nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2013‒11‒02
thirty-two papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Monetary Policy with Heterogeneous Agents By Makoto Nakajima
  2. Sectoral Composition of Government Spending and Macroeconomic (In)stability By Juin-Jen Chang; Jang-Ting Guo; Jhy-Yuan Shieh; Wei-Neng Wang
  3. Monetary and Macroprudential Policy in an Estimated DSGE Model of the Euro Area By Dominic Quint; Pau Rabanal
  4. Solving and Estimating Indeterminate DSGE Models By Roger Farmer; Vadim Khramov
  5. Inflation Dynamics: The Role of Public Debt and Policy Regimes By Woong Yong Park; Jae Won Lee; Saroj Bhattarai
  6. External Habit in a Production Economy By Andrew Y. Chen
  7. Public Research Spending in an Endogenous Growth Model By Kunihiko Konishi
  8. Entry and markup dynamics in an estimated business cycle model By Vivien LEWIS; Arnaud STEVENS
  9. Public debt in an OLG model with imperfect competition: long-run effects of austerity programs and changes in the growth rate By Peter Skott; Soon Ryoo
  10. Managing Financial Crises: Lean or Clean? By Takayuki Tsuruga; Ryo Kato; Mitsuru Katagiri
  11. Unconventional government debt purchases as a supplement to conventional monetary policy By Martin Ellison
  12. A Stochastic Dynamic Model of Trade and Growth: Convergence and Diversi?cation By Partha Chatterjee; Malik Shukayev
  13. The Composition of Fiscal Consolidation Matters: Policy Simulations for Hungary By Alejandro D. Guerson
  14. Understanding Uncertainty Shocks By Laura Veldkamp; Anna Orlik
  15. Shopping Externalities and Self-Fulfilling Unemployment Fluctuations By Greg Kaplan; Guido Menzio
  16. An Evaluation of the Revenue side as a source of fiscal consolidation in high debt economies By Ritwik Banerjee
  17. On Learning and Growth By Leonard J. Mirman; Kevin Reffett; Marc Santugini
  18. The Formal Sector Wage Premium and Firm Size for Self-employed Workers By Olivier Bargain; Eliane El Badaoui; Prudence Kwenda; Eric Strobl; Frank Walsh
  19. Fiscal Reform and Government Debt in Japan: A Neoclassical Perspective By Gary D. Hansen; Selahattin Imrohoroglu
  20. Infectious Diseases and Economic Growth By Aditya Goenkay; Lin Liu; Manh-Hung Nguyen
  21. Endogenous Health in a Model of Calories, Medical Services and Health Shocks By Pedro Gomis Porqueras; Solmaz Moslehi; Richard M. H. Suen
  22. On the stability of money demand By Juan Nicolini
  23. On the Redistributive Effects of Inflation: an International Perspective By Boel, Paola
  24. Consumption, Market Price of Risk, and Wealth Accumulation under Induced Uncertainty By Luo, Yulei; Young, Eric
  25. Identifying Fiscal Inflation By De Graeve, Ferre; Queijo von Heideken, Virginia
  26. A Quantitative Theory of Credit Scoring By Xuan Tam; Eric Young; Kartik Athreya
  27. Assessing the Impact of the Maternity Capital Policy in Russia Using a Dynamic Model of Fertility and Employment By Slonimczyk, Fabian; Yurko, Anna
  28. Implementing a Fiscal Transfer Mechanism in a Heterogeneous Monetary Union: A DSGE approach. By Thierry Betti
  29. Inflation tax in the lab: a theoretical and experimental study of competitive search equilibrium with inflation By Nejat Anbarci; Richard Dutu; Nick Feltovich
  30. The Money Value of a Man By Mark Huggett; Greg Kaplan
  31. Approximate dynamic programming with postdecision states as a solution method for dynamic economic models By Hull, Isaiah
  32. An Order-Theoretic Approach to Dynamic Programming: An Exposition By Takashi Kamihigashi

  1. By: Makoto Nakajima (Federal Reserve Bank of Philadelphia)
    Abstract: We build a New Keynesian model in which heterogeneous workers differ with regard to their employment status due to search and matching frictions in the labor market, their potential labor income, and their amount of savings. We use this laboratory to quantitatively assess who stands to win or lose from unanticipated monetary accommodation and who benefits most from systematic monetary stabilization policy. We find substantial redistribution effects of monetary policy shocks; a contractionary monetary policy shock increases income and welfare of the wealthiest 5 percent, while the remaining 95 percent experience lower income and welfare. Consequently, the negative effect of a contractionary monetary policy shock to social welfare is larger if heterogeneity is taken into account.
