nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2014‒05‒24
sixteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Unemployment and Endogenous Reallocation over the Business Cycle By Carlos Carrillo-Tudela; Ludo Visschers
  2. Normative Fiscal Policy and Growth: Some Quantitative Implications for the Chilean Economy By Emilio Espino; Martín González Rozada
  3. Sectoral interdependence and business cycle synchronization in small open economies By Drago Bergholt; Tommy Sveen
  4. Preference Shocks, International Frictions, and International Business Cycles By Hideaki Hirata
  5. Environmental taxation, health and the life-cycle By Nathalie Mathieu-Bolh; Xavier Pautrel
  6. Income tax and retirement schemes By Philippe Choné; Guy Laroque
  7. Uncertainty Shocks and Unemployment Dynamics in U.S. Recessions By Giovanni Caggiano; Efrem Castelnuovo; Nicolas Groshenny
  8. Unemployement Protection for Informal Workers in Latin America and the Caribbean By Alan Finkelstein-Shapiro; Miguel Sarzosa
  9. Immigration, Search, and Redistribution: A Quantitative Assessment of Native Welfare By Michele Battisti; Gabriel Felbermayr; Giovanni Peri; Panu Poutvaara
  10. Towards a "New" Inflation Targeting Framework: The Case of Uruguay By Martín Sola; Martin González-Rozada
  11. Why is Old Workers’ Labor Market more Volatile? Unemployment Fluctuations over the Life-Cycle By Jean-Olivier Hairault; François Langot; Thepthida Sopraseuth
  12. Has U.S. monetary policy tracked the efficient interest rate? By Curdia, Vasco; Ferrero, Andrea; Ng, Ging Cee; Tambalotti, Andrea
  13. External debt and military spending: the case of Africa's conflict countries By Muhanji, Stella; Ojah, Kalu
  14. Racial Discrimination in the U.S. Labor Market: Employment and Wage Differentials by Skill By Daniel Borowczyk-Martins; Jake Bradley; Linas Tarasonis
  15. A Model of Monetary Policy and Risk Premia By Itamar Drechsler; Alexi Savov; Philipp Schnabl
  16. Coordination and Crisis in Monetary Unions By Mark Aguiar; Manuel Amador; Emmanuel Farhi; Gita Gopinath

  1. By: Carlos Carrillo-Tudela; Ludo Visschers
    Abstract: This paper studies unemployed workers’ decisions to change occupations, and their impact on fluctuations in aggregate unemployment and its underlying duration distribution. We develop an analytically and computationally tractable stochastic equilibrium model with heterogenous labor markets. In this model three different types of unemployment arise: search, rest and reallocation unemployment. We document new evidence on unemployed workers’ gross occupational mobility and use it to calibrate the model. We show that rest unemployment is the main driver of unemployment fluctuations over the business cycle and causes cyclical unemployment to be highly volatile. The resulting unemployment duration distribution generated by the model responds realistically to the business cycle, creating substantial longer-term unemployment in downturns. Finally, rest unemployment also makes our model simultaneously consistent with procyclical occupational mobility of the unemployed, countercyclical job separations into unemployment and a negatively-sloped Beveridge curve.
    Keywords: Unemployment, Business Cycle, Rest, Search, Occupational Mobility
    JEL: E24 E30 J62 J63 J64
    Date: 2014–04
  2. By: Emilio Espino; Martín González Rozada
    Abstract: This paper explores the qualitative and quantitative implications of optimal taxation in a developing economy when economic growth is endogenously determined. We differentiate this class of economies from a developed economy in two aspects: informal sector is quantitatively significant and tax-collecting technologies are more rudimentary. We characterize competitive equilibrium allocations and Ramsey allocations in the context of a small open economy in which the interest rate is endogenously determined, some workers can be hired in the informal market, and imperfect tax-collecting technology can be heterogeneous across different types of taxes. We calibrate the parameters of our model to the Chilean economy. Overall, our results suggest that capital should still be taxed but considerably less than actual taxes (that is, 10.78 percent versus 18.5 percent). Labor should be subsidized (to stimulate accumulation of human capital), while consumption taxes should be increased by 50 percent approximately (from 19 percent to 28 percent). As expected, the better the tax collecting technologies, the higher the corresponding taxes. In this context, the resulting growth rate increases only slightly along the balanced growth path.
