nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2014‒06‒14
seventeen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. The financial accelerator and market-based debt instruments: A role for maturities? By Kühl, Michael
  2. Information Aggregation in a DSGE Model By Tarek A. Hassan; Thomas M. Mertens
  3. Matching with Phantoms By Arnaud Chéron; Bruno Decreuse
  4. The maximum debt-GDP ratio and endogenous growth in the Diamond overlapping generations model: Three overlapping generations are better than two By Mark Roberts
  5. News, Housing Boom-Bust Cycles, and Monetary Policy By Birol Kanik; Wei Xiao
  6. Firm Dynamics and Assortative Matching By Leland D. Crane
  7. Saving Europe?: The Unpleasant Arithmetic of Fiscal Austerity in Integrated Economies By Enrique G. Mendoza; Linda L. Tesar; Jing Zhang
  8. Imperfect Financial Markets and the Cyclicality of Social Spending By Maren Froemel
  9. A Politico-economic Approach on Public Debt in an Endogenous Growth Economy By Arai, Real; Naito, Katsuyuki
  10. Comparing numerical methods for solving the competitive storage model By Christophe Gouel
  11. Trade Structure and Growth Effects of Taxation in a Two-Country World By Amano, Daisuke; Mino, Kazuo
  12. Macroprudential Policy Implementation in a Heterogeneous Monetary Union By Margarita Rubio
  13. Delaying the normal and early retirement ages in Spain: behavioural and welfare consequences for employed and unemployed workers By Alfonso R. Sánchez; J. Ignacio García-Pérez; Sergi Jiménez-Martín
  14. Gasoline Prices, Transport Costs, and the U.S. Business Cycles By Hakan Yilmazkuday
  15. Monetary policy effects on bank risk taking By Abbate, Angela; Thaler, Dominik
  16. International capital flows and the boom-bust cycle in Spain By in 't Veld, Jan; Kollmann, Robert; Pataracchia, Beatrice; Ratto, Marco; Roeger, Werner
  17. The zero lower bound and endogenous uncertainty By Plante, Michael D.; Richter, Alexander; Throckmorton, Nathaniel

  1. By: Kühl, Michael
    Abstract: This paper shows how the average maturity of corporate bonds can affect the transmission of shocks if financial frictions prevail. We modify a standard financial accelerator model à la Bernanke, Gertler, and Gilchrist (1999) and allow for market-based debt which has a market-determined price. Our results show that the average maturity of bonds is essential for the transmission of shocks. The dynamics are largely identical to the standard BGG model for shorter maturities, while the model behaves differently for longer maturities. In this case a prolongation channel becomes apparent which attenuates the original amplification mechanism. --
    Keywords: DSGE Model,Financial Frictions,Maturites,Financial Accelerator,Capital Market
    JEL: E3 E44 G3
    Date: 2014
  2. By: Tarek A. Hassan; Thomas M. Mertens
    Abstract: We introduce the information microstructure of a canonical noisy rational expectations model (Hellwig, 1980) into the framework of a conventional real business cycle model. Each household receives a private signal about future productivity. In equilibrium, the stock price serves to aggregate and transmit this information. We find that dispersed information about future productivity affects the quantitative properties of our real business cycle model in three dimensions. First, households' ability to learn about the future affects their consumption-savings decision. The equity premium falls and the risk-free interest rate rises when the stock price perfectly reveals innovations to future productivity. Second, when noise trader demand shocks limit the stock market's capacity to aggregate information, households hold heterogeneous expectations in equilibrium. However, for a reasonable size of noise trader demand shocks the model cannot generate the kind of disagreement observed in the data. Third, even moderate heterogeneity in the equilibrium expectations held by households has a sizable effect on the level of all economic aggregates and on the correlations and standard deviations produced by the model. For example, the correlation between consumption and investment growth is 0.29 when households have no information about the future, but 0.41 when information is dispersed.
