nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2014‒05‒04
fifteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Heterogeneity and redistribution shocks in business cycles By Keiichiro Kobayashi; Daichi Shirai
  2. Uncertainty in a model with credit frictions By Cesa-Bianchi, Ambrogio; Fernandez-Corugedo, Emilio
  3. Informality and formality: Fiscal policy in DSGE model By Jesús Botero G.; Christian Vargas; Álvaro Hurtado Rendón; Humberto Franco
  4. How Does Tax Progressivity and Household Heterogeneity Affect Laffer Curves? By Hans A. Holter; Dirk Krueger; Serhiy Stepanchuk
  5. The Rise of the English Economy 1300-1900: A Lasting Response to Demographic Shocks By Foreman-Peck, James; Zhou, Peng
  6. The "Second Dividend" and the Demographic Structure By Jouvet, Pierre-André; Gonand, Frédéric
  7. Unemployment Benefit Extensions Caused Jobless Recoveries!? By Kurt Mitman; Stanislav Rabinovich
  8. Constrained inefficiency and optimal taxation with uninsurable risks By Piero Gottardi; Atsushi Kajii; Tomoyuki Nakajima
  9. The role of financial intermediaries in monetary policy transmission By Thorsten Beck; Andrea Colciago; Damjan Pfajfar
  10. Post Reunification Economic Fluctuations in Germany: A Real Business Cycle Interpretation By Michael A. Flor
  11. Fiscal Policy in an Unemployment Crisis By Pontus Rendahl
  12. On the optimality of the Friedman Rule in a New Monetarist Model By Ryoji Hiraguchi; Keiichiro Kobayashi
  13. Efecto de la política fiscal en un modelo de equilibrio general dinámico con sector informal: una aplicación para Colombia By Fernando Jaramillo; Monica Gomez; Andres Garcia
  14. The Krusell-Smith Algorithm: Are Self-fulfilling Equilibria Likely? By Marco Cozzi
  15. Accuracy, Speed and Robustness of Policy Function Iteration By Todd B. Walker; Alexander W. Richter; Nathaniel A. Throckmorton

  1. By: Keiichiro Kobayashi; Daichi Shirai
    Abstract: This paper uses a simple heterogeneous-agent economy model to show that redistribution of wealth among heterogeneous agents can play a significant role in business cycle dynamics and financial crises. In an economy where firms with heterogeneous productivity operate under borrowing constraints, redistribution of wealth reproduces the key features of business cycle fluctuations such as persistence and nonlinearity in output and labor, and procyclicality in observed productivity. This model suggests the hypothesis that a redistribution shock may be one of the key driving forces of business cycles. The aggregate variables exhibit strong nonlinearity in both our model and the standard model: however, while the behavior of individual agents does not involve nonlinearity in our model, strong nonlinearity is assumed in the standard model.
    Date: 2014–03
  2. By: Cesa-Bianchi, Ambrogio (Bank of England); Fernandez-Corugedo, Emilio (Bank of England)
    Abstract: This paper investigates the relationship between uncertainty and economic activity in a DSGE model with sticky prices and credit frictions. We analyse the effect of a mean preserving shock to the variance of aggregate total factor productivity (macro uncertainty) and we compare it to the effect of a mean preserving shock to the dispersion of entrepreneurs' idiosyncratic productivity (micro uncertainty). We find that micro uncertainty has a larger impact on economic activity. While macro uncertainty is transmitted through precautionary savings, micro uncertainty primarily acts through the cost of external debt and capital demand and, therefore, it is greatly magnified by the credit friction. Our findings suggest that uncertainty shocks can generate sizable impact on economic activity only when transmitted through a credit channel.
    Keywords: Uncertainty shocks; credit frictions; business cycles; micro uncertainty; macro uncertainty; financial accelerator
    JEL: E32 E44
    Date: 2014–04–17
  3. By: Jesús Botero G.; Christian Vargas; Álvaro Hurtado Rendón; Humberto Franco
    Abstract: We develop a DSGE model of the Colombian economy to assess the effect of tax policy on informal employment and income distribution.The model recreates a small open economy, with persistent income inequality, a substantial degree of informality, and different possibilities of government intervention. This paper evaluates the consequences of government transfer payments to households with lower incomes. We find that although transfer payments have a positive effect on income distribution, financing them requires an adjustment in government finances (cut spending or increase revenue through the use of various taxes), have negative effects on the economic as a whole. ***** Desarrollamos un modelo DSGE de la economía colombiana para evaluar el efecto de la política fiscal sobre el empleo informal y distribución del ingreso. El modelo recrea una economía pequeña y abierta, con la persistente desigualdad de ingresos, un alto grado de informalidad, y las diferentes posibilidades de intervención del gobierno. Este documento evalúa las consecuencias de los pagos de transferencia del gobierno a los hogares con ingresos más bajos. Encontramos que si bien los pagos de transferencias tienen un efecto positivo sobre la distribución del ingreso, su financiación requiere un ajuste en las finanzas públicas (reducir el gasto o aumentar los ingresos a través del uso de diversos impuestos), tienen efectos negativos sobre la economía en su conjunto.
