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on Dynamic General Equilibrium |
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Issue of 2014‒04‒05
nineteen papers chosen by Christian Zimmermann Federal Reserve Bank of St. Louis |
| By: | Wei Cui; Sören Radde |
| Abstract: | We endogenize asset liquidity in a dynamic general equilibrium model with search frictions on asset markets. In the model, asset liquidity is tantamount to the ease of issuance and resaleability of private financial claims, which is driven by investors' participation on the search market. Limited resaleability of private claims creates a role for liquid assets, such as government bonds or fiat money, to ease funding constraints. We show that liquidity and asset prices positively co-move. When the capacity of the asset market to channel funds to entrepreneurs deteriorates, the hedging value of liquid assets increases. Our model is thus able to match the flight to liquidity observed during recessions. Finally, we show that investors' search market participation is more intense in a constrained efficient economy. |
| Keywords: | endogenous asset liquidity, search frictions |
| JEL: | E22 E44 E58 |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:diw:diwwpp:dp1367&r=dge |
| By: | Costa Junior, Celso José; Sampaio, Armando Vaz |
| Abstract: | There is a widespread feeling in Brazilian society that tax reform has become necessary. Analysts seek to mitigate the perverse impact of taxation on economic efficiency and competitiveness of the productive sector. In view of this, the objective of this work is to contribute to the discussion about tax reduction in the productive sector through a dynamic stochastic general equilibrium (DSGE) model. To achieve this purpose, two stochastic shocks will be analyzed in the tax rates changes on labor income and capital income. The results suggest that the tax reduction in the first tax is greater than the same effect in the second. In this first shock, there were increases in output, consumption and investment and decreases in public debt and government spending. In the second shock, the poor performance was related to low growth in the capital stock. The results of the tax revenues were similar for the two tax reductions. They showed alignment with the major tax reform proposals for Brazil, a decrease in direct taxes and an increase in indirect taxes. |
| Keywords: | DSGE Models; Tax Reduction; Simulation |
| JEL: | C63 E37 E62 |
| Date: | 2014–04 |
| URL: | http://d.repec.org/n?u=RePEc:cpm:dynare:036&r=dge |
| By: | Tayler, William; Zilberman, Roy |
| Abstract: | This paper examines the macroprudential roles of bank capital regulation and monetary policy in a Dynamic Stochastic General Equilibrium model with endogenous financial frictions and a borrowing cost channel. We identify various transmission channels through which credit risk, commercial bank losses, monetary policy and bank capital requirements affect the real economy. These mechanisms generate significant financial accelerator effects, thus providing a rationale for a macroprudential toolkit. Following credit shocks, countercyclical bank capital regulation is more effective than monetary policy in promoting financial, price and overall macroeconomic stability. For supply shocks, macroprudential regulation combined with a strong response to inflation in the central bank policy rule yield the lowest welfare losses. The findings emphasize the importance of the Basel III regulatory accords and cast doubt on the desirability of conventional Taylor rules during periods of financial distress. |
| Keywords: | Bank Capital Regulation; Macroprudential Policy; Basel III; Monetary Policy; Borrowing Cost Channel |
| JEL: | E32 E44 E52 E58 G28 |
| Date: | 2014–04 |
| URL: | http://d.repec.org/n?u=RePEc:cpm:dynare:037&r=dge |
| By: | Williamson, Stephen D. (Washington University in St. Louis); Carapella, Francesca (Board of Governors of the Federal Reserve System) |
| Abstract: | A dynamic model with credit under limited commitment is constructed, in which limited memory can weaken the effects of punishment for default. This creates an endogenous role for government debt in credit markets, and the economy can be non-Ricardian. Default can occur in equilibrium, and government debt essentially plays a role as collateral and thus improves borrowers’ incentives. The provision of government debt acts to discourage default, whether default occurs in equilibrium or not. |
| JEL: | E4 E5 E6 |
| Date: | 2014–02–24 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2014-010&r=dge |
| By: | Rotillon, Gilles; Jouvet, Pierre-André; Bréchet, Thierry |
| Abstract: | In this paper we study the dynamic general equilibrium path of an economy and the associated optimal growth path in a two-sector overlapping generation model with a stock pollutant. A sector (power generation) is polluting, and the other (final good) is not. Pollution is regulated by tradable emission permits. The issue is to see whether the optimal growth path can be replicated in equilibrium with pollution permits, given that some permits must be issued free of charge for the sake of political acceptability. We first analyze the many adverse impacts of free allowances, and then we propose a policy rule that allows optimality and acceptability to be reconciled. |
| Keywords: | General equilibrium; Optimal growth; Pollution; Tradable emission permits; Acceptability; |
