nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2014‒07‒28
29 papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. The Business Cycle with Nominal Contracts and Search Frictions By Moon, Weh-Sol
  2. Online Appendix to "Unemployment Insurance and Optimal Taxation in a Search Model of the Labor Market" By Athanasios Geromichalos
  3. Endogenous Wage Indexation and Aggregate Shocks By JULIO CARRILLO; GERT PEERSMAN; JORIS WAUTERS
  4. Semi-Global Solutions to DSGE Models: Perturbation around a Deterministic Path By Viktors Ajevskis
  5. OccBin: A Toolkit for Solving Dynamic Models With Occasionally Binding Constraints Easily By Guerrieri, Luca; Iacoviello, Matteo
  6. The cost of business cycles with heterogeneous trading technologies By Chien, YiLi
  7. Robust Dynamic Optimal Taxation and Environmental Externalities By Ted Temzelides; Borghan Narajabad
  8. Sticky Leverage By Urban Jermann; Lukas Schmid; Joao Gomes
  9. Modeling an Immigration Shock By Boldrin, Michele; Montes, Ana
  10. Environmental Policies under Debt Constraint By Mouez Fodha; Thomas Seegmuller; Hiroaki Yamagami
  11. The Cost of Pollution on Longevity, Welfare and Economic Stability By Natacha Raffin; Thomas Seegmuller
  12. Online Appendix to "Bargaining with Commitment Between Workers and Large Firms" By William Hawkins
  13. Monetary and Fiscal Policy with Sovereign Default By Joost Röttger
  14. Endogenous Fluctuations in an Endogenous Growth Model with Infl ation Targeting By Rangan Gupta; Lardo Stander
  15. Childcare Subsidies and Household Labor Supply By Guner, Nezih; Kaygusuz, Remzi; Ventura, Gustavo
  16. Policy-oriented macroeconomic forecasting with hybrid DGSE and time-varying parameter VAR models By Stelios D. Bekiros; Alessia Paccagnini
  17. Macroeconomic Regimes By L. BAELE; G. BEKAERT; S. CHO; K. INGHELBRECHT; A. MORENO
  18. Risk and Ambiguity in Models of Business Cycles By David Backus; Axelle Ferriere; Stanley Zin
  19. Reputation and Aggregate Shocks By Julien Prat; Boyan Jovanovic
  20. Markups Dynamics with Customer Markets By Nicholas Trachter; Andrea Pozzi; Luigi Paciello
  21. Reputation and Liquidity Traps By Taisuke Nakata
  22. Skill-Biased Technical Change and the Cost of Higher Education By Fang Yang; John Bailey Jones
  23. Trade Integration and Business Cycle Synchronization in the EMU: The Negative Effect of New Trade Flows By Jean-Sébastien Pentecôte; Jean-Christophe Poutineau; Fabien Rondeau
  24. Imitation Induced Innovation in General Equilibrium By Karsten Wasiluk
  25. Labor Tax Cuts and Employment: A General Equilibrium Approach for France By Raphael A. Espinoza; Esther Pérez Ruiz
  26. Who do Unions Target? Unionization over the Life-Cycle of U.S. Businesses By Jeremy Greenwood; Henry Hyatt; Emin Dinlersoz
  27. Default Risk Premia on Government Bonds in a Quantitative Macroeconomic Model By Falko Juessen; Ludger Linnemann; Andreas Schabert
  28. Implications of heterogeneity in preferences, beliefs and asset trading technologies for the macroeconomy By Chien, YiLi; Cole, Harold L.; Lustig, Hanno
  29. Fiscal Devaluations By Farhi, Emmanuel; Gopinath, Gita; Itskhoki, Oleg

  1. By: Moon, Weh-Sol
    Abstract: I construct a dynamic stochastic general equilibrium (DSGE) model characterized by flexible prices, search frictions, and nominal wage contracts, and examine to what extent the model can explain the quantitative business cycle properties of real macroeconomic variables in the U.S. economy. I consider efficient bargaining that the firm and the worker enter into bargaining over the future nominal hourly wage rate and future hours worked under the generalized Nash bargaining framework. The Nash product is assumed to consist of the discounted present value of the expected match surplus. Under efficient bargaining, the model hardly produces unrealistically high volatility of real variables or countercyclical productivity because hours per worker are fixed ahead of time and employment is a slow-moving variable with search frictions. Moreover, efficient bargaining requires firms to rely on job creation heavily to adjust the wedge between the marginal product of labor and the real wage rate in response to shocks. As contract length increases, the volatilities of the unemployment rate and vacancy rate increase significantly, but those of output and total hours worked do not appreciably change. I also investigate the model under different assumptions such as the right-to-manage approach, the Nash product with the current value of match surplus, and instantaneous hiring. Efficient and forward-looking bargaining are important in accounting for the U.S. business cycle properties.
