nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2013‒09‒26
nineteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Credit disruptions and the spillover effects between the household and business sectors By Nilavongse, Rachatar
  2. Zero Lower Bound and Parameter Bias in an Estimated DSGE Model By Yasuo Hirose; Atsushi Inoue
  3. Credit Constraints, Productivity Shocks and Consumption Volatility in Emerging Economies By Rudrani Bhattacharya; Ila Patnaik
  4. Social capital, product imitation and growth with learning externalities By Agenor, Pierre-Richard; Dinh, Hinh T.
  5. Intersectoral Linkages, Diverse Information, and Aggregate Dynamics in a Neoclassical Model By Manoj Atolia; Ryan Chahrour
  6. Perturbation Methods for Markov-Switching DSGE Models By Foerster, Andrew; Rubio-Ramírez, Juan Francisco; Waggoner, Daniel F; Zha, Tao
  7. A Model of Aggregate Demand and Unemployment By Michaillat, Pascal; Saez, Emmanuel
  8. Houses as ATMs? Mortgage Refinancing and Macroeconomic Uncertainty By Hui Chen; Michael Michaux; Nikolai Roussanov
  9. Immigration, Wages, and Education: A Labor Market Equilibrium Structural Model By Joan Llull
  10. Imperfect rationality, macroeconomic equilibrium and price rigidities By Giuseppe Ciccarone; Francesco Giuli; Enrico Marchetti
  11. Rational Housing Bubble By Bo Zhao
  12. Sudden stops, time inconsistency, and the duration of sovereign debt By Juan Carlos Hatchondo; Leonardo Martinez
  13. Options and Strategies for Fiscal Consolidation in India By Sampawende J.-A. Tapsoba
  14. The regime-dependent evolution of credibility: A fresh look at Hong Kong’s linked exchange rate system By Blagov , Boris; Funke, Michael
  15. Risks to price stability, the zero lower bound and forward guidance: a real-time assessment By Coenen, Günter; Warne, Anders
  16. Household Finance: Education, Permanent Income and Portfolio Choice By Russell Cooper; Guozhong Zhu
  17. Endogenous Grids in Higher Dimensions: Delaunay Interpolation and Hybrid Methods By Ludwig, Alexander; Schön, Matthias
  18. State Dependent Monetary Policy By Francesco Lippi; Stefania Ragni; Nicholas Trachter
  19. Policy design with private sector skepticism in the textbook New Keynesian model By Yang Lu; Ernesto Pasten; Robert King

  1. By: Nilavongse, Rachatar
    Abstract: This paper studies the effects of credit supply disruptions in a dynamic stochastic general equilibrium (DSGE) framework. First, this paper examines the effects of credit supply disruptions in the business sector. The model with financially constrained households generates a bigger decline in aggregate consumption and GDP than the model without financially constrained households. The reason is that the spillover effect from the business sector to the household sector occurs through a labor income channel. With financially constrained households in the model, a collateral channel strengthens the spillover effects and amplifies business cycles. Then this paper examines the effects of credit supply disruptions in the household sector. A tightening of household credit conditions causes a substantial drop in aggregate consumption, which pushes inflation downward. Debt deflation further depresses consumption, labor demand, and investment, altogether generating a sharp decline in GDP. --
    Keywords: financially constrained households,entrepreneurs,credit conditions,spillover effects,housing prices,collateral value
    JEL: E31 E32 E44 G01
    Date: 2013
  2. By: Yasuo Hirose; Atsushi Inoue
    Abstract: This paper examines how and to what extent parameter estimates can be biased in a dynamic stochastic general equilibrium (DSGE) model that omits the zero lower bound constraint on the nominal interest rate. Our experiments show that most of the parameter estimates in a standard sticky-price DSGE model are not biased although some biases are detected in the estimates of the monetary policy parameters and the steady-state real interest rate. Nevertheless, in our baseline experiment, these biases are so small that the estimated impulse response functions are quite similar to the true impulse response functions. However, as the probability of hitting the zero lower bound increases, the biases in the parameter estimates become larger and can therefore lead to substantial differences between the estimated and true impulse responses.
