nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2014‒10‒22
thirteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Financial Frictions in a DSGE Model for Latvia By Ginters Buss
  2. A policy model to analyze macroprudential regulations and monetary policy By Sami Alpanda; Gino Cateau; Cesaire Meh
  3. Monetary and macroprudential policy with foreign currency loans By Michał Brzoza-Brzezina; Marcin Kolasa; Krzysztof Makarski
  4. Optimal Life Cycle Unemployment Insurance By Claudio Michelacci; Hernan Ruffo
  5. Social Security in an Analytically Tractable Overlapping Generations Model with Aggregate and Idiosyncratic Risk By Daniel Harenberg; Alexander Ludwig
  6. Reverse mortgage loans: a quantitative analysis By Nakajima, Makoto; Telyukova, Irina A.
  7. Progressive Taxation, Endogenous Growth, and Macroeconomic (In)stability By Jang-Ting Guo; Shu-Hua Chen
  8. Fiscal multipliers in a small euro area economy: How big can they get in crisis times? By Gabriela Castro; Ricardo M. Felix; Paulo Julio; Jose R. Maria
  9. Pareto-improving Immigration and Its Effect on Capital Accumulation in the Presence of Social Security By Hisahiro Naito
  10. The Political Economy of Growth, Inequality, the Size and Composition of Government Spending By Klaus Schmidt-Hebbel; José Carlos Tello
  11. Equilibria Under Monetary and Fiscal Policy Interactions with Distortionary Taxation By Gliksberg, Baruch
  12. Simple Markovian Equilibria in Dynamic Spatial Legislative Bargaining By Jan Zapal
  13. A Fixed-Point Theory of Price Level Determination in General Equilibrium By Gliksberg, Baruch

  1. By: Ginters Buss
    Abstract: This paper builds a dynamic stochastic general equilibrium (DSGE) model for Latvia that would be suitable for policy analysis and forecasting purposes at Latvijas Banka. For that purpose, the DSGE model with financial frictions of Christiano, Trabandt and Walentin (2011) is adapted to Latvia's data, estimated, and studied as to whether adding the financial frictions block to an otherwise identical (baseline) model is an improvement with respect to several dimensions. The main findings are: 1) adding of financial frictions block provides a more appealing interpretation for the drivers of economic activity and allows reinterpreting their role; 2) financial frictions played an important part in Latvia's 2008 recession; 3) the financial frictions model beats both the baseline model and the random walk model in forecasting CPI inflation and GDP, and performs roughly the same as a Bayesian structural vector autoregression.
    Keywords: DSGE model, financial frictions, small open economy, Bayesian estimation, currency union
    JEL: E0 E3 F0 F4 G0 G1
    Date: 2014–08–12
  2. By: Sami Alpanda; Gino Cateau; Cesaire Meh
    Abstract: We construct a small-open-economy, New Keynesian dynamic stochastic general-equilibrium model with real-financial linkages to analyze the effects of financial shocks and macroprudential policies on the Canadian economy. Our model has four key features. First, it allows for non-trivial interactions between the balance sheets of households, firms and banks within a unified framework. Second, it incorporates a risk-taking channel by allowing the risk appetite of investors to depend on aggregate economic activity and funding conditions. Third, it incorporates long-term debt by allowing households and businesses to pay back their stock of debt over multiple periods. Fourth, it incorporates targeted and broader macroprudential instruments to analyze the interaction between macroprudential and monetary policy. The model also features nominal and real rigidities, and is calibrated to match dynamics in Canadian macroeconomic and financial data. We study the transmission of monetary policy and financial shocks in the model economy, and analyze the effectiveness of various policies in simultaneously achieving macroeconomic and financial stability. We find that, in terms of reducing household debt, more targeted tools such as loan-to-value regulations are the most effective and least costly, followed by bank capital regulations and monetary policy, respectively.
    Keywords: macroprudential policy, DSGE, real-fi?nancial linkages
    Date: 2014–09
  3. By: Michał Brzoza-Brzezina (Narodowy Bank Polski and Warsaw School of Economics); Marcin Kolasa (National Bank of Poland, Warsaw School of Economics); Krzysztof Makarski (Narodowy Bank Polski and Warsaw School of Economics)
    Abstract: In a number of countries a substantial proportion of mortgage loans is denominated in foreign currency. In this paper we demonstrate how their presence affects economic policy and agents’ welfare. To this end we construct a small open economy model with financial frictions where housing loans can be denominated in domestic or foreign currency. We calibrate the model for Poland - a typical small open economy with a large share of foreign currency loans (FCL) - and use it to conduct a series of simulations. They show that FCLs negatively affect the transmission of monetary policy. In contrast, their impact on the effectiveness of macroprudential policy is much weaker but positive. We also demonstrate that FCLs increase welfare when domestic interest rate shocks prevail and decrease it when risk premium (exchange rate) shocks dominate. Under a realistic calibration of the stochastic environment FCLs are welfare reducing. Finally, we show that regulatory policies that correct the share of FCLs may cause a cyclical slowdown.