    Keywords: Business Cycles, Search Frictions, Nominal Wage Contracts, Efficient Bargaining
    JEL: E24 E32
    Date: 2011–06–10
  2. By: Athanasios Geromichalos (University of California Davis)
    Abstract: Online appendix for the Review of Economic Dynamics article
    Date: 2014
    Abstract: wage indexation to past in ation, a nding that is at odds with the assumption of constant indexation parameters in most New-Keynesian DSGE models. We build a DSGE model with endogenous wage indexation in which utility maximizing workers select a wage indexation rule in response to aggregate shocks and monetary policy. We show that workers index wages to past in ation when output uctuations are primarily explained by technology and permanent in ation-target shocks, whereas they index to trend in ation when aggregate demand shocks dominate output uctuations. The model's equilibrium wage setting can explain the time variation in wage indexation found in post-WWII U.S. data.
    Keywords: Wage indexation, Welfare costs, Nominal rigidities
    JEL: E24 E32 E58
    Date: 2014–05
  4. By: Viktors Ajevskis
    Abstract: This study presents an approach based on a perturbation technique to construct global solutions to dynamic stochastic general equilibrium models (DSGE). The main idea is to expand a solution in a series of powers of a small parameter scaling the uncertainty in the economy around a solution to the deterministic model, i.e. the model where the volatility of the shocks vanishes. If a deterministic path is global in state variables, then so are the constructed solutions to the stochastic model, whereas these solutions are local in the scaling parameter. Under the assumption that a deterministic path is already known the higher order terms in the expansion are obtained recursively by solving linear rational expectations models with timevarying parameters. The present work proposes a method which rests on backward recursion for solving this type of models.
    Keywords: DSGE, perturbation method, rational expectations models with timevarying parameters, asset pricing model
    JEL: C61 C62 C63 D50 D58
    Date: 2014–07–04
  5. By: Guerrieri, Luca (Board of Governors of the Federal Reserve System (U.S.)); Iacoviello, Matteo (Board of Governors of the Federal Reserve System (U.S.))
    Abstract: We describe how to adapt a first-order perturbation approach and apply it in a piecewise fashion to handle occasionally binding constraints in dynamic models. Our examples include a real business cycle model with a constraint on the level of investment and a New Keynesian model subject to the zero lower bound on nominal interest rates. We compare the piecewise linear perturbation solution with a high-quality numerical solution that can be taken to be virtually exact. The piecewise linear perturbation method can adequately capture key properties of the models we consider. A key advantage of this method is its applicability to models with a large number of state variables.
    Keywords: Occasionally binding constraints; DSGE models; regime shifts; first-order perturbation
    Date: 2014–07–07
  6. By: Chien, YiLi (Federal Reserve Bank of St. Louis)
    Abstract: This paper investigates the welfare cost of business cycles in an economy where households have heterogeneous trading technologies. In an economy with aggregate risk, the different portfolio choices induced by heterogeneous trading technologies lead to a larger consumption inequality in equilibrium, while this source of inequality vanishes in an economy without business cycles. Put simply, the heterogeneity in trading technologies amplifies the effect of aggregate output fluctuation on consumption inequality. The welfare cost of business cycles is, therefore, larger in such an economy. In the benchmark economy with a reasonable low risk aversion rate, the business cycle costs 6.49% per period consumption for an average household when I calibrate this model to match the risk premium.