    Date: 2013
  2. By: Juin-Jen Chang (Institute of Economics, Academia Sinica, Taipei, Taiwan); Jang-Ting Guo (University of California, Riverside, CA, USA); Jhy-Yuan Shieh (Department of Economics, Soochow University, Taipei, Taiwan); Wei-Neng Wang (Department of Economics, Soochow University, Taipei, Taiwan)
    Abstract: This paper examines the quantitative interrelations between sectoral composition of public spending and equilibrium (in)determinacy in a two-sector real business cycle model with positive productive externalities in investment. When government purchases of con- sumption and investment goods are set as constant fractions of their respective sectoral output, we show that the public-consumption share plays no role in the models local dynamics, and that a sufficiently high public-investment share can stabilize the economy against endogenous belief-driven cyclical uctuations. When each type of government spending is postulated as a constant proportion of the economys total output, we …find that there exists a trade-off between public consumption versus investment expenditures to yield saddle-path stability and equilibrium uniqueness.
    Keywords: Government Spending; Equilibrium (In)determinacy; Business Cycles
    JEL: E32 E62 O41
    Date: 2013–10
  3. By: Dominic Quint; Pau Rabanal
    Abstract: In this paper, we study the optimal mix of monetary and macroprudential policies in an estimated two-country model of the euro area. The model includes real, nominal and financial frictions, and hence both monetary and macroprudential policy can play a role. We find that the introduction of a macroprudential rule would help in reducing macroeconomic volatility, improve welfare, and partially substitute for the lack of national monetary policies. Macroprudential policy would always increase the welfare of savers, but their effects on borrowers depend on the shock that hits the economy. In particular, macroprudential policy may entail welfare costs for borrowers under technology shocks, by increasing the countercyclical behavior of lending spreads.
    Keywords: Monetary policy;Euro Area;European Economic and Monetary Union;Macroprudential Policy;Credit expansion;Economic models;Monetary Policy, EMU, Basel III, Financial Frictions.
    Date: 2013–10–14
  4. By: Roger Farmer; Vadim Khramov
    Abstract: We propose a method for solving and estimating linear rational expectations models that exhibit indeterminacy and we provide step-by-step guidelines for implementing this method in the Matlab-based packages Dynare and Gensys. Our method redefines a subset of expectational errors as new fundamentals. This redefinition allows us to treat indeterminate models as determinate and to apply standard solution algorithms. We provide a selection method, based on Bayesian model comparison, to decide which errors to pick as fundamental and we present simulation results to show how our procedure works in practice.
    Keywords: Economic models;Monetary policy;Indeterminacy, DSGE Models, Expectational Errors.
    Date: 2013–10–01
  5. By: Woong Yong Park (University of Hong Kong); Jae Won Lee (Rutgers University); Saroj Bhattarai (Pennsylvania State University)
    Abstract: We investigate the roles of a time-varying inflation target and monetary and fiscal policy stances on the dynamics of inflation in a DSGE model. Under an active monetary and passive fiscal policy regime, inflation closely follows the path of the inflation target and a stronger reaction of monetary policy to inflation decreases the equilibrium response of inflation to non-policy shocks. In sharp contrast, under an active fiscal and passive monetary policy regime, inflation moves in an opposite direction from the inflation target and a stronger reaction of monetary policy to inflation increases the equilibrium response of inflation to non-policy shocks. Moreover, a weaker response of fiscal policy to debt decreases the response of inflation to non-policy shocks. These results are due to variation in the value of public debt that leads to wealth effects on households. Finally, under a passive monetary and passive fiscal policy regime, both monetary and fiscal policy stances affect inflation dynamics, but because of a role for self-fulfilling beliefs due to equilibrium indeterminacy, theory provides no clear answer on the overall behavior of inflation. We characterize these results analytically in a simple model and numerically in a richer quantitative model.
