nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2014‒01‒10
sixteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Bargaining with Existing Workers, Over-hiring of Firms, and Labor Market Fluctuations By Jiwoon Kim
  2. Robust Control, Informational Frictions, and International Consumption Correlations By Yulei Luo; Jun Nie; Eric R. Young
  3. Trade, Unemployment, and Monetary Policy By Matteo Cacciatore
  4. Consumption and Credit Constraints: A Model and Evidence for Ireland By Gerlach, Petra; Merola, Rossana
  5. A R&D Based Real Business Cycle Model By Fung, Ka Wai Terence; Lau, Chi Keung Marco; Chan, Kwok Ho
  6. Institutional quality, the cyclicality of monetary policy and macroeconomic volatility By Duncan, Roberto
  7. General equilibrium dynamics with naive and sophisticated hyperbolic consumers in an overlapping generations economy By Takeshi Ojima
  8. Mortgages and monetary policy By Garriga, Carlos; Kydland, Finn E.; Šustek, Roman
  9. Achieving Fiscal Balance in Japan By Tomoaki Yamada; Sagiri Kitao; Selahattin Imrohoroglu
  10. Unemployment Insurance Experience Rating and Labor Market Dynamics By Ratner, David
  11. Monetary Policy in Korea through the lense of Taylor Rule in DSGE model By Tae Bong Kim
  12. Financial Development, Econmic Growth and R&D Cyclical Movement By Fung, Ka Wai Terence; Lau, Chi Keung Marco
  13. The stimulative effect of forward guidance By Gavin, William T.; Keen, Benjamin D.; Richter, Alexander; Throckmorton, Nathaniel
  14. How should financial intermediation services be taxed? By Ben Lockwood
  15. Dynamic Dispersed Information and the Credit Spread Puzzle By Elias Albagli; Christian Hellwig; Aleh Tsyvinski
  16. Aging and Deflation from a Fiscal Perspective By Hideki Konishi; Kozo Ueda

  1. By: Jiwoon Kim (University of Minnesota)
    Abstract: This paper investigates the effects of intra-firm bargaining on the standard real business cycle (RBC) search and matching model by explicitly considering the outside option of a firm in the bargaining with a new worker. In this paper, the outside option of a firm in the bargaining with a new worker is bargaining with existing workers (i.e., intra-firm bargaining). According to Stole and Zwiebel (1996), under the assumption that the firm facing diminishing marginal productivity of labor and its workers cannot commit to future wages, intra-firm bargaining gives the firm an incentive to hire an excessive amount of workers in order to drive wages of workers down. (i.e., the firm “over-hires†workers.) We show the outside option of a firm is crucial for the bargaining with a new worker in the sense that how much the firm pays existing workers, when the match breaks down, determines how many workers it over-hires. In this paper, wages in the outside option of a firm depend on the stochastic bargaining weight of existing workers (i.e., a bargaining shock), which can be identified through labor share data from U.S. Bargaining shocks affect the degree of over-hiring behavior of a firm, and in turn, provide another source to explain the behavior of labor markets in business cycles. The inclusion of intra-firm bargaining and bargaining shocks improves the capacity of the standard RBC search and matching model, especially in labor markets. Our calibrated model generates more volatile total hours, employment, hours per worker while labor share overshoots in response to productivity shocks. In particular, the volatility of employment in the model is similar to the actual U.S. data. Furthermore, the model provides a theory about the overshooting property of labor share, which can be explained by the general equilibrium effects of time-varying bargaining weights of existing workers and over-hiring behavior of the firm.
    Date: 2013
  2. By: Yulei Luo (The University of Hong Kong and Hong Kong Institute for Monetary Research); Jun Nie (Federal Reserve Bank of Kansas City); Eric R. Young (University of Virginia)
    Abstract: In this paper we examine the effects of model misspecification (robustness or RB) on international consumption correlations in two otherwise standard small open economy models: one with perfect state observation and the other with imperfect state observation. We show that in the presence of capital mobility in financial markets, RB lowers the international consumption correlations by generating heterogeneous responses of consumption to income shocks across countries facing different macroeconomic uncertainty. However, the calibrated RB model with perfect state observation cannot explain the observed consumption correlations quantitatively. We then show that the RB model with imperfect state observation is capable of matching the behavior of international consumption quantitatively via two channels: (i) the gradual response to income shocks that increases the correlations and (ii) the presence of the common noise shocks that reduce the correlations.
