due to the simultaneous occurrence of a bad aggregate shock. Our framework endogenously generates limited cross-sectional wealth heterogeneity among the agents (despite the presence of uninsured idiosyncratic shocks), which allows us to characterise analytically the shape of the entire yield curve, including the yields on bonds of arbitrarily long maturities. Agents desire to hedge the idiosyncratic risk together with their fear of having to liquidate long bonds at unfavourable terms imply that a greater bond supply raises the level of the yield curve, while an increase in the relative supply of long bonds raises its slope.
    Keywords: Incomplete markets; Borrowing constraint; Yield curve.
    Date: 2013–07–10
  11. By: Florian Scheuer
    Abstract: This paper analyzes Pareto optimal non-linear taxation of profits and labor income in a private information economy with endogenous firm formation. Individuals differ in both their skill and their cost of setting up a firm, and choose between becoming workers and entrepreneurs. I show that a tax system in which entrepreneurial profits and labor income must be subject to the same non-linear tax schedule makes use of general equilibrium (or "trickle down'') effects through wages to indirectly achieve redistribution between entrepreneurs and workers. As a result, constrained Pareto optimal policies can involve low marginal tax rates at the top and, if available, input taxes that distort the firms' input choices. However, these properties disappear when a differential tax treatment of profits and labor income is possible. In this case, redistribution is achieved directly through the tax system rather than "trickle down'' effects, and production efficiency is always optimal.
    JEL: D5 D8 E2 E6 H2 J2 J3 J6
    Date: 2013–07
  12. By: Guido Lorenzoni; Ivan Werning
    Abstract: What circumstances or policies leave sovereign borrowers at the mercy of self-fulfilling increases in interest rates? To answer this question, we study the dynamics of debt and interest rates in a model where default is driven by insolvency. Fiscal deficits and surpluses are subject to shocks but influenced by a fiscal policy rule. Whenever possible the government issues debt to meet its current obligations and defaults otherwise. We show that low and high interest rate equilibria may coexist. Higher interest rates, prompted by fears of default, lead to faster debt accumulation, validating default fears. We call such an equilibrium a slow moving crisis, in contrast to rollover crises where investor runs precipitate immediate default. We investigate how the existence of multiple equilibria is affected by the fiscal policy rule, the maturity of debt, and the level of debt.
    JEL: E6 F3 F34
    Date: 2013–07
  13. By: Sona Kilianova; Daniel Sevcovic
    Abstract: In this paper we propose and analyze a method based on the Riccati transformation for solving the evolutionary Hamilton-Jacobi-Bellman equation arising from the stochastic dynamic optimal allocation problem. We show how the fully nonlinear Hamilton-Jacobi-Bellman equation can be transformed into a quasi-linear parabolic equation whose diffusion function is obtained as the value function of certain parametric convex optimization problem. Although the diffusion function need not be sufficiently smooth, we are able to prove existence, uniqueness and derive useful bounds of classical H\"older smooth solutions. We furthermore construct a fully implicit iterative numerical scheme based on finite volume approximation of the governing equation. A numerical solution is compared to a semi-explicit traveling wave solution by means of the convergence ratio of the method. We compute optimal strategies for a portfolio investment problem motivated by the German DAX 30 Index as an example of application of the method.
    Date: 2013–07

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