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on Dynamic General Equilibrium |
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Issue of 2014‒02‒15
seventeen papers chosen by Christian Zimmermann Federal Reserve Bank of St. Louis |
| By: | Chase Coleman (Stern School, New York University); Kerk Phillips (Department of Economics, Brigham Young University) |
| Abstract: | This paper explores the merits of a DSGE model incorporating Schumpeterian type growth into an otherwise standard RBC model similar to the one in Phillips and Wrase (2006). We consider a model with two exogenous shocks. The first is a standard productivity shock. The second is an aggregate shock to the stock of basic knowledge and arrives as a Poisson process with an arrival rate influenced by economy-wide spending on R\&D. We show that this model is capable of generating both an observed total factor productivity and GDP series that is autocorrelated, even when all the shock processes are serially uncorrelated. We present empirical evidence that the driving process in our model is consistent with the behavior of the U.S. economy |
| Keywords: | autocorrelation, dynamic stochastic general equilibrium, business cycles, technology persistence, Schumpeterian, economic growth, GDP, TFP |
| JEL: | C63 E32 E37 |
| Date: | 2014–02 |
| URL: | http://d.repec.org/n?u=RePEc:byu:byumcl:201401&r=dge |
| By: | Tovonony Razafindrabe |
| Abstract: | This paper develops an estimated multi-country open economy dynamic stochastic general equilibrium (DSGE) model with incomplete Exchange Rate Pass-Through (ERPT) for the Euro-area. It is designed to model global international linkages and to assess international transmission of shocks under an endogenous framework and incomplete ERPT assumption. On the one hand, we relax the small open economy framework (SOEF) but derive a canonical representation of the equilibrium conditions to maintain analytical tractability of the complex international transmission mechanism underlying the model. Namely, the model considers economies of different size that are open and endogenously related. On the other hand, in order to take into account international linkages, possible cointegration relationships within domestic variables and between domestic and foreign variables, and the role of common unobserved and observed global factors such as the oil price, we use the Global VAR model to estimate the steady state of observed endogenous variables of the multi-country DSGE model. Namely, steady states are computed as long-horizon forecasts from a reduced-form cointegrating GVAR model. ERPT analysis conducted from the estimated multi-country DSGE model for the Euro-area in relation with its ve main trade partners which are the United Kingdom, the United States, China, Japan and Switzerland yields the following results. First, exchange rate volatility contributes to a large part of import price inflation variation of the Euro-area in contrast to foreign mark-up shocks. Second, deviation from inflation objective of the foreign trade partners contributes to another source of the Euro-area import price variability. Third, nominal rigidity induces a persistent but a lower impact of the exchange rate changes on import inflation. |
| Keywords: | Pass-through, multi-country DSGE, Bayesian estimation, monetary policy |
| JEL: | F31 F41 E52 C11 |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:drm:wpaper:2014-6&r=dge |
| By: | Juergen Jung (Department of Economics, Towson University); Chung Tran (Research School of Economics, The Australian National University) |
| Abstract: | We quantify the effects of the Affordable Care Act using a stochastic general equilibrium overlapping generations model with endogenous health capital accumulation calibrated to match U.S. data on health spending and insurance take-up rates. The introduction of an insurance mandate and the expansion of Medicaid, that are at the core of the Affordable Care Act, increase the insurance coverage rate of workers from 76 to 90 percent while simultaneously causing a reduction in capital accumulation, labor supply and aggregate output. Individuals in poor health with low income experience welfare gains while high income individuals in good health experience welfare losses. The insurance mandate, enforced by penalties and subsidies, reduces the adverse selection problem in private health insurance markets and counteracts the crowding-out effect of the Medicaid expansion. In addition, an alternative design of the insurance mandate with more aggressive penalties can lead to universal insurance coverage at smaller efficiency and welfare losses. |
| Keywords: | Affordable Care Act 2010, insurance mandate, Medicaid, endogenous health capital, life-cycle health spending and financing, dynamic stochastic general equilibrium model, Grossman health capital. |
| JEL: | H51 I18 I38 E21 E62 |
| Date: | 2014–02 |
| URL: | http://d.repec.org/n?u=RePEc:tow:wpaper:2014-01&r=dge |
| By: | Javier García-Cicco; Markus Kirchner; Santiago Justel |