    Keywords: Asset Pricing; Cost of Business Cycles; Heterogeneous Agents
    JEL: E32 G11 G12
    Date: 2014–06–10
  7. By: Ted Temzelides (Rice University); Borghan Narajabad (Federal Reserve)
    Abstract: We study a dynamic stochastic general equilibrium model where agents are concerned about model uncertainty regarding climate change. An externality from greenhouse gas emissions adversely affects the economys capital stock. We assume that the mapping from climate change to damages is subject to uncertainty, and we adapt and use techniques from robust control theory in order to study efficiency and optimal policy. We obtain a sharp analytical solution for the implied environmental externality, and we characterize dynamic optimal taxation. A small increase in the concern about model uncertainty can cause a significant drop in optimal energy extraction. The optimal tax which restores the social optimal allocation is Pigouvian. Under more general assumptions, we develop a recursive method and solve the model computationally. We find that the introduction of uncertainty matters qualitatively and quantitatively. We study optimal output growth in the presence and in the absence of concerns about uncertainty and find that these can lead to substantially dfferent conclusions.
    Date: 2014
  8. By: Urban Jermann (University of Pennsylvania); Lukas Schmid (UCLA); Joao Gomes (University of Pennsylvania)
    Abstract: We examine the effects of long-lived nominal debt contracts in a quantitative business cycle model with financial frictions. In our setting, as in reality, firms fund themselves with a mix of nominal defaultable debt and equity securities to issue in every period. Debt is priced fairly taking into account default and inflation risk, but is attractive because of the tax-deductibility of interest payments. Unanticipated inflation changes the real burden of corporate debt and, more significantly, distorts corporate investment and production decisions. These effects are large and very persistent. Interest rates rules stabilize the economy, supporting their popularity with policy makers.
    Date: 2014
  9. By: Boldrin, Michele; Montes, Ana
    Abstract: In this paper, we model an overlapping generation economy affected by an unexpected immigration shock and determine how households would insure themselves against "immigration risks" efficiently. We use the model to study the impact of immigration on (i) the welfare of various generations, (ii) the distributions of income among factors of production, and (iii) the optimal design of the intergenerational welfare state. In particular, we construct a system of public education and public pensions that mimics efficient complete market allocation. We also show the impact of immigration shocks in a small open economy. In this case, our model suggests that the external capital flows can act as substitutes for the missing private insurance markets. Our analysis delivers a set of predictions that we find useful for understanding certain aspects of the Spanish experience during 1996 and 2007.
    Keywords: social security, human capital, overlapping generations, immigration, trade deficit, risk sharing
    JEL: F22 H53 H55
    Date: 2013–07–20
  10. By: Mouez Fodha (EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris); Thomas Seegmuller (AMSE - Aix-Marseille School of Economics - Centre national de la recherche scientifique (CNRS) - École des Hautes Études en Sciences Sociales (EHESS) - Ecole Centrale Marseille (ECM)); Hiroaki Yamagami (Seikei University - Seikei University)
    Abstract: This article analyzes the consequences of environmental tax policies when the government imposes a constraint on stabilizing public debt. A public sector of pollution abatement is financed by taxation and by issuing public debt. Considering a simple overlapping-generations model, the tax reform stimulates steady-state investment. Then, the environmental quality and the aggregate consumption increase if and only if (i) pollution abatement is large enough and (ii) there is under-accumulation of the per capita capital stock. This arises if environmental taxation allows a decrease of either income taxation or debt-output ratio.