    JEL: C63 D83 E2 E3 E44 G11
    Date: 2014–06
  3. By: Arnaud Chéron (Maine University and EDHEC); Bruno Decreuse (Aix-Marseille University (Aix-Marseille School of Economics))
    Abstract: Searching for partners involves informational persistence that reduces future traders' matching probability. In this paper, traders who are no longer available but who left tracks on the market are called phantoms. We examine a discrete-time matching market in which phantoms are a by-product of search activity, no coordination frictions are assumed, and non-phantom traders may lose time trying to match with phantoms. The resulting aggregate matching technology features increasing returns to scale in the short run, but has constant returns to scale in the long run. We embed this matching function in the canonical equilibrium search unemployment model. Although the model may feature sunspot fluctuations, its typical calibration on monthly US data displays the saddle-path property. The model predicts the same monthly job-finding probability and quarterly aggregate volatility as the standard model with a Cobb-Douglas matching function.
    Keywords: information persistence, endogenous matching function, business cycle
    JEL: J60
    Date: 2014–04
  4. By: Mark Roberts
    Abstract: While the public debt has an interior maximum in the Diamond OLG model, due to an inherent nonlinearity [Rankin and Roffia (2003)], this feature also extends to a linear, AK model when it is conjoined with a backward-looking adjustment process for public debt [Braeuninger (2005)]. We show that if the debt dynamics are forward-looking, the maximum will instead be at a degeneracy – another possibility considered by Rankin and Roffia. However, the main point of the present paper is to show that any debt maximum in a finite-horizon model will be of an implausibly low order of magnitude, unless households save over at least two periods. This is because it is the debt flow that crowds-out investment flows, while this is synonymous with the debt stock in a model with only two, non-altruistic, overlapping generations, thus leading to a low maximum stock by default. Removing this restriction produces plausible results, and causes a low rate of economic growth to be a cause as well as a consequence of a high public debt.
    Keywords: Public debt, endogenous growth, primary deficit/surplus, dynamics, bifurcation, degeneracy, backward-looking, forward-looking
    Date: 2014
  5. By: Birol Kanik; Wei Xiao
    Abstract: We explore the possibility that a housing market boom-bust cycle may arise when public beliefs are driven by news shocks. News, imperfect and noisy by nature, may generate expectations that are overly optimistic or pessimistic. Over-optimism easily leads to excessive accumulation of housing assets, and creates a housing boom that is not based on fundamentals. When the news is found false or inaccurate, investors revert their actions, and a downturn in the housing market follows. By altering agents’ net worth conditions, a housing cycle can have significant repercussions in the aggregate economy. In this paper, we construct a dynamic general equilibrium model that can give rise to a news-driven housing boom-bust cycle, and we consider how monetary policies should respond to it.
    Keywords: Business cycle; News; Monetary policy.
    JEL: E3 E4 E5
    Date: 2014
  6. By: Leland D. Crane
    Abstract: I study the relationship between firm growth and the characteristics of newly hired workers. Using Census microdata I obtain a novel empirical result: when a given firm grows faster it hires workers with higher past wages. These results suggest that productive, fast-growing firms tend to hire more productive workers, a form of positive assortative matching. This contrasts with prior research that has found negligible or negative sorting between workers and firms. I present evidence that this difference arises because previous studies have focused on cross-sectional comparisons across firms and industries, while my results condition on firm characteristics (e.g. size, industry, or firm fixed effects). Motivated by the empirical findings I develop a search model with heterogeneous workers and firms. The model is the first to study worker-firm sorting in an environment with worker heterogeneity, firm productivity shocks, multi-worker firms, and search frictions. Despite this richness the model is tractable, allowing me to characterize assortative matching, compositional dynamics and other properties analytically. I show that the model reproduces the positive firm growth-quality of hires correlation when worker and firm types are strong complements in production (i.e. the production function is strictly log-supermodular).