    Keywords: Robustness, Imperfect State Observation, International Consumption Correlations
    JEL: D83 E21 F41 G15
    Date: 2013–11
  3. By: Matteo Cacciatore (HEC Montreal)
    Abstract: We study the effects of trade integration for the conduct of monetary policy in a two-country model with heterogeneous firms, endogenous producer entry, and labor market frictions. The model reproduces important empirical regularities related to international trade, namely synchronization of business cycles across trading partners and reallocation of market shares across producers. Three key results emerge. First, when trade linkages are weak, the optimal policy is inward-looking but requires significant departures from price stability both in the long run and over the business cycle. Second, as trade integration reallocates market share toward more productive firms, the need of positive inflation to correct long-run distortions is reduced. Third, increased business cycle synchronization implies that country-specific shocks have more global consequences. Welfare gains from cooperation are small relative to optimal non-cooperative policy, but sizable relative to historical Federal Reserve behavior. The constrained efficient allocation generated by optimal cooperative policy can still be achieved by appropriately designed inward-looking policy rules. However, sub-optimal (historical) policy implies inefficient fluctuations in cross-country demands that result in large welfare costs when trade linkages are strong.
    Date: 2013
  4. By: Gerlach, Petra; Merola, Rossana
    Abstract: Since the onset of the financial crisis, consumption has fallen in many economies. This paper presents a small-scale DSGE model with occasionally binding credit constraints. Indebted households start facing credit constraints when the value of their main asset, which we assume to be housing, declines. As a response, they stop smoothing consumption and deleverage. We show that even households that only expect to face a credit constraint in the future deleverage. In an Irish dataset collected during the crisis, we reject the permanent income hypothesis for highly leveraged households and thus find evidence for a disruption in consumption smoothing. This effect suggests the presence of credit constraints.
    Keywords: DSGE/Ireland/housing collateral/Occasionally binding credit constraint
    Date: 2013–11
  5. By: Fung, Ka Wai Terence; Lau, Chi Keung Marco; Chan, Kwok Ho
    Abstract: The New Keynesian Real Business Cycle model with staggered price adjustment is augmented with a R&D producing sector. Two sources of economic shocks are considered, namely random paritcipation (perturbances to value of alternative investment opportunities in another sector) and financial intermediation (shocks to the cost of raising capital in the financial intermediation market). We find that, when comparing to the baseline model, both models can explain pro-cyclical R&D spending. Additionally, the investment oversensitivity problem is corrected. However, only the financial intermediation model is consistent with the observed finding that volatility of R&D is larger than that of investment and output.
    Keywords: Endogenous growth model, real business cycle, asymmetric information, research and development
    JEL: E30 O3 O30 O4 O40 O42
    Date: 2013
  6. By: Duncan, Roberto (Federal Reserve Bank of Dallas)
    Abstract: In contrast to industrialized countries, emerging market economies are characterized by proor acyclical monetary policies and high output volatility. This paper argues that those facts can be related to a long-run feature of the economy - namely, its institutional quality (IQL). The paper presents evidence that supports the link between an index of IQL (law and order, government stability, investment profile, etc.), and (i) the cyclicality of monetary policy, and (ii) the volatilities of output and the nominal interest rate. In a DSGE model, foreign investors that choose a portfolio of direct investment and lending to domestic agents, face a probability of partial confiscation which works as a proxy that captures IQL. The economy is hit by external shocks to demand for home goods and productivity shocks while its central bank seeks to stabilize inflation and output. In the long run, a lower IQL tends to discourage external liabilities. If there is a positive external demand shock, we observe an increase in output and real appreciation. The latter operates through two opposite channels. First, it directly increases the opportunity cost of leisure generating incentives to expand labor supply. Second, it reduces the real value of the debt denominated in foreign currency which stimulates consumption but contracts the labor supply. If the IQL is low, the economy attracts fewer loans for domestic consumers and shows a lower debt-to-consumption ratio in the steady state. This implies that the reduction of the real value of the debt caused by the real appreciation is smaller. Given this low wealth effect, the real appreciation leads to an expansion of the labor supply. Wages drop and inflation diminishes. The central bank reacts by cutting its policy rate to stabilize inflation and generates a negative comovement between output and the nominal interest rate (procyclical policy). As a corollary, negative correlations between policy rates and output are not necessarily an indicator of destabilizing polices even in the presence of demand shocks.