    Date: 2013
  6. By: Andrew Y. Chen
    Abstract: A unified framework for understanding asset prices and aggregate fluctuations is critical for understanding both issues. I show that a real business cycle model with external habit preferences and capital adjustment costs provides one such framework. The estimated model matches the first two moments of the equity premium and risk-free rate, return and dividend predictability regressions, and the second moments of output, consumption, and investment. The model also endogenizes a key mechanism of consumption-based asset pricing models. In order to address the Shiller volatility puzzle, external habit, long-run risk, and disaster models require the assumption that the volatility of marginal utility is countercyclical. In the model, this countercyclical volatility arises endogenously. Production makes precautionary savings effects show up in consumption. These effects lead to countercyclical consumption volatility and countercyclical volatility of marginal utility. External habit amplifies this channel and makes it quantitatively significant.
    JEL: G12 E21 E30
    Date: 2013–10–22
  7. By: Kunihiko Konishi (Graduate School of Economics, Osaka University)
    Abstract: This study constructs a variety expansion growth model with public research spending, in which public researchers raise the productivity of private R&D. We show that the rela- tionship between public research spending and the growth rate follows an inverted U-shape. This is because public research spending increases private R&D productivity, but crowds out labor input to private R&D. It is also shown that the welfare-maximizing level of pub- lic research spending is below the growth-maximizing level. With regards to tax policy, a zero-proffit tax maximizes both growth and welfare. Finally, the study analyzes the stability of the steady state, showing that the equilibrium is indeterminate when the governmentfs revenue source depends on asset income tax.
    Keywords: Public expenditure, Endogenous growth, Innovation, Indeterminacy
    JEL: E62 O41
    Date: 2013–10
  8. By: Vivien LEWIS; Arnaud STEVENS
    Abstract: How do changes in market structure affect the US business cycle? We estimate a monetary DSGE model with endogenous firm/product entry and a translog expenditure function by Bayesian methods. The dynamics of net business formation allow us to identify the extent to which desired price markups and inflation decrease when entry rises. We find that a 1 percent increase in the number of competitors lowers desired markups by 0.17 percent. While markup fluctuations due to sticky prices or exogenous shocks account for a large proportion of US inflation variability, endogenous changes in desired markups also play a non-negligible role.
    Date: 2013–10
  9. By: Peter Skott (University of Massachusetts Amherst); Soon Ryoo (Adelphi University)
    Abstract: We show that (i) dynamic inefficiency may be empirically relevant in a modified Diamond model with imperfect competition, (ii) if fiscal policy is used to avoid inefficiency and maintain an optimal capital intensity, the required debt ratio will be inversely related to the growth rate, and (iii) austerity policies reductions in government consumption and entitlement programs for the old generation raise the required debt ratio.
    Keywords: Public debt, dynamic efficiency, growth effects, austerity
    JEL: E62 E22
    Date: 2013
  10. By: Takayuki Tsuruga (Kyoto Unviersity); Ryo Kato (Bank of Japan); Mitsuru Katagiri (Bank of Japan)
    Abstract: This paper discusses the lean vs. clean policy debate in managing financial crises based on dynamic general equilibrium models with an occasionally binding collateral constraint. We show that a full state-contingent subsidy for debtors can restore the first-best allocations by forestalling disorderly deleveraging in a crisis. While this result appears to favor the clean policy against a lean policy that achieves the second-best allocation, further assessment points to various risks associated with the clean policy from a practical viewpoint. First, the optimal clean policy is likely to call for an unrealistically large amount of fiscal resources. Second, if the clean policy is activated with an empirically realistic intervention, the less-than-optimal clean policy incentivizes debtors to take on undue risks, exposing the economy to higher crisis probabilities. Finally, the less-than-optimal clean policy may give rise to huge welfare losses due to the policy maker's misrecognition of the state of the economy.