    Keywords: Economic Development & Growth, Fiscal Policy, Optimal fiscal growth, economic growth, inefficient tax collecting technology
    Date: 2013–09
  3. By: Drago Bergholt (BI Norwegian Business School and Norges Bank); Tommy Sveen (BI Norwegian Business School and Norges Bank)
    Abstract: Existing DSGE models are not able to reproduce the observed influence of international business cycles on small open economies. We construct a two-sector New Keynesian model to address this puzzle. The set-up takes into account intermediate trade and producer heterogeneity, where goods and service industries differ in terms of i) price flexibility, ii) trade intensity, iii) technology, iv) I-O structure, and v) the volatility of productivity innovations. The combination of intermediate markets and heterogeneous producers makes international business cycles highly important for the small economy, even if it has a large service sector. Exploiting I-O matrices of Canadian and US industries, the model is able to reproduce the role of international disturbances typically found in empirical studies. Model simulations deliver cross-country correlations in macroeconomic variables of about 0:7, with half of the variation in domestic variables attributed to foreign shocks.
    Keywords: Small open economy, Multi-sector, Intermediate trade, International business cycles.
    JEL: E32 F41 F44
    Date: 2014–04–14
  4. By: Hideaki Hirata
    Abstract: Replicating the degree of cross-country comovements of macroeconomic aggregates, dynamics of prices and quantities of international trade, and the behavior of consumption and labor remains an important challenge in international business cycle literature. This paper incorporates preference shocks into a standard two-country model in which there exist international frictions, such as costs of transportation and restrictions to international asset trade. Country-specific preference shocks that generate fluctuations in each country’s consumption and labor solve the puzzles, except for the discrepancy between theory and data regarding international trade variables. The presence or absence of international frictions plays a limited role in solving the puzzles.
    Date: 2014–01
  5. By: Nathalie Mathieu-Bolh (University of Vermont - University of Vermont); Xavier Pautrel (LEMNA - Laboratoire d'économie et de management de Nantes Atlantique - Université de Nantes : EA4272)
    Abstract: We build a model that takes into consideration the evolution of health over the life cycle and its consequences on individual optimal choices. In this framework, the effects of environmental taxation are not limited to the traditional negative crowding-out and positive productivity effects. We show that environmental taxation generates new general equilibrium effects ignored by previous contributions. Indeed, as the environmental tax improves the health profile over the life-cycle, it influences saving, labor supply, and retirement. We also show that whether those general equilibrium effects are positive or negative for the economy crucially depends on the degree of substitutability between young and old labor. Our numerical examples suggest that ignoring those new effects may result in large overstatement of the negative effect of an increase in environmental taxation on output, and understatement of the positive effect on welfare. ∗
    Keywords: Health ; environmental policy ; economic growth
    Date: 2014–05–13
  6. By: Philippe Choné (Centre de Recherche en Économie et Statistique); Guy Laroque (Centre de Recherche en Économie et Statistique)
    Abstract: This article aims at understanding the interplay between pension schemes and tax instruments. The model features extensive labor supply in a stationary environment with overlapping generations and perfect financial markets. Compared with the reference case of a pure taxation economy, we find that taxes become more redistributive when the pension instrument is available, while pensions provide incentives to work.
    Date: 2014–06
  7. By: Giovanni Caggiano (Department of Economics and Management, University of Padova); Efrem Castelnuovo (Melbourne Institute of Applied Economic and Social Research, The University of Melbourne; Department of Economics and Management, University of Padova; and Research Unit, Bank of Finland); Nicolas Groshenny (School of Economics, The University of Adelaide)
    Abstract: We investigate the effects of uncertainty shocks on unemployment dynamics in the post- WWII U.S. recessions via non-linear (Smooth-Transition) VARs. The relevance of uncertainty shocks is found to be much larger than that predicted by standard linear VARs in terms of (i) magnitude of the reaction of the unemployment rate to such shocks, and (ii) contribution to the variance of the prediction errors of unemployment at business cycle frequencies. We discuss the ability of different classes of DSGE models to replicate our results.
