nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2014‒08‒16
sixteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Macroprudential Rules in Small Open Economies By Amado, María
  2. Fiscal shocks and the exchange rate. By Giorgio Di Giorgio; Salvatore Nisticò; Guido Traficante
  3. Multiple Interior Steady States in the Ramsey Model with Elastic Labor Supply By Takashi Kamihigashi
  4. Optimal monetary policy and financial stability in a non-Ricardian economy. By Salvatore Nisticò
  5. Fertility Choice in a Life Cycle Model with Idiosyncratic Uninsurable Earnings Risk By Sommer, Kamila
  6. Wealth Distribution and the Business Cycle By Benjamin Moll
  7. QE: when and how should the Fed exit? By Wen, Yi
  8. A DSGE-RBC Approach to Measuring Impacts of Wealth Transfers By Kurt Annen; Michael Batu; Stephen Kosempel
  9. Business Cycles and Household Formation By Greg Kaplan
  10. Heterogeneity and Government Revenues: Higher Taxes at the Top? By Guner, Nezih; Lopez-Daneri, Martin; Ventura, Gustavo
  11. Taxing top earners: a human capital perspective By Badel, Alejandro; Huggett, Mark
  12. Modeling financial integration, intra-EMU and Asian-US external imbalances By Karl Farmer; Irina Ban
  13. Patent Protection as a Tax on Competition and Innovation By Pedro Bento
  14. A Model of Technology Assimilation By Chong-Kee Yip; Tsz-Nga Wong
  15. Formal Education Versus Learning-by-Doing By Gavrel, Frédéric; Lebon, Isabelle; Rebiere, Therese
  16. Intergenerational Transfers and the Fertility-Income Relationship By Cordoba, Juan Carlos; Ripoll, Marla

  1. By: Amado, María (UCLA)
    Abstract: This document to evaluates the effectiveness, in terms of macroeconomic stability, of monetary policy rules and instruments of prudential supervision. Specifically, it seeks to distinguish between the gains of including in the standard monetary policy rule indicators of financial stress, such as credit growth -augmented rule-; and the gains of applying, in parallel to this augmented rule, a macroprudential instrument that allows a supervisory authority to affect credit interest rates directly. This analysis is performed using a dynamic stochastic general equilibrium model for a small open economy with financial rigidities, and is evaluated in the context of four shocks: financial, productivity, foreign demand and foreign interest rate. The model is calibrated in order to reflect the stylized facts of the Peruvian economy. The results obtained suggest that the effectiveness of the rules depends on the nature of the shock affecting the economy.
    Keywords: macroprudential, monetary policy, small open economy, DSGE model
    JEL: E52 E61
    Date: 2014–07
  2. By: Giorgio Di Giorgio (LUISS Guido Carli, Department of Economics and Finance, Rome (Italy)); Salvatore Nisticò (Dipartimento di Scienze Sociali ed Economiche, Sapienza University of Rome); Guido Traficante (European University of Rome)
    Abstract: This paper studies how the interaction between the monetary policy regime and the degree of home bias in public consumption affects the exchange-rate response to fiscal shocks in dynamic open-economy models. Our analysis compares the classic Redux model of Obstfeld and Rogoff (1995) and a modern New Keynesian DSGE two-country model, and highlights the substantially different transmission mechanism between the two.
    Keywords: Redux Model, Exchange Rate, Fiscal Shocks, Endogenous Monetary and Fiscal Policy.
    JEL: E52 E62 F41 F42
    Date: 2014–07
  3. By: Takashi Kamihigashi (Research Institute for Economics & Business Administration (RIEB), Kobe University, Japan)
    Abstract: In this paper we show that multiple interior steady states are possible in the Ramsey model with elastic labor supply. In particular we establish the following three results: (i) for any discount factor and production function, there is a utility function such that a continuum of interior steady states exist; (ii) the number of interior steady states can also be any finite number; and (iii) for any discount factor and production function, there is a utility function such that there is no interior steady state. Some numerical examples are provided.
    Keywords: Multiple steady states, Ramsey model, Elastic labor supply, Neoclassical growth
    JEL: C61 C62 E13 O41
    Date: 2014–07
  4. By: Salvatore Nisticò (Dipartimento di Scienze Sociali ed Economiche, Sapienza University of Rome and LUISS Guido Carli)
    Abstract: This paper presents a normative analysis of monetary policy in a non-Ricardian economy with an active stock market: it derives a welfare-based monetary policy loss function consistent with Calvo and Obstfeld (1988), and shows that financial stability arises as an additional and independent target, besides inflation and output stability. Evaluation of optimal policy under discretion and commitment reveals that price stability is no longer optimal, even absent inefficient supply shocks: some fluctuations in output and inflation will be optimal as long as they reduce financial instability. Ignoring the non-Ricardian features of this economy potentially leads monetary policy to induce substantially higher welfare losses.