    Keywords: environmental tax reform; debt; public emission abatement; double dividend
    Date: 2014–06
  11. By: Natacha Raffin (EconomiX - CNRS : UMR7166 - Université Paris X - Paris Ouest Nanterre La Défense, Climate Economics Chair - University Paris Dauphine); Thomas Seegmuller (AMSE - Aix-Marseille School of Economics - Centre national de la recherche scientifique (CNRS) - École des Hautes Études en Sciences Sociales (EHESS) - Ecole Centrale Marseille (ECM))
    Abstract: This paper presents an overlapping generations model where pollution, private and public healths are all determinants of longevity. Public expenditure, financed through labour taxation, provide both public health and abatement. We study the complementarity between the three components of longevity on welfare and economic stability. At the steady state, we show that an appropriate fiscal policy may enhance welfare. However, when pollution is heavily harmful for longevity, the economy might experience aggregate instability or endogenous cycles. Nonetheless, a fiscal policy, which raises the share of public spending devoted to health, may display stabilizing virtues and rule out cycles. This allows us to recommend the design of the public policy that may comply with the dynamic and welfare objectives.
    Keywords: longevity; pollution; welfare; complex dynamics
    Date: 2014–07
  12. By: William Hawkins (Yeshiva University)
    Abstract: Online appendix for the Review of Economic Dynamics article
    Date: 2014
  13. By: Joost Röttger
    Abstract: How does the option to default on debt payments affect the conduct of public policy? To answer this question, this paper studies optimal monetary and fiscal policy without commitment in a model with nominal debt and endogenous sovereign default. When the government can default on its debt, public policy changes in the short and the long run relative to a setting without default option. The risk of default increases the volatility of interest rates, impeding the government's ability to smooth tax distortions across states. It also limits public debt accumulation and reduces the government's incentive to implement high inflation in the long run. The welfare costs associated with the short-run effects of sovereign default are found to be outweighed by the welfare gains due to lower average debt and inflation.
    Keywords: Monetary and Fiscal Policy, Lack of Commitment, Sovereign Default, Domestic Debt, Markov-Perfect Equilibrium
    JEL: E31 E63 H63
    Date: 2014–06–02
  14. By: Rangan Gupta (Department of Economics, University of Pretoria); Lardo Stander (Department of Economics, University of Pretoria)
    Abstract: This paper develops a monetary endogenous growth overlapping generations model characterized by production lags - specifically lagged capital inputs - and an infl ation targeting monetary authority, and analyses the growth dynamics that emerge from this framework. The growth process is endogenized by allowing productive government expenditure on infrastructure, complementing the lagged private capital input. Following the extant literature, money is introduced by imposing a cash reserve requirement on an otherwise competitive banking sector. Given this framework, we show that multiple equilibria emerge along different growth paths, with the low-growth (high-growth) equilibrium being unstable (stable) and locally determinate (locally indeterminate). In addition, we show that convergent or divergent endogenous fl uctuations and even topological chaos could emerge around the high-growth equilibrium in the growth path where the monetary authority follows a high infl ation targeting regime. Conversely, when the monetary authority follows a low infl ation targeting regime, oscillations do not occur around either the low-growth or high-growth equilibrium.
    Keywords: Endogenous fl uctuations, in flation targeting, chaos, production lags, indeterminacy
    JEL: C62 E32 O42
    Date: 2014–06
  15. By: Guner, Nezih (MOVE, Barcelona); Kaygusuz, Remzi (Sabanci University); Ventura, Gustavo (Arizona State University)
    Abstract: What would be the aggregate effects of adopting a more generous and universal childcare subsidy program in the U.S.? We answer this question in a life-cycle equilibrium model with joint labor-supply decisions of married households along extensive and intensive margins, heterogeneity in terms of the presence of children across households and skill losses of females associated to non-participation. We find that subsidies have substantial effects on female labor supply, which are largest at the bottom of the skill distribution. Fully subsidized childcare available to all households leads to long-run increases in the participation of married females and total hours worked by about 10.1% and 1.0%, respectively. There are large differences across households in welfare gains, as a small number of households – poorer households with children – gain significantly while others lose. Welfare gains of newborn households amount to 1.9%. Our findings are robust to differences among households in fertility and childcare expenditures.