| Abstract: | We set up and estimate a DSGE model of a small open economy to assess the role of domestic financial frictions in propagating foreign shocks. In particular, the model features two types of financial frictions: one in the relationship between depositors and banks (following Gertler and Karadi, 2011) and the other between banks and borrowers (along the lines of Bernanke et al, 1999). We use Chilean data to estimate the model, following a Bayesian approach. We find that the presence of financial frictions increases the importance of foreign shocks in explaining consumption, inflation, the policy rate, the real exchange rate and the trade balance. In contrast, under financial frictions the role of these foreign shocks in explaining output and investment is somehow reduced. The behavior of the real exchange rate and its interaction with the financial frictions is key to understand the results. |
| Date: | 2014–01 |
| URL: | http://d.repec.org/n?u=RePEc:chb:bcchwp:722&r=dge |
| By: | Nie, Jun (Federal Reserve Bank of Kansas City); Fang, Lei |
| Keywords: | Unemployment; Unemployment Insurance (UI)Benefits; Matching Model; Human Capital; Labor Market |
| JEL: | E24 J08 |
| Date: | 2014–01–01 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedkrw:rwp13-10&r=dge |
| By: | Saroj Bhattarai; Gauti Eggertsson; Raphael Schoenle |
| Abstract: | We study the implications of increased price flexibility on output volatility. In a simple DSGE model, we show analytically that more flexible prices always amplify output volatility for supply shocks and also amplify output volatility for demand shocks if monetary policy does not respond strongly to inflation. More flexible prices often reduce welfare, even under optimal monetary policy if full efficiency cannot be attained. We estimate a medium-scale DSGE model using post-WWII U.S. data. In a counterfactual experiment we find that if prices and wages are fully flexible, the standard deviation of annualized output growth more than doubles. |
| JEL: | E31 E32 E52 |
| Date: | 2014–02 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:19886&r=dge |
| By: | Athreya, Kartik B. (Federal Reserve Bank of Richmond); Sanchez, Juan M. (Federal Reserve Bank of St. Louis); Tam, Xuan S. (City University of Hong Kong); Young, Eric R. (University of Virginia) |
| Abstract: | In 2005, bankruptcy laws were reformed significantly, making personal bankruptcy substantially more costly to file than before. Shortly after, the US began to experience its most severe recession in seventy years. While personal bankruptcy rates rose, they rose only modestly given the severity of the rise in unemployment, perhaps as a consequence of the reform. Moreover, in the subsequent recovery, households have been widely viewed as “develeraging” (Mian and Sufi (2011), Krugman and Eggertson (2012)), an interpretation consistent with the largest reduction in the volume of unsecured debt in the past three decades. In this paper, we aim to measure the role jointly played by recent bankruptcy reforms and labor market risks during the Great Recession in accounting for the use of consumer credit and debt default. We use a setting that features high-frequency life-cycle consumption-savings decisions, defaultable debt, search frictions, and aggregate risk. Our results suggest that the 2005 bankruptcy reform likely prevented a substantial increase in bankruptcy filings, but had only limited effect on the observed path of delinquencies. Thus, the reform appears to have “worked.” We also find that fluctuations in the job separation rate observed over the Great Recession did not significantly affect the dynamics of default; all of the work is done, instead, by the large decline in the job-finding rate. |
| JEL: | D9 E21 K35 |
| Date: | 2014–02–01 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2014-002&r=dge |
| By: | Heathcote, Jonathan (Federal Reserve Bank of Minneapolis); Storesletten, Kjetil (University of Oslo); Violante, Giovanni L. (New York University) |
| Abstract: | What shapes the optimal degree of progressivity of the tax and transfer system? On the one hand, a progressive tax system can counteract inequality in initial conditions and substitute for imperfect private insurance against idiosyncratic earnings risk. At the same time, progressivity reduces incentives to work and to invest in skills, and aggravates the externality associated with valued public expenditures. We develop a tractable equilibrium model that features all of these trade-offs. The analytical expressions we derive for social welfare deliver a transparent understanding of how preferences, technology, and market structure parameters influence the optimal degree of progressivity. A calibration for the U.S. economy indicates that endogenous skill investment, flexible labor supply, and the externality linked to valued government purchases play quantitatively similar roles in limiting desired progressivity. |
| Keywords: | Progressivity; Income distribution; Skill investment; Labor supply; Partial insurance; Valued government expenditures; Welfare |
| JEL: | D30 E20 H20 H40 J22 J24 |
| Date: | 2014–01–31 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedmsr:496&r=dge |
| By: | Hirakata, Naohisa (Asian Development Bank Institute); Iwasaki, Yuto (Asian Development Bank Institute); Kawai, Masahiro (Asian Development Bank Institute) |
