nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2013‒12‒15
35 papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Financial crises and time- varying risk premia in a small open economy: a Markov-Switching DSGE model for Estonia By Boris Blagov
  2. Life Cycle Uncertainty and Portfolio Choice Puzzles By Yongsung Chang; Jay Hong; Marios Karabarbounis
  3. The role of financial frictions during the crisis: An estimated DSGE model By Rossana Merola
  4. External Debt and Taylor Rules In a Small Open Economy By Shigeto Kitano; Kenya Takaku
  5. Redistributive effects and labour market dynamics. By Di Pace, Federico; Villa, Stefania
  6. Demand for Liquidity and Welfare Cost of Inflation by Cohort and Age of Households By Yaz Terajima; Jose-Victor Rios-Rull; Césaire Meh; Shutao Cao
  7. The Great Moderation: Inventories, Shocks or Monetary Policy? By Marcel Förster
  8. On Existence and Bubbles of Ramsey Equilibrium with Borrowing Constraints By Robert Becker; Stefano Bosi; Cuong Le Van; Thomas Seegmuller
  9. Imperfect Knowledge About Asset Prices and Credit Cycles By Pei Kuang
  10. Limited Asset Market Participation, Income Inequality and Macroeconomic Volatility By Giorgio Motta; Patrizio Tirelli
  11. DSGE models in the frequency domain By Luca Sala
  12. Child Labor, Idiosyncratic Shocks, and Social Policy By Alice Fabre; Stéphane Pallage
  13. Tax Evasion, Human Capital, and Productivity Induced Tax Rate Reduction By Max Gillman; Michal Kejak
  14. Assessing DSGE Model Nonlinearities By S. Borağan Aruoba; Luigi Bocola; Frank Schorfheide
  15. Time is Money: Life Cycle Rational Inertia and Delegation of Investment Management By Hugh H. Kim; Raimond Maurer; Olivia S. Mitchell
  16. Large Scale Asset Purchases with segmented mortgage and corporate loan markets. By Meixing Dai; Frédéric Dufourt; Qiao Zhang
  17. Interest Rate Policy and Financial Regulation: How to Control Excessive Risk Taking? By Malik Shukayev; Alexander Ueberfeldt; Simona Cociuba
  18. Self Employment in Developing Countries: a Search-Equilibrium Approach By Renata Narita
  19. Optimal life-cycle portfolios for heterogeneous workers By Fabio Bagliano; Carolina Fugazza; Giovanna Nicodano
  20. Modelo de equilibrio general dinámico y estocástico con rigideces nominales para el análisis de política y proyecciones en la República Dominicana. By Ramirez, Francisco A.; Torres, Francisco A.
  21. Assortative matching through signals By Friedrich Poeschel
  22. Optimal macroeconomic stabilization policy of food, metal, and energy price cycles in small open economies By Carlos Garcia; Jesisbé Mejía
  23. Interest Rate Fluctuations and Equilibrium in the Housing Market By Yavuz Arslan
  24. Financial stability in open economies By Ippei Fujiwara, Yuki Teranishi
  25. Optimal Time-Consistent Macroprudential Policy By Javier Bianchi; Enrique G. Mendoza
  26. The Governance of Perpetual Financial Intermediaries By Jos van Bommel; Jose Penalva
  27. Power Generation and the Business Cycle: The Impact of Delaying Investment By Renato Agurto; Fernando Fuentes; Carlos Garcia; Esteban Skoknic
  28. Why Does Monetary Policy Respond to the Real Exchange Rate in Small Open Economies? A Bayesian Perspective By Carlos Garcia
  29. Online Appendix to "Size, Trend, and Policy Implications of the Underground Economy" By Renzo Orsi; Davide Raggi; Francesco Turino
  30. Regional Mismatch and Labor Reallocation in an Equilibrium Model of Migration By Plamen Nenov
  31. The influence of decision costs on investments in Individual Savings Accounts By Justin van de Ven
  32. Unconventional Fiscal Policy at the Zero Bound By Emmanuel Farhi; Isabel Correia; Juan Pablo Nicolini; Pedro Teles
  33. Wage dynamics in long-term contracts By Philip Jung; Moritz Kuhn
  34. The Cyclicality of the Opportunity Cost of Employment By Gabriel Chodorow-Reich; Loukas Karabarbounis
  35. Online Appendix to "Structural Transformation and the Oil Price" By Radoslaw Stefanski

  1. By: Boris Blagov
    Abstract: Under a currency board the central bank relinquishes control over its monetary policy and domestic interest rates converge toward the foreign rates. Nevertheless a spread between both usually remains. This spread can be persistently positive due to increased risk in the economy. This paper models that feature by building a DSGE model with a currency board, where the domestic interest rate is derived as a function of the foreign rate, the external debt position and an exogenous risk premium component. Applying Markov-Switching allows for time variation in the volatility of the risk premium component. The model shows that the size of risk premia shocks in an economy with a currency board is small in quiet times but the shocks are much larger during crises, which the standard model would understate. The model is applied with Bayesian methods to Estonian data and is able to match the banking and financial crises