    Date: 2013
  11. By: Martin Ellison
    Abstract: In response to the Great Financial Crisis, the Federal Reserve, the Bank of England and many other central banks have adopted unconventional monetary policy instruments.� We investigate if one of these, purchases of long-term government debt, could be a valuable addition to conventional short-term interest rate policy even if the main policy rate is not constrained by the zero lower bound.� To do so, we add a stylised financial sector and central bank asset purchases to an otherwise standard New Keynesian DSGE model.� Asset quantities matter for interest rates through a preferred habitat channel.� If conventional and unconventional monetary policy instruments are coordinated appropriately then the central bank is better able to stabilise both output and inflation.
    Keywords: Quantitative Easing, Large-Scale Asset Purchases, Preferred Habitat, Optimal Monetary Policy
    JEL: E40 E43 E52 E58
    Date: 2013–10–16
  12. By: Partha Chatterjee (FMS, University of Delhi, Delhi 110007); Malik Shukayev (Bank of Canada)
    Abstract: There is a growing literature that studies the properties of models that combine international trade and neoclassical growth theory, but mostly in a de- terministic setting. In this paper we introduce uncertainty in a dynamic Heckscher-Ohlin model and characterize the equilibrium of a small open economy in such an environment. We show that, when trade is balanced period-by-period, the per capita output and consumption of a small open economy converge to an invariant distribution that is independent of the initial wealth. Further, at the invariant distribution, there are periods in which the small economy diversi?es. Numerical simulations show that the speed of convergence increases with the size of the shocks. In the limit, when there is no uncertainty, there is no convergence and countries may specialize permanently. The paper highlights the role of market incompleteness, as a result of the period-by-period trade balance, in this setup. Through an analytical example we also illustrate the importance of country speci?c risk in delivering our results.
    Keywords: Economic Growth; International Trade; Heckscher-Ohlin; Convergence; Stochastic Growth Theory; Diversi?cation; Incomplete markets; Risk.
    JEL: F1 F4 O4 E2
    Date: 2013
  13. By: Alejandro D. Guerson
    Abstract: This paper evaluates policy alternatives to achieve permanent fiscal consolidation in Hungary, based on a general equilibrium calibration. The main finding is that the composition of the consolidation, as determined by the mix of revenue and expenditure measures, has important implications for growth, employment, investment, and other key macroeconomic variables. A reduction in current expenditures yields the smallest GDP contraction in the short term and can increase output in the long term by stimulating labor participation and private investment. On the other end of the spectrum, a consolidation of government investment and corporate taxes are the most costly, as disincentives for private investment result in protracted declines in GDP that compound over time to GDP losses that are multiple times the initial size of the consolidation.
    Keywords: Fiscal consolidation;Hungary;Fiscal policy;Economic models;fiscal consolidation, Hungary, DSGE models, overlapping generations households, liquidity constrained households, financial accelerator, macro-financial linkages
    Date: 2013–10–04
  14. By: Laura Veldkamp (NYU Stern); Anna Orlik (Federal Reserve Board of Governors)
    Abstract: or decades, macroeconomists have searched for shocks that are plausible drivers of business cycles. A recent advance in this quest has been to explore uncertainty shocks. Researchers use a variety of forecast and volatility data to justify heteroskedastic shocks in a model, which can then generate realistic cyclical uctuations. But the relevant measure of uncertainty in most models is the conditional variance of a forecast. When agents form such forecasts with state, parameter and model uncertainty, neither forecast dispersion nor innovation volatilities are good proxies for conditional forecast variance. We use observable data to select and estimate a forecasting model and then ask the model to inform us about what uncertainty shocks look like and why they arise.
    Date: 2013
  15. By: Greg Kaplan (Princeton University); Guido Menzio (University of Pennsylvania)
    Abstract: We propose a novel theory of self-ful?lling ?uctuations in the labor market. A ?rm employing an additional worker generates positive externalities on other ?rms, because employed workers have more income to spend and have less time to shop for low prices than unemployed workers. We quantify these shopping externalities and show that they are su¢ ciently strong to create strategic complementarities in the employment decisions of di¤erent ?rms and to generate multiple rational expectations equilibria. Equilibria di¤er with respect to the agents?(rational) expectations about future unemployment. We show that negative shocks to the agents?expectations lead to ?uctuations in vacancies, unemployment, labor productivity and the stock market that closely resemble those observed in the US during the Great Recession.