    Keywords: Public expenditure; exogenous shock; DSGE
    JEL: E62 D58
    Date: 2014–03–11
  4. By: Hans A. Holter (Uppsala University and UCFS); Dirk Krueger (Department of Economics, University of Pennsylvania, CEPR and NBER); Serhiy Stepanchuk (Cole Polytechnique Federale de Lausanne)
    Abstract: The recent public debt crisis in most developed economies implies an urgent need for increasing tax revenues or cutting government spending. In this paper we study the importance of household heterogeneity and the progressivity of the labor income tax schedule for the ability of the government to generate tax revenues. We develop an overlapping generations model with uninsurable idiosyncratic risk, endogenous human capital accumulation as well as labor supply decisions along the intensive and extensive margins. We calibrate the model to macro, micro and tax data from the US as well as a number of European countries, and then for each country characterize the labor income tax Laffer curve under the current country-specific choice of the progressivity of the labor income tax code. We find that more progressive labor income taxes significantly reduce tax revenues. For the US, converting to a flat tax code raises the peak of the laffer curve by 7%. We also find that modeling household heterogeneity is important for the shape of the Laffer curve.
    Keywords: Progressive Taxation, Fiscal Policy, Laffer Curve, Government Debt
    JEL: E62 H20 H60
    Date: 2014–03–01
  5. By: Foreman-Peck, James (Cardiff Business School); Zhou, Peng (Cardiff Business School)
    Abstract: We construct a Dynamic Stochastic General Equilibrium model of the interaction between demography and the economy for six centuries of English history. At the core of the four overlapping generations, rational expectations model is household choice about target number and quality of children, as well as female age at first marriage. The parameters are formally estimated rather than calibrated. Data on births, deaths, population and the real wage, and data moments can be closely matched by the estimated model. We show that the marriage age rises to reach that typical of the Western European Marriage Pattern at the end of the high mortality epoch of the 14th century. Higher marriage age lowers costs of child quality so that human capital gradually accumulates over the generations. But it does so more slowly than that of population initially, so that there is a negative correlation between population and wage. Ultimately the growth of human capital catches up with that of population and triggers a break out from the Malthusian equilibrium at the end of the 18th century. Without the contribution of late female age to human capital, human capital would have been about 20% of what it actually was around 1800, and real wages would only have attained about half their actual value.
    Keywords: Economic development; Demography; DGSE model; English economy
    JEL: O11 J11 N13
    Date: 2014–04
  6. By: Jouvet, Pierre-André; Gonand, Frédéric
    Abstract: The demographic structure of a country influences economic activity. The "second dividend" modifies growth. Accordingly, in general equilibrium, the second dividend and the demographic structure are interrelated. This paper aims at assessing empirically the "second dividend" in a dynamic, empirical and intertemporal setting that allows for measuring its impact on growth, its intergenerational redistributive effects, and its interaction with the demographic structure. The article uses a general equilibrium model with overlapping generations, an energy module and a public finance module. Policy scenarios compare the consequences of recycling a carbon tax through lowe r proportional income tax rather than higher public lumpsum expenditures. They are computed for two countries with different demographics (France and Germany). Results suggest that the magnitude of the "second dividend" is significantly related with the demographic structure. The more concentrated the demographic structure on cohorts with higher income and saving rate, the stronger the effect on capital supply of the second dividend. The second dividend weighs on the welfare of relatively aged working cohorts. It fosters the wellbeing of young working cohorts and of future generations. The more concentrated the demog raphic structure on aged working cohorts, the higher the intergenerational redistributive effects of the second dividend.