    Keywords: Markov-Switching DSGE Models, currency board, stochastic risk premium
    JEL: E32 F41 C51 C52
    Date: 2013–12–09
  2. By: Yongsung Chang (University of Rochester / Yonsei Univ.); Jay Hong (University of Rochester); Marios Karabarbounis (Federal Reserve Bank of Richmond)
    Abstract: The standard theory of household portfolio choice is hard to reconcile with the following facts. (i) Despite a high rate of returns the average household holds a low share of risky assets (equity premium puzzle). (ii) The share of risky assets increases in age. (iii) The share of risky assets is disproportionately larger for richer households. We show that a simple life-cycle model with learning about earnings ability can successfully address all three puzzles. Young workers, on average asset poor, face larger uncertainty in their life-time labor income because they do have perfect knowledge of their ability in the market. They hedge this risk in human capital by investing in relatively safe financial assets. As earnings ability is gradually revealed over time, they take more risk in financial investment. When the labor income risks are calibrated to those observed in the Panel Study of Income Dynamics, our model with learning reproduces the investment profile we see in the Survey of Consumer Finances.
    Date: 2013
  3. By: Rossana Merola (ESRI, Economic Analysis Division; Trinity College Dublin)
    Abstract: After the recent banking crisis in 2008, financial market conditions have turned out to be a relevant factor for economic fluctuations. This paper provides a quantitative assessment of the impact of financial frictions on the U.S. business cycle. The analysis compares the original Smets and Wouters model (2003, 2007) with an alternative version augmented with the financial accelerator mechanism à la Bernanke, Gertler and Gilchrist (1996,1999). Both versions are estimated using Bayesian techniques over a sample extended to 2012. The analysis supports the role of financial channels, namely the financial accelerator mechanism, in transmitting dysfunctions from financial markets to the real economy. The Smets and Wouters model, augmented with the financial accelerator mechanism, is suitable to capture much of the historical developments in U.S. financial markets that led to the financial crisis. The model can account for the output contraction in 2008, as well as the widening in corporate spreads and supports the argument that financial conditions have amplified the U.S. business cycle and the intensity of the recession.
    Keywords: DSGE models, business cycle, financial frictions, Bayesian estimation
    JEL: C11 E32 E44
    Date: 2013–12
  4. By: Shigeto Kitano (Research Institute for Economics & Business Administration (RIEB), Kobe University, Japan); Kenya Takaku (Graduate School of Economics, Nagoya University)
    Abstract: We develop a dynamic stochastic general equilibrium model of a small open economy in which both price rigidity and financial friction exist. We compare two cases featuring different interest rate rules. Both cases use the standard Taylor-type interest rate rules, but the second case also considers external debt levels. We find that when friction in foreign borrowing is large, adding an external debt level to Taylor rules improves welfare. The welfare curve, however, exhibits a hump shape since excessive reactions to changes in external debt reduce welfare.
    Keywords: External debt; Taylor rules; small open economy; DSGE; welfare; emerging market economies
    JEL: E5 F4
    Date: 2013–11
  5. By: Di Pace, Federico; Villa, Stefania
    Abstract: We propose and estimate, using Bayesian techniques, a Dynamic Stochastic General Equilibrium model featuring search and matching frictions with redistributive productivity shocks – which account for fluctuations in the distribution of income across factors of production. We first find supporting evidence that the model is able to replicate cyclical properties of labour market variables. We then disentangle two endogenous sources of labour market amplification: (i) deep habits and (ii) the replacement ratio. The latter appears to be a powerful endogenous amplification mechanism given the shock structure of the model. As far as the exogenous amplification is concerned, labour market variability can be largely explained by redistributive innovations. Finally, contrary to Total Factor Productivity shocks, redistributive shocks increase total hours.