    Keywords: vacancies, unemployment, labor productivity, stock market, Great Recession
    JEL: J01 J20 J21 J60 J68
    Date: 2013–05
  16. By: Ritwik Banerjee (Department of Economics and Business, Aarhus University)
    Abstract: Unsustainable levels of debt in some European economies are causing considerable strain in the Euro area. Successful debt consolidation in high debt economies is one of the most important important objective for the European policy makers. I use a dynamic general equilibrium closed economy model to compute the dynamic Laffer Curves for Portugal, Ireland, Greece and Spain for different class of taxes. The general equilibrium effects of the interaction of labor tax, consumption tax and capital tax is demonstrated. Location of each economy on its Laffer curve suggests that there exists a scope for considerable revenue generation by raising consumption and labor tax rates but no such possibilities exist for capital tax rate. Thus revenue generation with certain tax rates as instruments, may hold a key to successful and sustained debt reduction.
    Keywords: Laffer Curve, Public Debt, Portugal, Ireland, Greece, Spain
    JEL: E60 E62 H30
    Date: 2013–10–22
  17. By: Leonard J. Mirman; Kevin Reffett; Marc Santugini
    Abstract: We study the effect of learning on optimal growth. We first derive the Euler equation in a general learning environment without experimentation. We then consider the case of iso-elastic utility and linear production, for general distributions of the random shocks and beliefs (i.e., no conjugate priors) and for any horizon. We characterize the unique optimal policy function for this learning model. We show how learning alters the maximization problem of the social planner. We also compare the learning model with the deterministic and stochastic models. This work builds on the work on learning and growth in a Brock-Mirman environment initiated by Koulovatianos, Mirman, and Santugini (2009) (KMS) for the Mirman-Zilcha model (with log utility and Cobb-Douglas production). While the Mirman-Zilcha model provides some insights about the effect of learning on growth, it also hides many important features of learning that the model in this paper takes account of. In other words, compared to the Mirman-Zilcha model, we show that the case of iso-elastic utility and linear production yields a more profound effect of learning on dynamic programming and thus optimal behavior.
    Keywords: Brock-Mirman environment, Dynamic programming, Learning, Optimal growth
    JEL: D8 D9 E2
    Date: 2013
  18. By: Olivier Bargain (Aix-Marseille School of Economics); Eliane El Badaoui (Université de Cergy-Pontoise); Prudence Kwenda (University College Dublin); Eric Strobl (Ecole Polytechnique Paris); Frank Walsh (University College Dublin)
    Abstract: We develop a model where workers may enter self-employment or search for jobs as employees and where there is heterogeneity across workers’ managerial ability. Workers with higher skills will manage larger firms while workers with low managerial ability will run smaller firms and will be in self-employment only when they cannot find a salaried job. For these workers self-employment is a secondary/informal form of employment. The Burdett and Mortensen (1998) equilibrium search model is used for illustration as a special case of our more general framework. Empirical evidence from Mexico is provided and demonstrates that firm size wage effects for employees and selfemployed workers are broadly consistent with the model.
    Keywords: Self-employment, Managerial ability, Informal sector
    JEL: J31 O17
    Date: 2013–10–23
  19. By: Gary D. Hansen (University of California, Los Angeles (E-mail:; Selahattin Imrohoroglu (University of Southern California (E-mail: selo@
    Abstract: Past government spending in Japan is currently imposing a significant fiscal burden that is reflected in a net debt to output ratio near 150 percent. In addition, the aging of Japanese society implies that public expenditures and transfers payments relative to output are projected to continue to rise until at least 2050. In this paper we use a standard growth model to measure the size of this burden in the form of additional taxes required to finance these projected expenditures and to stabilize government debt. The fiscal adjustment needed is very large, in the range of 30-40% of total consumption expenditures. Using a distorting tax such as the consumption tax or the labor income tax requires either tax to rise to unprecedented highs, although the former is much less distorting than the latter. The extremely high tax rates we find highlight the importance of considering alternatives that attenuate the projected increases in public spending and/or enlarge the tax base.