| Abstract: | This paper examines the international transmission effects that a positive supply shock in emerging economies may have on inflation in developed economies. A three-country dynamic stochastic general equilibrium (DSGE) model is constructed to analyze the impact of a supply shock in an emerging economy, the People's Republic of China (PRC), on inflation rates in two developed economies, Japan and the United States (US). The assumed asymmetric trade structures among the three countries and the PRC's choice of exchange rate regime appear to influence the international transmission of a supply shock in the PRC. Specifically, Japan is under a greater deflationary pressure than the US because of its vertical trade specialization vis-à-vis the PRC and the PRC's US-dollar-pegged regime. This outcome suggests that, even though Japan and the US may face common positive supply shocks from emerging economies, the deflationary impact of the shock is greater for Japan. |
| Keywords: | supply shocks; emerging economies; trade structure; exchange rate regimes; three-country DSGE model |
| JEL: | F32 F41 F44 F47 |
| Date: | 2014–02–07 |
| URL: | http://d.repec.org/n?u=RePEc:ris:adbiwp:0459&r=dge |
| By: | Cheremukhin, Anton A. (Federal Reserve Bank of Dallas); Tutino, Antonella (Federal Reserve Bank of Dallas); Restrepo-Echavarria, Paulina (Federal Reserve Bank of Dallas) |
| Abstract: | We present a theory of targeted search, where people with a finite information processing capacity search for a match. Our theory explicitly accounts for both the quantity and the quality of matches. It delivers a unique equilibrium that resides in between the random matching and the directed search outcomes. The equilibrium that emerges from this middle ground is inefficient relative to the constrained Pareto allocation. Our theory encompasses the outcomes of the random matching and the directed search literature as limiting cases. |
| Keywords: | matching; assignment; search; efficiency; information |
| JEL: | C78 D83 E24 J64 |
| Date: | 2014–02–13 |
| URL: | http://d.repec.org/n?u=RePEc:fip:feddwp:1402&r=dge |
| By: | Jair N. OJeda; Julián A. Parra Polanía; Carmiña O. Vargas |
| Abstract: | This document analyzes the macroeconomic effects of a boom in a small-open economy’s natural-resource sector. We study the effects of this shock on the most important macroeconomic variables, the resource reallocation across sectors and on welfare under alternative fiscal rules. We employ a DSGE featuring three productive sectors (non-tradable, manufacturing and commodity goods), government and two types of consumers (Ricardian and non-Ricardian). Our results show that the natural-resource boom leads to an initial reduction of the manufacturing sector’s employment and production. The opposite temporal effect is obtained in the remaining two productive sectors. However, the effect on welfare is positive for all consumers since the boom increases consumption in all households. Finally, we find that a countercyclical fiscal rule leads to a slight increase in welfare compared with a balanced-budget rule. |
| Keywords: | Fiscal rule, Natural-Resource Boom, Consumer Welfare, Equilibrium Model Classification JEL: E62, F47, H30, H63 |
| Date: | 2014–01 |
| URL: | http://d.repec.org/n?u=RePEc:bdr:borrec:807&r=dge |
| By: | Zhiguo He; Arvind Krishnamurthy |
| Abstract: | Systemic risk arises when shocks lead to states where a disruption in financial intermediation adversely affects the economy and feeds back into further disrupting financial intermediation. We present a macroeconomic model with a financial intermediary sector subject to an equity capital constraint. The novel aspect of our analysis is that the model produces a stochastic steady state distribution for the economy, in which only some of the states correspond to systemic risk states. The model allows us to examine the transition from “normal” states to systemic risk states. We calibrate our model and use it to match the systemic risk apparent during the 2007/2008 financial crisis. We also use the model to compute the conditional probabilities of arriving at a systemic risk state, such as 2007/2008. Finally, we show how the model can be used to conduct a macroeconomic “stress test” linking a stress scenario to the probability of systemic risk states. |
| JEL: | E44 G01 G2 |
| Date: | 2014–02 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:19885&r=dge |
| By: | Wen, Yi (Federal Reserve Bank of St. Louis) |