    Date: 2013–11
  6. By: Yaz Terajima (Bank of Canada); Jose-Victor Rios-Rull (University of Minnesota); Césaire Meh (Bank of Canada); Shutao Cao (Bank of Canada)
    Abstract: Cross-sectional data show that money holding differs significantly over household consumption and age. Liquidity demand for money (i.e., money holding per dollar of consumption) decreases as household consumption increases. It also increases with household age conditional on the level of consumption. Observed age differences in money holdings contain not only age-specific information but also cohort-specific one. Using a life-cycle model, this paper disentangles these two effects on money demand and quantifies welfare gains of reducing the long-run inflation rate. We dynamically calibrate the model to micro data and macroeconomic conditions over time. We find that, although a large part of the observed cross-sectional age differences in money demand can be accounted for by some age effects, cohort effects play a non-negligible part, supporting a presence of financial innovation. In addition, changing inflation has significantly different impacts across household groups due to their heterogeneity in money holding. When inflation increases from the 2009 level to 10%, we find the aggregate welfare loss in consumption to be 1.34%. These losses are accrued mostly by generations that are currently alive and less by future cohorts. Finally, poorer households lose more than their rich peers.
    Date: 2013
  7. By: Marcel Förster (University of Giessen)
    Abstract: This paper presents a New Keynesian DSGE model with inventory holding firms. The model distinguishes between goods and materials, for both production as well as for inventories. The more detailed treatment of inventory holdings offers new insights into the determinants of business cycles before and during the Great Moderation. Via Bayesian estimation we determine the distributions of the parameters for U.S. data for two subsamples. Our results show that impulse responses change significantly in terms of magnitude and persistence over time. Shocks in the labor market have gained importance since the Great Moderation and they explain the volatility of many variables. We reject the hypothesis of better inventory management and improved monetary policy as explanations for the Great Moderation. Instead, labor supply developments and changes in cost associated with capital play a key role for the reduced fluctuations.
    Keywords: Inventories, Great Moderation, Bayesian Estimation, DSGE model, Business Cycles
    JEL: C13 E20 E30
    Date: 2013
  8. By: Robert Becker (Department of Economics, Indiana University - Indiana University); Stefano Bosi (EPEE - Centre d'Etudes des Politiques Economiques - Université d'Evry-Val d'Essonne); Cuong Le Van (Ipag Business School - Ipag Business School, VCREME - VanXuan Center of Research in Economics, Management and Environment - VanXuan Center of Research in Economics, Management and Environment); Thomas Seegmuller (AMSE - Aix-Marseille School of Economics - Aix-Marseille Univ. - Centre national de la recherche scientifique (CNRS) - École des Hautes Études en Sciences Sociales [EHESS] - Ecole Centrale Marseille (ECM))
    Abstract: We study the existence of equilibrium and rational bubbles in a Ramsey model with heterogeneous agents, borrowing constraints and endogenous labor. Applying a nonstandard fixed-point theorem by Gale and Mas-Colell's (1975), we prove the existence of equilibrium in a time-truncated bounded economy. A common argument shows this solution to be an equilibrium for any unbounded economy with the same fundamentals. Taking the limit of a sequence of truncated economies, we eventually obtain the existence of equilibrium in the Ramsey model. In the second part of the paper, we address the issue of rational bubbles and we prove that they never occur in a productive economy à la Ramsey.
    Keywords: existence of equilibrium; bubbles; Ramsey model; heterogeneous agents; borrowing constraint; endogenous labor
    Date: 2013–11
  9. By: Pei Kuang
    Abstract: This paper develops an equilibrium model with a housing collateral constraint in which rational agents are uncertain about the collateral price process. Bayesian learning by agents can endogenously generate booms and busts in collateral prices and significantly strengthen the role of the collateral constraint as an amplification mechanism through the interaction of agents' price beliefs, price realizations and credit limits. Over-optimism or pessimism is fueled when a surprise in price expectations is interpreted partially by the agents as a permanent change in the parameters governing the collateral price process and is validated by subsequently realized prices. The learning model can quantitatively account for the recent US boom-bust cycle in house prices, household debt and aggregate consumption dynamics during 2001-2008. The paper also demonstrates that the leveraged economy with a higher steady state leverage ratio is more prone to self-inforcing learning dynamics.
