nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2013‒09‒13
nineteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Land prices and unemployment By Zheng Liu; Jianjun Miao; Tao Zha
  2. Evaluating Quantitative Easing: A DSGE Approach By Falagiarda, Matteo
  3. The macro-dynamics of sorting between workers and firms By Jeremy Lise; Jean-Marc Robin
  4. Decreasing Marginal Impatience and Capital Accumulation in a Two-country World Economy By Ken-Ichi Hirose; Shinsuke Ikeda
  5. A Growth Perspective on Foreign Reserve Accumulation. By Cheng, G.
  6. Health-Related Life Cycle Risks and Public Insurance By Daniel Kemptner
  7. Collateral constraints and rental markets By d'Albis, Hippolyte; Iliopoulos, Eleni
  8. Capital mobility, search unemployment and labor market policies: The case of minimum wages By Frédéric Gavrel
  9. Voluntary Sovereign Debt Exchanges By Juan Carlos Hatchondo; Leonardo Martinez; Cesar Sosa Padilla
  10. Procyclical Debt as Automatic Stabilizer. By Wesselbaum, D.
  11. Business cycles in EU new member states: How and why are they different? By Marcin Kolasa
  12. Liquidity Effects of Central Banks' Asset Purchase Programs By Mahmoudi, Babak
  13. Fixed versus Variable Rate Debt Contracts and Optimal Monetary Policy By Tatiana Kirsanova; Jack Rogers
  14. Endogenous Trade Participation with Incomplete Exchange Rate Pass-Through By Yuko Imura
  15. Exchange Rates and Fundamentals: Closing a Two-country Model By Kano, Takashi
  16. Repos in Over-the-Counter Markets By Hajime Tomura
  17. Fiscal delegation in a monetary union with decentralized public spending By Henrique S. Basso; James Costain
  18. On the Welfare Cost of Consumption Fluctuationsin the Presence of Memorable Goods By Rong Hai; Dirk Krueger; Andrew Postlewaite
  19. Smoothed Interest Rate Setting by Central Banks and Staggered Loan Contracts By Yuki Teranishi

  1. By: Zheng Liu; Jianjun Miao; Tao Zha
    Abstract: We integrate the housing market and the labor market in a dynamic general equilibrium model with credit and search frictions. The model is confronted with the U.S. macroeconomic time series. Our estimated model can account for two prominent facts observed in the data. First, the land price and the unemployment rate tend to move in opposite directions over the business cycle. Second, a shock that moves the land price is capable of generating large volatility in unemployment. Our estimation indicates that a 10 percent drop in the land price leads to a 0.34 percentage point increase of the unemployment rate (relative to its steady state).
    Keywords: Housing ; Labor market
    Date: 2013
  2. By: Falagiarda, Matteo
    Abstract: This paper develops a simple Dynamic Stochastic General Equilibrium (DSGE) model capable of evaluating the effect of large purchases of treasuries by central banks. The model exhibits imperfect asset substitutability between government bonds of different maturities and a feedback from the term structure to the macroeconomy. Both are generated through the introduction of portfolio adjustment frictions. As a result, the model is able to isolate the portfolio rebalancing channel of Quantitative Easing (QE). This theoretical framework is employed to evaluate the impact on yields and the macroeconomy of large purchases of medium- and long-term treasuries recently carried out in the US and UK. The results from the calibrated model suggest that large asset purchases of government assets had stimulating effects in terms of lower long-term yields, and higher output and inflation. The size of the effects is nevertheless sensitive to the speed of the exit strategy chosen by monetary authorities.
    Keywords: unconventional monetary policies, quantitative easing, DSGE models, asset prices
    JEL: E43 E44 E52 E58
    Date: 2013–09
  3. By: Jeremy Lise (Institute for Fiscal Studies and University College London); Jean-Marc Robin (Institute for Fiscal Studies and Sciences Po)
    Abstract: We develop an equilibrium model of on-the-job search with ex-ante heterogeneous workers and firms, aggregate uncertainty and vacancy creation. The model produces rich dynamics in which the distributions of unemployed workers, vacancies and worker-firm matches evolve stochastically over time. We prove that the surplus function, which fully characterises the match value and the mobility decision of workers, does not depend on these distributions. We estimate the model on US labour market data from 1951-2007 and predict the fit for 2008-12. We use the model to measure the cyclicality of mismatch between workers and jobs.
