nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2014‒09‒25
eighteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. The Cyclical Dynamics of Illiquid Housing, Debt, and Foreclosures By Aaron Hedlund
  2. Indeterminacy with Progressive Taxation and Sector-Specific Externalities By Jang-Ting Guo; Sharon G. Harrison
  3. The Ramsey Steady State under Optimal Monetary and Fiscal Policy for Small Open Economies By Angelo Marsiglia Fasolo
  4. Tax smoothing in a business cycle model with capital-skill complementarity By Angelopoulos, Konstantinos; Asimakopoulos, Stylianos; Malley, James
  5. Growth, Unemployment, and Fiscal Policy: A Political Economy Analysis By Tetsuo Ono
  6. Employment, hours and optimal monetary policy By Maarten Dossche; Vivien Lewis; Céline Poilly
  7. On the (De)Stabilizing Effect of Public Debt in a Ramsey Model with Heterogeneous Agents By Kazuo Nishimura; Carine Nourry; Thomas Seegmuller; Alain Venditti
  8. Discount Factor Shocks and Labor Market Dynamics By Julien Albertini; Arthur Poirier; ;
  9. Employment and Firm Heterogeneity, Capital Allocation, and Countercyclical Labor Market Policies By Epstein, Brendan; Shapiro, Alan Finkelstein
  10. Can Removing the Tax Cap Save Social Security? By Shantanu Bagchi
  11. Credit spread variability in U.S. business cycles: the Great Moderation versus the Great Recession By Hylton Hollander; Guangling Liu
  12. On the Consequences of Generically Distributed Investments on Flexible Projects in an Endogenous Growth Model By Mauro Bambi; Cristina Di Girolami; Salvatore Federico; Fausto Gozzi
  13. Macroprudential Regulation and the Role of Monetary Policy By William Tayler; Roy Zilberman
  14. Land Collateral and Labor Market Dynamics in France By Leo Kaas; Patrick Pintus; Simon Ray
  15. Financial fragility in small open economies: firm balance sheets and the sectoral structure By Y. Kalantzis
  16. Labour Market Reforms and Current Account Imbalances: Beggar-thy-neighbour policies in a currency union? By Baas, Timo; Belke, Ansgar
  17. Simple Macroeconomic Policies and Welfare: a quantitative assessment By Eurilton Araújo; Alexandre B. Cunha
  18. Straightforward approximate stochastic equilibria for nonlinear Rational Expectations models By Johnston, Michael K.; King, Robert G.; Lie, Denny

  1. By: Aaron Hedlund (Department of Economics, University of Missouri-Columbia)
    Abstract: This paper quantitatively accounts for the cyclical dynamics of key macroeconomic housing and mortgage market variables using a tractable, search-theoretic model of housing with equilibrium mortgage default. To explain these dynamics, the model highlights the importance of liquidity spirals which arise from the interaction of search frictions and en- dogenous credit constraints. During housing busts, longer selling times spill over into higher foreclosure risk, thereby magnifying the response of credit constraints to the depressed housing market. This contraction in credit then deepens the downturn. During booms, the reverse occurs. Based on these insights, I consider a foreclosure reform that makes all mortgages full recourse, and I show that implementing such a reform would reduce foreclosures and dampen housing dynamics. and output. In a parametrized model, I establish that the optimal estate tax rate is significantly above zero.
    Keywords: housing, liquidity, search theory, credit constraints, household debt, foreclosure
    JEL: D31 D83 E21 E22 G11 G12 G21 R21 R31
    Date: 2014–08–22
  2. By: Jang-Ting Guo (Department of Economics, University of California Riverside); Sharon G. Harrison (Barnard College, Columbia University)
    Abstract: This paper quantitatively examines the empirical plausibility of equilibrium indeterminacy and sunspot-driven cyclical fluctuations in a real business cycle model with two distinct production sectors that yield consumption and investment goods, together with separable or non-separable preferences. When calibrated to match the observed progressivity of the U.S. federal individual income tax schedule, each version of our model economy exhibits an indeterminate steady state under empirically realistic combinations of the household's labor supply elasticity and the degree of productive externalities in the investment goods sector. Therefore, macroeconomic instability due to agents' self-fulfilling expectations may in fact be a prevalent feature of the U.S.
    Keywords: Indeterminacy, Progressive Taxation, Sector-Specific Externalities.