| Abstract: | This paper develops an analytically tractable Bewley model of money demand to shed light on some important questions in monetary theory, such as the welfare cost of inflation. It is shown that when money is a vital form of liquidity to meet uncertain consumption needs, the welfare costs of inflation can be extremely large. With log utility and parameter values that best match both the aggregate money demand curve suggested by Lucas (2000) and the variance of household consumption, agents in our model are willing to reduce consumption by 3% ~ 4% to avoid 10% annual inflation. The astonishingly large welfare costs of inflation arise because inflation increases consumption risk by eroding the buffer-stock-insurance value of money, thus hindering consumption smoothing at the household level. Such an inflation-induced increase in consumption risk at the micro level cannot be captured by representative-agent models or the Bailey triangle. Although the development of financial intermediation can mitigate the problem, with realistic credit limits the welfare loss of moderate inflation still remains several times larger than estimations based on the Bailey triangle. Our findings provide not only a justification for adopting a low inflation target by central banks, but also a plausible explanation for the robust positive relationship between moderate inflation and social unrest in developing countries where money is the major form of household financial wealth. |
| Keywords: | Liquidity Preference; Money Demand; Financial Intermediation; Velocity; Welfare Costs of Inflation |
| JEL: | D10 D31 D60 E31 E41 E43 E49 E51 |
| Date: | 2014–02–07 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2014-003&r=dge |
| By: | Airaudo, Marco (School of Economics LeBow College of Business Drexel University); Olivero, María Pía (School of Economics LeBow College of Business Drexel University) |
| Abstract: | We study optimal monetary policy in a New Keynesian-DSGE model where the combination of a credit channel and customer-market features in banking gives rise to counter-cyclical credit spreads. In our setting, monopolistically competitive banks set lending rates in a forward-looking fashion as they internalize the fact that, due to borrowers. bank-specific (hence deep) habits, current interest rates also affect the future demand for loans by financially constrained. In particular, during a phase of economic expansion, banks might find it optimal to lower current lending rates to build up a larger customer base, which will be locked into a long-term relationship. The resulting counter-cyclicality of credit spreads makes optimal monetary policy depart substantially from the efficient allocation (and hence from price stability), under both discretion and commitment. Our analysis shows that the welfare costs of setting monetary policy under discretion (with respect to the optimal Ramsey plan) and of using simpler sub-optimal policy rules are strictly increasing in the magnitude of deep habits in credit markets and market power in banking. |
| Keywords: | Optimal monetary policy; Cost Channel; New-Keynesian model; Credit frictions; Deep habits; Credit spreads |
| JEL: | E32 E44 E50 |
| Date: | 2014–01–25 |
| URL: | http://d.repec.org/n?u=RePEc:ris:drxlwp:2014_001&r=dge |
| By: | Elías 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. |
| Date: | 2014–01 |
| URL: | http://d.repec.org/n?u=RePEc:chb:bcchwp:720&r=dge |
| By: | Kliber, Pawel |
| Abstract: | In the article we present some extension for the classical problem of dynamic investment optimization. We take the neoclassical model of growth with one product and many consumption goods. The number of consumption goods can be infinite and the consumption bundle is defined on some abstract, measurable space. The instantaneous social utility of consumption is measured as the integral of individual utilities of the consumption goods. The process of transforming product into consumption goods is described by another measure. The performance of the economy is measured by current value of the total utility in some planning horizon. We show that the problem of choosing optimal consumption paths for each good can be decomposed into 1) problem of choosing optimal aggregate consumption, which can be solved using standard methods of optimal control theory, 2) problem of distribution aggregate consumption into consumption of specific goods. |
| Keywords: | optimal growth, golden rule, optimal control, multiple consumption goods, optimal consumption plans |
| JEL: | C61 E13 E22 O41 |
| Date: | 2014–02–10 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:53636&r=dge |
| By: | Guglielmo Maria Caporale; Michael Donadelli; Alessia Varani |
| Abstract: | A canonical two country-two good model with standard preferences does not address three classic international macroeconomic puzzles as well as two well-known asset pricing puzzles. Specifically, under financial autarky, it does not account for the high real exchange rate (RER) volatility relative to consumption volatility (RER volatility puzzle), the negative RER-consumption differentials correlation (Backus-Smith anomaly), the relatively low cross- country consumption correlation (consumption correlation puzzle), the low risk-free rate (risk-free rate puzzle) and the high equity risk premium (equity premium puzzle) in the data. In this paper, we show that instead a two country-two good model with recursive preferences, international complete markets and correlated long-run innovations can address all five puzzles for a relatively large range of parameter values, specifically in the case of the US and China. Therefore, in contrast to other IBC models, its performance does not rely on any financial market imperfections. |
| Keywords: | Financial autarky, complete markets, long-run risk, anomalies |
| JEL: | F3 F4 |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:diw:diwwpp:dp1362&r=dge |