    Keywords: On-the-job search, heterogeneity, aggregate fluctuations, mis-match
    JEL: E24 E32 J63 J64
    Date: 2013–08
  4. By: Ken-Ichi Hirose; Shinsuke Ikeda
    Abstract: This research is the first to examine dynamic general equilibrium in a growing two-country economy under decreasing marginal impatience (DMI). The stability condition is shown to be more restrictive than in the case of an endowment economy and/or under increasing marginal impatience (IMI). By analyzing global-economy adjustment to time preference shocks, international transfers, and productivity shocks, equilibrium dynamics in the presence of DMI differ drastically from what is obtained when the standard IMI model is used. For example, in a country characterized by DMI, a positive productivity shock improves the country's welfare level and lowers its steady-state time preference and, hence, the steady-state interest rate. This leads to an increase in the neighboring country's capital stock.
    Date: 2013–08
  5. By: Cheng, G.
    Abstract: Based on a dynamic open-economy macroeconomic model, this paper aims at understanding the contribution of domestic financial underdevelopment to foreign reserve accumulation in some emerging market economies, especially in China. It is argued that foreign reserve accumulation is part and parcel of a growth strategy based on strong capital investment in a financially constrained economy. It is further proved using a Ramsey problem that purchasing international reserves is a welfare-improving policy in terms of production efficiency gains if it is jointly used with capital controls. In fact, when domestic firms are occasionally credit-constrained and they do not have a direct access to international financial market, they need domestic saving instruments to increase their retained earnings so that they can sufficiently invest in capital. The central bank plays the role of financial intermediary and provides domestic firms with liquid public bonds, thus relaxing domestic financial constraints. The proceeds of domestic public bonds are invested abroad due to the limited scope of domestic financial market and a depressed domestic interest rate, leading to foreign reserve stockpiling. The speed of foreign reserve accumulation would slow down once the economic growth rate decelerates and the domestic financial market develops.
    Keywords: Foreign reserves, capital controls, credit constraints, domestic savings, capital investment, economic growth, Chinese economy.
    JEL: E22 F31 F41 F43
    Date: 2013
  6. By: Daniel Kemptner
    Abstract: This paper proposes a dynamic life cycle model of health risks, employment, early retirement, and wealth accumulation in order to analyze the health-related risks of consumption and old age poverty. In particular, the model includes a health process, the interaction between health and employment risks, and an explicit modeling of the German public insurance schemes. I rely on a dynamic programming discrete choice framework and estimate the model using data from the German Socio-Economic Panel. I quantify the health-related life cycle risks by simulating scenarios where health shocks do or do not occur at different points in the life cycle for individuals with differing endowments. Moreover, a policy simulation investigates minimum pension benefits as an insurance against old age poverty. While such a reform raises a concern about an increase in abuse of the early retirement option, the simulations indicate that a means test mitigates<br /> the moral hazard problem substantially.
    Keywords: dynamic programming, discrete choice, health, employment, early retirement, consumption, tax and transfer system
    JEL: C61 I14 J22 J26
    Date: 2013
  7. By: d'Albis, Hippolyte; Iliopoulos, Eleni
    Abstract: We study a benchmark model with collateral constraints and heterogeneous discounting. Contrarily to a rich literature on borrowing limits, we allow for rental markets. By incorporating this missing market, we show that impatient agents choose to rent rather than to own the collateral in the neighborhood of the deterministic steady state. Consequently, impatient agents are not indebted and borrowing constraints play no role in local dynamics.
    Keywords: heterogeneous discounting, collateral constraints, rental market, credit market.