    JEL: E30 E32 E62
    Date: 2014–09
  3. By: Angelo Marsiglia Fasolo
    Abstract: This paper describes the steady state allocations and prices for small open economies under optimal monetary and fiscal policy in a medium-scale DSGE model. The model encompasses the most common nominal and real rigidities normally found in the literature in a single framework. The Ramsey solution for the optimal monetary and fiscal policy is computed for a large space of the parameter set and for different combinations of fiscal policy instruments. Results show that, despite the large number of frictions in the model, optimal fiscal policy follows the usual results in the literature, with high taxes over labor income and low taxes (subsidies) on capital income. On the other hand, the choice of fiscal policy instruments is critical to characterize optimal monetary policy. Frictions associated with the small open economy framework do not play a critical role in characterizing the Ramsey planner's policy choices
    Date: 2014–07
  4. By: Angelopoulos, Konstantinos; Asimakopoulos, Stylianos; Malley, James
    Abstract: This paper undertakes a normative investigation of the quantitative properties of optimal tax smoothing in a business cycle model with state contingent debt, capital-skill complementarity, endogenous skill formation and stochastic shocks to public consumption as well as total factor and capital equipment productivity. Our main finding is that an empirically relevant restriction which does not allow the relative supply of skilled labour to adjust in response to aggregate shocks, signi cantly changes the cyclical properties of optimal labour taxes. Under a restricted relative skill supply, the government fi nds it optimal to adjust labour income tax rates so that the average net returns to skilled and unskilled labour hours exhibit the same dynamic behaviour as under fl exible skill supply.
    Keywords: skill premium, tax smoothing, optimal scal policy,
    Date: 2014
  5. By: Tetsuo Ono (Graduate School of Economics, Osaka University)
    Abstract: This study presents an overlapping-generations model featuring endogenous growth, collective wage-bargaining, and probabilistic voting over fiscal policy. We charac- terize a Markov-perfect political equilibrium of the voting game within and across generations and show the following results. First, greater bargaining power of unions lowers the growth rate of capital and creates a positive correlation between unem- ployment and government debt. Second, greater political power of the old lowers the growth rate and shifts government expenditure from the unemployed to the old. Third, a balanced budget requirement increases the growth rate but may benefit the old at the expense of the unemployed.
    Keywords: Economic Growth; Fiscal Policy; Government Debt; Unemployment; Voting
    JEL: E24 E62 H60
    Date: 2014–08
  6. By: Maarten Dossche (National Bank of Belgium, Research Department); Vivien Lewis (Center for Economic Studies, KU Leuven, Belgium); Céline Poilly (University of Lausanne, HEC-DEEP Switzerland)
    Abstract: We characterize optimal monetary policy in a New Keynesian search-and-matching model where multiple-worker firms satisfy demand in the short run by adjusting hours per worker. Imperfect product market competition and search frictions reduce steady state hours per worker below the efficient level. Bargaining results in a convex ‘wage curve’ linking wages to hours. Since the steadystate real marginal wage is low, wages respond little to hours. As a result, firms overuse the hours margin at the expense of hiring, which makes hours too volatile. The Ramsey planner uses inflation as an instrument to dampen inefficient hours fluctuations.
    Keywords: employment, hours, wage curve, optimal monetary policy
    JEL: E30 E50 E60
    Date: 2014–09
  7. By: Kazuo Nishimura (RIEB, Kobe University - Kobe University, KIER, Kyoto University - Kyoto University); Carine Nourry (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), IUF - Institut Universitaire de France - Ministère de l'Enseignement Supérieur et de la Recherche Scientifique); 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)); Alain Venditti (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), EDHEC Business School - Département Comptabilité, Droit, Finance et Economie)
    Abstract: We introduce public debt in a Ramsey model with heterogenous agents and a public spending externality affecting utility which is financed by income tax and public debt. We show that public debt considered as a fixed portion of GDP can have a stabilizing or destabilizing effect depending on some fundamental elasticities. When the public spending externality is weak and the elasticity of capital labor substitution is low enough, public debt can only be destabilizing, generating damped or persistent macroeconomic fluctuations. Whereas when the public spending externality and the elasticity of capital labor substitution are strong enough, public debt can be stabilizing, driving to monotone convergence an economy experiencing damped or persistent fluctuations without debt.
    Keywords: endogenous cycles; heterogeneous agents; public spending; public debt; borrowing constraint
    Date: 2014–06
  8. By: Julien Albertini; Arthur Poirier; ;
    Abstract: In this paper we investigate the labor market dynamics in a matching model where fluctuations are driven by movements in the discount factor. A comparison with the standard productivity shock is provided. Movements in the discount factor can be used as a proxy for variations in financial risks, especially the expected payoff from hiring workers. It is shown that the canonical matching model under a very standard calibration is able to generate an important volatility of unemployment and vacancies with respect to output. We estimate the structural model with the two shocks and using the Bayesian methodology. The bulk of variations in unemployment and vacancies is mainly explained by disturbances pertaining to the discount factor. Productivity shocks account for most of the historical output variations but the discount factor plays a more important role over the last two decades.
