nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2014‒10‒17
thirteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Fiscal Devaluation and Structural Gaps. By F. Langot; L. Patureau; T. Sopraseuth
  2. The effectiveness of countercyclical capital requirements and contingent convertible capital: a dual approach to macroeconomic stability By Hylton Hollander
  3. The zero lower bound and parameter bias in an estimated DSGE model By Yasuo Hirose; Atsushi Inoue
  4. Credit spread variability in U.S. business cycles: The Great Moderation versus the Great Recession By Hylton Hollander and Guangling Liu
  5. Identification of DSGE Models - the Effect of Higher-Order Approximation and Pruning By Willi Mutschler
  6. Firms´ Entry, Monetary Policy and the International Business Cycle By Lilia CAVALLARI
  7. An Economical Business-Cycle Model By Pascal Michaillat; Emmanuel Saez
  8. Corporate Cash Hoarding in a Model with Liquidity Constraints By Falk Mazelis; ; ;
  9. Inflation Stabilization and Default Risk in a Currency Union By Okano Eiji; Masashige Hamano; Pierre Picard
  10. Constrained Efficiency in a Risky Human Capital Model By Yena Park
  11. Multiplicity of monetary steady states By Ryoji Hiraguchi; Keiichiro Kobayashi
  12. Financial Intermediaries, Leverage Ratios, and Business Cycles By Yasin MIMIR
  13. Unemployment Risk and Wage Differentials By Roberto Pinheiro (University of Colorado); Ludo Visschers (The University of Edinburgh, Universidad Carlos III and CESifo)

  1. By: F. Langot; L. Patureau; T. Sopraseuth
    Abstract: The paper characterizes the optimal tax scheme in an open economy with structural inefficiencies on the labor market and on government size. On analytical grounds first, we show that the economy can use fiscal revaluation to exploit the terms of trade externality and to dampen the impact of an excessive public spending. However, if real labor market rigidities are large enough, fiscal devaluation may be desirable. Second, we provide a quantitative assessment of the optimal tax reform using France as the benchmark economy. Our results show that France would benefit more from fiscal devaluation than a economy where the labor market is more flexible, as the US. We also show that the welfare gains from the optimal tax reform crucially depend on the ability of the government to target its optimal size.
    Keywords: Consumption tax, payroll tax, Ramsey allocation, labor market search, open economy, public spending.
    JEL: E27 E62 H21 J38
    Date: 2014
  2. By: Hylton Hollander (Department of Economics, University of Stellenbosch)
    Abstract: This paper studies the effectiveness of countercyclical capital requirements and contingent convertible capital (CoCos) in limiting financial instability, and its associated influence on the real economy. To do this, I augment both features into a standard real business cycle framework with an equity market and a banking sector. The model is calibrated to real U.S. data and used for simulations. The findings suggest that CoCos effectively re-capitalize the banking sector and foster the objectives of countercyclical capital requirements (i.e., Basel III). Under financial shocks, CoCos provide an effective automatic stabilization effect on the financial cycle and the real economy. Conversely, a countercyclical capital adequacy rule dominates CoCos in the stabilization of real shocks.
    Keywords: Contingent convertible debt, bank capital, bank regulation, Basel
    JEL: G28 G38 E44
    Date: 2014
  3. By: Yasuo Hirose (Keio University); Atsushi Inoue (Vanderbilt University)
    Abstract: This paper examines how and to what extent parameter estimates can be biased in a dynamic stochastic general equilibrium (DSGE) model that omits the zero lower bound (ZLB) constraint on the nominal interest rate. Our Monte Carlo experiments using a standard sticky-price DSGE model show that no significant bias is detected in parameter estimates and that the estimated impulse response functions are quite similar to the true ones. However, as the probability of hitting the ZLB increases, the parameter bias becomes larger and therefore leads to substantial differences between the estimated and true impulse responses. It is also demonstrated that the model missing the ZLB causes biased estimates of structural shocks even with the virtually unbiased parameters.
    JEL: E3 E5
    Date: 2014–09–09
  4. By: Hylton Hollander and Guangling Liu
    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
  5. By: Willi Mutschler
    Abstract: Several formal methods have been proposed to check local identification in linearized DSGE models using rank criteria. Recently there has been huge progress in the estimation of non-linear DSGE models, yet formal identification criteria are missing. The contribution of the paper is threefold: First, we extend the existent methods to higher-order approximations and establish rank criteria for local identification given the pruned state-space representation. It is shown that this may improve overall identification of a DSGE model via imposing additional restrictions on the moments and spectrum. Second, we derive analytical derivatives of the reduced-form matrices, unconditional moments and spectral density for the pruned state-space system. Third, using a second-order approximation, we are able to identify previously non-identifiable parameters: namely the parameters governing the investment adjustment costs in the Kim (2003) model and all parameters in the An and Schorfheide (2007) model, including the coeffcients of the Taylor-rule.