    Keywords: Government debt, fiscal policy, aging, Japan
    JEL: E2 E62 H6
    Date: 2013–10
  20. By: Aditya Goenkay (Department of Economics, National University of Singapore, AS2, Level 6, 1 Arts Link, Singapore 117570); Lin Liu (Department of Economics, Harkness Hall, University of Rochester, Rochester, NY 14627, USA); Manh-Hung Nguyen (LERNA-INRA, Toulouse School of Economics, Manufacture des Tabacs, 21 All¶ee de Brienne, 31000 Toulouse, France)
    Abstract: This paper develops a framework to study the economic impact of infectious diseases by integrating epidemiological dynamics into a continuous time neo-classical growth model. There is a two way interaction between the economy and the disease: the incidence of the disease affects labor supply and investment in health capital can affect the incidence and recuperation from the disease. Thus, both the disease incidence and the income levels are endogenous. It is a general framework to study the effect and control of infectious diseases where there is an interaction with physical capital and health expenditures. The dynamics of the disease make the control problem non-convex and thus, a new existence theorem is given. We fully characterize the local dynamics of the model. There can be multiple steady states, and as the underlying parameters change there can be bifurcations. There can also be steady states where the disease is endemic but the optimal response is not to spend any resources on controlling it. We also see how the endogenous variables change as some underlying economic parameters are varied.
    Keywords: Epidemiology; Infectious Disease; Bifurcation; Existence of equilibrium
    JEL: C61 D51 E13 O41 E32
    Date: 2013
  21. By: Pedro Gomis Porqueras; Solmaz Moslehi; Richard M. H. Suen
    Abstract: This paper presents a theoretical framework that incorporates both preventive actions and treatment opportunities to study health outcomes. In particular, we allow for an agent's eating decision to alter the distribution of future health shocks. Once a shock is realized medical care can be used to improve her health. Thus, choosing a healthier diet is a form of self-protection while medical expenditures are a form of self-insurance. The model helps rationalize why agents choose to be overweight even though they are fully aware of its adverse health consequences. Moreover, this framework predicts that wealthier individuals, on average, have lower morbidity rates and lead a healthier lifestyle. Finally, our numerical exercise captures U.S. cross-sectional facts regarding the choice of diet, medical expenditures as well as health and non-food expenditures.
    Keywords: Calories, Medical Care, Health Shock.
    JEL: D81 I12 J11
    Date: 2013–10–25
  22. By: Juan Nicolini (Federal Reserve Bank of Minneapolis)
    Abstract: In this paper we consider a simple model of transactional assets management to evaluate the changes in banking regulation that passed between 1980 and 1982. The model implies that the newly created deposits in the US after the deregulation should be taken into account in the proper definition of money, in a way the model itself makes explicit. We show that once this is taken into account, the money demand equation characterized by Meltzer (1960) and Lucas (2000) remained remarkably stable.
    Date: 2013
  23. By: Boel, Paola (Monetary Policy Department, Central Bank of Sweden)
    Abstract: I calibrate the microfounded model in Boel and Camera (2009) to quantify the redistributive effects of inflation for a sample of OECD countries. In doing so, I address two important quantitative issues. First, using harmonized microdata from the Luxembourg Wealth Study, I provide an international comparison of the distribution of households' deposit accounts and financial assets. Second, I account for structural breaks when estimating money demand. I find that several results hold for the countries considered. First, the welfare cost of inflation changes over time, but the direction of the change varies across countries. Second, inflation acts as a regressive tax when a nominal asset other than money is held. Third, the magnitude of the redistributive effects differs across countries and it depends not only on wealth inequality, but also on the curvature and the level of the money demand curve. Last, I show that a subset of the population always prefers an inflationary policy when I extend the model to incorporate a political-economy equilibrium where agents can bargain over the inflation rate.