    Keywords: Search and matching, discount factor shock, Bayesian estimation, unemployment volatility puzzle.
    JEL: E3 J6
    Date: 2014–07
  9. By: Epstein, Brendan (Board of Governors of the Federal Reserve System (U.S.)); Shapiro, Alan Finkelstein (University of the Andes)
    Abstract: Many countries have large employment shares in micro and small firms that have limited access to formal financing and therefore rely on input credit. Such countries are mainly emerging and developing economies, whose business cycle dynamics are increasingly important for the global economy in light of the dramatic rise in international linkages and spillovers that have occurred over the last several decades. Emerging and developing economies implemented a host of countercyclical labor market policies amid the global financial crisis, but data limitations on high-frequency labor and job flows prevent a detailed empirical assessment of the effectiveness of these policies. To address this problem, we develop a business cycle model with frictional labor markets that is novel in light of its consistency with the employment and firm structure of emerging and developing economies. We use the model to assess the aggregate impact of key countercyclical labor market policies. We find that hiring subsidies and job intermediation services for large firms are particularly effective in aiding recoveries. Policies targeting smaller firms yield limited aggregate benefits and may even be detrimental to the recovery process. The labor market structure shapes sectoral allocation and explains the economy's differential response to policy.
    Keywords: Business cycles; search frictions; fiscal policy; self employment; small firms; input credit
    JEL: E24 E32 J64
    Date: 2014–08–21
  10. By: Shantanu Bagchi (Department of Economics, Towson University)
    Abstract: The maximum amount of earnings in a calendar year that can be taxed by Social Security in the U.S. is currently capped at $106,800. In this paper, I use a general-equilibrium overlapping-generations model to examine if removing this cap can solve Social Security's budgetary problems. I find that in general, removal of the cap increases Social Security revenues, but by only a small percentage, and most of these extra revenues go towards paying benefits to high-income retirees no longer subject to the cap. Even when the cap is removed only from taxes but retained on the amount of earnings creditable towards Social Security benefits, the fiscal advantages are quite small.
    Keywords: Social Security, Tax cap, Mortality risk, Productivity shock, Partial insurance, general equilibrium.
    JEL: E21 E62 H55
    Date: 2014–09
  11. By: Hylton Hollander (Department of Economics, University of Stellenbosch); Guangling Liu (Department of Economics, University of Stellenbosch)
    Abstract: This paper establishes the prevailing financial factors that influence credit spread variability, and its impact on the U.S. business cycle over the Great Moderation and Great Recession periods. To do so, we develop a dynamic general equilibrium framework with a central role of financial intermediation and equity assets. Over the Great Moderation and Great Recession periods, we find an important role for bank market power (sticky rate adjustments and loan rate markups) on credit spread variability in the U.S. business cycle. Equity prices exacerbate movements in credit spreads through the financial accelerator channel, but cannot be regarded as a main driving force of credit spread variability. Both the financial accelerator and bank capital channels play a significant role in propagating the movements of credit spreads. We observe a remarkable decline in the influence of technology and monetary policy shocks over three recession periods. From the demand-side of the credit market, the influence of LTV shocks has declined since the 1990 - 91 recession, while the bank capital requirement shock exacerbates and prolongs credit spread variability over the 2007 - 09 recession period. Across the three recession periods, there is an increasing trend in the contribution of loan markup shocks to the variability of retail credit spreads.
    Keywords: financial intermediation, credit spreads, financial frictions, great recession
    JEL: E32 E43 E44 E51 E52
    Date: 2014
  12. By: Mauro Bambi; Cristina Di Girolami; Salvatore Federico; Fausto Gozzi
    Abstract: In this paper we argue that differences in the investment projects’ features can help to explain the observed differentials in output growth and in output volatility across countries. This result is achieved by studying analytically an endogenous growth model where investments are (generically) distributed over multi-period flexible projects leading to new capital once completed. Recently developed techniques in dynamic programming are adapted and used to fully characterized the balanced growth path and transitional dynamics of this model. Based on this analytical ground, several numerical exercises are performed to show how the key results of our analysis are also quantitatively relevant.
    Keywords: investment projects, distributed delays, optimal control, dynamic programming, infinite dimensional problem.