    JEL: E30 R31
    Date: 2013–09–03
  8. By: Frédéric Gavrel (CREM - Centre de Recherche en Economie et Management - CNRS : UMR6211 - Université de Rennes 1 - Université de Caen Basse-Normandie, TEPP - Travail, Emploi et Politiques Publiques - CNRS : FR3435 - Université Paris-Est Marne-la-Vallée (UPEMLV))
    Abstract: In order to study the in uence of capital mobility on labor market policy, this paper adapts the search-matching approach to an economy with an exogenous stock of capital. Contrary to most matching models, laissez-faire is unavoidably ine cient. However, public policy can neutralize this market failure by implementing a minimum wage. This result leads us to address a much-debated issue: Does capital mobility constrain labor market policies when governments cannot cooperate? To that end we extend the analysis to a n-country symmetric model where the setting of minimum wages results from a Nash non-cooperative game. We nd that, in this context, capital mobility does not a ect the e ciency of public policy.
    Keywords: Capital mobility; Search unemployment; Minimum wage effi ciency
    Date: 2013–03
  9. By: Juan Carlos Hatchondo; Leonardo Martinez; Cesar Sosa Padilla
    Abstract: We show that some recent sovereign debt restructurings were characterized by (i) the absence of missed debt payments prior to the restructurings, (ii) reductions in the government’s debt burden, and (iii) increases in the market value of debt claims for holders of the restructured debt. Since both the government and its creditors are likely to benefit from such restructurings, we label these episodes as “voluntary” debt exchanges. We present a model in which voluntary debt exchanges can occur in equilibrium when the debt level takes values above the one that maximizes the market value of debt claims. In contrast to previous studies on debt overhang, in our model opportunities for voluntary exchanges arise because a debt reduction implies a decline of sovereign default risk. This is observed in the absence of any effect of debt reductions on future output levels. Although voluntary exchanges are Pareto improving at the time of the restructuring, we show that eliminating the possibility of conducting voluntary exchanges may improve welfare from an ex-ante perspective. Thus, our results highlight a cost of initiatives that facilitate debt restructurings.
    Keywords: Sovereign Default, Debt Restructuring, Voluntary Debt Exchanges, Long-term Debt, Endogenous Borrowing Constraints.
    JEL: F34 F41
    Date: 2013–08
  10. By: Wesselbaum, D.
    Abstract: This paper shows that government debt creates a so far neglected wealth effect that has sizable effects on business cycle fluctuations. We present a new channel through which governments can influence cyclical fluctuations generated by any type of shock and contribute to macroeconomic stability. We provide evidence for the United States that debt moves procyclical with output. Then, we build a Real Business Cycle model with Non-Ricardian agents and use rules to describe fiscal policy. We show that procyclical debt generates smaller fluctuations compared to countercyclical debt. The striking consequence is that classical Keynesian fiscal policy destabilizes the business cycle in our framework.
    Keywords: Debt, Fiscal Rules, Non-Ricardian Agents, SVAR.
    JEL: E32 E62 H3
    Date: 2013
  11. By: Marcin Kolasa (National Bank of Poland, Warsaw School of Economics)
    Abstract: This paper uses the business cycle accounting framework to investigate the differences between economic fluctuations in Central and Eastern European (CEE) countries and the euro area. We decompose output movements into the contributions of four economic wedges, affecting the production technology, the agents’ intra- and intertemporal choices, and the aggregate resource constraint. We next analyze the observed cross-country differences in business cycles with respect to these four identified wedges. Our results indicate that business cycles in the CEE countries do differ from those observed in the euro area, even though substantial convergence has been achieved after the eastern EU enlargement. The major differences concern the importance of the intraand intertemporal wedges, which account for a larger proportion of output fluctuations in the CEE region and also exhibit relatively little comovement with their euro area counterparts.
    Keywords: business cycle accounting; business cycle synchronization
    JEL: E32 F44
    Date: 2013
  12. By: Mahmoudi, Babak
    Abstract: I construct a model of the monetary economy, in which different assets provide liquidity services. Assets differ in terms of the liquidity services they provide, and money is the most liquid asset. The central bank can implement policies by changing the relative supply of money and other assets. I show that the central bank can change the overall liquidity and welfare of the economy by changing the relative supply of assets with different liquidity characteristics. A liquidity trap exists away from the Friedman rule that has a positive real interest rate; the central bank's asset purchase/sale programs may be ineffective in instances of low enough inflation rates. My model also enables me to study the welfare effects of a restriction on trade with government bonds.