    Keywords: Money; Heterogeneity; Friedman Rule; Welfare Cost of Inflation; Calibration
    JEL: E40 E50
    Date: 2013–09–01
  24. By: Luo, Yulei; Young, Eric
    Abstract: In this paper we examine implications of model uncertainty due to robustness (RB) for consumption-saving, market price of uncertainty, and aggregate wealth accumulation under limited information-processing capacity (rational inattention or RI) in an otherwise standard permanent income model. We first solve the robust permanent income models with inattentive consumers and show that RI by itself creats an additional demand for robustness that leads to higher ¡°induced uncertainty¡± facing consumers. Second, we explore how the induced uncertainty composed by (i) model uncertainty due to RB and (ii) state uncertainty due to RI, affects consumption-saving decisions and the market price of uncertainty. Particurly, we find that induced uncertainty can better explain the observed market price of uncertainty. Furthermore, we explore the observational equivalence between RB and risk-sensitivity (RS) in this filtering problem. Finally, we evaluate the importance of induced uncertainty and fundamental uncertainty in determining equilibrium aggregate wealth.
    Keywords: Robust Filtering, Rational Inattention, Observational Equivalence, Induced Uncertainty, Market Prices of Uncertainty, Wealth Accumulation
    JEL: D8 D83 E2 E21
    Date: 2013–10–10
  25. By: De Graeve, Ferre (Monetary Policy Department, Central Bank of Sweden); Queijo von Heideken, Virginia (Monetary Policy Department, Central Bank of Sweden)
    Abstract: Fiscal theorists warn about the risk of future inflation as a consequence of current fiscal imbalances in the US. Because actual inflation remains historically low and data on inflation expectations do not corroborate such risks, warnings for fiscal inflation are often ignored in policy and academic circles. This paper shows that a canonical NK- DSGE model enables identifying an anticipated component of inflation expectations that is closely related to fiscal policy. Estimation results suggest that fiscal inflation concerns have induced a 1.6%-points increase in long-run inflation since 2001. The model also rationalizes why data on inflation expectations do not reveal such concerns outright.
    Keywords: Fiscal policy; inflation; news
    JEL: E31 E62
    Date: 2013–09–01
  26. By: Xuan Tam (Cambridge University); Eric Young (University of Virginia); Kartik Athreya (Federal Reserve Bank of Richmond)
    Abstract: Starting in the early 1990s credit scoring became widespread and central in credit granting decisions. Credit scores are scalar representations of default risk. They are used, in turn, to price credit, and as a result alter household borrowing and default decisions. We build on recent work on defaultable consumer credit under asymmetric information to develop a quantitative theory of credit scores. We construct and solve a rich and quantitatively-disciplined lifecycle model of consumption in which households have access to defaultable debt, and lenders are asymmetrically informed about household characteristics relevant to predicting default. We then allow lenders to keep record of inferences on the hidden type of a borrower, as well as a binary 'flag' indicating a past default. These inferences arise endogenously from a signalling game induced by borrowers' need to obtain loans. We show how lenders’ inferences evolve over the lifecycle as a function of household behavior in a way that can be naturally interpreted as 'credit scores.' In particular, we first show that lenders' assessments that a household has relatively low default risk matter significantly for the interest rates households pay. We then show that such assessments rise most sharply an d interest rates paid by borrowers fall most sharply (on the order of 5-6 percentage points) when the bankruptcy flag is removed, consistent with work of Musto (2005). Lastly, we compare allocations across information regimes to provide a measure of the social value of credit scores, and the dependence of these measures on lenders' ability to observe borrower characteristics.
    Date: 2013
  27. By: Slonimczyk, Fabian (Higher School of Economics, Moscow); Yurko, Anna (Higher School of Economics, Moscow)
    Abstract: With declining population and fertility rates below replacement levels, Russia is currently facing a demographic crisis. Starting in 2007, the federal government has pursued an ambitious pro-natalist policy. Women who give birth to at least two children are entitled to "maternity capital" assistance ($11,000). In this paper we estimate a structural dynamic programming model of fertility and labor force participation in order to evaluate the effectiveness of the policy. We find that the program increased long-run fertility by about 0.15 children per woman.
