nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2014‒07‒05
thirteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Forecasting In a Non-Linear DSGE Model By Sergey Ivashchenko
  2. Government spending shocks, wealth effects and distortionary taxes By James Cloyne
  3. Leverage Restrictions in a Business Cycle Model By Lawrence Christiano; Daisuke Ikeda
  4. Forecasting with DSGE models with financial frictions By Kolasa, Marcin; Rubaszek, Michał
  5. Equilibrium and Optimal Fertility with Increasing Returns to Population and Endogenous Fertility By Cuberes, David; Tamura, Robert
  6. Understanding the Great Recession By Christiano, Lawrence J.; Eichenbaum, Martin; Trabandt, Mathias
  7. Optimal Monetary Policy in the Presence of Human Capital Depreciation during Unemployment By Lien Laureys
  8. The Macroeconomic Consequences of Asset Bubbles and Crashes By Shi, Lisi; Suen, Richard M. H.
  9. Growth and Mitigation Policies with Uncertain Climate Damage By Lucas Bretschger; Alexandra Vinogradova
  10. Consumer default and optimal consumption decisions By Bechlioulis, Alexandros; Brissimis, Sophocles
  11. International Capital Flows and the Boom-Bust Cycle in Spain By Beatrice Pataracchia; Robert Kollmann; Marco Ratto; Werner Roeger; Jan in’t Veld
  12. R&D Investment and Financial Frictions By Oscar M. Valencia
  13. A Comparison of Programming Languages in Economics By S. Borağan Aruoba; Jesús Fernández-Villaverde

  1. By: Sergey Ivashchenko
    Abstract: A medium-scale nonlinear dynamic stochastic general equilibrium (DSGE) model is estimated (54 variables, 29 state variables, 7 observed variables). The model includes a observed variable for stock market returns. The root-mean square error (RMSE) of the in-sample and out-of-sample forecasts is calculated. The nonlinear DSGE model with measurement errors outperforms AR (1), VAR (1) and the linearized DSGE in terms of the quality of the out-of-sample forecasts. The nonlinear DSGE model without measurement errors is actually of a quality equal to that of the linearized DSGE model.
    Keywords: nonlinear DSGE, Quadratic Kalman Filter, QKF, out-of-sample forecasts
    JEL: E32 E37 E44 E47
    Date: 2014–05–17
  2. By: James Cloyne (Bank of England; Centre for Macroeconomics (CFM))
    Abstract: The size and sign of the government spending multiplier crucially depends on how the spending is financed and how consumers respond to implied future tax increases. I investigate this issue in an estimated New Keynesian DSGE model with distortionary labor and capital taxes and, importantly, with preferences that allow the wealth effect on labor supply to vary. Specifically I assess whether the model can explain the empirical evidence for the United States and examine the transmission mechanism, for realistic policy rules. I show that the model can match the positive empirical response of key variables including output, consumption and the real wage. I find that the role of the wealth effect on labor supply is small and that while tax rates rise following a spending shock these increases are modest, with debt rising. Deficit financed spending increases are therefore expansionary, but this is due to sticky prices rather than the wealth effect channel.
    Keywords: Fiscal policy, government spending shocks, spending multiplier, business cycles
    JEL: E20 E32 E62 H20
    Date: 2014–05
  3. By: Lawrence Christiano; Daisuke Ikeda
    Abstract: We modify an otherwise standard medium-sized DSGE model, in order to study the macroeconomic effects of placing leverage restrictions on financial intermediaries. The financial intermediaries (`bankers') in the model must exert effort in order to earn high returns for their creditors. An agency problem arises because banker effort is not observable to creditors. The consequence of this agency problem is that leverage restrictions on banks generate a very substantial welfare gain in steady state. We discuss the economics of this gain. As a way of testing the model, we explore its implications for the dynamic effects of shocks.
