nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2014‒05‒17
twenty papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Welfare Benefits of Capital Controls:The Case of Spain By Shigeto Kitano; Yoichi Matsubayashi
  2. Fiscal Stimulus and Unemployment Dynamics By Chun-Hung Kuo; Hiroaki Miyamoto
  3. Uncertainty Shocks, Asset Supply and Pricing over the Business Cycle By Francesco Bianchi; Cosmin Ilut; Martin Schneider
  4. Error correction dynamics of house prices: an equilibrium benchmark By Leung, Charles Ka Yui
  5. Inflation in the Great Recession and New Keynesian Models By Marco Del Negro; Marc P. Giannoni; Frank Schorfheide
  6. Business Cycle Accounting in a Small Open Economy By Jacek Rothert; Mohammad Rahmati
  7. Financial Frictions and Firm Dynamics By Paul Bergin; Ling Feng; Ching-Yi Lin
  8. Natural-Resource Booms, Fiscal Rules and Welfare in a Small Open Economy By Jair N. Ojeda; Julián A. Parra-Polanía; Carmiña O. Vargas
  9. Trade adjustment dynamics and the welfare gains from trade By Alessandria, George; Choi, Horag; Ruhl, Kim J.
  10. Risk Matters: A Comment By Born, Benjamin; Pfeifer, Johannes
  11. Optimal Allocation of Social Cost for Electronic Payment System: A Ramsey Approach By Pidong Huang; Young Sik Kim; Manjong Lee
  12. Uncertainty and fiscal cliffs By Davig, Troy A.; Foerster, Andrew T.
  13. A DSGE Model with loss aversion in consumption and leisure: An explanation for business cycles aymmetries By Wilman Gomez
  14. Optimal Exchange Rate Policy in a Growing Semi-Open Economy By Philippe Bacchetta; Kenza Benhima; Yannick Kalantzis
  15. Composition of Portfolio and Cost of Inflation By Manjong Lee; Sung Guan Yun
  16. Capital requirements in a quantitative model of banking industry dynamics By Corbae, Dean; D'Erasmo, Pablo
  17. Segregated Security Exchanges with Ex Ante Rights to Trade: A Market-Based Solution to Collateral-Constrained Externalities By Weerachart T. Kilenthong; Robert M. Townsend
  18. Bequests and Heterogeneity in Retirement Wealth By Mariacristina De Nardi; Fang Yang
  19. Análisis del ciclo económico en una economía con rigideces nominales y un amplio sector informal By Monica Gomez
  20. The Over-the-Counter Theory of the Fed Funds Market: A Primer By Afonso, Gara M.; Lagos, Ricardo

  1. By: Shigeto Kitano (Research Institute for Economics & Business Administration (RIEB), Kobe University, Japan); Yoichi Matsubayashi (Graduate School of Economics, Kobe University, Japan)
    Abstract: We estimate a small open economy RBC model augmented with a simple form of financial frictions using Spanish data and Bayesian methods. The estimated model matches well with key Spanish business cycle statistics. Using the estimated model, we find that significant welfare benefits may accrue from capital controls.
    Keywords: Capital controls, Welfare, DSGE, Small open economy models, Bayesian estimation
    JEL: F41
    Date: 2014–05
  2. By: Chun-Hung Kuo (International University of Japan); Hiroaki Miyamoto (The University of Tokyo)
    Abstract: Focusing on both hiring and firing margins, this paper revisits effects of fiscal expansion on unemployment. We provide evidence that an increase in government spending increases the job finding rate and reduces the separation rate, lowering unemployment in the U.S. by using a structural VAR model. We then develop a DSGE model with search frictions where job separation is endogenously determined. Our model can capture the empirical pattern of responses of the job finding, separation, and unemployment rates to a government spending shock. We also demonstrate that model's predictions are in contrast with earlier studies that assume exogenous separation.
    Keywords: Fiscal Policy, Unemployment, Labor market, Search and matching, Endogenous separation
    JEL: E24 E62 J64
    Date: 2014–05
  3. By: Francesco Bianchi; Cosmin Ilut; Martin Schneider
    Abstract: This paper studies a DSGE model with endogenous financial asset supply and ambiguity averse investors. An increase in uncertainty about profits leads firms to substitute away from debt and reduce shareholder payout in bad times when the equity premium is high. Regime shifts in volatility generate large low frequency movements in asset prices due to uncertainty premia that are disconnected from the business cycle.
