nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2013‒10‒25
eighteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Money Targeting, Heterogeneous Agents and Dynamic Instability By Giorgio Motta; Patrizio Tirelli
  2. Export dynamics in large devaluations By George Alessandria; Sangeeta Pratap; Vivian Yue
  3. Macroprudential and Monetary Policies: Implications for Financial Stability and Welfare By José A Carrasco-Gallego; Margarita Rubio
  4. Macroprudential Measures, Housing Markets and Monetary Policy By José A Carrasco-Gallego; Margarita Rubio
  5. Recent Reforms in Spanish Housing Markets: An Evaluation using a DSGE Model By Juan S Mora-Sanguinetti; Margarita Rubio
  6. Green Spending Reforms, Growth and Welfare with Endogenous Subjective Discounting By Eugenia Vella; Evangelos Dioikitopoulos; Sarantis Kalyvitis
  7. Consumption Inequality and Discount Rate Heterogeneity By Gang Sun
  8. Illiquid Life Annuities By d'Albis, Hippolyte; Etner, Johanna
  9. Evaluating unconventional monetary policies -why aren’t they more effective? By Yi Wen
  10. Complete Markets Strikes Back: Revisiting Risk Sharing Tests under Discount Rate Heterogeneity By Gang Sun
  11. The Consequences of Uncertain Debt Targets By Alexander W. Richter; Nathaniel A. Throckmorton
  12. Fiscal rules and the maximum sustainable size of the public debt in the Diamond overlapping generations model By Mark A Roberts
  13. Family connections and entrepreneurial human capital: The uncertain destiny of proprietary capitalism By Maria Rosaria Carillo; Vincenzo Lombardo; Alberto Zazzaro
  14. Vieillissement démographique, longévité et épargne. Le cas du Maroc By Loumrhari, Ghizlan
  15. Optimal growth under a climate constraint By Amigues, Jean-Pierre; Moreaux, Michel
  16. Linkages across Sovereign Debt Markets By Cristina Arellano; Yan Bai
  17. Money as a Unit of Account By Matthias Doepke; Martin Schneider
  18. A theory of investment and energy use By Antonia Díaz; Luis A. Puch

  1. By: Giorgio Motta; Patrizio Tirelli
    Abstract: Following a seminal contribution by Bilbiie (2008), the Limited Asset Market Participation hypothesis has triggered a debate on DSGE models determinacy when the central bank implements a standard Taylor rule. We reconsider the issue here in the context of an exogenous money supply rule, documenting the role of nominal and real frictions in determining these results. A general conclusion is that frictions matter for stability insofar as they redistribute income between Ricardian and non-Ricardian households when shocks hit the economy. Finally, we extend the model to allow for the possibility that consumers who do not participate to the market for interest-bearing securities hold money. In this case endogenous monetary transfers between the two groups allow to smooth consumption differences and the model is determinate provided that the non-negativity constraint on individual money holdings is satisfied.
    Keywords: Rule of Thumb Consumers, DSGE, Determinacy, Limited Asset Market Participation, Money Targeting
    JEL: E52 E58
    Date: 2013–10
  2. By: George Alessandria; Sangeeta Pratap; Vivian Yue
    Abstract: We study the source and consequences of sluggish export dynamics in emerging markets following large devaluations. We document two main features of exports that are puzzling for standard trade models. First, given the change in relative prices, exports tend to grow gradually following a devaluation. Second, high interest rates tend to suppress exports. To address these features of export dynamics, we embed a model of endogenous export participation due to sunk and per period export costs into an otherwise standard small open economy. In response to shocks to productivity, the interest rate, and the discount factor, we find the model can capture the salient features of export dynamics documented. At the aggregate level, the features giving rise to sluggish exports lead to more gradual net export reversals, sharper contractions and recoveries in output, and endogenous stagnation in labor productivity.
    Date: 2013
  3. By: José A Carrasco-Gallego; Margarita Rubio
    Abstract: In this paper, we analyse the implications of macroprudential and monetary policies for business cycles, welfare, and .nancial stability. We consider a dynamic stochastic general equilibrium (DSGE) model with housing and collateral constraints. A macroprudential rule on the loan-to-value ratio (LTV), which responds to output and house price deviations, interacts with a traditional Taylor rule for monetary policy. From a positive perspective, introducing a macroprudential tool mitigates the effects of booms in the economy by restricting credit. However, monetary and macroprudential policies may enter in conflict when shocks come from the supply-side of the economy. From a normative point of view, results show that the introduction of this macroprudential measure is welfare improving. Then, we calculate the combination of policy parameters that maximizes welfare and find that the optimal LTV rule should respond relatively more aggressively to house prices than to output deviations. Finally, we study the efficiency of the policy mix. We propose a tool that includes not only the variability of output and inflation but also the variability of borrowing, to capture the effects of policies on financial stability: a three-dimensional policy frontier (3DPF). We find that both policies acting together unambiguously improve the stability of the system.