    Date: 2014–03
  4. By: Kolasa, Marcin; Rubaszek, Michał
    Abstract: This paper compares the quality of forecasts from DSGE models with and without financial frictions. We find that accounting for financial market imperfections does not result in a uniform improvement in the accuracy of point forecasts during non-crisis times while the average quality of density forecast even deteriorates. In contrast, adding frictions in the housing market proves very helpful during the times of financial turmoil, overperforming both the frictionless benchmark and the alternative that incorporates financial frictions in the corporate sector. Moreover, we detect complementarities among the analyzed setups that can be exploited in the forecasting process.
    Keywords: DSGE models; Financial frictions; Housing market
    JEL: C11 C53 E44
    Date: 2014–06
  5. By: Cuberes, David; Tamura, Robert
    Abstract: We present a general equilibrium dynamic model that characterizes the gap between optimal and equilibrium fertility and investment in human capital. In the model, the aggregate production function exhibits increasing returns to population arising from specialization but households face the standard quantity-quality trade-off when deciding how many children they have and how much education these children receive. In the benchmark model, we solve for the equilibrium and optimal levels of fertility and investment per child and show that competitive fertility is too low and investment per child too high. We next introduce mortality of young adults in the model and assume that households have a precautionary demand for children. Human capital investment raises the likelihood that a child survives to the next generation. In this setup, the model endogenously generates a demographic transition but, since households do not internalize the positive effects of a larger population on productivity and the negative effects of human capital on mortality, both the industrial revolution and the demographic transition take place much later than it would have been optimal. Our model can be interpreted as a bridge between the literature on endogenous demographic transitions and papers that study welfare issues associated with fertility and human capital decisions.
    Keywords: increasing returns to population, endogenous fertility, endogenous mortality
    JEL: J1 J24 O1
    Date: 2014–07–02
  6. By: Christiano, Lawrence J. (Northwestern University); Eichenbaum, Martin (Northwestern University); Trabandt, Mathias (Board of Governors of the Federal Reserve System (U.S.))
    Abstract: We argue that the vast bulk of movements in aggregate real economic activity during the Great Recession were due to financial frictions interacting with the zero lower bound. We reach this conclusion looking through the lens of a New Keynesian model in which firms face moderate degrees of price rigidities and no nominal rigidities in the wage setting process. Our model does a good job of accounting for the joint behavior of labor and goods markets, as well as inflation, during the Great Recession. According to the model the observed fall in total factor productivity and the rise in the cost of working capital played critical roles in accounting for the small size of the drop in inflation that occurred during the Great Recession.
    Keywords: Inflation; unemployment; labor force; zero lower bound
    JEL: E24 E32
    Date: 2014–04–02
  7. By: Lien Laureys (Bank of England; Centre for Macroeconomics (CFM))
    Abstract: When workers are exposed to human capital depreciation during periods of unemployment, hiring affects the unemployment pool’s composition in terms of skills, and hence the economy’s production potential. Introducing human capital depreciation during unemployment into an otherwise standard New Keynesian model with search frictions in the labour market leads to the finding that the flexibleprice allocation is no longer constrained-efficient even when the standard Hosios (1990) condition holds. This is because it generates a composition externality in job creation: firms ignore how their hiring decisions affect the extent to which the unemployed workers’ skills erode, and hence the output that can be produced by new matches. Consequently, it might be desirable from a social point of view for monetary policy to deviate from strict inflation targeting. Although optimal price inflation is no longer zero, strict inflation targeting is shown to stay close to the optimal policy.
    Date: 2014–06
  8. By: Shi, Lisi; Suen, Richard M. H.
    Abstract: This paper examines the macroeconomic effects of asset price bubbles and crashes in an overlapping generations economy. The model highlights the effects of asset price fluctuations on labor supply decisions, and demonstrates how labor market adjustment can help propagate the effects of these fluctuations to the aggregate economy. It is shown that, under certain conditions, asset bubbles can crowd in productive investment and lead to an expansion in total employment, and the bursting of these bubbles can have an immediate negative impact on these variables.