    JEL: E40 E50 E60 F30 F40
    Date: 2014–01–03
  7. By: Takeshi Ojima
    Abstract: Using an overlapping generations model, this paper describes interactions between naive and sophisticated hyperbolic discounters in general equilibrium. The naifs, who overestimate their future propensity to save and hence over-forecast the future equilibrium asset prices, are exploited through capital transactions by sophisticates, who correctly forecast the future asset prices by incorporating the naifsf mis-forecasts. Due to the capital losses, the naifs fall into bankruptcy when they are highly present-biased, highly patient, and having a low population density. Under generous conditions, the equilibrium is shown to be globally stable and Pareto inefficient in the ex-post sense.
    Date: 2013–09
  8. By: Garriga, Carlos (Federal Reserve Bank of St. Louis); Kydland, Finn E. (University of California–Santa Barbara); Šustek, Roman (Queen Mary, University of London)
    Abstract: Mortgage loans are a striking example of a persistent nominal rigidity. As a result, under incomplete markets, monetary policy affects decisions through the cost of new mortgage borrowing and the value of payments on outstanding debt. Observed debt levels and payment to income ratios suggest the role of such loans in monetary transmission may be important. A general equilibrium model is developed to address this question. The transmission is found to be stronger under adjustable- than fixed-rate contracts. The source of impulse also matters: persistent inflation shocks have larger effects than cyclical fluctuations in inflation and nominal interest rates.
    Keywords: Mortgages; debt servicing costs; monetary policy; transmission mechanism; housing investment.
    JEL: E32 E52 G21 R21
    Date: 2013–12–05
  9. By: Tomoaki Yamada (Meiji University); Sagiri Kitao (Hunter College); Selahattin Imrohoroglu (University of Southern California)
    Abstract: In this paper we build a micro-data based, large-scale overlapping generations model for Japan in which individuals differ in age, gender, employment status, income, and asset holdings, and incorporate the Japanese pension rules in detail. We estimate age-consumption and age-earnings profiles from the Family Income and Expenditure Survey data, assume complete markets and use these to generate tax revenues and transfer payments for government accounts. We calibrate the model so that it produces the main macroeconomic indicators for 2010. Using existing pension law and fiscal parameters and the medium variants of fertility and survival probability projections, we produce predicted time paths for the ratio JGBs and the pension fund.
    Date: 2013
  10. By: Ratner, David (Board of Governors of the Federal Reserve System (U.S.))
    Abstract: Unemployment insurance experience rating imposes higher payroll tax rates on firms that have laid off more workers in the past. To analyze the effects of UI tax policy on labor market dynamics, this paper develops a search model of unemployment with heterogeneous firms and realistic UI financing. The model predicts that higher experience rating reduces both job creation and job destruction. Using firm-level data from the Quarterly Census of Employment and Wages, the model is tested by comparing job creation and job destruction across states and industries with different UI tax schedules. The empirical analysis shows a strong negative relationship between job flows and experience rating. Consistent with the empirical results, comparative steady state tax experiments show that a 5% increase in experience rating reduces job flows by an average of 1.4%. While the unemployment rate falls on average by .21 percentage points, the effect on tax revenues is ambiguous. The model has implications for UI financing reform currently being considered at the state and national level. Two alternative reforms that close half of the UI financing gap are considered: the reform that increases experience rating is shown to improve labor market outcomes. In a version of the model with aggregate shocks, higher experience rating dampens the response of layoffs and unemployment over the business cycle. Experience rating also induces nonlinear responses of unemployment to proportionally larger shocks as well as asymmetry in response to booms and busts.
    Keywords: Unemployment insurance; experience rating
    Date: 2014–01–07
  11. By: Tae Bong Kim (Korea Development Institute)
    Abstract: This paper shows assessments on the monetary policy of Korea based on an estimated model. During the sample period of the in ation targeting scheme, the monetary policy discretion, which is the monetary policy shock after the historical decomposition of the model, has been mostly in ationary while it was reducing the volatility of output growth and thus countercyclical. 3% target rate could have been achieved when the monetary policy shock's standard deviation was approximately half of its posterior estimate. Various degree of monetary policy stance has been simulated with the sample period. An aggressive monetary policy towards in ation stabilization would have generally led to the average level of in ation rate closer to its target rate but at the cost of higher volatilities of the output growth.