    Keywords: Assortative Matching, Firm Growth, Wages, Unemployment, Vacancies, Search Theory, Microdata
    JEL: E24 J31 J63 J64
    Date: 2014–05
  7. By: Enrique G. Mendoza; Linda L. Tesar; Jing Zhang
    Abstract: What are the macroeconomic effects of tax adjustments in response to large public debt shocks in highly integrated economies? The answer from standard closed-economy models is deceptive, because they underestimate the elasticity of capital tax revenues and ignore cross-country spillovers of tax changes. Instead, we examine this issue using a two-country model that matches the observed elasticity of the capital tax base by introducing endogenous capacity utilization and a partial depreciation allowance. Tax hikes have adverse effects on macro aggregates and welfare, and trigger strong cross-country externalities. Quantitative analysis calibrated to European data shows that unilateral capital tax increases cannot restore fiscal solvency, because the dynamic Laffer curve peaks below the required revenue increase. Unilateral labor tax hikes can do it, but have negative output and welfare effects at home and raise welfare and output abroad. Large spillovers also imply that unilateral capital tax hikes are much less costly under autarky than under free trade. Allowing for one-shot Nash tax competition, the model predicts a "race to the bottom" in capital taxes and higher labor taxes. The cooperative equilibrium is preferable, but capital (labor) taxes are still lower (higher) than initially. Moreover, autarky can produce higher welfare than both Nash and Cooperative equilibria.
    JEL: E6 E62 F34 F42 H6
    Date: 2014–06
  8. By: Maren Froemel (Department of Economics, University of Konstanz, Germany)
    Abstract: I develop a novel link between frictions in international financial markets and fiscal procyclicality.Complementing existing evidence, A decomposition of government expenditure into social spending and public good spending reveals that the cyclical correlation of social spending exhibits the biggest differences across countries. I build a small open economy model with income inequality, endogenous fiscal policy and sovereign default risk to rationalize this spending procyclicality. Government spending, divided into a public good and social spending, is financed by taxation and external debt. External debt is subject to endogenous risk premia because the government cannot commit to repay its debt. The government conducts a procyclical tax and social spending policy when debt is in or close to the risky zone. Social spending then only redistributes income, failing to smooth private consumption over time. Far away from the crisis zone, fiscal policy is countercyclical, only public goods spending is always procyclical. Social spending is cut most when the government faces positive risk premia, because it is better a substitute of private income than public good spending. It also accounts for the largest part in fiscal adjustment: because taxes are distortionary and cannot be targeted well. Fiscal procyclicality becomes stronger with higher economic inequality as revenue raising through taxation becomes more costly.
    Keywords: Procyclical fiscal policy, default risk, income inequality, redistribution, emerging markets, social spending.
    JEL: E62 F34 F41
    Date: 2014–06–10
  9. By: Arai, Real; Naito, Katsuyuki
    Abstract: We consider an overlapping generations closed economy in which a government finances the cost of public good provision by labor income taxation and/or public debt issuance. The size of these public policies is determined in a repeated probabilistic voting game. We investigate the characteristics of a Markov perfect politico-economic equilibrium in which the size of public policies depends on both the stock of public debt and the level of physical capital, and show that individuals' stronger preferences for public good provision tighten fiscal discipline and promote economic growth.
    Keywords: public debt; probabilistic voting; Markov perfect equilibrium; economic growth
    JEL: D72 H41 H63 O43
    Date: 2014–05–27
  10. By: Christophe Gouel (Economie Publique, INRA; Centre d'Etudes Prospectives et d'Informations Internationales)
    Abstract: This paper compares numerical methods for solving the competitive storage model. Because storage implies a nonnegativity constraint on stocks, the solution methods must be considered carefully. The model is solved using value function iteration and several projection approaches, including parameterised expectations and decision rules approximation. In considering a storage model with convenience yield, in which the inequality constraint is smoothed, perturbation methods are also applied. Parameterised expectations approximation proves to be the most accurate method, whereas perturbation techniques are shown inadequate for solving this highly nonlinear model. The endogenous grid method allows rapid solution if supply is assumed to be inelastic.