    Keywords: Zero lower bound, DSGE model, Parameter bias, Bayesian estimation
    JEL: C32 E30 E52
    Date: 2013–09
  3. By: Rudrani Bhattacharya; Ila Patnaik
    Abstract: How does access to credit impact consumption volatility? Theory and evidence from advanced economies suggests that greater household access to finance smooths consumption. Evidence from emerging markets, where consumption is usually more volatile than income, indicates that financial reform further increases the volatility of consumption relative to output. We address this puzzle in the framework of an emerging economy model in which households face shocks to trend growth rate, and a fraction of them are credit constrained. Unconstrained households can respond to shocks to trend growth by raising current consumption more than rise in current income. Financial reform increases the share of such households, leading to greater relative consumption volatility. Calibration of the model for pre and post financial reform in India provides support for the model's key predictions.
    Keywords: Credit;Emerging markets;India;Productivity;Consumption;External shocks;Household credit;Access to capital markets;Economic models;Macroeconomics, real business cycles, emerging market business cycle stylized facts, financial development.
    Date: 2013–05–22
  4. By: Agenor, Pierre-Richard; Dinh, Hinh T.
    Abstract: Links between social capital, human capital, and product imitation are studied in an overlapping generations model of endogenous growth where the key benefit of social capital is to promote imitation. There is also a two-way interaction between imitation and human capital. Building social capital (which brings direct utility) requires time. Because life expectancy is endogenously related to human capital, time allocation between market work and social capital accumulation is also endogenously determined. Social capital accumulation depends also on access to infrastructure. The model is calibrated numerically for a low-income country. A policy that helps to promote social capital accumulation may be very effective to foster economic growth, even if it involves offsetting cuts in other productive components of government spending, such as education outlays or infrastructure investment. Offsetting cuts in infrastructure investment, however, may be less effective.
    Keywords: Political Economy,Economic Theory&Research,Debt Markets,Social Capital,Emerging Markets
    Date: 2013–09–01
  5. By: Manoj Atolia (Florida State University); Ryan Chahrour (Boston College)
    Abstract: What do firms learn from their interactions in markets, and what are the implications for aggregate dynamics? We address this question in a multi-sector real-business cycle model with a sparse input-output structure. In each sector, firms observe their own productivity, along with the prices of their inputs and the price of their output. We show that general equilibrium market-clearing conditions place heavy constraints on average expectations, and characterize a set of cases where average expectations (and average dynamics) are exactly those of the full-information model. This "aggregate irrelevance" of information can occur even when sectoral expectations and dynamics are quite different under partial information, and despite the fact that each sector represents a non-negligible portion of the overall economy. In numerical examples, we show that even when the conditions for aggregate irrelevance of information are not met, aggregate dynamics remain nearly identical to the full-information model under reasonable calibrations.
    Keywords: Imperfect information, Information frictions, Dispersed information, Sectoral linkages, Strategic complementarity, Higher-order expectations
    JEL: D52 D57 D80 E32
    Date: 2013–09–16
  6. By: Foerster, Andrew; Rubio-Ramírez, Juan Francisco; Waggoner, Daniel F; Zha, Tao
    Abstract: This paper develops a general perturbation methodology for constructing high-order approximations to the solutions of Markov-switching DSGE models. We introduce an important and practical idea of partitioning the Markov-switching parameter space so that a steady state is well defined. With this definition, we show that the problem of definding an approximation of any order can be reduced to solving a system of quadratic equations. We propose using the theory of Grobner bases in searching all the solutions to the quadratic system. This approach allows us to obtain all the approximations and ascertain how many of them are stable. Our methodology is applied to three models to illustrate its feasibility and practicality.