    Date: 2013
  12. By: Fung, Ka Wai Terence; Lau, Chi Keung Marco
    Abstract: This paper builds up an endogenous growth model à la Aghion and Howitt (1992) and Boucekkine et al (2005). We assume that R&D firms use only investment good as input, instead of final good as hypothesized in the above two models. We show that investment price will be a negative function of aggregate quality index; and thus decline over time. In this model, subsidy on R&D has growth-enhancing effect. Moreover, this model predicts unambiguously that R&D is procyclical.
    Keywords: Endogeneous growth model, real business cycle, research and development
    JEL: E30 O3 O4 O40
    Date: 2013
  13. By: Gavin, William T. (Federal Reserve Bank of St. Louis); Keen, Benjamin D. (University of Oklahoma); Richter, Alexander (Auburn University); Throckmorton, Nathaniel (Indiana University)
    Abstract: This article quantifies the stimulative effect of central bank forward guidance—the public announcement of the intended path for monetary policy in the future—when the nominal interest rate is stuck at its zero lower bound (ZLB). We use a global solution to a conventional nonlinear New Keynesian model to show how the forward guidance horizon impacts the stimulative effect. Forward guidance enters our model as news shocks to the monetary policy rule, which commits the central bank to a lower policy rate than its policy rule suggests. The success of forward guidance depends on whether households expect the economy to recover. When households expect a recovery, forward guidance about a future expansionary monetary policy shock lowers the expected nominal interest rate and increases current consumption. A longer forward guidance horizon strengthens this effect, but at a decreasing rate.
    Keywords: Monetary Policy; Forward Guidance; Zero Lower Bound; Global Solution Method
    JEL: E31 E42 E58 E61
    Date: 2013–12–24
  14. By: Ben Lockwood (CBT, CEPR and Department of Economics, University of Warwick)
    Abstract: This paper considers the optimal taxation of savings intermediation services in a dynamic general equilibrium setting, when the government can also use consumption, income and profit taxes. When 100% taxation of profit is available, taxes on services supplied to firms should be deductible from profit, implying the optimality of a VAT-type tax. As for the rate of tax, in the steady state, an optimal arrangement is to set it equal to the rate of tax on capital income, not consumption. In turn, the capital income tax is zero when the when an unrestricted profit tax is available, but in the more realistic case when such a tax is not available, this rate can be positive or negative, but generally different to the optimal rate of tax on consumption.
    Keywords: financial intermediation services, tax design, banks, payment services
    JEL: G21 H21 H25
    Date: 2013
  15. By: Elias Albagli; Christian Hellwig; Aleh Tsyvinski
    Abstract: We develop a dynamic nonlinear, noisy REE model of credit risk pricing under dispersed information that can theoretically and quantitatively account for the credit spread puzzle. The first contribution is a sharp analytical characterization of the dynamic REE equilibrium and its comparative statics. Second, we show that the nonlinearity of the bond payoff in the environment with dispersed information and limits to arbitrage leads to underpricing of corporate debt and to spreads that over-state the probability of default. This underpricing is most pronounced for high investment grade, short maturity bonds. Third, we calibrate to the empirical data on the belief dispersion and show that the model generates spreads that explain between 16 to 42% of the empirical values for 4-year high investment grade, and 35 to 46% for 10-year, high investment grade bonds. These magnitudes are in line with empirical estimates linking bond spreads to empirical measures of investor disagreement, and substantially higher than most structural models of credit risk. The primary contribution of our paper in moving NREE models towards a more realistic asset pricing environment -- dynamic, nonlinear, and quantitative -- that holds significant promise for explaining empirical asset pricing puzzles.
    JEL: G12
    Date: 2014–01
  16. By: Hideki Konishi (School of Political Science and Economics, Waseda University (; Kozo Ueda (School of Political Science and Economics, Waseda University (
    Abstract: Negative correlations between inflation and demographic aging have been observed across developed nations recently. To understand the phenomenon from a political economy perspective, we embed the fiscal theory of the price level into an overlapping-generations model. We suppose that short-lived governments successively choose income tax rates and bond issues, considering political influence from existing generations and the expected policy responses of future governments. Our analysis reveals that the effects of aging depend on its causes; aging is deflationary when caused by an unexpected increase in longevity, but is inflationary when caused by a decline in the birth rate. Our analysis also sheds new light on the traditional debate about the burden of national debt. Because of price adjustment, the accumulation of government debt imposes no burden on future generations.
    Keywords: Deflation, Fiscal theory of the price level, Population aging, Redistribution across
    JEL: D72 E30 E62 E63 H60
    Date: 2013–12

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