| JEL: | D61 D9 Q28 |
| Date: | 2013–07 |
| URL: | http://d.repec.org/n?u=RePEc:dau:papers:123456789/12953&r=dge |
| By: | Paul Castillo (Banco Central de Reserva del Perú); Cesar Carrera (Banco Central de Reserva del Perú); Marco Ortiz (Banco Central de Reserva del Perú); Hugo Vega (Banco Central de Reserva del Perú) |
| Abstract: | This paper extends the model of Aoki et al. (2009) considering a two sector small open economy. We study the interaction of borrowing, asset prices, and spillovers between tradable and non-tradable sectors. Our results suggest that when it is difficult to enforce debtors to repay their debt unless it is secured by collateral, a productivity shock in the tradable sector generates an increase in asset prices and leverage that spills over to the non-tradable sector, generating an appreciation of the real exchange and an increase in domestic lending. Macro-prudential instruments are introduced under the form of cyclical loan-to-value ratios that limit the amount of capital that entrepreneurs can pledge as collateral. Cyclical taxes that respond to the movements in the price of non-tradable goods are analysed. Simulation results show that this type of instruments significantly lessen the amplifying effects of borrowing constraints on small open economies and consequently reduce output and asset price volatility. |
| Keywords: | Collateral, productivity, small open economy |
| JEL: | E21 E23 E32 E44 G01 O11 O16 |
| Date: | 2014–03 |
| URL: | http://d.repec.org/n?u=RePEc:apc:wpaper:2014-010&r=dge |
| By: | Beaubrun-Diant, Kevin; Tripier, Fabien |
| Abstract: | The present paper contributes to the body of knowledge on search frictions in credit markets by demonstrating their ability to explain why the net interest margins of banks behave countercyclically. During periods of expansion, a fall in the net interest margin proceeds from two mechanisms: (i) lenders accept that they must finance entrepreneurs that have lower productivity and (ii) the liquidity of the credit market rises, which simplifies access to loans for entrepreneurs and thereby reinforces their threat point when bargaining the interest rate of the loan. |
| Keywords: | Search Friction; Matching Model; Nash Bargaining; Bank Interest Margin; |
| JEL: | C78 E32 E44 G21 |
| Date: | 2013–12 |
| URL: | http://d.repec.org/n?u=RePEc:dau:papers:123456789/13009&r=dge |
| By: | Carroll, Christopher D.; Slacalek, Jiri; Tokuoka, Kiichi |
| Abstract: | We present a macroeconomic model calibrated to match both microeconomic and macroeconomic evidence on household income dynamics. When the model is modified in a way that permits it to match empirical measures of wealth inequality in the U.S., we show that its predictions (unlike those of competing models) are consistent with the substantial body of microeconomic evidence which suggests that the annual marginal propensity to consume (MPC) is much larger than the 0.02_0.04 range implied by commonly-used macroeconomic models. Our model also (plausibly) predicts that the aggregate MPC can differ greatly depending on how the shock is distributed across categories of households (e.g., low-wealth versus high-wealth households). JEL Classification: D12, D31, D91, E21 |
| Keywords: | consumption dynamics, microfoundations, MPC, wealth inequality |
| Date: | 2014–03 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20141655&r=dge |
| By: | Daniel Harenberg (ETH Zurich, Switzerland); Alexander Ludwig (CMR & FiFo, University of Cologne) |
| Abstract: | We ask whether a PAYG-financed social security system is welfare improving in an economy with idiosyncratic and aggregate risk. We argue that interactions between the two risks are important for this question. One is a direct interaction in the form of a countercyclical variance of idiosyncratic income risk. The other indirectly emerges over a household's life-cycle because retirement savings contain the history of idiosyncratic and aggregate shocks. We show that this leads to risk interactions, even when risks are statistically independent. In our quantitative analysis, we find that introducing social security with a contribution rate of two percent leads to welfare gains of 2.2% of lifetime consumption in expectation, despite substantial crowding out of capital. This welfare gain stands in contrast to the welfare losses documented in the previous literature, which studies one risk in isolation. We show that jointly modeling both risks is crucial: 60% of the welfare benefits from insurance result from the interactions of risks. |
| Keywords: | Social security; idiosyncratic risk; aggregate risk; welfare |
| JEL: | C68 E27 E62 G12 H55 |
| Date: | 2014–03 |
| URL: | http://d.repec.org/n?u=RePEc:eth:wpswif:14-193&r=dge |
| By: | Ryan Chahrour (Boston College); Justin Svec (College of the Holy Cross) |
| Abstract: | This paper analyzes the impact of consumer uncertainty on optimal fiscal policy in a model with capital. The consumers lack confidence about the probability model that characterizes the stochastic environment and so apply a max-min operator to their optimization problem. An altruistic fiscal authority does not face this Knightian uncertainty. We show analytically that, in responding to consumer uncertainty, the government no longer sets the expected capital tax rate exactly equal to zero, as is the case in the full-confidence benchmark model. Rather, our numerical results indicate that the government chooses to subsidize capital income, albeit at a modest rate. We also show that the government responds to consumer uncertainty by smoothing the labor tax across states and by making the labor tax persistent. |