    Keywords: Boom-Bust, Collateral Constraints, Learning, Leverage, Housing
    JEL: D83 D84 E32 E44
    Date: 2013–11
  10. By: Giorgio Motta; Patrizio Tirelli
    Abstract: By introducing external consumption habits and Limited Asset Market Participation in an otherwise standard New Keynesian DSGE model we uncover a causality link between limited asset market participation, consumption inequality and macroeconomic volatility. We also obtain that monetary contractions have redistributive effects in favor of asset holders, broadly con�rming the �findings in Coibion et al. (2012). Finally we analyze the impact of redistributive �scal policies that target consumption inequality between households groups. Such policies have bene�cial implications for macroeconomic stability, bringing the dynamic performance of the model close to the one generated by representative-agent DSGE models.
    Keywords: Limited Asset Market Participation, DSGE, Determinacy, Consumption Habits, Income Inequality, Redistribution
    JEL: E52 E63
    Date: 2013–12
  11. By: Luca Sala
    Abstract: We use frequency domain techniques to estimate a medium-scale DSGE model on different frequency bands. We show that goodness of t, forecasting performance and parameter estimates vary substantially with the frequency bands over which the model is estimated. Estimates obtained using subsets of frequencies are characterized by signicantly different parameters, an indication that the model cannot match all frequencies with one set of parameters. In particular, we find that: i) the low frequency properties of the data strongly affect parameter estimates obtained in the time domain; ii) the importance of economic frictions in the model changes when different subsets of frequencies are used in estimation. This is particularly true for the investment cost friction and habit persistence: when low frequencies are present in the estimation, the investment cost friction and habit persistence are estimated to be higher than when low frequencies are absent. JEL Classication: C11, C32, E32 Keywords: DSGE models, frequency domain, band maximum likelihood.
    Date: 2013
  12. By: Alice Fabre (AMSE - Aix-Marseille School of Economics - Aix-Marseille Univ. - Centre national de la recherche scientifique (CNRS) - École des Hautes Études en Sciences Sociales [EHESS] - Ecole Centrale Marseille (ECM)); Stéphane Pallage (CIRPEE and Département des Sciences Economiques - Université du Québec à Montréal)
    Abstract: In this paper, we provide a dynamic model with heterogeneous agents to study child labor in an economy with idiosyncratic shocks to employment. Households facing adverse shocks may use child labor as a buffer to smooth consumption. We show that the introduction of an unemployment insurance program and/or a universal basic income system help eliminate child labor endogenously in this context. A calibration to South Africa in the 1990s is provided.
    Keywords: child labor; idiosyncratic shocks; unemployment insurance; universal basic income; heterogeneous agents; child labor ban
    Date: 2013–11
  13. By: Max Gillman (Department of Economics, University of Missouri-St. Louis); Michal Kejak
    Abstract: The paper shows a key role of human capital in explaining how US postwar growth and welfare could have increased while tax rates declined. As in evidence, we assume that the share of government revenue in output has remained stable and model tax evasion within an endogenous growth model with human capital. A trend upwards in the productivity of the goods or human capital sectors grad- ually decreases the degree of tax evasion, and causes a trend upwards in time spent in human capital accumulation. These productivity increases also increase the ratio of tax revenue to GDP at any given tax rate such that the tax rate must be reduced in order to be consistent with the stylized fact of a constant share of government revenue in output. Based on estimated US postwar goods and hu- man capital sectoral productivities, the model explains 30% of the actual decline in a weighted average of postwar US top marginal personal and corporate tax rates. The estimated joint sectoral productivity increases are asymmetric with a larger relative increase in the human capital investment sector, a result related to McGrattan and PrescottÂ’s (2010) relatively larger increase in the productivity of the sector producing intangible capital relative to the goods sector. We show that in a special case of exogenous growth without human capital investment, the explanatory power of the tax trend drops signiÂ…cantly.
    Keywords: Tax evasion, intermediation technology, endogenous growth, human capital productivity, dynamic general equilibrium.
    JEL: E13 E62 H26 O41
    Date: 2013–11
  14. By: S. Borağan Aruoba; Luigi Bocola; Frank Schorfheide
    Abstract: We develop a new class of nonlinear time-series models to identify nonlinearities in the data and to evaluate nonlinear DSGE models. U.S. output growth and the federal funds rate display nonlinear conditional mean dynamics, while inflation and nominal wage growth feature conditional heteroskedasticity. We estimate a DSGE model with asymmetric wage/price adjustment costs and use predictive checks to assess its ability to account for nonlinearities. While it is able to match the nonlinear inflation and wage dynamics, thanks to the estimated downward wage/price rigidities, these do not spill over to output growth or the interest rate.
