nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2014‒09‒29
eighteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Comparing Solution Methods for DSGE Models with Labor Market Search By Hong Lan; ; ;
  2. Mismatch Shocks and Unemployment During the Great Recession By Francesco Furlanetto; Nicolas Groshenny
  3. The Cyclical Behavior of Unemployment and Vacancies with Loss of Skills during Unemployment By Victor Ortego-Marti
  4. Financial Business Cycles By Iacoviello, Matteo
  5. Labor Supply and the Optimality of Social Security By Shantanu Bagchi
  6. Estimating Dynamic Equilibrium Models with Stochastic Volatility By Jesus Fernandez-Villaverde; Pablo Guerron-Quintana; Juan F. Rubio-Ramirez
  7. Welfare Analysis of Policy Measures for Financial Stability By Ko Munakata; Koji Nakamura; Yuki Teranishi
  8. On the (De)Stabilizing Effect of Public Debt in a Ramsey Model with Heterogeneous Agents By Kazuo Nishimura; Carine Nourry; Thomas Seegmuller; Alain Venditti
  9. Traditional and matter-of-fact financial frictions in a DSGE model for Brazil: the role of macroprudential instruments and monetary policy By Fabia A. de Carvalho; Marcos R. Castro; Silvio M. A. Costa
  10. Illiquidity and its Discontents: Trading Delays and Foreclosures in the Housing Market By Aaron Hedlund
  11. Unemployment History and Frictional Wage Dispersion By Victor Ortego-Marti
  12. Effectiveness of the Australian Fiscal Stimulus Package: A DSGE Analysis By Shuyun May Li; Adam Spencer
  13. Risk shocks and divergence between the Euro area and the US By Thomas Brand; Fabien Tripier
  14. On the Individual Optimality of Economic Integration By Rui CASTRO; Nelnan KOUMTINGUÉ
  15. Fiscal Policy, Debt Constraint and Expectation-Driven Volatility By Kazuo Nishimura; Thomas Seegmuller; Alain Venditti
  16. Pareto-improving Immigration in the Presence of Social Security By Hisahiro Naito
  17. Deep versus superficial habit: It’s all in the persistence By Cristiano Cantore; Paul Levine; Giovanni Melina
  18. Model comparisons in unstable environments By Raffaella Giacomini; Barbara Rossi

  1. By: Hong Lan; ; ;
    Abstract: I compare the performance of solution methods in solving a standard real business cycle model with labor market search frictions. Under the conventional calibration, the model is solved by the projection method using the Chebyshev polynomials as its basis, and the perturbation methods up to third order in both levels and logs. Evaluated by two accuracy tests, the projection approximation achieves the highest degree of accuracy, closely followed by the third order perturbation in levels. Although different in accuracy, all the approximated solutions produce simulated moments similar in value.
    Keywords: Computational methods; DSGE; Business cycles; Search and matching; Accuracy test
    JEL: C63 C68 E32
    Date: 2014–09
  2. By: Francesco Furlanetto; Nicolas Groshenny
    Abstract: We investigate the macroeconomic consequences of fluctuations in the effectiveness of the labor-market matching process with a focus on the Great Recession. We conduct our analysis in the context of an estimated medium-scale DSGE model with sticky prices and equilibrium search unemployment that features a shock to the matching efficiency (or mismatch shock). We find that this shock is not important for unemployment fluctuations in normal times. However, it plays a somewhat larger role during the Great Recession when it contributes to raise the actual unemployment rate by around 1.3 percentage points and the natural rate by around 2 percentage points. The mismatch shock is the dominant driver of the natural rate of unemployment and explains part of the recent shift of the Beveridge curve.
    Keywords: Search and matching frictions, unemployment, natural rates
    JEL: E32 C51 C52
    Date: 2014–08
  3. By: Victor Ortego-Marti (Department of Economics, University of California Riverside)
    Abstract: This paper studies the cyclical fluctuations in unemployment and vacancies in a search and matching model in which workers lose skills during periods of unemployment. Firms' profits fluctuate more because aggregate productivity affects the economy's human capital level. Moreover, wages for workers with lower levels of human capital are closer to the value of non-market time, leading to more rigid wages. Fluctuations in the vacancy-unemployment ratio are larger than is the case in the baseline search and matching model. For mid-range values of non-market time the improvement is substantial, and the model accounts for most observed labor market fluctuations.