| Keywords: | Model uncertainty, capital income tax, public debt |
| JEL: | E62 H21 |
| Date: | 2014–04–01 |
| URL: | http://d.repec.org/n?u=RePEc:boc:bocoec:854&r=dge |
| By: | Gabriele Sarais; Damiano Brigo |
| Abstract: | We develop a model to price inflation and interest rates derivatives using continuous-time dynamics that have some links with macroeconomic monetary DSGE models equipped with a Taylor rule: in particular, the reaction function of the central bank, the bond market liquidity, inflation and growth expectations play an important role. The model can explain the effects of non-standard monetary policies (like quantitative easing or its tapering) and shed light on how central bank policy can affect the value of inflation and interest rates derivatives. The model is built under standard no-arbitrage assumptions. Interestingly, the model yields short rate dynamics that are consistent with a time-varying Hull-White model, therefore making the calibration to the nominal interest curve and options straightforward. Further, we obtain closed forms for both zero-coupon and year-on-year inflation swap and options. The calibration strategy we propose is fully separable, which means that the calibration can be carried out in subsequent simple steps that do not require heavy computation. A market calibration example is provided. The advantages of such structural inflation modelling become apparent when one starts doing risk analysis on an inflation derivatives book: because the model explicitly takes into account economic variables, a trader can easily assess the impact of a change in central bank policy on a complex book of fixed income instruments, which is normally not straightforward if one is using standard inflation pricing models. |
| Date: | 2014–03 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1403.7799&r=dge |
| By: | Williamson, Stephen D. (Washington University in St. Louis) |
| Abstract: | A model of money, credit, and banking is constructed in which the differential pledgeability of collateral and the scarcity of collateralizable wealth lead to a term premium — an upward-sloping nominal yield curve. Purchases of long-maturity government debt by the central bank are always a good idea, but for unconventional reasons. A floor system is preferred to a channel system, as a floor system permits welfare-improving asset purchases by the central bank. |
| JEL: | E4 E5 |
| Date: | 2014–01–15 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2014-008&r=dge |
| By: | Tsasa Vangu, Jean-Paul Kimbambu |
| Abstract: | Ce papier se propose d’analyse la dynamique de la politique monétaire en République démocratique du Congo (RDC), en adoptant une approche de modélisation par l’équilibre général dynamique stochastique (DSGE). Le modèle DSGE construit à cet effet considère trois relations macroéconomiques standards ; six catégories d’agents économiques ; trois types de rigidités nominales en plus des rigidités réelles introduites via les habitudes de consommation. Les résultats obtenus à l’issue de nos investigations révèle notamment, que l’écart de production est moins sensible aux variations du taux d’intérêt, ce qui réduit l’impact des effets réels des chocs de la politique monétaire sur la demande globale, et que par ailleurs, l’inflation courante pendant la décennie 2000 a été plus sensible à l’inflation future anticipée qu’à son niveau passé. |
| Keywords: | DSGE; SVAR; Monetary policy |
| JEL: | C61 E27 E32 E5 |
| Date: | 2014–04 |
| URL: | http://d.repec.org/n?u=RePEc:cpm:dynare:038&r=dge |
| By: | Wright, Randall (Federal Reserve Bank of Minneapolis); Trejos, Alberto (University of Michigan) |
| Abstract: | Many applications of search theory in monetary economics use the Shi-Trejos-Wright model, hereafter STW, while applications in finance use Duffie-Gârleanu-Pederson, hereafter DGP. These approaches have much in common, and both claim to be about liquidity, but the models also differ in a fundamental way: in STW agents use assets as payment instruments when trading goods; in DGP there are no gains from exchanging goods, but agents trade because they value assets differently with goods serving as payment instruments. We develop a framework nesting the two. This clarifies the connection between the literatures, and generates new insights and applications. Even in the special cases of the baseline STW and DGP models, we provide propositions generalizing and strengthening what is currently known, and rederiving some existing results using more tractable arguments. |
| Keywords: | Search; Bargaining; Money; Finance |
| JEL: | E40 E44 |
| Date: | 2014–03–19 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedmwp:709&r=dge |
| By: | Decker, Ryan (University of Maryland); D'Erasmo, Pablo (Federal Reserve Bank of Philadelphia); Moscoso Boedo, Herman J. (University of Virginia) |