    Keywords: DSGE; Markov-Switching; Perturbation
    JEL: E17 E37
    Date: 2013–05
  7. By: Michaillat, Pascal; Saez, Emmanuel
    Abstract: We present a static model of aggregate demand and unemployment. The economy has a nonproduced good, a produced good, and labor. Product and labor markets have matching frictions. A general equilibrium is a set of prices, market tightnesses, and quantities such that buyers and sellers optimize given prices and tightnesses, and actual tightnesses equal posted tightnesses. In each frictional market, there is one more variable than equilibrium condition. To close the model, we take all prices as parameters. We obtain the following results: (1) unemployment and unsold production prevail in equilibrium; (2) each market can be slack, efficient, or tight if the price is too high, efficient, or too low; (3) product market tightness and sales are positively correlated under aggregate demand shocks but negatively correlated under aggregate supply shocks; (4) transfers from savers to spenders stimulate aggregate demand, product market tightness, and employment; (5) the government-purchase multiplier is positive when the economy is slack, zero when the economy is efficient, and negative when the economy is tight; (6) with unequal distribution of profits and labor income, a wage increase may stimulate aggregate demand and reduce unemployment.
    Keywords: Aggregate Demand; Labor Market Tightness; Unemployment
    JEL: E24 E32 J64
    Date: 2013–08
  8. By: Hui Chen; Michael Michaux; Nikolai Roussanov
    Abstract: We estimate a structural model of household liquidity management in the presence of long-term mortgages. Households face counter-cyclical idiosyncratic labor income uncertainty and borrowing constraints, which affect optimal choices of leverage, precautionary saving in liquid assets and illiquid home equity, debt repayment, mortgage refinancing, and default. Taking the observed historical path of house prices, aggregate income, and interest rates as given, the model quantitatively accounts for the run-up in household debt and consumption boom prior to the financial crisis, their subsequent collapse, and mild recovery following the Great Recession, especially among the most constrained households.
    JEL: E21 E44 G21
    Date: 2013–09
  9. By: Joan Llull
    Abstract: This paper analyzes the effect of immigration on wages taking into account human capital and labor supply adjustments. Using U.S. micro-data for 1967-2007, I estimate a labor market equilibrium model that includes endogenous decisions on education, participation, and occupation, and allows for skill-biased technical change. Results suggest important labor market adjustments that mitigate the effect of immigration on wages. These adjustments include career switches, labor market detachment and changes in schooling decisions, and are heterogeneous across the workforce. The adjustments generate substantial self-selection biases at the lower tail of the wage distribution that are corrected by the estimated model.
    Keywords: immigration, wages, human capital, labor supply, dynamic discrete choice, labor market equilibrium
    JEL: J2 J31 J61
    Date: 2013–09
  10. By: Giuseppe Ciccarone; Francesco Giuli; Enrico Marchetti
    Abstract: We introduce some elements of Prospect Theory into a general equilibrium model with monopolistic competition in the good market and real wage rigidities due to (right to manage or efficient) wage bargaining, or to efficiency wages. We show that, under these types of labor market frictions, an increase in workers’ loss aversion: (i) reduces the equilibrium wage and in this way increases potential output; (ii) induces workers to work and consume less and in this way decreases potential output. If the former effect is greater (smaller) than the latter one, loss aversion increases(decreases) potential output. We also show that, under all the types of labor market frictions we consider, if loss aversion reduces equilibrium output, it also enhances the plausibility of nominal price rigidities.
    Keywords: Macroeconomic equilibrium; Prospect theory; Behavioral economics
    JEL: E20 D03
    Date: 2013–09
  11. By: Bo Zhao
    Abstract: This paper studies an economy inhabited by overlapping generations of homeowners and investors, with the only difference between the two being that homeowners derive utility from housing services whereas investors do not. Tight collateral constraint limits the borrowing capacity of homeowners and drives the equilibrium interest rate level down to the housing price growth rate, which makes housing attractive as a store of value for investors. As long as the rental market friction is high enough, the investors will hold a positive number of vacant houses in equilibrium. A housing bubble arises in an equilibrium in which investors hold houses for resale purposes only and without the expectation of receiving a dividend either in terms of utility or rent. The model can be applied to China, where the housing bubble can be attributed to the rapid decline in the replacement rate of the pension system.