    JEL: C11 C32 C52 E32
    Date: 2013–12
  15. By: Hugh H. Kim; Raimond Maurer; Olivia S. Mitchell
    Abstract: We investigate the theoretical impact of including two empirically-grounded insights in a dynamic life cycle portfolio choice model. The first is to recognize that investors incur opportunity costs in terms of current and future human capital accumulation when managing their own financial wealth, particularly if human capital is acquired via learning by doing. The second is that we incorporate age-varying efficiency patterns in financial decision making. Both enhancements produce inactivity in portfolio adjustment patterns consistent with empirical evidence. We also analyze individuals’ optimal choice between self-managing their wealth versus delegating the task to a financial advisor. Delegation proves most valuable to the young and the old. Our calibrated model quantifies welfare gains from including investment time and money costs, as well as delegation, in a life cycle setting.
    JEL: D1 D11 D12 D13 D14 D91 G11 J14 J22 J26
    Date: 2013–12
  16. By: Meixing Dai; Frédéric Dufourt; Qiao Zhang
    Abstract: We introduce Large Scale Asset Purchases (LSAPs) in a New-Keynesian DSGE model that features distinct mortgage and corporate loan markets. We show that following a significant disruption of financial intermediation, central-bank purchases of mortgage-backed securities (MBS) are less effective at easing credit market conditions and stabilizing economic activity than outright purchases of corporate bonds. Moreover, the size of the effects crucially depends on the extent to which credit markets are segmented, i.e. to which a "portfolio balance channel" is at work in the economy. More segmented credit markets imply larger, but more local effects of particular asset purchases. With strongly segmented credit markets, large scale purchases of MBS are useful to stabilize the housing market but do little to mitigate the contractionary effect of the crisis on employment and output.
    Keywords: Financial frictions, mortgage-backed securities (MBS), corporate bonds, unconventional monetary policy, large scale asset purchases (LSAPs), portfolio balance channel, credit spreads.
    JEL: E32 E44 E52 E58
    Date: 2013
  17. By: Malik Shukayev (Bank of Canada); Alexander Ueberfeldt (Bank of Canada); Simona Cociuba (University of Western Ontario)
    Abstract: This paper characterizes the optimal combination of monetary policy and financial regulation in a quantitative infinite horizon model with a risk taking channel of monetary policy. The model economy is rich enough to match main characteristics of the U.S. economy and its financial sector, yet tractable enough to deliver clear prescriptions regarding the optimal policy mix. The optimal policy mix has a simple state contingent leverage regulation and a small financial contribution tax on profits of financial intermediaries. Revenue derived from this tax helps to secure equity financing to solvent financial institutions during economic downturns. Leverage regulation and monetary policy act as complements when policy deviates from the optimum. Standard capital-adequacy regulation is welfare decreasing though effective at reducing risk taking.
    Date: 2013
  18. By: Renata Narita
    Abstract: Self employment comprises around thirty percent of the workforce in Latin America. Most self employed evade payroll taxes, have low education, and run small businesses requiring low skills. I develop and estimate a life cycle search model where workers can be wage earners in the formal or informal sector, self employed or unemployed. Firms in the formal sector pay payroll and severance taxes, and in the informal sector, they can be fined. The estimated model (i) reproduces well the composition of workers over the life cycle as observed in Brazilian Labour Force data, and (ii) shows that the job value of the self employed is similar to that of informal wage earners. The model is used as a tool to evaluate the welfare impact of labour market policies, where self employment may be an option. When simulating an increase in the cost of informality by ten percent, results showed (i) small impact on employment composition and informality; (ii) significant cost pass-through to wages in the informal sector, meaning a reduction in the lowest wages in the economy, hence higher wage inequality. On the other hand, (iii) it led to substantial improvement in the welfare of formal firms and of all workers. These results prove that taking into account labour market frictions is important in welfare analyses of policies in multisectoral labour markets. As simulations which increase the cost of informality suggest, stricter enforcement of labour regulations (at least to a certain degree) can be a way towards efficient labor markets.