    Keywords: fertility, female labor supply, structural estimation, Russia
    JEL: J13 C61
    Date: 2013–10
  28. By: Thierry Betti
    Abstract: This paper deals with the implementation of a fiscal transfer mechanism among countries of a monetary union. I use a DSGE model of a monetary union close to Beetsma and Jensen (2005) and introduce both national fiscal policies and a transfer mechanism. I show the transfer has two effects: an obvious shift in demand but also a destabilizing effect due to a higher degradation of the term of trade for the recipient member. Then, I focus on two structural heterogeneities: the sensitivity to the transfer and the relative size of the two countries. I discuss in what extent these heterogeneities affect the effectiveness of the transfer.
    Keywords: fiscal federalism, transfer mechanism, new-Keynesian models, monetary union.
    JEL: E32
    Date: 2013
  29. By: Nejat Anbarci; Richard Dutu; Nick Feltovich
    Abstract: How does the inflation tax impact on buyers’ and sellers’ behaviour? How strong is its effect on aggregate economic activity? To answer, we develop a model of directed search and monetary exchange with inflation. In the model, sellers post prices, which buyers observe before deciding on cash holdings that are costly due to inflation. We derive simple theoretical propositions regarding the effects of inflation in this environment. We then test the model’s predictions with a laboratory experiment that closely implements the theoretical framework. Our main finding confirms that not only is the inflation tax harmful to the economy – with cash holdings, GDP and welfare all falling as inflation rises – but also that its effect is relatively larger at low rates of inflation than at higher rates. For instance, when inflation rises from 0% to 5%, GDP falls by 2.8 percent, an effect 5 to 7 times stronger than when inflation rises from 5% to 30%. Our findings lead us to conclude that the inflation tax is a monetary policy channel of primary importance, even at low inflation rates.
    Keywords: money, inflation tax, directed search, posted prices, cash balances, welfare loss, frictions, experiment
    JEL: E31 E40 C90
    Date: 2013–10–18
  30. By: Mark Huggett (Georgetown University); Greg Kaplan (Princeton University)
    Abstract: This paper posits a notion of the value of an individual's human capital and the associated return on human capital. These concepts are examined using U.S. data on male earnings and financial asset returns. We find that (1) the value of human capital is far below the value implied by discounting earnings at the risk-free rate, (2) mean human capital returns exceed stock returns early in life and decline with age, (3) the stock component of the value of human capital is smaller than the bond component at all ages and (4) human capital returns and stock returns have a small positive correlation over the working lifetime.
    Keywords: Value of Human Capital, Return on Human Capital, Idiosyncratic and Aggregate Risk, Incomplete Markets, Heterogeneous Agents
    JEL: D91 E21 G12 J24
    Date: 2013–07
  31. By: Hull, Isaiah (Monetary Policy Department, Central Bank of Sweden)
    Abstract: I introduce and evaluate a new stochastic simulation method for dynamic economic models. It is based on recent work in the operations research and engineering literatures (Van Roy et. al, 1997; Powell, 2007; Bertsekas, 2011). The baseline method involves rewriting the household's dynamic program in terms of post-decision states. This makes it possible to choose controls optimally without computing an expectation. I add a subroutine to the original algorithm that updates the values of states not visited frequently on the simulation path; and adopt a stochastic stepsize that efficiently weights information. Finally, I modify the algorithm to exploit GPU computing.
    Keywords: Numerical Solutions; Approximations; Heterogeneous Agents; Nonlinear Numerical Solutions; Dynamic Programming
    JEL: C60 C61 C63 D52
    Date: 2013–09–01
  32. By: Takashi Kamihigashi (Research Institute for Economics & Business Administration (RIEB), Kobe University, Japan)
    Abstract: In this note, we discuss an order-theoretic approach to dynamic programming. In particular, we explain how order-theoretic fixed point theorems can be used to establish the existence of a fixed point of the Bellman operator, as well as why they are not sufficient to characterize the value function. By doing this, we present the logic behind the simple yet useful result recently obtained by Kamihigashi (2013) based on this order-theoretic approach.
    Keywords: Dynamic programming, Bellman equation, value function, fixed point
    JEL: C61
    Date: 2013–10

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