    Keywords: Open-Market Operation, Liquidity Effects, Liquidity Trap
    JEL: E0 E4 E5
    Date: 2013–06–21
  13. By: Tatiana Kirsanova (University of Glasgow); Jack Rogers (Department of Economics, University of Exeter)
    Abstract: What role does the proportion of fixed versus variable rate debt contracts play in the macroeconomy? We explore this issue by integrating borrowing-constrained households with a quantity-optimising banking sector that lends under either fixed or variable rates. Our framework is then used to investigate the relationships between the structure of debt contracts and monetary policy. In particular, we study the propagation of productivity shocks in the non-durable sector under Ramsey monetary policy. The introduction of overlapping debt contracts tempers the effect of the financial multiplier and reduces the deterministic component of social welfare, but we also show that an appropriate design of debt contracts, including both their length and their interest rate composition, can reduce volatility of the key economic variables, in such a way that the financial sector can play a stabilising role in the economy. We demonstrate that an intermediate ratio of fixed- and variable-rate debt contracts is socially optimal.
    Keywords: Optimal Monetary Policy, Fixed Rate Debt, Durable Goods, Collateral Constraints, Financial Accelerator.
    JEL: E52
    Date: 2013
  14. By: Yuko Imura
    Abstract: This paper investigates the implications of endogenous trade participation for international business cycles, trade flow dynamics and exchange rate pass-through when price adjustments are staggered across firms. I develop a two-country dynamic stochastic general equilibrium model wherein firms make state-dependent decisions on entry and exit in the export market and the frequency of price adjustment is time-dependent. Consistent with recent empirical findings, producers of traded goods in this model differ in their productivities, trade status and prices. At the aggregate level, quantitative properties of the model successfully reproduce some important characteristics of international business cycle moments in data. In contrast to previous findings in the literature, my model reveals that the inclusion of exporter entry and exit generates large, immediate responses in the number of exporters, export volumes and the export price index following aggregate shocks. I trace this result to the micro-level price stickiness present in my model but absent in existing models of endogenous trade participation. Moreover, I show that productivity heterogeneity rather than price age differences plays a dominant role in firms’ export decisions, and hence the additional realism of endogenous trade participation in the model does not mitigate incomplete exchange rate pass-through arising from nominal rigidity. This suggests that exporter characteristics, market structure and pricing conventions may be critical in analyzing the role of endogenous trade participation for international business cycles and exchange rate pass-through.
    Keywords: Business fluctuations and cycles; Exchange rates; International topics
    JEL: F44 F12
    Date: 2013
  15. By: Kano, Takashi
    Abstract: In an influential paper, Engel and West (2005) claim that the near random-walk behavior of nominal exchange rates is an equilibrium outcome of a variant of present-value models when economic fundamentals follow exogenous first-order integrated processes and the discount factor approaches one. Subsequent empirical studies further confirm this proposition by estimating a discount factor that is close to one under distinct identification schemes. In this paper, I argue that the unit market discount factor implies the counterfactual joint equilibrium dynamics of random-walk ex-change rates and economic fundamentals within a canonical, two-country, incomplete market model. Bayesian posterior simulation exercises of a two-country model based on post-Bretton Woods data from Canada and the United States reveal difficulties in reconciling the equilibrium random-walk proposition within the two-country model; in particular, the market discount factor is identified as being much lower than one.
    Keywords: Exchange rates, Present-value model, Economic fundamentals, Random walk, Two- country model, Incomplete markets, Cointegrated TFPs, Debt elastic risk premium
    JEL: E31 E37 F41
    Date: 2013–09
  16. By: Hajime Tomura (Graduate School of Economics and Business Administration,Hokkaido University)
    Abstract: This paper presents a dynamic matching model featuring dealers and short-term investors in an over-the-counter bond market. The model illustrates that bilateral bar- gaining in an over-the-counter market results in an endogenous bond-liquidation cost for short-term investors. This cost makes short-term investors need repurchase agree- ments to buy long-term bonds. The cost also explains the existence of a margin specific to repurchase agreements held by short-term investors, if repurchase agreements must be renegotiation-proof. Without repurchase agreements, short-term investors do not buy long-term bonds. In this case, the bond yield rises unless dealers have enough capital to buy and hold bonds.