    Keywords: Uncertainty shocks, unemployment dynamics, Smooth Transition Vector-AutoRegressions, recessions
    JEL: C32 E32 E52
    Date: 2014–05
  8. By: Alan Finkelstein-Shapiro; Miguel Sarzosa
    Abstract: We use a dynamic stochastic general equilibrium search and matching model with salaried employment and informal self-employment to analyze the implications of introducing universal unemployment protection for informal workers through transfers, which are conditional on participation in training programs. We study how changes in unemployment benefits (UB) for unemployed workers in training programs (training UB), modify labor market outcomes for the unemployed. The model suggests that increasing training UB reduces unprotected unemployment and improves labor market outcomes through higher formal salaried employment and lower informal self-employment. Allowing for idiosyncratic quality in these training programs is key for these results. Higher training UB can also reduce total informal employment through a drastic reduction in the share of informal self-employment, without necessarily causing a large increase in total unemployment. Finally, the model suggests that increasing training UB may increase the volatility of unprotected unemployment. The influence of training programs on formal wage-setting is crucial to explain these results.
    Keywords: Labor Policy, Social Security, WP-385, Business cycles, informality, labor search
    Date: 2012–09
  9. By: Michele Battisti; Gabriel Felbermayr; Giovanni Peri; Panu Poutvaara
    Abstract: We study the effects of immigration on native welfare in a general equilibrium model featuring two skill types, search frictions, wage bargaining, and a redistributive welfare state. Our quantitative analysis suggests that, in all 20 countries studied, immigration attenuates the effects of search frictions. These gains tend to outweigh the welfare costs of redistribution. Immigration has increased native welfare in almost all countries. Both high-skilled and low-skilled natives benefit in two thirds of countries, contrary to what models without search frictions predict. Median total gains from migration are 1.19% and 1.00% for high and low skilled natives, respectively.
    JEL: F22 J31 J61 J68
    Date: 2014–05
  10. By: Martín Sola; Martin González-Rozada
    Abstract: Using a dynamic stochastic general equilibrium model with financial frictions, this paper evaluates the effects of a rule that incorporates not only the interest rate but also the legal reserve requirements as instruments of monetary policy. It is found that reserve requirements can be used to achieve the Central Bank's inflation objectives. The use of this instrument, however, produces a real appreciation of the Uruguayan peso. When the Central Bank uses the monetary policy rate as an instrument, the effect of an increase in reserve requirements is to contribute to reducing the negative impact on consumption, investment and output. Nevertheless, the quantitative results in terms of inflation reduction are rather poor. The policy rate becomes more effective in reducing inflation when the reserve requirement instrument is solely directed at achieving financial stability. The paper's main policy conclusion is that a well-targeted non-conventional policy instrument can help to effectively control inflation.
    Keywords: Monetary Policy, Inflation targeting, IDB-WP-486
    Date: 2014–02
  11. By: Jean-Olivier Hairault; François Langot; Thepthida Sopraseuth
    Date: 2014
  12. By: Curdia, Vasco (Federal Reserve Bank of San Francisco); Ferrero, Andrea (University of Oxford); Ng, Ging Cee (University of Chicago); Tambalotti, Andrea (Federal Reserve Bank of New York)
    Abstract: Interest rate decisions by central banks are universally discussed in terms of Taylor rules, which describe policy rates as responding to inflation and some measure of the output gap. We show that an alternative specification of the monetary policy reaction function, in which the interest rate tracks the evolution of a Wicksellian efficient rate of return as the primary indicator of real activity, fits the U.S. data better than otherwise identical Taylor rules. This surprising result holds for a wide variety of specifications of the other ingredients of the policy rule and of approaches to the measurement of the output gap. Moreover, it is robust across two different models of private agents’ behavior.