    Keywords: Optimal Monetary Policy, Perpetual Youth, Financial Stability, DSGE Model, Asset Prices.
    JEL: E12 E44 E52
    Date: 2014–07
  5. By: Sommer, Kamila (Board of Governors of the Federal Reserve System (U.S.))
    Abstract: This paper studies the link between rising income uncertainty and household fertility patterns in an Aiyagari-Bewley-Huggett framework augmented to include fertility decisions and infertility risk. Building on Becker and Tomes (1976), I model fertility decisions as sequential, irreversible choices over the number of children, accompanied by parental choices of time and money invested toward improving children's quality. The calibrated model is used to quantify the contribution of earnings uncertainty to the changes in the key fertility indicators between steady states. I show that realistic increases in uninsurable earnings risk lead to a postponement in births by young households, and are associated with a decline in the total number of births. The linkage between earnings risk and fertility patterns highlights the important role that labor market conditions can play in determining both short-term cyclical fluctuations in fertility (such as those in the recent U.S. data) and longer-term demographic trends (such as persistently depressed fertility rates in Southern Europe where youth unemployment rates are high and unemployment spell are very persistent).
    Keywords: Fertility choice; life cycle; heterogenous agents; uninsurable idiosyncratic income risk
    Date: 2014–04–04
  6. By: Benjamin Moll (Princeton University)
    Abstract: We study a class of continuous time heterogeneous agent models with idiosyncratic shocks and incomplete markets. This class can be boiled down to a system of two coupled partial differential equations: a Hamilton-Jacobi-Bellman equation and a Kolmogorov Forward equation, a system that Lasry and Lions (2007) have termed a "Mean Field Game." We study two concrete model economies to show that continuous time allows for both tighter theoretical results compared to traditional discrete time methods as well as precise and efficient computations. The first one is an exact reformulation of Aiyagari (1994) and we obtain three theoretical results: a tight characterization of household savings behavior near the borrowing constraint, uniqueness of a stationary equilibrium (not yet in the current draft), and a tight link between the amount of capital "overaccumulation" and the number of borrowing constrained households. In our second economy, heterogeneous producers face collateral constraints and fixed costs in production, creating the possibility of a ``poverty trap," i.e. multiple stationary equilibria. We find that such ``poverty traps" arise only in extreme special cases. Instead the economy typically features a unique but twin-peaked stationary distributions to which it converges extremely slowly. The precision of our algorithm is key for this finding, and a coarse, simulation-based algorithm may have obtained misleading results. We conclude by discussing an extension of our framework to the case with both idiosyncratic and aggregate shocks as in Krusell and Smith (1998).
    Date: 2014
  7. By: Wen, Yi (Federal Reserve Bank of St. Louis)
    Abstract: The essence of Quantitative Easing (QE) is to reduce the costs of private borrowing through large-scale purchases of privately issue debts, instead of public debts (Ben Bernanke, 2009). Notwithstanding the effectiveness of this highly unconventional monetary policy in reviving private investment and the economy, it is time to think about the likely impacts of the unwinding of QE (or the reversed private-asset purchases) on the economy. In a standard economic model, if monetary injections can increase aggregate output and employment, then the reversed action will likely undo such effects. Would this imply that the U.S. economy will dive into a recession once the Fed starts its large-scale asset sales (under the assumption that QE has successfully pulled the economy out of the Great Recession)? This paper shows that three aspects of the Federal Reserve’s exit strategy matter for achieving (or maintaining) maximum gains in aggregate output and employment under QE (if any): (i) the timing of exit, (ii) the pace of exit, and (iii) the private sector’s expectations of when and how the Fed will exit.
    Keywords: Large-Scale Asset Purchases; Unconventional Monetary Policies; Quantitative Easing; Qualitative Easing; Optimal Exit Strategies.
    JEL: E50 E52
    Date: 2014–07–21
  8. By: Kurt Annen (Department of Economics and Finance, University of Guelph); Michael Batu (Department of Economics and Finance, University of Guelph); Stephen Kosempel (Department of Economics and Finance, University of Guelph)
    Abstract: In this paper we quantify the impact of wealth transfers such as remittances and foreign aid using a DSGE-RBC model. We calibrate and simulate the model using data from 85 recipient countries. Within this framework we demonstrate: First, the income eect created from a permanent increase in wealth transfers could actually reduce output. The net impact of permanent wealth transfers on disposable income in the long run is zero. Second, positive temporary wealth transfer shocks have a lagged positive response on output provided that persistence is suciently low, but these eects are small in comparison to other aggregate shocks.