    Keywords: Asset Bubbles, Overlapping Generations, Endogenous Labor
    JEL: E22 E44
    Date: 2014–06
  9. By: Lucas Bretschger; Alexandra Vinogradova
    Abstract: We analyze an endogenously growing economy in which production generates greenhouse gas emissions leading to global temperature increase. Global warming causes stochastic climate shocks, modeled by the Poisson process, which destroy part of the economy's capital stock. Part of the output may be devoted to emissions abatement and thus damages from climate shocks may be reduced. We solve the model in closed form and show that the optimal path is characterized by a constant growth rate of consumption and capital stock until a shock arrives, triggering a downward jump in both variables. The magnitude of the jump depends on the Poisson arrival rate, abatement efficiency, damage intensity, and the elasticity of intertemporal consumption substitution. Optimum mitigation policy consists of spending a constant share of output on abatement, which is an increasing function of the Poisson arrival rate, the economy's productivity, polluting intensity of output, and the intensity of environmental damage. Optimum growth and abatement react sharply to changes in the arrival rate and the damage intensity, suggesting more stringent climate policies for a realistic world with uncertainty compared to the certainty-equivalent case. We extend the baseline model by adding climate-induced fluctuations around the growth trend and stock pollution effects, showing the robustness of our results.
    Keywords: climate policy, uncertainty, natural disasters, endogenous growth
    JEL: O10 Q52 Q54
    Date: 2014–05–28
  10. By: Bechlioulis, Alexandros; Brissimis, Sophocles
    Abstract: We examine the optimal consumption decisions of households in a micro-founded framework that assumes two financial frictions: heterogeneity between borrowing and saving households, and endogenous default. We study default in the context of two-period overlapping processes of consumer behavior, assuming that penalty costs are imposed on borrowers if they are delinquent in the first period and are subsequently refinanced by banks. The utility function of borrowing households is specified to include a term reflecting strategic decisions as regards non-payment of debt. From the solution of the household optimization problem, we derive an augmented Euler equation for consumption, which is a function inter alia of an expected default factor. We use this equation to calculate in a static equilibrium the optimal value of the percentage of debt repaid. We finally provide an ordering by size of the household discount factor: borrowers who do not repay all of their loans have the lowest discount factor, followed in turn by borrowers who fully repay them and by savers.
    Keywords: borrowing household; saving household; household behavior; consumer default; optimal consumption
    JEL: C61 E21
    Date: 2014–06–25
  11. By: Beatrice Pataracchia; Robert Kollmann; Marco Ratto; Werner Roeger; Jan in’t Veld
    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 the 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.
    JEL: C11 E21 E32 E62
    Date: 2014–06
  12. By: Oscar M. Valencia
    Abstract: R&D intensity for small firms is high and persistent over time. At the same time, small firms are often financially constrained. This paper proposes a theoretical model that explains the coexistence of these two stylized facts. It is shown that self-financed R&D investment can distort the effort allocated to different projects in a firm. In a dynamic environment, it is optimal for the firm to invest in R&D projects despite the borrowing constraints. In addition, this paper shows that beyond a certain threshold, effort substitution between R&D and production appears. When transfers from investor to entrepreneur are large enough, R&D intensity decreases with respect to financial resources. Conditional on survival, the more innovative and financially constrained firms are, faster they grow and exhibit higher volatility.
    Keywords: Moral Hazard, Endogenous Borrowing Constraints, Technological Change.
    JEL: O41 D86
    Date: 2014–06–26
  13. By: S. Borağan Aruoba; Jesús Fernández-Villaverde
    Abstract: We solve the stochastic neoclassical growth model, the workhorse of modern macroeconomics, using C++11, Fortran 2008, Java, Julia, Python, Matlab, Mathematica, and R. We implement the same algorithm, value function iteration with grid search, in each of the languages. We report the execution times of the codes in a Mac and in a Windows computer and comment on the strength and weakness of each language.
    JEL: C0 E0
    Date: 2014–06

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