    JEL: E22 E32 O40
    Date: 2014–07
  13. By: William Tayler; Roy Zilberman
    Abstract: We study the macroprudential roles of bank capital regulation and monetary policy in a borrowing cost channel model with endogenous financial frictions, driven by credit risk, bank losses and bank capital costs. These frictions induce financial accelerator mechanisms and motivate the examination of a macroprudential toolkit. Following credit shocks, countercyclical regulation is more effective than monetary policy in promoting price, financial and macroeconomic stability. For supply shocks, combining macroprudential regulation with a stronger anti-inflationary policy stance is optimal. The findings emphasize the importance of the Basel III accords and cast doubt on the desirability of conventional Taylor rules during periods of financial distress.
    Date: 2014
  14. By: Leo Kaas (University of Konstanz); Patrick Pintus (Aix-Marseille Université (Aix-Marseille School of Economics), CNRS & EHESS); Simon Ray (Aix-Marseille University (Aix-Marseille School of Economics), CNRS & EHESS, and Banque de France.)
    Abstract: The value of land in the balance sheet of French firms correlates positively with their hiring and investment flows. To explore the relationship between these variables, we develop a macroeconomic model with firms that are subject to both credit and labor market frictions. The value of collateral is driven by the forward-looking dynamics of the land price, which reacts endogenously to fundamental and non-fundamental (sunspot) shocks. We calibrate the model to French data and find that land price shocks give rise to significant amplification and hump-shaped responses of investment, vacancies and unemployment that are in line with the data.
    Keywords: financial shocks, labor market frictions.
    JEL: E24 E32 E44
    Date: 2014–09
  15. By: Y. Kalantzis
    Abstract: Episodes of large capital inflows in small open economies are often associated with a shift of resources from the tradable to the non-tradable sector and sometimes lead to balance-of-payments crises. This paper builds a two-sector dynamic model to study the evolution of the sectoral structure and its impact on financial fragility. The model embeds a static mechanism of balance-of-payments crisis which produces multiple equilibria within a single time period when the non-tradable sector is large enough compared to the tradable sector. The paper studies the dynamics induced by an increase in financial openness. It shows that the relative size of the non-tradable sector overshoots, which makes the economy more likely to be financially fragile during the transitory dynamics. Using an extended version of the model, the paper conducts a quantitative analysis and shows that this mechanism accounts well for several episodes of large capital inflows that led to financial crises.
    Keywords: two-sector models, capital account liberalization, balance-of-payments crises, foreign currency debt, borrowing constraint, euro area crisis.
    JEL: E44 F32 F34 F43 O41
    Date: 2014
  16. By: Baas, Timo; Belke, Ansgar
    Abstract: Member countries of the Economic and Monetary Union (EMU) initiated wide-ranging labour market reforms in the last decade. This process is ongoing as countries that are faced with serious labour market imbalances perceive reforms as the fastest way to restore competitiveness within a currency union. This fosters fears among observers about a beggar-thy-neighbour policy that leaves non-reforming countries with a loss in competitiveness and an increase in foreign debt. Using a two-country, two-sector search and matching DSGE model, we analyse the impact of labour market reforms on the transmission of macroeconomic shocks in both non-reforming and reforming countries. By analysing the impact of reforms on foreign debt, we contribute to the debate on whether labour market reforms increase or reduce current account imbalances.
    Date: 2014–09
  17. By: Eurilton Araújo; Alexandre B. Cunha
    Abstract: We quantitatively compare three macroeconomic policies in a cash-credit goods framework. The policies are: the optimal one; another one that fully smoothes out oscillations in output; and a simple one that prescribes constant values for tax and monetary growth rates. As often found in the related literature, the welfare gains or losses from changing from a given policy to another are small. We also show that the simple policy dominates the one that leads to constant output
    Date: 2014–08
  18. By: Johnston, Michael K.; King, Robert G.; Lie, Denny
    Abstract: We present a new approach to the approximation of equilibrium solutions to nonlinear rational expectations models that applies to any order of approximation. The approach relies on a particular version of Taylor series approximations-the differential version-and on a scalar perturbation of the support of the entire history of shocks. The resulting solution for any order can always be directly cast in a linear state-space form, permitting the solution to be used for many practical applications such as forecasting, estimation, and computing impulse responses. Using the approach, we show that there cannot be multiple solutions in any order of approximation if the associated first-order approximate solution is determinate. Our approach can be used simply to verify key propositions of the earlier literature, to extend its range of applications, and to resolve puzzles left by it. While the paper only provides an explicit solution up to a third-order approximation, extensions to any higher order approximations are straightforward.
    Keywords: Solution methods; higher order approximations; perturbation, di¤erential Taylor series approximation; nonlinear rational expectations models; pruning; DSGE
    Date: 2014–08

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