    Keywords: foreign currency loans, monetary and macroprudential policy, DSGE models with banking sector
    JEL: E32 E44 E58
    Date: 2014
  4. By: Claudio Michelacci (EIEF and CEPR); Hernan Ruffo (UTDT)
    Abstract: We argue that US welfare would rise if unemployment insurance were increased for younger and decreased for older workers. This is because the young tend to lack the means to smooth consumption during unemployment and want jobs to accumulate high-return human capital. So unemployment insurance is most valuable to them, while moral hazard is mild. By calibrating a life cycle model with unemployment risk and endogenous search effort, we find that allowing unemployment replacement rates to decline with age yields sizeable welfare gains to US workers.
    Date: 2014
  5. By: Daniel Harenberg (ETH Zurich, Switzerland); Alexander Ludwig (CMR & FiFo, University of Cologne)
    Abstract: When markets are incomplete, social security can partially insure against idiosyncratic and aggregate risks. We incorporate both risks into an analytically tractable model with two overlapping generations and demonstrate that they interact over the life-cycle. The interactions appear even though the two risks are orthogonal and they amplify the welfare consequences of introducing social security. On the one hand, the interactions increase the welfare benefits from insurance. On the other hand, they can in- or decrease the welfare costs from crowding out of capital formation. This ambiguous effect on crowding out means that the net effect of these two channels is positive, hence the interactions of risks increase the total welfare benefits of social security.
    Keywords: social security; idiosyncratic risk; aggregate risk; welfare; insurance; crowding out
    JEL: C68 E27 E62 G12 H55
    Date: 2014–09
  6. By: Nakajima, Makoto (Federal Reserve Bank of Philadelphia); Telyukova, Irina A. (University of California–San Diego)
    Abstract: Supersedes Working Paper 13-27. Reverse mortgage loans (RMLs) allow older homeowners to borrow against housing wealth without moving. Despite growth in this market, only 2.1% of eligible homeowners had RMLs in 2011. In this paper, the authors analyze reverse mortgages in a calibrated life-cycle model of retirement. The average welfare gain from RMLs is $885 per homeowner. The authors’ model implies that low-income, low-wealth, and poor-health households benefit the most, consistent with empirical evidence. Bequest motives, nursing-home-move risk, house price risk, and loan costs all contribute to the low take-up. The Great Recession may lead to increased RML demand, by up to 30% for the lowest-income and oldest households.
    Keywords: Reverse Mortgage; Mortgage; Housing; Retirement; Home Equity Conversion Mortgage; HECM
    JEL: D91 E21 G21 J14
    Date: 2014–09–08
  7. By: Jang-Ting Guo (Department of Economics, University of California Riverside); Shu-Hua Chen (National Taipei University)
    Abstract: In the context of a standard one-sector AK model of endogenous growth, we show that the economy exhibits equilibrium indeterminacy and belief-driven aggregate fluctuations under progressive taxation of income. When the tax schedule is regressive or flat, the economy's balanced growth path displays saddle-path stability and equilibrium uniqueness. These results imply that in sharp contrast to a conventional automatic stabilizer, progressive income taxation may destabilize an endogenously growing macroeconomy by generating cyclical fluctuations driven by agents' self-fulfilling expectations or sunspots.
    Keywords: Progressive Income Taxation, Endogenous Growth, Equilibrium (In)determinacy.
    JEL: E62 O41
    Date: 2014–09
  8. By: Gabriela Castro (Economics and Research Department, Banco de Portugal); Ricardo M. Felix (Economics and Research Department, Banco de Portugal); Paulo Julio (Economics and Research Department, Banco de Portugal; and CEFAGE); Jose R. Maria (Economics and Research Department, Banco de Portugal)
    Abstract: Using PESSOA, a DSGE model for a small euro area economy, we analyze the size of fiscal multipliers associated with a large fiscal consolidation in "normal times" and in "crisis times." The crisis times scenario embodies a temporary increase in nominal rigidities and in financial frictions, purportedly better reflecting the underlying economic environment during the "Great Recession." Results show that impact multipliers are around 50-70 percent larger in crisis times for expenditure-based fiscal consolidations. A government consumption-based adjustment yields the highest impact multiplier (1.8 in crisis times vis-à-vis 1.2 in normal times). Revenue-based fiscal consolidations are also more recessive in crisis times, though the differences against normal times are less pronounced. Length: 37 pages
    Keywords: Fiscal multipliers; crisis; DSGE model; euro area; monetary union; small open economy.