    Keywords: Search and Matching; Unemployment Fluctuations; Unemployment History; Human Capital Depreciation
    JEL: E2
    Date: 2014–09
  4. By: Iacoviello, Matteo (Board of Governors of the Federal Reserve System (U.S.))
    Abstract: Using Bayesian methods, I estimate a DSGE model where a recession is initiated by losses suffered by banks and exacerbated by their inability to extend credit to the real sector. The event triggering the recession has the workings of a redistribution shock: a small sector of the economy -- borrowers who use their home as collateral -- defaults on their loans. When banks hold little equity in excess of regulatory requirements, the losses require them to react immediately, either by recapitalizing or by deleveraging. By deleveraging, banks transform the initial shock into a credit crunch, and, to the extent that some firms depend on bank credit, amplify and propagate the shock to the real economy. I find that redistribution and other financial shocks that affect leveraged sectors accounts for two-thirds of output collapse during the Great Recession.
    Keywords: Banks; DSGE models; collateral constraints; housing; Bayesian estimation
    JEL: E32 E44 E47
    Date: 2014–08–28
  5. By: Shantanu Bagchi (Department of Economics, Towson University)
    Abstract: Traditional economic theory predicts that unfunded social security can be justified on the basis of its ability to efficiently finance retirement, and also for its ability to provide insurance against mortality risk and uninsurable shocks to labor income. In this paper, I demonstrate that the quantitative importance of the traditional roles of social security depends on how household labor supply responds to social security. I build a calibrated general-equilibrium model where social security has a large welfare-improving role, and I show that the distortionary effect on households' labor hours erases virtually all the welfare gains from social security. I also find that this result is robust within the range of labor supply elasticities usually encountered in the macroeconomic literature..
    Keywords: Labor supply, Social security, Mortality risk, Productivity shock, Insurance, Elasticity.
    JEL: E21 H55 J22
    Date: 2014–09
  6. By: Jesus Fernandez-Villaverde; Pablo Guerron-Quintana; Juan F. Rubio-Ramirez
    Abstract: This paper develops a particle …ltering algorithm to estimate dynamic equilibrium models with stochastic volatility using a likelihood-based approach. The algorithm, which exploits the structure and profusion of shocks in stochastic volatility models, is versatile and computationally tractable even in large-scale models. As an application, we use our algorithm and Bayesian methods to estimate a business cycle model of the U.S. economy with both stochastic volatility and parameter drifting in monetary policy. Our application shows the importance of stochastic volatility in accounting for the dynamics of the data.
    Keywords: Dynamic equilibrium models, Stochastic volatility, Parameter drifting, Bayesian methods
    JEL: E10 E30 C11
    Date: 2014–09
  7. By: Ko Munakata (Bank of Japan); Koji Nakamura (Bank of Japan); Yuki Teranishi (Bank of Japan)
    Abstract: We introduce the financial market friction through the search and matching in the loan market into a dynamic stochastic general equilibrium (DSGE) model. We reveal that the second order approximation of social welfare includes the terms relating credit, such as credit market tightness, the volume of credit, and a loan separation rate, in addition to the inflation rate and the output gap under the financial market friction. Our analytical result justifies the reason why the optimal policy should take the credit variation into account. We introduce a monetary policy and other policy measures for the financial stability into the model. The optimal outcome is achieved through the monetary and other policy measures by taking into account not only price stability but also financial stability.