    Keywords: childcare, household labor supply
    JEL: E62 H24 H31
    Date: 2014–07
  16. By: Stelios D. Bekiros; Alessia Paccagnini
    Abstract: Micro-founded dynamic stochastic general equilibrium (DSGE) models appear to be particularly suited for evaluating the consequences of alternative macroeconomic policies. Recently, increasing efforts have been undertaken by policymakers to use these models for forecasting, although this proved to be problem- atic due to estimation and identification issues. Hybrid DSGE models have become popular for dealing with some of model misspecifications and the trade-off between theoretical coherence and empirical fit, thus allowing them to compete in terms of predictability with VAR models. However, DSGE and VAR models are still linear and they do not consider time-variation in parameters that could account for inher- ent nonlinearities and capture the adaptive underlying structure of the economy in a robust manner. This study conducts a comparative evaluation of the out-of-sample predictive performance of many different specifications of DSGE models and various classes of VAR models, using datasets for the real GDP, the harmonized CPI and the nominal short-term interest rate series in the Euro area. Simple and hybrid DSGE models were implemented including DSGE-VAR and Factor Augmented DGSE, and tested against standard, Bayesian and Factor Augmented VARs. Moreover, a new state-space time-varying VAR model is presented. The total period spanned from 1970:1 to 2010:4 with an out-of-sample testing period of 2006:1-2010:4, which covers the global financial crisis and the EU debt crisis. The results of this study can be useful in conducting monetary policy analysis and macro-forecasting in the Euro area.
    Keywords: Model validation, Forecasting, Factor Augmented DSGE, Time-varying parameter VAR, DGSE-VAR, Bayesian analysis
    JEL: C11 C15 C32
    Date: 2014–07–15
    Abstract: We estimate a New-Keynesian macro model accommodating regime-switching behavior in monetary policy and in macro shocks. Key to our estimation strategy is the use of survey-based expectations for inflation and output. Output and inflation shocks shift to the low volatility regime around 1985 and 1990, respectively. However, we also identify multiple shifts between accommodating and active monetary policy regimes, which play an as important role as shock volatility in driving the volatility of the macro variables. We provide new estimates of the onset and demise of the Great Moderation and quantify the relative role played by macro-shocks and monetary policy. The estimated rational expectations model exhibits indeterminacy in the mean-square stability sense, mainly because monetary policy is excessively passive.
    Keywords: Markov-Switching (MS) DSGE models, Survey Expectations, Great Moderation, Monetary Policy, Determinacy in MS DSGE models
    JEL: E31 E32 E52 E58 C42 C53
    Date: 2013–12
  18. By: David Backus; Axelle Ferriere; Stanley Zin
    Abstract: We inject aggregate uncertainty – risk and ambiguity – into an otherwise standard business cycle model and describe its consequences. We find that increases in uncertainty generally reduce consumption, but they do not account, in this model, for either the magnitude or the persistence of the most recent recession. We speculate about extensions that might do better along one or both dimensions.
    JEL: D81 E32 G12
    Date: 2014–07
  19. By: Julien Prat (CREST); Boyan Jovanovic (New York University)
    Abstract: Investment in reputation responds positively to news shocks and to current aggregate shocks when they are autocorrelated. Idiosyncratic risk is contractionary and reduces the response to aggregate shocks. In this sense the rise in idiosyncratic risk can explain the great moderation -- the two have happened roughly at the same time. The greater cyclicality of durables can also be explained with this mechanism because durables have greater technological products and firms making them have more prove by exerting effort.