    Keywords: non-linear DSGE, rank condition, analytical derivatives, pruned state-space
    JEL: C10 C51 C52 E1
    Date: 2014–10
  6. By: Lilia CAVALLARI
  7. By: Pascal Michaillat (Centre for Macroeconomics (CFM); Economics Department London School of Economics (LSE)); Emmanuel Saez (Department of Economics University of California-Berkeley)
    Abstract: In recent decades, advanced economies have experienced low and stable inflation and long periods of liquidity trap. We construct an alternative business-cycle model capturing these two features by adding two assumptions to a money-in-the-utility-function model: the labor market is subject to matching frictions, and real wealth enters the utility function. These assumptions modify the two core equations of the standard New Keynesian model. With matching frictions, we can analyze equilibria in which inflation is fixed and not determined by a forward-looking Phillips curve. With wealth in the utility, the Euler equation is modified and we can obtain steady-state equilibria with a liquidity trap, positive inflation, and labor market slack. The model is simple enough to inspect the mechanisms behind cyclical fluctuations and to study the effects of conventional and unconventional monetary and fiscal policies. As a byproduct, the model provides microfoundations for the classical IS-LM model. Finally, we show how directed search can be combined with costly price adjustments to generate a forward-looking Phillips curve and recover some insights from the New Keynesian model.
    Date: 2014–09
  8. By: Falk Mazelis; ; ;
    Abstract: This paper studies the role of uncertainty in the corporate cash hoarding puzzle. The baseline model is a stochastic neoclassical growth model featuring idiosyncratic and uninsurable productivity shocks and a cash-in-advance constraint on new in- vestments on the individual rm level. Individual agents' choices regarding cash holdings are analyzed. After a wealth threshold is reached, the cash-in-advance con- straint ceases to have an eect on the agent's behavior. The resulting aggregate cash holdings of households increases with uncertainty. Aggregate consumption is also higher, but the added volatility of consumption decreases lifetime utility. Al- lowing rms to borrow and lend available unused cash increases average variables. An exogenous increase in the interest rate at which they intermediate funds leads to increased intermediation activity, corresponding to the lending channel of monetary policy transmission.
    Keywords: CO2 Emission Allowances, CO2 Emission Trading, Spot Price Modelling, Markov Switching GARCH Models, Volatility Forecasting
    JEL: C63 E21 E41 D81
    Date: 2014–09
  9. By: Okano Eiji (Nagoya City University,); Masashige Hamano (Sophia University); Pierre Picard (University of Luxembourg)
    Abstract: By developing a class of dynamic stochastic general equilibrium models with nominal rigidities and assuming a two-country currency union with sovereign risk, we show that there is not necessarily a trade-off between the prevention of default risk and stabilizing inflation. Under optimal monetary and fiscal policy, comprising a de facto inflation stabilization policy, the tax rate as an optimal fiscal policy tool plays an important role in stabilizing inflation, although not completely because of the distorted steady state. Changes in the tax rate to minimize welfare costs via stabilizing inflation then improve the fiscal surplus, and because of this and the incompletely stabilized inflation, the default rate does not increase as much.
    Keywords: Sovereign Risk; European Crisis; Optimal Monetary Policy; Fiscal Theory of the Price Level; Currency Union
    JEL: E52 E60 F41 F47
    Date: 2014–09
  10. By: Yena Park (University of Rochester)
    Date: 2014–09
  11. By: Ryoji Hiraguchi; Keiichiro Kobayashi
    Abstract: In the Lagos-Wright model of money, monetary frictions alone cannot be a source of equilibrium multiplicity. However, the conclusion depends on the assumption that the agents always enter the centralized market after completing a transaction in the decentralized markets. In this paper, we investigate a monetary model in which the centralized market opens once, but the decentralized markets open twice in each period. We show that as the sellers money balances affect the buyers problem in the first decentralized market, there may be multiple stationary equilibria.
    Date: 2014–09
  12. By: Yasin MIMIR
  13. By: Roberto Pinheiro (University of Colorado); Ludo Visschers (The University of Edinburgh, Universidad Carlos III and CESifo)
    Abstract: Workers in less-secure jobs are often paid less than identical-looking workers in more secure jobs. We show that this lack of compensating differentials for unemployment risk can arise in equilibrium when all workers are identical and firms differ only in job security (i.e. the probability that the worker is not sent into unemployment). In a setting where workers search for new positions both on and off the job, the worker’s marginal willingness to pay for job security is endogenous, increasing with the rent received by a worker in his job, and depending on the behavior of all firms in the labor market. We solve for the labor market equilibrium and find that wages increase with job security for at least all firms in the risky tail of the distribution of firm-level unemployment risk. Unemployment becomes persistent for low-wage and unemployed workers, a seeming pattern of ‘unemployment scarring’ created entirely by firm heterogeneity. Higher in the wage distribution, workers can take wage cuts to move to more stable employment.
    Keywords: Layoff Rates, Unemployment risk, Wage Differentials, Unemployment Scarring
    JEL: J31 J63
    Date: 2014–09–24

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