    Keywords: Macroprudential, monetary policy, welfare, financial stability, three-dimensional policy frontier, loan-to-value, Taylor curve
  4. By: José A Carrasco-Gallego; Margarita Rubio
    Abstract: The recent financial crisis has raised the discussion among policy makers and researchers on the need of macroprudential policies to avoid systemic risks in financial markets. However, these new measures need to be combined with the traditional ones, namely monetary policy. The aim of this paper is to study how the interaction of macroprudential and monetary policies affect the economy. We take as a baseline a dynamic stochastic general equilibrium (DSGE) model which features a housing market in order to evaluate the performance of a rule on the loan-to-value ratio (LTV) interacting with the traditional monetary policy conducted by central banks. We find that, introducing the macroprudential rule mitigates the effects of booms on the economy by restricting credit. From a normative perspective, results show that the combination of monetary policy and the macroprudential rule is unambiguously welfare enhancing, especially when monetary policy does not respond to output and house prices and only to inflation.
    Keywords: Macroprudential, monetary policy, collateral constraint, credit,loan-to-value
  5. By: Juan S Mora-Sanguinetti; Margarita Rubio
    Abstract: After a long academic debate, Spain finally repealed in 2012 the deduction for home purchase. The abrogation took effect in 2013. In parallel, the VAT for the purchase of new housing was increased after a short period in which it had a reduced rate. The aim of this paper is to assess the macroeconomic effects of these two relevant housing market reforms. In order to do that, we use a dynamic stochastic general equilibrium (DSGE) model calibrated to capture the key ratios of the Spanish economy. The model includes a housing market, covering both the rental market side and the property market side and credit-constrained agents. We find that these measures drive down housing prices and have a negative impact on output and employment in the construction sector. However, in the long run, this last effect is offset by the benefits of a reduction in distortionary taxes.
    Keywords: Housing Market Reforms, Rental Market, House Prices, Home Purchase Deduction, VAT on New Home Purchase
  6. By: Eugenia Vella; Evangelos Dioikitopoulos (Brunel University); Sarantis Kalyvitis (DIEES, AUEB)
    Abstract: This paper studies optimal fiscal policy, in the form of taxation and the allocation of tax revenues between infrastructure and environmental investment, in a general-equilibrium growth model with endogenous subjective discounting. A green spending reform, defined as a reallocation of government expenditures towards the environment, can procure a double dividend by raising growth and improving environmental conditions, although the environment does not impact the production technology. Also, endogenous Ramsey fiscal policy eliminates the possibility of an `environmental and economic poverty trap'. Contrary to the case of exogenous discounting, green spending reforms are the optimal response of the Ramsey government to a rise in the agents' environmental concerns.
    Keywords: endogenous time preference, growth, environmental quality, second-best fiscal policy
    JEL: D90 E21 E62 H31
  7. By: Gang Sun (University of St Andrews)
    Abstract: Although standard incomplete market models can account for the magnitude of the rise in consumption inequality over the life cycle, they generate unrealistically concave age profiles of consumption inequality and unrealistically less wealth inequality. In this paper, I investigate the role of discount rate heterogeneity on consumption inequality in the context of incomplete market life cycle models. The distribution of discount rates is estimated using moments from the wealth distribution. I find that the model with heterogeneous income profiles (HIP) and discount rate heterogeneity can successfully account for the empirical age profile of consumption inequality, both in its magnitude and in its non-concave shape. Generating realistic wealth inequality, this simulated model also highlights the importance of ex ante heterogeneities as main sources of life time inequality.
    Keywords: consumption inequality discount rate heterogeneity life cycle risk sharing
    JEL: D31 D91 E21
  8. By: d'Albis, Hippolyte; Etner, Johanna
    Abstract: In this article, we consider illiquid life annuity contracts and show that they may be preferred to Yaari (1965)’s liquid contracts. In an overlapping-generation economy, liquid life annuities are demanded only if the equilibrium is dynamically inefficient. Alternatively, an equilibrium displaying a positive demand for illiquid life annuities is efficient. In this latter case, the welfare at steady-state is larger if illiquid life annuity contracts are available.