    Date: 2014
  20. By: Nicholas Trachter (Federal Reserve Bank of Richmond); Andrea Pozzi (Einaudi Institute for Economics and Fina); Luigi Paciello (Einaudi Institute (EIEF))
    Abstract: We study a model where customers face frictions when changing their supplier, generating sluggishness in the firm's customer base. Firms care about expanding their customer base and this affects their pricing strategy. We characterize optimal pricing in this model and estimate it using data on the evolution of the customer base of a large US retailer. The introduction of customer markets reduces average markups, more markedly for less productive firms. We use the model to perform a counterfactual exercise and investigate the cyclical behaviour of markups in response to both aggregate supply and demand shocks.
    Date: 2014
  21. By: Taisuke Nakata (Federal Reserve Board)
    Abstract: This paper studies credible policies in a New Keynesian economy in which the nominal interest rate is subject to the ZLB constraint and contractionary shocks hit the economy occasionally. The Ramsey policy involves keeping the policy rate low even after the shock disappears, but the central bank would be tempted to raise the rate to close consumption and inflation gaps if it could re-optimize. I find that the Ramsey policy is credible if the contractionary shock occurs sufficiently frequently. In the best credible plan, if the central bank reneges on the promise of low policy rates, it will lose reputation and the private sector will not believe such promises in future recessions. When the shock hits the economy sufficiently frequently, the incentive to maintain reputation outweighs the short-run incentive to close consumption and inflation gaps, and keeps the central bank on the originally announced path of low nominal interest rates.
    Date: 2014
  22. By: Fang Yang; John Bailey Jones
    Abstract: We document the growth in higher education costs and tuition over the past 50 years. To explain these trends, we develop a general equilibrium model with skill- and sector-biased technical change. Finding the model’s parameters through a combination of estimation and calibration, we show that it can explain the rise in college costs between 1961 and 2009, along with the increase in college attainment and the change in the relative earnings of college graduates. The model predicts that if college costs had ceased to grow after 1961, enrollment in 2010 would be 3 to 6 percent higher.
  23. By: Jean-Sébastien Pentecôte (CREM - Centre de Recherche en Economie et Management - CNRS : UMR6211 - Université de Rennes 1 - Université de Caen Basse-Normandie); Jean-Christophe Poutineau (CREM - Centre de Recherche en Economie et Management - CNRS : UMR6211 - Université de Rennes 1 - Université de Caen Basse-Normandie); Fabien Rondeau (CREM - Centre de Recherche en Economie et Management - CNRS : UMR6211 - Université de Rennes 1 - Université de Caen Basse-Normandie)
    Abstract: This paper questions the impact of trade integration on business cycle sychronization in the EMU by distinguishing increase of existing trade flows (the intensive margin) and creation of new trade flows (the extensive margin). Using a DSGE model, we find that synchronization is weakened when new firms are allowed to export as a response to productivity gains. Consistenly with our model and using disaggregated data over 1995-2007 for the 11 founding members of the EMU, we find that trade intensity has a positive direct effect while new trade flows have a negative effect on business cycle synchronization. Furthermore, new flows play essentially an indirect role by intensifying specialization and explain 60 % of the overall effect of trade intensity and specialization on synchronization.
    Keywords: Trade integration; business cycles; European Monetary Union
    Date: 2014
  24. By: Karsten Wasiluk (Department of Economics, University of Konstanz, Germany)
    Abstract: This paper analyzes the effect of imitation on the rate of technological progress in an endogenous growth model. Quality leaders protect themselves from imitation by secondary development, which increases technological progress. Nevertheless, lower intellectual property rights protection reduces the incentives to enter the research sector which reduces innovation by outsiders. Simulations show that the net effect of increased imitation on the growth rate is ambiguous - it can be positive, negative, or inversely U-shaped, depending on the productivity of secondary research. Lower patent protection also reduces the degree of market power in the economy so that output, the wage rate, and welfare is typically increased.