    Keywords: U.S. monetary policy; Interest rate rules; DSGE models; Bayesian model comparison
    JEL: C11 E43 E58
    Date: 2014–05
  13. By: Muhanji, Stella; Ojah, Kalu
    Abstract: In the light of the exigency and apparent irrationality of war and, the fact that most Heavily Indebted Poor Countries (HIPCs) in Africa are associated with prolonged conflicts, there is more than a suspicion that military spending contributes to the indebtedness of Africa’s conflict countries. We therefore model this suspected nexus and compute the impulse response functions to the shock in military spending and, particularly determine what precise time around war external debt accumulation is prevalent. We confirm a positive correlation between military spending and external debt for most of the conflict countries, with external debt increasing in response to a shock to military spending for all these countries. Using panel analysis, we find evidence of military expenditure’s upward pressure on external indebtedness during pre-war, war and post-war periods; interestingly, the post-war period registers the fastest rate of external debt accumulation than other relevant periods. Our results suggest that military spending can be an important and nuanced factor in designing external debt management policies for Africa’s conflict countries and their likes.
    Keywords: External debt, Military spending, DSGE model, Conflict countries, Relevant war periods
    JEL: F34 F41 F52
    Date: 2014–05–19
  14. By: Daniel Borowczyk-Martins (University of Bristol); Jake Bradley (University of Bristol); Linas Tarasonis (Aix-Marseille University (Aix-Marseille School of Economics), CNRS & EHESS)
    Abstract: In the US labor market the average black worker is exposed to a lower employment rate and earns a lower wage compared to his white counterpart. Lang and Lehmann (2012) argue that these mean differences mask substantial heterogeneity along the distribution of workers’ skill. In particular, they argue that black-white wage and employment gaps are smaller for high-skill workers. In this paper we show that a model of employer taste-based discrimination in a labor market characterized by search frictions and skill complementarities in production can replicate these regularities. We estimate the model with US data using methods of indirect inference. Our quantitative results portray the degree of employer prejudice in the US labor market as being strong and widespread, and provide evidence of an important skill gap between black and white workers. We use the model to undertake a structural decomposition and conclude that discrimination resulting from employer prejudice is quantitatively more important than skill differences to explain wage and employment gaps. In the final section of the paper we conduct a number of counterfactual experiments to assess the effectiveness of different policy approaches aimed at reducing racial differences in labor market outcomes.
    Keywords: employment and wage differentials, discrimination, job search
    JEL: J31 J64 J71
    Date: 2014–04
  15. By: Itamar Drechsler; Alexi Savov; Philipp Schnabl
    Abstract: We present a dynamic heterogeneous-agent asset pricing model in which monetary policy affects the risk premium component of the cost of capital. Risk tolerant agents (banks) borrow from risk averse agents (depositors) and invest in risky assets subject to a reserve requirement. By varying the nominal interest rate, the central bank affects the spread banks pay for external funding (i.e., leverage), a link that we show has strong empirical support. Lower nominal rates result in increased leverage, lower risk premia and overall cost of capital, and higher volatility. The effects of policy shocks are amplified via bank balance sheet effects. We use the model to implement dynamic interventions such as a ``Greenspan put'' and forward guidance, and analyze their impact on asset prices and volatility.
    JEL: E52 E58 G12 G21
    Date: 2014–05
  16. By: Mark Aguiar; Manuel Amador; Emmanuel Farhi; Gita Gopinath
    Abstract: We characterize fiscal and monetary policy in a monetary union with the potential for rollover crises in sovereign debt markets. Member-country fiscal authorities lack commitment to repay their debt and choose fiscal policy independently. A common monetary authority chooses inflation for the union, also without commitment.� We first describe the existence of a fiscal externality that arises in the presence of limited commitment and leads countries to over borrow; this externality rationalizes the imposition of debt ceilings in a monetary union. We then investigate the impact of the composition of debt in a monetary union, that is the fraction of high-debt versus low-debt members, on the occurrence of self-fulfilling debt crises. We demonstrate that a high-debt country may be less vulnerable to crises and have higher welfare when it belongs to a union with an intermediate mix of high- and low-debt members, than one where all other members are low-debt. This contrasts with the conventional wisdom that all countries should prefer a union with low-debt members, as such a union can credibly deliver low inflation. These findings shed new light on the criteria for an optimal currency area in the presence of rollover crises.
    Date: 2014–01

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