    JEL: D8 E3 E4 G1 G3
    Date: 2014–05
  4. By: Leung, Charles Ka Yui (City University of Hong Kong)
    Abstract: Central to recent debates on the "mis-pricing" in the housing market and the proactive policy of central bank is the determination of the "fundamental house price." This paper builds a dynamic stochastic general equilibrium (DSGE) model that produces reduced-form dynamics that are consistent with the error-correction models proposed by Malpezzi (1999) and Capozza et al (2004). The dynamics of equilibrium house prices are tied to the dynamics of the house-price-to-income ratio. This paper also shows that house prices and incomes should be co-integrated, and hence provides a justification of using co-integration tests to detect possible "mis-pricing" in the housing market.
    Keywords: prices; business fluctuations; cycles; economic growth; real estate markets
    JEL: E30 O40 R30
    Date: 2014–05–13
  5. By: Marco Del Negro; Marc P. Giannoni; Frank Schorfheide
    Abstract: It has been argued that existing DSGE models cannot properly account for the evolution of key macroeconomic variables during and following the recent great recession. We challenge this argument by showing that a standard DSGE model with financial frictions available prior to the recent crisis successfully predicts a sharp contraction in economic activity along with a modest and protracted decline in inflation, following the rise in financial stress in 2008Q4. The model does so even though inflation remains very dependent on the evolution of economic activity and of monetary policy.
    JEL: C52 E31 E32 E37
    Date: 2014–04
  6. By: Jacek Rothert (United States Naval Academy); Mohammad Rahmati (Sharif University of Technology)
    Abstract: Building on Chari et al. (2007), we develop a method to assess theories of business cycles in small open economies. We build a diagnostic economy with time-varying distortions (wedges), which measure the gap between model generated aggregates and the data. We introduce two new wedges, which allow us to fully account for the movements in the trade balance and the current account: (i) the trend-shock wedge and (ii) the debt price wedge. We show how various detailed models with frictions map to economy with new wedges. Finally, we empirically evaluate dierent theories of uctuations in emerging economies.
    Date: 2014–03
  7. By: Paul Bergin; Ling Feng; Ching-Yi Lin
    Abstract: Firm entry dynamics are an integral part of the propagation of financial shocks to the real economy. A VAR documents that adverse financial shocks in the U.S. postwar period are associated with a fall in new firm creation and a fall in firm equity values. We propose a DSGE model with endogenous firm entry and financial frictions that is able to explain these facts. The model is novel in giving firms a choice of financing up-front entry costs through a combination of debt as well as equity, so that financial shocks directly impact the financing of firm entry. The model is also novel in making use of the asset pricing implications of the firm entry condition to explain the equity price response to a financial shock. The model indicates that free entry of new firms limits the ability of incumbent firms to respond to negative financial shocks through endogenous capital restructuring. Also, allowing the number of firms to fall after an adverse financial shock is a useful margin of macroeconomic adjustment, reducing the overall impact of the shock on aggregate output. This is because the remaining firms become financially stronger and better able to withstand a financial shock.
    JEL: E32 E44 G32
    Date: 2014–05
  8. 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
    JEL: E62 F47 H30 H63
    Date: 2014–01–31
  9. By: Alessandria, George (Federal Reserve Bank of Philadelphia); Choi, Horag (Monash University); Ruhl, Kim J. (NYU Stern School of Business)
    Abstract: We build a micro-founded two-country dynamic general equilibrium model in which trade responds more to a cut in tariffs in the long run than in the short run. The model introduces a time element to the fixed-variable cost trade-off in a heterogeneous producer trade model. Thus, the dynamics of aggregate trade adjustment arise from producer-level decisions to invest in lowering their future variable export costs. The model is calibrated to match salient features of new exporter growth and provides a new estimate of the exporting technology. At the micro level, we find that new exporters commonly incur substantial losses in the first three years in the export market and that export profits are backloaded. At the macro level, the slow export expansion at the producer level leads to sluggishness in the aggregate response of exports to a change in tariffs, with a long-run trade elasticity that is 2.9 times the short-run trade elasticity. We estimate the welfare gains from trade from a cut in tariffs, taking into account the transition period. While the intensity of trade expands slowly, consumption overshoots its new steady-state level, so the welfare gains are almost 15 times larger than the long-run change in consumption. Models without this dynamic export decision underestimate the gains to lowering tariffs, particularly when constrained to also match the gradual expansion of aggregate trade flows.
    Keywords: Sunk cost; Fixed cost; Establishment heterogeneity; Tariffs; Welfare; DSGE
    JEL: E31 F12
    Date: 2014–04–25
  10. By: Born, Benjamin; Pfeifer, Johannes
    Abstract: Jesús-Fernández-Villaverde, Pablo A. Guerrón-Quintana, Juan F. Rubio-Ramírez and Martín Uribe (2011) find that risk shocks are an important factor in explaining emerging market business cycles. We show that their model needs to be recalibrated because it underpredicts the targeted business cycle moments by a factor of three once a time aggregation error is corrected. Recalibrating the corrected model for the benchmark case of Argentina, the peak response of output after an interest rate risk shock increases by 63 percent and the contribution of interest rate risk shocks to business cycle volatility more than doubles. Hence, risk matters more in the recalibrated model. However, the recalibrated model does worse in capturing the business cycle properties of net exports once an additional error in the computation of net exports is corrected.