    Keywords: Foreign aid, remittances, volatility, growth
    JEL: F24 F35 F44
    Date: 2014
  9. By: Greg Kaplan (Princeton University)
    Abstract: We provide new evidence on the the cyclical behavior of household size in the United States from 1979 to 2010. During economic downturns, people live in larger households. This is mostly, but not entirely, driven by young people moving into or delaying departure from the parental home. We assess the importance of these cyclical movements for aggregate labor supply by building a model of endogenous household formation within a real business cycle structure. We use the model to measure how much more volatile are hours due to two mechanisms: (i) the presence of a large group of mostly young individuals with non-traditional living arrangements; and (ii) the possibility for these individuals to change their living situation in response to aggregate conditions. Our exercise assumes that older people living in stable households have a Frisch elasticity that is consistent with the micro evidence that is based on such people. The inclusion of people living in unstable households yields an implied aggregate, or macro, Frisch elasticity that is around 45% larger than the assumed micro elasticity.
    Date: 2014
  10. By: Guner, Nezih (MOVE, Barcelona); Lopez-Daneri, Martin (University of Southern California); Ventura, Gustavo (Arizona State University)
    Abstract: We evaluate the effectiveness of a more progressive tax scheme in raising government revenues. We develop a life-cycle economy with heterogeneity and endogenous labor supply. Households face a progressive income tax schedule, mimicking the Federal Income tax, and flat-rate taxes that capture payroll, state and local taxes and the corporate income tax. We parameterize this model to reproduce aggregate and cross-sectional observations for the U.S. economy, including the shares of labor income for top earners. We find that a tilt of the Federal income tax schedule towards high earners leads to small increases in revenues which are maximized at an effective marginal tax rate of about 36.9% for the richest 5% of households – in contrast to a 21.7% marginal rate in the benchmark economy. Maximized revenue from Federal income taxes is only 8.4% higher than it is in the benchmark economy, while revenues from all sources increase only by about 1.6%. The room for higher revenues from more progressive taxes is even lower when average taxes are higher to start with. We conclude that these policy recommendations are misguided if the aim is to exclusively raise government revenue.
    Keywords: taxation, progressivity, labor supply
    JEL: E6 H2
    Date: 2014–07
  11. By: Badel, Alejandro (Federal Reserve Bank of St. Louis); Huggett, Mark (Georgetown University)
    Abstract: We assess the consequences of substantially increasing the marginal tax rate on U.S. top earners using a human capital model. The top of the model Laffer curve occurs at a 53 percent top tax rate. Tax revenues and the tax rate at the top of the Laffer curve are smaller compared to an otherwise similar model that ignores the possibility of skill change in response to a tax reform. We also show that if one applies the methods used by Diamond and Saez (2011) to provide quantitative guidance for setting the tax rate on top earners to model data then the resulting tax rate exceeds the tax rate at the top of the model Laffer curve.
    Keywords: Human Capital; Marginal Tax Rates; Inequality; Laffer Curve
    JEL: D91 E21 H2 J24
    Date: 2014–07–23
  12. By: Karl Farmer (University of Graz); Irina Ban (Babes-Bolyai-University Cluj-Napoca)
    Abstract: Intra-EMU external imbalances in the pre-crisis period up to 2008 are traditionally explained by EMU-oriented factors, e.g. euro-related financial integration. Chen et al. (2013) also emphasize external trade shocks, such as the competitive challenge of emerging Asia and oil exporters to EMU-periphery's exports. Moreover, Asian-US external imbalances are attributed to financial integration between East Asia and the USA in the aftermath of the East-Asian currency crises in the late 1990s (Angeletos et al. 2011). Acknowledging these empirical facts this paper develops a Buiter (1981) three-country (EMU, Asia, US), two-region (EMU core, EMU periphery) OLG model to investigate the effects of both intra-EMU and Asian-US financial integration on intra- EMU, Asian and US external imbalances. We find that the widening of the intra-EMU external imbalances, in particular of trade imbalances, is related to the growth in Asian-US imbalances and the dynamic inefficiency of the world economy, caused by excessive saving in Asia.