    Keywords: Repo; Over-the-counter market; Securities broker-dealer; Short-term in-vestor; Margin.
    JEL: G24
    Date: 2013–02
  17. By: Henrique S. Basso (Banco de España); James Costain (Banco de España)
    Abstract: This paper studies the effects of delegating control of sovereign debt issuance to an independent authority in a monetary union where public spending decisions are decentralized. The model assumes that no policy makers are capable of commitment to a rule. However, consistent with Rogoff (1985) and with the recent history of central banking, it assumes that an institution may be designed to have a strong preference for achieving some clear, simple, quantitative policy goal. Following Beetsma and Bovenberg (1999), we show that in a monetary union where a single central bank interacts with many member governments, debt is excessive relative to a social planner’s solution. We extend their analysis by considering the establishment of an independent fiscal authority (IFA) mandated to maintain long-run budget balance. We show that delegating sovereign debt issuance to an IFA in each member state shifts down the time path of debt, because this eliminates aspects of deficit bias inherent in democratic politics. Delegating to a single IFA at the union level lowers debt further, because common pool problems across regions’ deficit choices are internalized. The establishment of a federal government with fiscal powers over the whole monetary union would be less likely to avoid excessive deficits, because only the second mechanism mentioned above would apply. Moreover, the effective level of public services would be lower, if centralized spending decisions are less informationally efficient
    Keywords: fi scal authority, delegation, decentralization, monetary union, sovereign debt
    JEL: E61 E62 F41 H63
    Date: 2013–09
  18. By: Rong Hai (Department of Economics, University of Chicago); Dirk Krueger (Department of Economics, University of Pennsylvania); Andrew Postlewaite (Department of Economics, University of Pennsylvania)
    Abstract: We propose a new classification of consumption goods into nondurable goods, durable goods and a new class which we call “memorable" goods. A good is memorable if a consumer can draw current utility from its past consumption experience through memory. We propose a novel consumption-savings model in which a consumer has a well-defined preference ordering over both nondurable goods and memorable goods. Memorable goods consumption differs from nondurable goods consumption in that current memorable goods consumption may also impact future utility through the accumulation process of the stock of memory. In our model, households optimally choose a lumpy profile of memorable goods consumption even in a frictionless world. Using Consumer Expenditure Survey data, we then document levels and volatilities of different groups of consumption goods expenditures, as well as their expenditure patterns, and show that the expenditure patterns on memorable goods indeed differ significantly from those on nondurable and durable goods. Finally, we empirically evaluate our model's predictions with respect to the welfare cost of consumption fluctuations and conduct an excess-sensitivity test of the consumption response to predictable income changes. We find that (i) the welfare cost of household-level consumption fluctuations may be overstated by 1:7 percentage points (11:9% points as opposed to 13:6% points of permanent consumption) if memorable goods are not appropriately accounted for; (ii) the finding of excess sensitivity of consumption documented in important papers of the literature might be entirely due to the presence of memorable goods.
    Keywords: Memorable Goods, Consumption Volatility, Welfare Cost
    JEL: D91 E21
    Date: 2013–08–23
  19. By: Yuki Teranishi
    Abstract: We investigate a new source of economic stickiness: namely, staggered loan interest rate contracts under monopolistic competition. The paper introduces this mechanism into a standard New Keynesian model. Simulations show that a response to a financial shock is greatly amplified by the staggered loan contracts though a response to a productivity, cost-push or monetary policy shock is not much affected. We derive an approximated loss function and analyse optimal monetary policy. Unlike other models, the function includes a quadratic loss of the first-order difference in loan rates. Thus, central banks have an incentive to smooth the policy rate.
    Keywords: Staggered loan interest rate, economic fluctuation, optimal monetary policy
    JEL: E32 E44 E52 G21
    Date: 2013–07

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