    JEL: E62 F41 H62
    Date: 2014
  9. By: Hisahiro Naito (Department of Economics, Graduate School of Humanities and Social Sciences,University of Tsukuba,)
    Abstract: The effect of accepting more immigrants on welfare in the presence of a pay-as-you- go social security system is analyzed qualitatively 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, the welfare gain is calculated 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 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: 2014–09
  10. By: Klaus Schmidt-Hebbel (Universidad Catolica de Chile); José Carlos Tello (Departamento de Economía de la PUC del Perú)
    Abstract: This paper develops a dynamic general-equilibrium political-economy model for the optimal size and composition of public spending. An analytical solution is derived from majority voting for three government spending categories: public consumption goods and transfers (valued by households), as well as productive government services (complementing private capital in an endogenous-growth technology). Inequality is re ected by a discrete distribution of innitely-lived agents that dier by their initial capital holdings. In contrast to the previous literature that derives monotonic (typically negative) relations between inequality and growth in one-dimensional voting environments, this paper establishes conditions, in an environment of multi-dimensional voting, under which a non-monotonic, inverted U-shape relation between inequality and growth is obtained. This more general result { that inequality and growth could be negatively or positively related { could be consistent with the ambiguous or inconclusive results documented in the empirical literature on the inequality-growth nexus. The paper also shows that the political-economy equilibrium obtained under multi-dimensional voting for the initial period is time-consistent. JEL Classification-JEL: D72, E62, H11, H31
    Keywords: Desigualdad, crecimiento endógeno, votación multidimensional, impuesto endógeno.
    Date: 2014
  11. By: Gliksberg, Baruch (Department of Economics, University of Haifa)
    Abstract: This paper studies how the presence of an income tax changes the properties of general equilibrium models. It fi�nds that relative to the previous literature [following Leeper (1991)] a new area of determinacy exists where a passive �fiscal rule combined with a passive monetary rule can still deliver determinacy where the same area of the parameter space would lead to multiple solutions if taxes were lump sum. It characterizes analytically the extent to which tax cuts are self �financing and how the distortionary tax Laffer curve looks near the steady state in order to obtain the size of the passive �fiscal-passive monetary regime. In this regime, �scal limits bring about a Tobin effect and nominal prices are determined according to the quantity theory of money.
    Keywords: Distorting Taxes; Dynamic Laffer Curve; Equilibrium Determinacy;
    JEL: C60 E60 H60
  12. By: Jan Zapal
    Abstract: The paper proves, by construction, the existence of Markovian equilibria in a model of dynamic spatial legislative bargaining. Players bargain over policies in an infinite horizon. In each period, a majority vote takes place between the proposal of a randomly selected player and the status-quo, the policy last enacted. This determines the policy outcome that carries over as the status-quo in the following period; the status-quo is endogenous. Proposer recognition probabilities are constant and discount factors are homogeneous. The construction relies on simple strategies determined by strategic bliss points computed by the algorithm we provide. A strategic bliss point is the policy maximizing the dynamic utility of a player with ample bargaining power. Relative to a bliss point, the static utility ideal, a strategic bliss point is a moderate policy. Moderation is strategic and germane to the dynamic environment; players moderate in order to constrain the future proposals of opponents. Moderation is a strategic substitute; when a player's opponents do moderate, she does not, and when they do not moderate, she does. We prove that the simple strategies induced by the strategic bliss points computed by the algorithm deliver a Stationary Markov Perfect equilibrium. Thus we prove its existence in a large class of symmetric games with more than three players and (possibly with slight adjustment) in any three-player game. Because the algorithm constructs all equilibria in simple strategies, we provide their general characterization, and we show their generic uniqueness. Finally, we analyse how the degree of moderation changes with changes in the model parameters, and we discuss the dynamics of the equilibrium policies.
    Keywords: dynamic decision-making; endogenous status-quo; spatial bargaining; legislative bargaining;
    JEL: C73 C78 D74 D78
    Date: 2014–08
  13. By: Gliksberg, Baruch (Department of Economics, University of Haifa)
    Abstract: This paper offers a fi�xed-point approach to the issue of price level determination in general equilibrium. It arrives at a solution method for rational expectations models with missing initial conditions for financial wealth. The paper emphasizes the calculation of an equilibrium initial valuation for government debt via a Krasnoselski-Mann-Bailey theorem. The analysis is performed from a global analysis perspective. Abstracting from policies that bring about zero eigen-values permits us to draw conclusions about global dynamics. This approach builds on the Hartman-Grobman Theorem and implies no loss of generality.
    Keywords: Boundary Value Problems; Distorting Taxes; General Equilibrium; Global Determinacy; Krasnoselski-Mann-Bailey theorem;
    JEL: C62 C68 E60 H30 H60

This nep-dge issue is ©2014 by Christian Zimmermann. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
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