    Keywords: External Imbalances; European Economic and Monetary Union; Overlapping Generations; Three-Country Model
    Date: 2014–07
  13. By: Pedro Bento (West Virginia University, College of Business and Economics)
    Abstract: I introduce patents into a general equilibrium model of innovation, where innovators choose between creating a new product market and competing in an existing market. Patent holders demand royalties from sequential innovators, but are constrained by the ability of innovators to work around patents. I show patent protection acts as a net tax on sequential innovators, reducing both competition and productivity growth. Calibrated to match moments from U.S. data, the model predicts that eliminating patent protection in the U.S. would generate a 23% increase in steady-state productivity growth as well as an increase in welfare equivalent to that from a 16% increase in annual consumption. I test several implications of the model using both U.S. and cross-country data. Consistent with the model, the data suggests an increase in the strength of patent protection reduces both productivity growth and the average quality of innovations.
    Keywords: patent protection, competition, innovation, productivity, regulation, growth
    JEL: O1 O4
    Date: 2013–10
  14. By: Chong-Kee Yip (Chinese University of Hong Kong); Tsz-Nga Wong (Bank of Canada)
    Abstract: What makes countries productive and rich? This paper endogenizes technology and total factor productivity (TFP) based on a model of technology assimilation. We consider an economy with a large stock of production ideas, where the factor requirements of ideas are different from its factor endowment. Firms can undergo an assimilation process which modifies ideas with respect to their factor endowment. The equilibrium level of TFP and the shape of the production function depend on the deep parameters that govern the assimilation power and the distribution of ideas. We apply the model to study cross- country income differences. Once foreign productive ideas are free to assimilate, there is symmetry breaking of the autarky equilibrium. Depending on the assimilation power, a laggard country can either catch up with the frontier countries (and their productive ideas) or fall into an assimilation trap with stagnant income. An advance in the world frontier technology polarizes the world economy. Finally, the model is used to study a number of challenging issues in growth and development, namely, the Lucas (1993) miracle, the "Twin Peaks" phenomenon of club convergence, the Flying-Geese Pattern of development, and the leapfrogging in technology.
    Date: 2014
  15. By: Gavrel, Frédéric (University of Caen); Lebon, Isabelle (University of Caen); Rebiere, Therese (CNAM, Paris)
    Abstract: The efficiency of educational choices is studied in a search-matching model where individuals face a tradeoff: acquiring formal education or learning while on the job. When their education effort is successful, newcomers directly obtain a high-skill job; otherwise, they begin with a low-skill job, learn-by-doing and then search while on-the-job for a high-skill job. Low-skill firms suffer from hold-up behavior by high-skill firms. The low-skill sector is insufficiently attractive and individuals devote too much effort to formal education. A self-financing tax and subsidy policy restores market efficiency.
    Keywords: formal education, learning-by-doing, market efficiency, on-the-job search, search unemployment
    JEL: H21 I20 J21 J64 J68
    Date: 2014–07
  16. By: Cordoba, Juan Carlos; Ripoll, Marla
    Abstract: �Extensive evidence from cross-sectional data reveals a robust negative relationship betweenfamily income and fertility. This paper argues that constraints to intergenerational transfersare crucial for understanding this relationship. If parents could legally impose debt obligationson their children as a way to recover the costs incurred in raising them, then fertility wouldbe independent of parental income. In this case, if the present value of a childÂ’s future incomeexceeds the cost of raising the child, as the evidence suggests is the case, parents would haveincentives to raise as many children as possible in order to maximize rents. A relationshipbetween fertility and income arises when parents are unable to leave debts behind either becauseof legal, enforcement, or moral constraints. We also derive the conditions under which thefertility-income relationship is negative. Notably, an intergenerational elasticity of substitutionlarger than one is required. In this case, parental consumption is a good substitute for childrenÂ’sconsumption making it optimal for income rich parents to have fewer children.Extensive evidence from cross-sectional data reveals a robust negative relationship between�family income and fertility. This paper argues that constraints to intergenerational transfers�are crucial for understanding this relationship. If parents could legally impose debt obligations�on their children as a way to recover the costs incurred in raising them, then fertility would�be independent of parental income. In this case, if the present value of a childÂ’s future income�exceeds the cost of raising the child, as the evidence suggests is the case, parents would have�incentives to raise as many children as possible in order to maximize rents. A relationship�between fertility and income arises when parents are unable to leave debts behind either because�of legal, enforcement, or moral constraints. We also derive the conditions under which the�fertility-income relationship is negative. Notably, an intergenerational elasticity of substitution�larger than one is required. In this case, parental consumption is a good substitute for childrenÂ’s�consumption making it optimal for income rich parents to have fewer children.�
    Keywords: Fertility; credit frictions; parental altruism; bequest constraints; elasticity of intertem-poral substitution
    JEL: D10 D64 D91 J1
    Date: 2014–06–05

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