    Keywords: Lifes Annuities; Overlapping generation models
    JEL: D11
    Date: 2013–07–16
  9. By: Yi Wen
    Abstract: We use a general equilibrium finance model that features explicit government purchases of private debts to shed light on some of the principal working mechanisms of the Federal Reserve’s large-scale asset purchases (LSAP) and their macroeconomic effects. Our model predicts that unless private asset purchases are highly persistent and extremely large (on the order of more than 50% of annual GDP), money injections through LSAP cannot effectively boost aggregate output and employment even if inflation is fully anchored and the real interest rate significantly reduced. Our framework also sheds light on some long- standing financial puzzles and monetary policy questions facing central banks around the world, such as (i) the fight to liquidity under a credit crunch and debt crisis, (ii) the liquidity trap, (iii) the inverted yield curve, and (iv) the low inflation puzzle under quantitative easing.
    Keywords: Monetary policy ; Liquidity (Economics) ; Inflation (Finance)
    Date: 2013
  10. By: Gang Sun (University of St Andrews)
    Abstract: Recent risk sharing tests strongly reject the hypothesis of complete markets, because in the data: (1) the individual consumption comoves with income and (2) the consumption dispersion increases over the life cycle. In this paper, I revisit the implications of these risk sharing tests in the context of a complete market model with discount rate heterogeneity, which is extended to introduce the individual choices of e¤ort in education. I find that a complete market model with discount rate heterogeneity can pass both types of the risk sharing tests. The endogenous positive correlation between income growth rate and patience makes the individual consumption comove with income, even if the markets are complete. I also show that this model is quantitatively admissible to account for both the observed comovement of consumption and income and the increase of consumption dispersion over the life cycle.
    Keywords: complete markets, discount rate heterogeneity, risk sharing
    JEL: E21 D31 D58 D91
  11. By: Alexander W. Richter; Nathaniel A. Throckmorton
    Abstract: Recent proposals to reduce U.S. debt reveal large differences in their implied targets. These differences demonstrate the uncertainty surrounding future tax rates and long-run debt targets. We use a standard real business cycle model in which a Bayesian household learns about the state-dependent debt target in an endogenous tax rule. The household extracts the debt target state from a noisy tax process and jointly estimates the transition probabilities. We compare the household's ability to learn and the consequences of the uncertainty across different limited information sets. The information set influences the household's behavior but also impose two-sided risk. Despite the popular viewpoint that fiscal uncertainty has negative effects, limited information can result in welfare gains or losses, depending on whether the household's expectations are consistent with the realization of future states. Although the welfare distribution includes gains, we stress that the uncertainty created by the recent fiscal policy debate slowed the recovery and led to welfare losses. When Congress provides clarity about future policy, output and welfare increase and the economy quickly recovers.
    Keywords: Bayesian learning; Limited information; Fiscal uncertainty; Welfare
    JEL: D83 E32 E62 H68
    Date: 2013–10
  12. By: Mark A Roberts
    Abstract: We show that the size of the maximum sustainable public debt in the Diamond (1965) OLG model depends on the choice of fiscal instrument. If tax revenue is exogenous, there is a maximum at an interior or bifurcation point, as in Rankin and Roffia’s (2003) initial paper but at a generally higher level than for their case of an exogenous debt. Conversely, if income tax rates are exogenous, the technical maximum is at a corner-point of degeneracy, provided the first Inada condition holds. However, as this implies notional average taxes of 100%, a Laffer Curve becomes important, giving rise to another concept of the maximum debt. More generally, for this closed economy case, the form of the production function in conjunction with the fiscal rule will determine whether the maximum debt is reached at a technical point of bifurcation or at a more behavioural one where tax payers en masse deny further payments to bond holders.
  13. By: Maria Rosaria Carillo (University of Naples Parthenope); Vincenzo Lombardo (University of Naples Parthenope); Alberto Zazzaro (Universit… Politecnica delle Marche, MoFiR)
    Abstract: Two general conclusions can be drawn from the historical and empirical economic research on family firms: (1) it is impossible to identify a single definitive destiny for proprietary capitalism in the process of industrial development regardless of the cultural and institutional context in which the family firms operate; (2) in the same or similar economic environments well-performing (well managed) coexist with underperforming (poorly managed) family firms. In this paper, we develop an overlapping generations model, where agents are endowed with heterogeneous innate talent, and family firms have a comparative advantage over non-family enterprises as they have access to an additional source of immaterial capital, namely the network of family connections. Our results accommodate both the polarization of family firms into two groups with different levels of profitability and the uncertain destiny of proprietary capitalism between a crony and an entrepreneurial society, depending on the institutional framework and technological dynamism of the economy.