    Keywords: Interest Rate Risk; Stochastic Volatility
    JEL: E32 E43 F32 F44
    Date: 2014–05
  11. By: Pidong Huang (Department of Economics, Korea University, Seoul, Republic of Korea); Young Sik Kim (Department of Economics, Seoul National University, Seoul, Republic of Korea); Manjong Lee (Department of Economics, Korea University, Seoul, Republic of Korea)
    Abstract: Using a standard Ramsey approach, we examine an optimal allocation of the social cost for electronic payment system in the context of a dynamic general equilibrium model where money is essential. The benevolent government provides electronic payment services and allocates the relevant social cost through taxation on the beneficiaries¡¯ labor and consumption. A higher tax rate on labor yields the following desirable allocations. First, it implies a lower welfare loss due to the distortionary consumption taxation. It also enhances economy of scale in the use of electronic payment technology, reducing per transaction cost of electronic payment. Finally, it saves the cost of withdrawing and carrying around cash by reducing the frequency of cash trades. All these channels together imply optimality of the unity tax rate on labor.
    Keywords: cash, electronic payment, social cost, Ramsey problem
    JEL: E40 E60
    Date: 2014
  12. By: Davig, Troy A. (Federal Reserve Bank of Kansas City); Foerster, Andrew T. (Federal Reserve Bank of Kansas City)
    Abstract: Motivated by the US Fiscal Cliff in 2012, this paper considers the short- and longer- term impact of uncertainty generated by fiscal policy. Empirical evidence shows increases in economic policy uncertainty lower investment and employment. Investment that is longer-lived and subject to a longer planning horizon responds to policy uncertainty with a lag, while capital that depreciates more quickly and can be installed with few costs falls immediately. A DSGE model incorporating uncertainty over future tax regimes produces responses to fiscal uncertainty that match key features of the data. The model features uncertainty over the average tax rate and rational expectations about the resolution of uncertainty with specific outcomes and timing. Uncertainty injects noise into the economy and lowers the level of economic activity.
    Keywords: Fiscal policy; Uncertainty; Distorting taxation
    Date: 2014–04–01
  13. By: Wilman Gomez
    Abstract: Abstract: In this paper, an asymmetric DSGE model is built in order to account for asymmetries in business cycles. One of the most important contributions of this work is the construcion of a general utility function which nests loss aversion, risk aversion and habits formation, by means of a smooth transition function. The main idea behind this asymmetric utility funcion is that under a recession, the agents over-smooth consumption and leisure choices in order to avoid a huge departure of them from the reference level of the utility; while under a boom, the agents simply smooth consumption and leisure but trying to be as far as possible from the reference level of utility. The simulations of this model by means of Perturbations Method show that it is possible to reproduce asymmetrical business cycles where recession (on shock) are stronger than booms and booms are more long lasting than recession. One additional and unexpected result is a downward stickyness shown by real wages and as consequence of this, a more persistente fall in employment in recession than in boom. Thus the model reproduces not only asymmetrical business cycles but also real stickyness and hysteresis.
    Date: 2014–04–01
  14. By: Philippe Bacchetta (University of Lausanne and Centre for Economic Policy Research and Hong Kong Institute for Monetary Research); Kenza Benhima (University of Lausanne and Centre for Economic Policy Research); Yannick Kalantzis (Banque de France)
    Abstract: In this paper, we consider an alternative perspective to China's exchange rate policy. We study a semi-open economy where the private sector has no access to international capital markets but the central bank has full access. Moreover, we assume limited financial development generating a large demand for saving instruments by the private sector. We analyze the optimal exchange rate policy by modelling the central bank as a Ramsey planner. Our main result is that in a growth acceleration episode it is optimal to have an initial real depreciation of the currency combined with an accumulation of reserves, which is consistent with the Chinese experience. This depreciation is followed by an appreciation in the long run. We also show that the optimal exchange rate path is close to the one that would result in an economy with full capital mobility and no central bank intervention.