    Keywords: Self employment; Occupational choice; Informal Sector; Job Search; Labour market welfare
    JEL: J30 J24 O17 J42 J60
    Date: 2013–11–28
  19. By: Fabio Bagliano; Carolina Fugazza; Giovanna Nicodano
    Abstract: Household portfolios include risky bonds, beyond stocks, and respond to permanent labour income shocks. This paper brings these features into a life-cycle setting, and shows that optimal stock investment is constant or increasing in age before retirement for realistic parameter combinations. The driver of such inversion in the life-cycle profile is the resolution of uncertainty regarding social security pension, which increases the investor’s risk appetite. This occurs if a small positive contemporaneous correlation between permanent labour income shocks and stock returns is matched by a realistically high degree of risk aversion. Absent this combination, the typical downward sloping profile obtains. Overlooking differences in optimal investment profiles across heterogeneous workers results in large welfare losses, in the order of 15-30% of lifetime consumption.
    Keywords: Life-cycle portfolio choice, background risk, age rule, investor heterogeneity, stock market participation
    JEL: G11
    Date: 2013–12
  20. By: Ramirez, Francisco A.; Torres, Francisco A.
    Abstract: This paper specifies and estimates a structural model of a small open economy to the Dominican Republic. The objective is to provide an analytical framework based on a rigorous theoretical component, but also including aspects that capture satisfactorily the dynamics of macroeconomic variables and being empirically plausible for its use for forecasting and policy analysis. The structure adopted in the model specification is standard in the literature of small open economies and is based on the work of Galí and Monacelli (2005 ) , Justiniano and Preston (2005), Ercerg , Henderson and Levin (2000) and Lubik and Schorfheide ( 2005 ) . The model is characterized by relationships between macroeconomic aggregates that reflect the behavior of economic agents and the technical and institutional constraints they face . The economy is populated by four types of agents: households , producers and importers of differentiated final goods consumption , and a government run monetary policy to influence economic conditions . Households choose each period how much to consume and work , while firms choose price and quantity of goods to offer to meet the demand . The external sector of the economy is characterized by the export of a fraction of domestic production and imports of goods consumed domestically, where the proportions are determined by the relative prices of domestically produced goods relative to foreign . Households have access to two vehicles for mobilizing resources intertemporally , a domestic bond and one external . Finally, the government is characterize by the behavior of the Central Bank who adjust it policy rate to offset inflation and output deviations from their equilibrium levels.
    Keywords: Modelos DSGE para Economías Pequeñas y Abiertas; Rigideces Nominales; Mecanismos de Transmisión de la Política Monetaria; Métodos Bayesianos
    JEL: E32 E52 F37
    Date: 2013–11–28
  21. By: Friedrich Poeschel
    Abstract: When agents do not know where to find a match, they search. However, agents could direct their search to agents who strategically choose a certain signal. Introducing cheap talk to a model of sequential search with bargaining, we find that signals will be truthful if there are mild complementarities in match production: supermodularity of the match production function is a necessary and sufficient condition. It simultaneously ensures perfect positive assortative matching, so that single-crossing property and sorting condition coincide. As the information from signals allows agents to avoid all unnecessary search, this search model exhibits nearly unconstrained efficiency.
    JEL: J64 D83 C78
    Date: 2013–12–07
  22. By: Carlos Garcia (Facultad de Economía y Negocios, Universidad Alberto Hurtado); Jesisbé Mejía
    Abstract: This paper proposes an optimal strategy for stabilizing macroeconomic policy to address jointly the effects of changes in the prices of food, minerals and energy (oil). Our approach differs from the general literature, which analyzes the effects of a commodity boom and therefore the solutions in terms of economic policy separately, that is, by type of commodity. The stabilization strategy that we propose considers a key fact affecting many small open economies, namely, that they not only are affected by increases in commodity prices, but also benefit from them. Consequently, we use a DSGE model for a small open economy with restricted households to show that welfare could be improved with a fiscal rule incorporating transfers to stabilize household consumption. This strategy noticeably dominates an aggressive monetary policy focused only on stabilizing inflation and a fiscal policy that has an excessive bias toward saving income from exports.