    Abstract: Cet article compare les méthodes numériques permettant de résoudre le modèle de stockage compétitif. Puisque le stockage implique une contrainte de non-négativité des stocks, les méthodes de résolution doivent être choisies avec soin. Le modèle est résolu par itération sur la fonction valeur et à l'aide de plusieurs méthodes de projection, incluant la paramétrisation des anticipations et l'approximation des règles de décisions. En considérant aussi un modèle de stockage avec rendement d'opportunité, dans lequel la contrainte d'inégalité est lissée, des méthodes de perturbation sont aussi appliquées. La paramétrisation des anticipations est la méthode la plus précise, alors que les méthodes de perturbation se montrent inadaptées pour résoudre ce modèle très non-linéaire. La méthode de grille endogène permet une résolution très rapide si l'offre est supposée inélastique.
    Keywords: Binding constraint, Nonlinear rational expectations models, Numerical methods, paramètre du modèle, paramétrisation, stockagecontrainte paramétriquecoût de stockage
    Date: 2013
  11. By: Amano, Daisuke; Mino, Kazuo
    Abstract: This paper explores the long-run impacts of tax policy in a two-country model of endogenous growth with variable labor supply. We focus on international spillover effects of tax reforms under alternative trade structures. It is shown that if the instantaneous utility function of the representative family in each country is additively separable and if international capital mobility is absent, then a change in taxation in one country does not directly affect capital formation in the other country. Such a conclusion is fundamentally modified if international borrowing and lending are allowed. Due to free financial flows, a change in tax policy in one country directly diffuses to the growth performance of the other country, even though preference structures are assumed to be log-additive forms.
    Keywords: factor-income tax, consumption tax, equilibrium dynamics, two-country model, endogenous growth, variable labor supply,
    Date: 2014–05
  12. By: Margarita Rubio
    Abstract: I develop a two-country new Keynesian general equilibrium model with housing and collateral constraints to explore how macroprudential policies should be conducted in a heterogeneous monetary union. I consider four types of cross-country heterogeneity: asymmetric shocks, di¤erent loan-to-value ratios (LTV), different proportion of borrowers, and mortgage contract heterogeneity (…xed and variable rates). As a macroprudential tool, I propose a Taylor-type rule for the LTV which responds to deviations in output and house prices. This policy can be applied at a national or union level. Results show that asymmetries matter for the implementation of macroprudential policies, especially when the heterogeneity delivers di¤erences in economic and …nancial volatilities. A centralized macroprudential policy is preferred if there is an asymmetric shock, to balance out the cross-country di¤erent …nancial volatilities. For the mortgage contract heterogeneity, the economy is better o¤ with a decentralized policy that compensates the lack of effectiveness of monetary policy in the …xed-rate country. For the LTV asymmetry and the di¤erent proportion of borrowers, conducting the macroprudential policy at a national or union level produces similar welfare gains.
    Keywords: Macroprudential, Housing market, LTV, monetary union, Â…nancial stability
    Date: 2014
  13. By: Alfonso R. Sánchez; J. Ignacio García-Pérez; Sergi Jiménez-Martín
    Abstract: In this paper, we explore the links between pension reform, early retirement, and the use of unemployment as an alternative pathway to retirement. We use a dynamic rational expectations model to analyze the search and retirement behaviour of employed and unemployed workers aged 50 or over. The model is calibrated to reproduce the main reemployment and retirement patterns observed between 2002 and 2008 in Spain. It is subsequently used to analyze the effects of the 2011 pension reform in Spain, characterized by two-year delays in both the early and the normal retirement ages. We find that this reform generates large increases in labour supply and sizable cuts in pension costs, but these are achieved at the expense of very large welfare losses, especially among unemployed workers. As an alternative, we propose leaving the early retirement age unchanged, but penalizing the minimum pension (reducing its generosity in parallel to the cuts imposed on individual pension benefits, and making it more actuarially fair with age). This alternative reform strikes a better balance between individual welfare and labour supply stimulus.