    Date: 2013–03–01
  8. By: Kazuo Nishimura (RIEB, Kobe University & KIER, Kyoto University); Carine Nourry (Aix-Marseille University (Aix-Marseille School of Economics), CNRS-GREQAM, EHESS & Institut Universitaire de France); Thomas Seegmuller (Aix-Marseille University (Aix-Marseille School of Economics), CNRS-GREQAM & EHESS); Alain Venditti (Aix-Marseille University (Aix-Marseille School of Economics), CNRS-GREQAM, EHESS & EDHEC)
    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
    JEL: C62 E32 H23
    Date: 2014–06
  9. By: Fabia A. de Carvalho; Marcos R. Castro; Silvio M. A. Costa
    Abstract: This paper investigates the transmission channel of macroprudential instruments in a closed economy DSGE model with a rich set of nancial frictions. Banks' decisions on risky retail loan concessions are based on borrowers' capacity to settle their debt with labor income. We also introduce frictions in banks' optimal choices of balance sheet composition to better reproduce banks'strategic reactions to changes in funding costs, in risk perception and in the regulatory environment.The model is able to reproduce not only price effects from macroprudential policies, but also quantity effects. The model is estimated with Brazilian data using Bayesian techniques. Unanticipated changes in reserve requirements have important quantitative effects, especially on banks' optimal asset allocation and on the choice of funding. This result holds true even for required reserves deposited at the central bank that are remunerated at the base rate. Changes in required core capital substantially impact the real economy and banks' balance sheet. When there is a lag between announcements and actual implementation of increased capital requirement ratios, agents immediately engage in anticipatory behavior. Banks immediately start to retain dividends so as to smooth the impact of higher required capital on their assets, more particularly on loans. The impact on the real economy also shifts to nearer horizons. Announcements that allow the new regulation on required capital to be anticipated also improve banks' risk positions, since banks achieve higher capital adequacy ratios right after the announcement and throughout the impact period. The effects of regulatory changes to risk weights on bank assets are not constrained to impact the segment whose risk was reassessed. We compare the model responses with those generated by models with collateral constraints traditionally used in the literature. The choice of collateral constraint is found to have important implications for the transmission mechanisms.
    Keywords: Collateral, productivity, small open economy
    Date: 2014–09
  10. By: Aaron Hedlund (Department of Economics, University of Missouri-Columbia)
    Abstract: This paper investigates the macroeconomic effects of search risk in the housing market. To do so, I introduce a tractable directed search model of housing with mul- tidimensional buyer and seller heterogeneity. I incorporate this framework in an in- complete markets macroeconomic model with long-term mortgages and equilibrium default. I show that search risk spills over into higher foreclosure risk by creating a debt overhang problem. Heavily indebted sellers post high selling prices, take a long time to sell, and frequently end up in foreclosure. As a result, search risk increases mortgage default premia and tightens credit constraints, thus exacerbating the debt overhang problem by making refinancing more difficult. This mechanism establishes a novel link between housing and mortgage markets based on the illiquidity of housing.
    Keywords: housing, liquidity, search theory, credit constraints, household debt,foreclosure
    JEL: D31 D83 E21 E22 G11 G12 G21 R21 R31
    Date: 2014–09–12
  11. By: Victor Ortego-Marti (Department of Economics, University of California Riverside)
    Abstract: This paper studies wage dispersion among identical workers in a random matching search model in which workers lose human capital during unemployment. Wage dispersion increases, as workers accept lower wages to avoid long unemployment spells. The model is an important improvement over baseline search models. It explains between a third and half of the observed residual wage dispersion. When adding on-the-job search, the model accounts for all of the residual wage dispersion and generates substantial dispersion even for high values of non-market time. The paper thus addresses the trade-off between explaining frictional wage dispersion and the cyclical behavior of unemployment.
    Keywords: Job search; search and matching; wage dispersion; unemployment history
    JEL: E2
    Date: 2014–09
  12. By: Shuyun May Li; Adam Spencer
    Abstract: We develop and estimate a small open economy DSGE model to investigate the eectiveness of the Australian scal stimulus package introduced in the aftermath of the global nancial crisis (GFC). The timing and magnitudes of GFC shocks, scal shocks that mimic the stimulus transfers, and accommodative monetary policy shocks are carefully calibrated and fed into various simulation experiments. The results suggest that the stimulus transfers were eective in combating the economic downturn caused by the GFC, however, the scale of the transfer initiative seems to be excessive. K
    Keywords: Australian scal stimulus; DSGE; Global nancial crisis; Bayesian estimation
    JEL: E32 E62 E65 F41
    Date: 2014
  13. By: Thomas Brand; Fabien Tripier
    Abstract: Why have the Euro area and the US diverged since 2011 while they were highly synchronized during the recession of 2008-2009? To explain this divergence, we provide a structural interpretation of these episodes through the estimation of a business cycle model with financial frictions for both economies. Our results show that risk shocks, measured as the volatility of idiosyncratic uncertainty in the financial sector, have played a crucial role in the divergence with the absence of risk reversal in the Euro area. Risk shocks have stimulated US credit and investment growth since the trough of 2009 whereas they have been at the origin of the double-dip recession in the Euro area. A companion website is available at vergence.