    Keywords: Energy transition; intergenerational redistribution; overlapping generations; double dividend; general equilibrium;
    JEL: D58 D63 E62 L7 Q28 Q43
    Date: 2014–04
  7. By: Kurt Mitman (Department of Economics, University of Pennsylvania); Stanislav Rabinovich (Department of Economics, Amherst College)
    Abstract: The last three recessions in the United States were followed by jobless recoveries: while labor productivity recovered, unemployment remained high. In this paper, we show that countercyclical unemployment benefit extensions lead to jobless recoveries. We augment the standard Mortensen-Pissarides model to incorporate unemployment benefits expiration and state-dependent extensions of unemployment benefits. In the model, an extension of unemployment benefits slows down the recovery of vacancy creation in the aftermath of a recession. We calibrate the model to US data and show that it is quantitatively consistent with observed labor market dynamics, in particular the emergence of jobless recoveries after 1990. Furthermore, counterfactual experiments indicate that unemployment benefits are quantitatively important in explaining jobless recoveries.
    Keywords: Unemployment Insurance, Business Cycles, Jobless Recoveries
    JEL: E24 E32 J65
    Date: 2014–04–21
  8. By: Piero Gottardi; Atsushi Kajii; Tomoyuki Nakajima
    Abstract: When individuals' labor and capital income are subject to uninsurable idiosyncratic risks, should capital and labor be taxed, and if so how? In a two period general equilibrium model with production, we derive a decomposition formula of the welfare e ects of these taxes into insurance and distribution e ects. This allows us to determine how the sign of the optimal taxes on capital and labor depend on the nature of the shocks, the degree of heterogeneity among consumers' income as well as on the way in which the tax revenue is used to provide lump sum transfers to consumers. When shocks a ect primarily labor income and heterogeneity is small, the optimal tax on capital is positive. However in other cases a negative tax on capital is welfare improving.
    Date: 2014–01
  9. By: Thorsten Beck; Andrea Colciago; Damjan Pfajfar
    Abstract: The recent financial crisis has stimulated theoretical and empirical research on the propagation mechanisms underlying business cycles, in particular on the role of financial frictions. Many issues concerning the interactions between banking and monetary policy forced policy makers to economic policies, and motivated macroeconomists to focus on the implications of financial intermediation constraints on asset price fluctuations, the behavior of non-financial firms, households, governments and in turn for real macroeconomic performance. This paper surveys research on the role of financial intermediaries and financial frictions in the transmission of monetary policy and discusses how to design both the new banking regulatory and supervisory structures and monetary policy in order to stabilize the economy. It also serves as an introduction to this special issue.
    Keywords: Financial Intermediation; DSGE models; Financial Frictions
    JEL: E40 E50 G20
    Date: 2014–04
  10. By: Michael A. Flor (University of Augsburg, Department of Economics)
    Abstract: We consider the cyclical properties of the German economy prior and after reunification in 1990 from the perspective of a real business cycle model. The model provides the framework for the selection and consistent measurement of the variables whose time series properties characterize the cycle. Simulations of the calibrated model reveal the model's potential to interpret the data. Major findings are that: i) the volatility of most aggregate time series has not changed significantly between the two time periods, ii) despite many conceptual differences between the European and the U.S. System of Accounts, the calibrated parameter values for the German economy are within the range of values usually employed in the real business cycle literature, iii) the model is closer to the data for the time period prior to reunification.
    Keywords: Macroeconomic Data, National Income, Product Accounts, Economic Fluctuations, Real Business Cycles
    JEL: C82 E01 E32
    Date: 2014–04
  11. By: Pontus Rendahl
    Abstract: This paper studies a model of equilibrium unemployment in which the ecacy of scal policy increases markedly in times of crises. A sudden rise in pessimism leads households to save rather than to spend, causing a fall in output and rising unemployment But as a persistent rise in unemployment fuels pessimism, the economy is set on a downward spiral in which thrift reinforces thrift. The government can put this process to an end. An expansion in public spending bolsters demand and lowers the unemployment rate both in the present and in the future. Pessimism is replaced by optimism and the vicious cycle is turned into a virtuous. The marginal impact of government spending on output is negative during normal times. But in a severe recession the scal multiplier rises to about three, and expansionary scal policy is unambiguously Pareto improving.