    Date: 2014–05
  14. By: Hakan Yilmazkuday (Department of Economics, Florida International University)
    Abstract: The e¡èects of gasoline prices on the U.S. business cycles are investigated. In order to distinguish between gasoline supply and gasoline demand shocks, the price of gasoline is endogenously determined through a transportation sector that uses gasoline as an input of production. The model is estimated for the U.S. economy using ?ve macroeconomic time series, including data on transport costs and gasoline prices. The results show that although standard shocks in the literature (e.g., technology shocks, monetary policy shocks) have significant effects on the U.S. business cycles in the long run, gasoline supply and demand shocks play an important role in the short run.
    Keywords: Business Cycles, Transport Costs, Gasoline Prices
    JEL: E32 E52 F41
    Date: 2014–06
  15. By: Abbate, Angela; Thaler, Dominik
    Abstract: The contribution of this paper is twofold. First, we provide empirical evidence on the existence of a risk-taking channel in the US economy. By identifying a Bayesian VAR through sign restrictions, we find that an expansionary monetary policy shock causes a persistent increase in proxies for bank risk-taking behaviour. We then develop a New Keynesian model with a risk-taking channel, where low levels of the risk free rates induce banks to extend credit to riskier borrowers. Conditional on calibration values, the simulated responses of key banking sector variables is compatible with the transmission mechanism observed in the data.
    Keywords: Bank Risk; Monetary policy; DSGE Models; Bayesian Analysis
    JEL: E12 E44 E58 C11
    Date: 2014
  16. By: in 't Veld, Jan (DG-ECFIN, EU Commission); Kollmann, Robert (ECARES, Université Libre de Bruxelles and CEPR); Pataracchia, Beatrice (JRC, EU Commission); Ratto, Marco (JRC, EU Commission); Roeger, Werner (DG-ECFIN, EU Commission)
    Abstract: We study the joint dynamics of foreign capital flows and real activity during the recent boom- bust cycle of the Spanish economy, using a three-country New Keynesian model with credit- constrained households and firms, a construction sector and a government. We estimate the model using 1995Q1-2013Q2 data for Spain, the rest of the Euro Area (REA) and the rest of the world. We show that falling risk premia on Spanish housing and non-residential capital, a loosening of collateral constraints for Spanish households and firms, as well as a fall in the interest rate spread between Spain and the REA fuelled the Spanish output boom and the persistent rise in foreign capital flows to Spain, before the global financial crisis. During and after the global financial crisis, falling house prices, and a tightening of collateral constraints for Spanish borrowers contributed to a sharp reduction in capital inflows, and to the persistent slump in Spanish real activity. The credit crunch was especially pronounced for Spanish households; firm credit constraints tightened later and more gradually, and contributed much less to the slump.
    Keywords: capital flows; boom-bust cycle; global financial crisis
    JEL: C11 E21 E32 E62
    Date: 2014–05–01
  17. By: Plante, Michael D. (Federal Reserve Bank of Dallas); Richter, Alexander (Auburn University); Throckmorton, Nathaniel (Indiana University)
    Abstract: This paper documents a strong negative correlation between macroeconomic uncertainty and real GDP growth since the Great Recession. Prior to that event the correlation was weak, even when conditioning on recessions. At the same time, many central banks reduced their policy rate to its zero lower bound (ZLB), which we contend contributed to the strong correlation between macroeconomic uncertainty and real GDP growth. To test that theory, we use a model where the ZLB occasionally binds. The model roughly matches the correlation in the data—away from the ZLB the correlation is weak but strongly negative when the ZLB binds.
    Keywords: monetary policy; uncertainty; economic activity; zero lower bound
    JEL: E32 E47 E58
    Date: 2014–05–21

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