    Keywords: Innovation, Intellectual Property Rights, Market Power
    JEL: L12
    Date: 2014–06–30
  25. By: Raphael A. Espinoza; Esther Pérez Ruiz
    Abstract: The paper presents a simple supply side, general equilibrium model to estimate the macroeconomic effects of labor tax cuts. The model assumes that output is produced using capital, unskilled and skilled workers, and public servants. Wage formation for skilled workers features a Blanchflower-Oswald wage curve, while the labor supply for unskilled workers is very elastic around the minimum wage for small changes in employment. The model is calibrated for France and used to estimate the output and employment effects induced by two recent tax reforms: the Crédit d’Impôt pour la Compétitivité et l’Emploi (CICE) and the Pacte de Solidarité Responsabilité (RSP). We find that the tax cuts, if not offset by other fiscal measures, would contribute overall to creating around 200,000 jobs in the short run (600,000 jobs in the long run). Since the model abstracts from demand side effects, the results should be interpreted as providing estimates of the effect of tax measures on potential output and potential employment.
    Date: 2014–07–01
  26. By: Jeremy Greenwood (University of Pennsylvania); Henry Hyatt (US Census Bureau); Emin Dinlersoz (U.S. Census Bureau)
    Abstract: What type of businesses do unions target for organizing and when? A dynamic model of the union organizing process is constructed to answer this question. A union monitors establishments in an industry to learn about their productivity, and decides which ones to organize and when. The predictions of the model find support in union certification elections data for 1977-2007 matched with data on establishment characteristics. Two selection effects emerge: unions target larger and more productive establishments early in their life-cycles, and, conditional on targeting, unions are more likely to win elections in smaller and less productive establishments.
    Date: 2014
  27. By: Falko Juessen; Ludger Linnemann; Andreas Schabert
    Abstract: We develop a macroeconomic model where the government does not guarantee to repay debt. We ask whether movements in the price of government bonds can be rationalized by lenders' unwillingness to fully roll over debt when the outstanding level of debt exceeds the government's repayment capacity. Investors do not support a Ponzi game and ration credit supply in this case, thus forcing default at an endogenously determined fractional repayment rate. Interest rates on government bonds re.ect expectations of this event. Numerical results show that default premia can emerge at moderately high debt-to-GDP ratios where even small changes in fundamentals lead to steeply rising interest rates. The behavior of risk premia broadly accords to recent observations for several European countries that experienced a worsening of fundamental fiscal conditions.
    Keywords: Sovereign default, fiscal policy, government debt
    JEL: E62 G12 H6
    Date: 2014–06–01
  28. By: Chien, YiLi (Federal Reserve Bank of St. Louis); Cole, Harold L. (University of Pennsylvania.); Lustig, Hanno (UCLA Anderson School of Management,)
    Abstract: This paper analyzes and computes the equilibria of economies with large numbers of heterogeneous agents who have different asset trading technologies, preferences, and beliefs. We illustrate the value of our method by using it to evaluate the implications of these heterogeneities through several quantitative exercises.
    Keywords: asset pricing; equilibrium survival; heterogeneous beliefs; heterogeneous preferences.
    JEL: D51 D84 E21 G1
    Date: 2014–07–14
  29. By: Farhi, Emmanuel; Gopinath, Gita; Itskhoki, Oleg
    Abstract: We show that even when the exchange rate cannot be devalued, a small set of conventional fiscal instruments can robustly replicate the real allocations attained under a nominal exchange rate devaluation in a dynamic New Keynesian open economy environment. We perform the analysis under alternative pricing assumptions—producer or local currency pricing, along with nominal wage stickiness; under arbitrary degrees of asset market completeness and for general stochastic sequences of devaluations. There are two types of fiscal policies equivalent to an exchange rate devaluation—one, a uniform increase in import tariff and export subsidy, and two, a value-added tax increase and a uniform payroll tax reduction. When the devaluations are anticipated, these policies need to be supplemented with a consumption tax reduction and an income tax increase. These policies are revenue neutral. In certain cases equivalence requires, in addition, a partial default on foreign bond holders. We discuss the issues of implementation of these policies, in particular, under the circumstances of a currency union.
    Date: 2014

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