    JEL: E58 F31 F32
    Date: 2014–05
  15. By: Manjong Lee (Department of Economics, Korea University, Seoul, Republic of Korea); Sung Guan Yun (Payment and Settlement Systems Department, Bank of Korea, Republic of Korea)
    Abstract: The welfare cost of inflation is explored via a search-theoretic model in which along with non-interest-bearing cash, interest-bearing liquid and illiquid assets are available. With inflation, agents are willing to replace higher-return illiquid assets with lower return liquid assets for consumption purchases. The opportunity cost incurred by this adjustment turns out to have quantitatively significant implications on the cost of inflation. A parameterized version of the model suggests that the cost of 10% inflation with liquid and illiquid interest-bearing assets is almost 3 times larger than that in a cash-only model. This implies that most existing measures of inflation cost with narrow money are substantially underestimated.
    Keywords: cash, narrow money, broad money, portfolio shift, inflation cost
    JEL: E31 E40 E50
    Date: 2014
  16. By: Corbae, Dean (University of Wisconsin - Madison and NBER); D'Erasmo, Pablo (Federal Reserve Bank of Philadelphia)
    Abstract: We develop a model of banking industry dynamics to study the quantitative impact of capital requirements on bank risk taking, commercial bank failure, and market structure. We propose a market structure where big, dominant banks interact with small, competitive fringe banks. Banks accumulate securities like Treasury bills and undertake short-term borrowing when there are cash flow shortfalls. A nontrivial size distribution of banks arises out of endogenous entry and exit, as well as banks’ buffer stocks of securities. We test the model using business cycle properties and the bank lending channel across banks of different sizes studied by Kashyap and Stein (2000). We find that a rise in capital requirements from 4% to 6% leads to a substantial reduction in exit rates of small banks and a more concentrated industry. Aggregate loan supply falls and interest rates rise by 50 basis points. The lower exit rate causes the tax/output rate necessary to fund deposit insurance to drop in half. Higher interest rates, however, induce higher loan delinquencies as well as a lower level of intermediated output.
    Keywords: Banking; Capital requirements; Risk; Commercial bank failure; Market structure
    Date: 2014–04–04
  17. By: Weerachart T. Kilenthong; Robert M. Townsend
    Abstract: This paper studies a competitive general equilibrium model with default and endogenous collateralized contracts. The possibility of trade in spot markets creates externalities, as spot prices and the bindingness of collateral constraints interact. We propose a market based solution which overcomes the externalities problem and obviates the needs for any government policy intervention. If agents are allowed to contract ex ante on market fundamentals determining the state-contingent spot prices used to unwind collateral, over and above contracting on true underlying states of the world, then standard existence and welfare theorems apply, that is, competitive equilibria are equivalent with Pareto optima.
    JEL: D52 D53 D61 D62
    Date: 2014–05
  18. By: Mariacristina De Nardi; Fang Yang
    Abstract: Households hold vastly heterogenous amounts of wealth when they reach retirement, and differences in lifetime earnings explain only part of this variation. This paper studies the role of intergenerational transmission of ability, voluntary bequest motives, and the recipiency of accidental and intended bequests (both in terms of timing and size), in generating wealth dispersion at retirement, in the context of a rich quantitative model. Modeling voluntary bequests, and realistically calibrating them, not only generates more wealth dispersion at retirement and reduces the correlation between retirement wealth and lifetime income, but also generates a skewed bequest distribution that is close to the one in the observed data.
    JEL: E21 J14
    Date: 2014–04
  19. By: Monica Gomez
    Abstract: Resumen: En este trabajo se construye un modelo de Equilibrio General Dinámico Estocástico (DSGE por su siglas en inglés) con sector informal y rigideces en precios, usando como marco de análisis la teoría de búsqueda y emparejamiento del mercado de trabajo. El objetivo principal es analizar el efecto de los diferentes tipos de choques económicos sobre las principales variables del mercado laboral, en una economía con presencia importante del sector informal. Igualmente se estudia el efecto de la política monetaria, ya que la presencia de este sector afecta la dinámica del ciclo económico, y por ende los mecanismos de transmisión de la política monetaria.
    Keywords: Política monetaria, trabajo informal, rigideces nominales, búsqueda y emparejamiento
    JEL: E52 E32 J64
    Date: 2013–08–01
  20. By: Afonso, Gara M. (Federal Reserve Bank of New York); Lagos, Ricardo (Federal Reserve Bank of Minneapolis)
    Abstract: We present a dynamic over-the-counter model of the fed funds market and use it to study the determination of the fed funds rate, the volume of loans traded, and the intraday evolution of the distribution of reserve balances across banks. We also investigate the implications of changes in the market structure, as well as the effects of central bank policy instruments such as open market operations, the discount window lending rate, and the interest rate on bank reserves.
    Keywords: Fed funds market; Search; Bargaining; Over-the-counter market
    JEL: C78 D83 E44 G10
    Date: 2014–04–18

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