    Keywords: Great recession;Business cycles;Uncertainty;Divergence;Risk Shocks
    JEL: E3 E4 G3
    Date: 2014–07
  14. By: Rui CASTRO; Nelnan KOUMTINGUÉ
    Abstract: Which countries find it optimal to form an economic union? We emphasize the risk-sharing benefits of economic integration. Consider an endowment world economy model, where international financial markets are incomplete and contracts not enforceable. A union solves both frictions among member countries. We uncover conditions on initial incomes and net foreign assets of potential union members such that forming a union is welfare-improving over standing alone in the world economy. Consistently with evidence on economic integration, unions in our model occur (i) relatively infrequently, and (ii) emerge more likely among homogeneous countries, and (iii) rich countries.
    Keywords: incomplete markets, endogenous borrowing constraints, risk sharing, economic integration
    JEL: F15 F34 F36 F41
    Date: 2014
  15. By: Kazuo Nishimura (RIEB, Kobe University - Kobe University, KIER, Kyoto University - Kyoto University); 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: Imposing some constraints on public debt is often justified regarding sustainability and stability issues. This is especially the case when the ratio of public debt over GDP is restricted to be constant. Using a Ramsey model, we show that such a constraint can however be a fundamental source of indeterminacy, and therefore, of expectation-driven fluctuations. Indeed, through the intertemporal budget constraint of the government, income taxation negatively depends on future debt, i.e. on the expected level of production. This mechanism ensures that expectations on the future tax rate may be self-fulfilling. We show that this is promoted by a larger ratio of debt over GDP.
    Keywords: indeterminacy; endogenous cycles; public debt; income taxation
    Date: 2014–06
  16. By: Hisahiro Naito
    Abstract: The effect of accepting more immigrants on welfare in the presence of a pay-as-you-go social security system is analyzed theoretically and quantitatively. First, it is shown that if initially there exist intergenerational government transfers from the young to the old, the government can lead an economy to the (modified) golden rule level within a finite time in a Pareto-improving way by increasing the percentage of immigrants to natives (PITN). Second, using the computational overlapping generation model, I calculate both the welfare gain of increasing the PITN from 15.5 percent to 25.5 percent and years needed to reach the (modified) golden rule level in a Pareto-improving way in a model economy. The simulation shows that the present value of the Pareto-improving welfare gain of increasing the PITN comprises 23 percent of the initial GDP. It takes 112 years for the model economy to reach the golden rule level in a Pareto-improving way.
    Date: 2014–07
  17. By: Cristiano Cantore (University of Surrey); Paul Levine (University of Surrey); Giovanni Melina (City University London)
    Abstract: Bayesian estimation is employed to investigate whether deep as opposed to superficial habit improves the fit of a dynamic stochastic general equilibrium model. If the stock of superficial habit features the additional persistence typical of deep habit, the two specifications are virtually as good. Introducing deep habit in public consumption does not improve the model’s fit.
    JEL: E30 E62
    Date: 2014–09
  18. By: Raffaella Giacomini; Barbara Rossi
    Abstract: The goal of this paper is to develop formal tests to evaluate the relative in-sample per- formance of two competing, misspecified, non-nested models in the presence of possible data instability. Compared to previous approaches to model selection, which are based on measures of global performance, we focus on the local relative performance of the models. We propose three tests that are based on different measures of local performance and that correspond to different null and alternative hypotheses. The empirical application provides insights into the time variation in the performance of a representative DSGE model of the European economy relative to that of VARs.
    Keywords: Model Selection Tests, Misspeci.cation, Structural Change, Kullback-Leibler Information Criterion
    JEL: C22 C52 C53
    Date: 2014–08

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