| Abstract: | First Draft: November 1, 2011 We propose a theory of endogenous firm-level volatility over the business cycle based on endogenous market exposure. Firms that reach a larger number of markets diversify market-specific demand risk at a cost. The model is driven only by total factor productivity shocks and captures the business cycle properties of firm-level volatility. Using a panel of U.S. firms (Compustat), we empirically document the countercyclical nature of firm-level volatility. We then match this panel to Compustat’s Segment data and the U.S. Census’s Longitudinal Business Database (LBD) to show that, consistent with our model, measures of market reach are procyclical, and the countercyclicality of firm-level volatility is driven mostly by those firms that adjust the number of markets to which they are exposed. This finding is explained by the negative elasticity between various measures of market exposure and firm-level idiosyncratic volatility we uncover using Compustat, the LBD, and the Kauffman Firm Survey. |
| Keywords: | Endogenous idiosyncratic risk; Business cycles; Market exposure; |
| JEL: | D21 D22 E32 L11 L25 |
| Date: | 2014–03–24 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedpwp:14-12&r=dge |
| By: | Carroll, Christopher D.; Slacalek, Jiri; Tokuoka, Kiichi |
| Abstract: | A large body of microeconomic evidence supports Friedman (1957)'s proposition that household income can be reasonably well described as having both transitory and permanent components. We show how to modify the widely-used macroeconomic model of Krusell and Smith (1998) to accommodate such a microeconomic income process. Our incorporation of substantial permanent income shocks helps our model to explain a substantial part of the large degree of empirical wealth heterogeneity that is unexplained in the baseline Krusell and Smith (1998) model, even without heterogeneity in preferences. JEL Classification: D12, D31, D91, E21 |
| Keywords: | aggregate uncertainty, household income process, wealth inequality |
| Date: | 2014–02 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20141633&r=dge |
| By: | Carroll, Christopher D.; Slacalek, Jiri; Tokuoka, Kiichi |
| Abstract: | Using new micro data on household wealth from fifteen European countries, the Household Finance and Consumption Survey, we first document the substantial cross-country variation in how various measures of wealth are distributed across individual households. Through the lens of a standard, realistically calibrated model of buffer-stock saving with transitory and permanent income shocks we then study how cross-country differences in the wealth distribution and household income dynamics affect the marginal propensity to consume out of transitory shocks (MPC). We find that the aggregate consumption response ranges between 0.1 and 0.4 and is stronger (i) in economies with large wealth inequality, where a larger proportion of households has little wealth, (ii) under larger transitory income shocks and (iii) when we consider households only using liquid assets (rather than net wealth) to smooth consumption. JEL Classification: D12, D31, D91, E21 |
| Keywords: | consumption dynamics, cross-country comparisons, liquid assets, MPC, wealth inequality |
| Date: | 2014–03 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20141648&r=dge |
| By: | D'Erasmo, Pablo (Federal Reserve Bank of Philadelphia); Moscoso Boedo, Herman J. (University of Virginia); Senkal, Asli (University of Virginia) |
| Abstract: | Accepted for publication, Journal of Economic Dynamics and Control The aim of this paper is to quantify the role of formal-sector institutions in shaping the demand for human capital and the level of informality. We propose a firm dynamics model where firms face capital market imperfections and costs of operating in the formal sector. Formal firms have a larger set of production opportunities and the ability to employ skilled workers, but informal firms can avoid the costs of formalization. These firm-level distortions give rise to endogenous formal and informal sectors and, more importantly, affect the demand for skilled workers. The model predicts that countries with a low degree of debt enforcement and high costs of formalization are characterized by relatively lower stocks of skilled workers, larger informal sectors, low allocative efficiency, and measured TFP. Moreover, we find that the interaction between entry costs and financial frictions (as opposed to the sum of their individual effects) is the main driver of these differences. This complementarity effect derives from the introduction of skilled workers, which prevents firms from substituting labor for capital and in turn moves them closer to the financial constraint. |
| Keywords: | Financial Structure; Informal Sector; Productivity; Policy Distortions; Human Capital; |
| JEL: | D24 E26 J24 L11 O16 O17 |
| Date: | 2014–03–24 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedpwp:14-11&r=dge |
| By: | Afonso, Gara M. (Federal Reserve Bank of New York); Lagos, Ricardo (Federal Reserve Bank of Minneapolis) |
| Abstract: | We develop a model of the market for federal funds that explicitly accounts for its two distinctive features: banks have to search for a suitable counterparty, and once they meet, both parties negotiate the size of the loan and the repayment. The theory is used to answer a number of positive and normative questions: What are the determinants of the fed funds rate? How does the market reallocate funds? Is the market able to achieve an efficient reallocation of funds? We also use the model for theoretical and quantitative analyses of policy issues facing modern central banks. |
| Keywords: | Fed funds market; Search; Bargaining; Over-the-counter market |
| JEL: | C78 D83 E44 G10 |
| Date: | 2014–03–27 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedmwp:710&r=dge |