    JEL: D21 E13 E21 R21
    Date: 2013–08
  12. By: Juan Carlos Hatchondo; Leonardo Martinez
    Abstract: We study the sovereign debt duration chosen by the government in the context of a standard model of sovereign default. The government balances off increasing the duration of its debt to mitigate rollover risk and lowering duration to mitigate the debt dilution problem. We present two main results. First, when the government decides the debt duration on a sequential basis, sudden stop risk increases the average duration by 1 year. Second, we illustrate the time inconsistency problem in the choice of sovereign debt duration: governments would like to commit to a duration that is 1.7 years shorter than the one they choose when decisions are made sequentially.
    Keywords: Sovereign debt;Borrowing;Economic models;sovereign debt, default, sudden stops, debt dilution, time inconsistency, debt maturity
    Date: 2013–07–19
  13. By: Sampawende J.-A. Tapsoba
    Abstract: The paper uses a multi-region DSGE model to quantify the macroeconomic implications of three adjustment scenarios for India: growth-friendly, social-friendly, and a benchmark case centered on bringing down unproductive spending and strengthening the consumption tax. Simulations indicate that fiscal consolidation yields considerable long-term benefits but also entails output costs in the near term. The scenarios in which deficit reduction is accompanied by greater investment and social spending lead to better results than the benchmark case. The consolidation package alone is not enough to maximize net gains. Other factors, such as the pace and the credibility of consolidation, the concomitant implementation of structural reforms, and global economic conditions, play a critical role in the success of fiscal consolidation.
    Keywords: Fiscal consolidation;India;Economic growth;Fiscal reforms;Economic models;fiscal consolidation, open economy macroeconomics, DSGE models, India.
    Date: 2013–05–29
  14. By: Blagov , Boris (BOFIT); Funke, Michael (BOFIT)
    Abstract: An estimated Markov-switching DSGE modelling framework that allows for parameter shifts across regimes is employed to test the hypothesis of regime-dependent credibility of Hong Kong’s linked exchange rate system. The model distinguishes two regimes with respect to the time-series properties of the risk premium. Regime-dependent impulse responses to macroeconomic shocks reveal substantial differences in spreads. These findings contribute to efforts at modelling exchange rate regime credibility as a non-linear process with two distinct regimes.
    Keywords: Markov-switching DSGE models; exchange rate regime credibility; Hong Kong
    JEL: C51 C52 E32 F41
    Date: 2013–09–04
  15. By: Coenen, Günter; Warne, Anders
    Abstract: This paper employs stochastic simulations of the New Area-Wide Model—a micro-founded open-economy model developed at the ECB—to investigate the consequences of the zero lower bound on nominal interest rates for the evolution of risks to price stability in the euro area during the recent financial crisis. Using a formal measure of the balance of risks, which is derived from policy-makers’ preferences about inflation outcomes, we first show that downside risks to price stability were considerably greater than upside risks during the first half of 2009, followed by a gradual rebalancing of these risks until mid-2011 and a renewed deterioration thereafter. We find that the lower bound has induced a noticeable downward bias in the risk balance throughout our evaluation period because of the implied amplification of deflation risks. We then illustrate that, with nominal interest rates close to zero, forward guidance in the form of a time-based conditional commitment to keep interest rates low for longer can be successful in mitigating downside risks to price stability. However, we find that the provision of time-based forward guidance may give rise to upside risks over the medium term if extended too far into the future. By contrast, time-based forward guidance complemented with a threshold condition concerning tolerable future inflation can provide insurance against the materialisation of such upside risks. JEL Classification: E31, E37, E52, E58
    Keywords: deflation, DSGE modelling, euro area, forward guidance, monetary policy, zero lower bound
    Date: 2013–08
  16. By: Russell Cooper; Guozhong Zhu
    Abstract: This paper studies household financial choices: why are these decisions dependent on the education level of the household? A life cycle model is constructed to understand a rich set of facts about decisions of households with different levels of education attainment regarding stock market participation, stock share in wealth, stock adjustment rate and wealth-income ratio. The model, including preferences and both participation and portfolio adjustment costs, is estimated to match the asset allocation decisions of different education groups. Using the estimated parameters we argue that education matters for financial decisions mainly through its effect on mean income. We also study the sensitivity of household financial decisions to: (i) government programs that support consumption floors and (ii) changes in reimbursement for medical expenditures.