    Keywords: commodity price boom, optimal fiscal and monetary policy, DSGE models
    JEL: E31 E32 E52 E62 E63 F1 F41
    Date: 2012–10
  23. By: Yavuz Arslan
    Abstract: I study the general equilibrium of the housing market in an economy populated by over-lapping generations of households. A contribution of the present paper is to solve for the housing market equilibrium in the presence of aggregate (interest rate) uncertainty with a realistic mortgage contract. In addition, households also face idiosyncratic uncertainty resulting from stochastic changes over the lifecycle in tastes (or need) for housing. In this environment, profit-maximizing banks offer fixed-rate mortgage (FRM) contracts to homebuyers. As seems plausible, each housing market transaction is subject to a fixed cost, which gives rise to S-s policy rules for housing transactions : existing homeowners change the size of their houses only if there is a sufficiently large change in the state of the economy (i.e., in interest rates, in their taste for housing, etc.). A plausibly calibrated version of the model is consistent with three empirically documented features of the housing market : (i) highly volatile housing prices and transaction volume, (ii) a strong positive correlation between transaction volume and housing prices, and (iii) a signi?cant negative relationship between interest rates and housing prices, which can rationalize a large part of the recent boom in housing prices in the U.S. and around the world.
    Keywords: House prices, Interest rates, Mortgage contracts
    JEL: D91 E21 G01 R21
    Date: 2013
  24. By: Ippei Fujiwara, Yuki Teranishi
    Abstract: Do financial frictions call for policy cooperation? This paper investigates the implications of financial frictions for monetary policy in the open economy. Welfare analysis shows that there are long-run gains which result from cooperation, but, dynamically, financial frictions per se do not require policy cooperation to improve global welfare over business cycles. In addition, inward-looking financial stability, namely eliminating inefficient fluctuations of loan premiums in the home country, is the optimal monetary policy in the open economy, irrespective of the existence of policy coordination.Length: 42 pages
    Keywords: Optimal monetary policy in open economy; financial market imperfectionsd estimator; Grid-t Confidence Interval
    JEL: E50 F41
    Date: 2013
  25. By: Javier Bianchi; Enrique G. Mendoza
    Abstract: Collateral constraints widely used in models of financial crises feature a pecuniary externality, because agents do not internalize how collateral prices respond to collective borrowing decisions, particularly when binding collateral constraints trigger a crisis. We show that agents in a competitive equilibrium borrow "too much" during credit expansions compared with a financial regulator who internalizes this externality. Under commitment, however, this regulator faces a time inconsistency problem: It promises low future consumption to prop up current asset prices when collateral constraints bind, but this is not optimal ex post. Instead, we study the optimal, time-consistent policy of a regulator who cannot commit to future policies. Quantitative analysis shows that this policy reduces the incidence and magnitude of crises, removes fat tails from the distribution of returns and reduces risk premia. A key element of this policy is a state-contingent macro-prudential debt tax (i.e. a tax imposed in normal times when a financial crisis has positive probability next period) of about 1 percent on average. Constant debt taxes also reduce the frequency of crises but are less effective at reducing their severity and reduce welfare when credit constraints bind.
    JEL: E0 F0 G0
    Date: 2013–12
  26. By: Jos van Bommel; Jose Penalva (LSF)
    Abstract: In this paper we investigate the risk sharing potential of financial intermediaries in an overlapping generations economy. We find that the intermediaries allocations are constrained by the temptation of the living to liquidate their intermediary s assets and share the proceeds amongst themselves. We characterize the characterize this constraint set, and show that only intermediaries that can avoid side trading and the rolling over of deposits can improve on the market allocation. Furthermore, intermediaries may not achieve the constrained optimal allocation because the living are not willing to build a sufficiently large asset buffer.
    Keywords: Financial Intermediation, Overlapping Generations
    JEL: G21 D91
    Date: 2012
  27. By: Renato Agurto; Fernando Fuentes (Facultad de Economía y Negocios, Universidad Alberto Hurtado); Carlos Garcia (Facultad de Economía y Negocios, Universidad Alberto Hurtado); Esteban Skoknic
    Abstract: This article presents the hypothesis that exogenous shocks in the electricity market can affect the business cycle of the Chilean economy in the short and medium terms. The shocks are identified as the delays in power-generation investment that have characterized the sector in recent years. The delays are due to political decisions and the process of attaining environmental approvals by state agencies. A comparison of different scenarios reveals that after eight years, the country would lose the equivalent of one year of GDP growth, with a consequent reduction in private investment, domestic consumption, and job creation. This result highlights the importance of environmental and energy policy in reducing business cycle fluctuations.