    Keywords: Fiscal multiplier; Fiscal policy; Liquidity trap; Unemployment inertia
    JEL: E24 E60 E62 H12 H30 J23 J64
    Date: 2014–04–29
  12. By: Ryoji Hiraguchi; Keiichiro Kobayashi
    Abstract: We study a monetary model in which buyers choose search intensity and prices are considered as given in the decentralized market. In doing so, we indicate that the Friedman rule may not be optimal. Buyers' search intensity is excessively low under the rule, because their surplus is less than the social surplus under the price-taking regime. A deviation from the rule increases buyers' surplus and search intensity, and thus raises welfare and output. Our result differs from Lagos and Rocheteau (International Economic Review 2005) in which the pricing mechanism is either bargaining or price-posting and the Friedman rule is optimal.
    Date: 2013–11
  13. By: Fernando Jaramillo; Monica Gomez; Andres Garcia
    Abstract: Resumen: El presente trabajo estudia el efecto de la política fiscal sobre el empleo y la producción de los sectores formales e informales. En particular, se estudia cuáles tipos de impuestos son más eficientes para financiar el gasto público, en el contexto de una economía con un sector informal importante. El modelo puede ser usado para evaluar el efecto de políticas fiscales tendientes a reducir el tamaño del sector informal, como la recientemente adoptada en Colombia. En este artículo se presenta un modelo dinámico con acumulación de capital y presencia del sector informal, con el fin de cuantificar el efecto de cambios en la política fiscal en un país con un sector informal importante, como Colombia. Para esto, se le introduce desempleo e informalidad a un modelo dinámico de crecimiento a la Ramsey-Cass-Koopmans con impuestos al consumo, al trabajo y al capital. A partir de esta estructura se construye un modelo Dinámico Estocástico de Equilibrio General (DSGE por su siglas en inglés) con fricciones en el mercado de trabajo a la Mortensen y Pissarides (1994) y con dos sectores productivos: el formal y el informal. Los resultados de los ejercicios confirman los resultados encontrados por Stiglitz en un modelo estático, en el sentido que el impuesto al consumo no necesariamente es más eficiente que otros impuestos que en la literatura tradicional son distorsionantes.
    Date: 2013–08–01
  14. By: Marco Cozzi (Queen's University)
    Abstract: I investigate whether the popular Krusell and Smith algorithm used to solve heterogeneous-agent economies with aggregate uncertainty and incomplete markets is likely to be subject to multiple self-fulfilling equilibria. In a benchmark economy, the parameters representing the equilibrium aggregate law of motion are randomly perturbed 500 times, and are used as the new initial guess to compute the equilibrium with this algorithm. In a sequence of cases, differing only in the magnitude of the perturbations, I do not find evidence of multiple self-fulfilling equilibria. The economic reason behind the result lies in a self-correcting mechanism present in the algorithm: compared to the equilibrium law of motion, a candidate one implying a higher (lower) expected future capital reduces (increases) the equilibrium interest rates, increasing (reducing) the savings of the wealth-rich agents only. These, on the other hand, account for a small fraction of the population and cannot compensate for the opposite change triggered by the wealth-poor agents, who enjoy higher (lower) future wages and increase (reduce) their current consumption. Quantitatively, the change in behavior of the wealth-rich agents has a negligible impact on the determination of the change in the aggregate savings, inducing stability in the algorithm as a by-product.
    Keywords: Unemployment Risk, Business Cycles, Incomplete Markets, Heterogeneous Agents, Numerical Methods, Self-fulfilling Equilibria
    JEL: C63 C68 E21 E32
    Date: 2014–04
  15. By: Todd B. Walker; Alexander W. Richter; Nathaniel A. Throckmorton
    Abstract: Policy function iteration methods for solving and analyzing dynamic stochastic general equilibrium models are powerful from a theoretical and computational perspective. Despite obvious theoretical appeal, significant startup costs and a reliance on grid-based methods have limited the use of policy function iteration as a solution algorithm. We reduce these costs by providing a user-friendly suite of MATLAB functions that introduce multi-core processing and Fortran via MATLAB's executable function. Within the class of policy function iteration methods, we advocate using time iteration with linear interpolation. We examine a canonical real business cycle model and a new Keynesian model that features regime switching in policy parameters, Epstein-Zin preferences, and monetary policy that occasionally hits the zero-lower bound on the nominal interest rate to highlight the attractiveness of our methodology. We compare our advocated approach to other familiar iteration and approximation methods, highlighting the tradeoffs between accuracy, speed and robustness.
    Keywords: Policy function iteration; Zero lower bound; Epstein-Zin preferences; Markov switching; Chebyshev polynomials; Real business cycle model; New Keynesian model
    JEL: C63 C68 E52 E62
    Date: 2014–04

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