    Keywords: Family firms, allocation of talents, economic growth, family connections, technological change
    JEL: J62 L26 O40
    Date: 2013–10
  14. By: Loumrhari, Ghizlan
    Abstract: In this paper we investigate empirically the relationship between population aging begins in Morocco and private savings. To do this, we use an overlapping generations model (OLG) and annual data from 1980 to 2010. Econometric estimates show that if the increase in the dependency ratio negatively affects the growth rate of savings, as predicted by the lifecycle theory, longevity to the contrary tends to stimulate the same savings. However, it seems that the first effect outweighs the second. Economic policies to promote private savings and incentives for households to have more children are needed to meet the challenge of severe aging population which will face Morocco in the coming decades.
    Keywords: Population aging, private saving, OLG model
    JEL: C13 E21 J11
    Date: 2013–09
  15. By: Amigues, Jean-Pierre; Moreaux, Michel
    Abstract: Inside a standard growth model with exhaustible resources, we study the optimal growth policy of an economy submitted to a climate constraint, taking the form of a ceiling over admissible atmospheric carbon concentrations. The optimal scenario is a three phases path: a rise of carbon concentrations until the carbon cap is attained followed by a time phase constrained by the ceiling on possible emissions and a last unconstrained phase of resource depletion. Depending upon the primitives of the model we show that the optimal path may be of two main kinds: paths characterized by a positive growth of the economy and paths corresponding to a complex structural adjustment process involving negative growth during some time interval.
    Keywords: Carbon pollution; economic growth; exhaustible resources
    JEL: Q00 Q32 Q43 Q54
    Date: 2013–01
  16. By: Cristina Arellano; Yan Bai
    Abstract: We develop a multicountry model in which default in one country triggers default in other countries. Countries are linked to one another by borrowing from and renegotiating with common lenders with concave payoffs. A foreign default increases incentives to default at home because it makes new borrowing more expensive and defaulting less costly. Foreign defaults tighten home bond prices because they lower lenders' payoffs. Foreign defaults make home default less costly by lowering future recoveries, because countries can extract more surplus if they renegotiate simultaneously. In our model, the home country may default only because the foreign country is defaulting. This dependency arises during fundamental foreign defaults, where the foreign country defaults because of high debt and low income, and also during self-fulfilling defaults, where both countries default only because the other is defaulting. The simultaneity in defaults induces a correlation in interest rate spreads across countries. The model can rationalize some of the recent economic events in Europe.
    JEL: F3 G01
    Date: 2013–10
  17. By: Matthias Doepke; Martin Schneider
    Abstract: We develop a theory that rationalizes the use of a dominant unit of account in an economy. Agents enter into non-contingent contracts with a variety of business partners. Trade unfolds sequentially in credit chains and is subject to random matching. By using a dominant unit of account, agents can lower their exposure to relative price risk, avoid costly default, and create more total surplus. We discuss conditions under which it is optimal to adopt circulating government paper as the dominant unit of account, and the optimal choice of "currency areas" when there is variation in the intensity of trade within and across regions.
    JEL: E4 E5 F33
    Date: 2013–10
  18. By: Antonia Díaz; Luis A. Puch
    Abstract: In this paper we propose a theory of investment and energy use to study the response of macroeconomic aggregates to energy price shocks. In our theory this response depends on the interaction between the energy efficiency built in capital goods (which is irreversible throughout their lifetime) and the growth rate of Investment Specific Technological Change (ISTC hereafter). We show that ISTC is a sort of energysaving technical change and, therefore, a substitute of energy efficiency: it rises the productivity of capital without rising energy use, which increases effective energy efficiency (i.e., the amount of energy use required per unit of quality-adjusted capital). Hence, our theory can account for the fall of energy use per unit of output observed during the 1990s, a period in which energy prices fell below trend. By increasing investment in the years of high ISTC growth, the economy was increasing the average efficiency of the economy (the capital-energy ratio), shielding the economy against the impact of the 2003-08 price shock.
    Keywords: Energy use, Vintage capital, Energy price shocks, Investment-specific technology shocks
    JEL: E22 E23
    Date: 2013–09

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