    JEL: D14 E21 G11
    Date: 2013–09
  17. By: Ludwig, Alexander; Schön, Matthias (Munich Center for the Economics of Aging (MEA))
    Abstract: This paper investigates extensions of the method of endogenous grid-points (ENDGM) introduced by Carroll (2006) to higher dimensions with more than one continuous endogenous state variable. We compare three different categories of algorithms: (i) the conventional method with exogenous grids (EXGM), (ii) the pure method of endogenous grid-points (ENDGM) and (iii) a hybrid method (HEGM). ENDGM comes along with Delaunay interpolation on irregular grids. Comparison of methods is done by evaluating speed and accuracy. We find that HEGM and ENDGM both dominate EXGM. The choice between HEGM and ENDGM depends on the number of dimensions and the number of grid-points in each dimension. With less than 150 grid-points in each dimension ENDGM is faster than HEGM, and vice versa. For a standard choice of 20 to 40 grid-points in each dimension, ENDGM is 1:6 to 1:8 times faster than HEGM.
    JEL: C63 E21
    Date: 2013–09–10
  18. By: Francesco Lippi (University of Sassari and EIEF); Stefania Ragni (University of Sassari); Nicholas Trachter (EIEF)
    Abstract: We study the optimal anticipated monetary policy in a flexible-price economy featuring heterogenous agents and incomplete markets which give rise to a business cycle. The optimal policy prescribes monetary expansions in recessions, when insurance is most needed by cash-poor unproductive agents. To minimize the inflationary effect of these expansions the policy prescribes monetary contractions in good times. Although the optimal monetary policy varies greatly through the business cycle it "echoes" Friedman's principle in the sense that the money supply is regulated such that its expected real return approaches the rate of time preference.
    Date: 2013
  19. By: Yang Lu (Hong Kong University of Science and Technology); Ernesto Pasten (Banco Central de Chile and Toulouse School of Economics); Robert King (Boston University)
    Abstract: How should policy be optimally designed when a monetary authority faces a private sector that is somewhat skeptical about policy announcements and which interprets economic data as providing evidence about the monetary authority's preferences or its ability to carry through on policy plans? To provide an answer to this question, we extend the standard New Keynesian macroeconomic model to include imperfect inflation control (implementation error relative to an inflation action) and Bayesian learning by private agents about whether the monetary authority is the committed type (capable of following through on announced plans) or an alternative type (producing higher and more volatile inflation). In a benchmark case, we find that optimal policy involves dramatic anti-inflation actions which include an interval of deflation during the early stages of a plan, motivated by investing in a reputation for strength. Such policies resemble recommendations during the 1980s for a "cold turkey" approach to disinflation. However, we also find that such policy is not robustly optimal. A more "gradualist" policy arises if the initial level of credibility is very low. We also investigate a setting where the alternative monetary authority follows a simple behavioral rule that mimics variations in the committed authority's policy action but with a bias toward higher and more volatile inflation. In this case, which we call a "tag along" alternative policymaker, a form of gradualism is always optimal.
    Date: 2013

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