    Keywords: Business Cycle, Electric Energy, Bayesian Econometrics, DSGE models
    JEL: E17 E27 E37 L94
    Date: 2013–07
  28. By: Carlos Garcia (Facultad de Economía y Negocios, Universidad Alberto Hurtado)
    Abstract: To estimate how monetary policy works in small open economies, we build a dynamic stochastic general equilibrium model that incorporates the basic features of these economies. We conclude that the monetary policy in a group of small open economies (including Australia, Chile, Colombia, Peru, and New Zealand) is rather similar to that observed in closed economies. Our results also indicate, however, that there are strong differences due to shocks from the international financial markets (mainly risk premium shocks). These differences explain most of the variability of the real exchange rate, which has important reallocation effects in the short run. Our results are consistent with an old idea from the Mundell-Fleming model: namely, a real depreciation to confront a risk premium shock is expansive or procyclical, in contradiction to the predictions of the balance sheet effect, the J curve effect, and the introduction of working capital into RBC models. In line with this last result, we have strong evidence that only in one of the five countries analyzed in this study does not intervene the real exchange rate, the case of New Zealand.
    Keywords: small open economy models; monetary policy rules; exchange rates; Bayesian econometrics
    JEL: F33 E52 F41
    Date: 2012–11
  29. By: Renzo Orsi (University of Bologna); Davide Raggi (University of Bologna); Francesco Turino (University of Alicante; )
    Abstract: Online appendix for the Review of Economic Dynamics article
    Date: 2013
  30. By: Plamen Nenov (Norwegian Business School (BI))
    Abstract: This paper examines the importance of regional labor reallocation for unemployment and studies the link between inter-regional mobility and reallocation. I construct a multi-region economy with segmented labor markets, endogenously determined regional house prices, and limited worker mobility, and structurally estimate it using state level data for the U.S. The estimated model can account for the comovements of relative house prices and unemployment with gross out- and in-migration observed in a panel of U.S. states. The estimation reveals large reallocation barriers across local labor markets in the form of imperfect directed migration, relative house price differences compensating for labor market differences, and a high moving cost for unemployed workers. These reallocation barriers dampen the response of individual migration decisions to regional labor market differences and contribute to regional mismatch and to shifts in the U.S. Beveridge curve. I apply this framework to understand the reallocation effects of the recent housing bust in the U.S.
    Date: 2013
  31. By: Justin van de Ven
    Abstract: This study considers the efficacy of a tax incentivised savings scheme in context of decision making rigidities. Analysis is based on a classical life-cycle model of savings and investment decisions, augmented with a salience cost over participation in Individual Savings Accounts (ISAs) currently run in the UK. Calibration results indicate that salience costs help to match the model to observed rates of participation in ISAs. The calibrated model suggests that the price effects of ISAs are insufficient to generate appreciable increases in private sector savings, with or without salience costs. In this context, salience costs have an important infl?uence on the distribution of welfare bene?fits that are delivered by the ISAs scheme.
    Date: 2013–03
  32. By: Emmanuel Farhi; Isabel Correia; Juan Pablo Nicolini; Pedro Teles
    Abstract: When the zero lower bound on nominal interest rates binds, monetary policy cannot provide appropriate stimulus. We show that, in the standard New Keynesian model, tax policy can deliver such stimulus at no cost and in a time-consistent manner. There is no need to use inefficient policies such as wasteful public spending or future commitments to low interest rates.
  33. By: Philip Jung (Bonn University); Moritz Kuhn (University of Bonn)
    Abstract: We prove existence, monotonicity and differentiability of firm profits and provide first-order conditions that characterize the properties of the optimal contract. We demonstrate how the shape of the contract depends on the persistence and variance of the productivity process, on worker and firm risk, and on non-pecuniary utility components.
    Date: 2013
  34. By: Gabriel Chodorow-Reich; Loukas Karabarbounis
    Abstract: The flow opportunity cost of moving from unemployment to employment consists of foregone public benefits and the foregone value of non-working time in units of consumption. Using detailed microdata, administrative data, and the structure of the search and matching model with concave and non-separable preferences, we document that the opportunity cost of employment is as procyclical as, and more volatile than, the marginal product of employment. The empirically-observed cyclicality of the opportunity cost implies that unemployment volatility in search and matching models of the labor market is far smaller than that observed in the data. This result holds irrespective of the level of the opportunity cost or whether wages are set by Nash bargaining or by an alternating-offer bargaining process. We conclude that appealing to aspects of labor supply does not help search and matching models explain aggregate employment fluctuations.
    Date: 2013–01
  35. By: Radoslaw Stefanski (University Laval)
    Abstract: Online appendix for the Review of Economic Dynamics article
    Date: 2013

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