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on Dynamic General Equilibrium |
| By: | Drago Bergholt |
| Abstract: | How are macroeconomic fluctuations in open economies affected by interna- tional business cycles? To shed some light on this question, I develop and estimate a medium scale DSGE model for a small open economy. The model incorporates i) international markets for firm-to-firm trade in production inputs, and ii) producer heterogeneity where technology and price setting constraints vary across industries. Using Bayesian techniques on Canadian and US data, I document several macroe- conomic regularities in the small open economy, all attributed to international dis- turbances. First, foreign shocks are crucial for domestic fluctuations at all forecast- ing horizons. Second, productivity is the most important driver of business cycles. Investment efficiency shocks on the other hand have counterfactual implications for international spillover. Third, the relevance of foreign shocks accumulates over time. Fourth, business cycles display strong co-movement across countries, even though shocks are uncorrelated and the trade balance is countercyclical. Fifth, exchange rate pass-through to aggregate CPI inflation is moderate, while pass-through at the sector level is positively linked to the frequency of price changes. Few of these fea- tures have been accounted for in existing open economy DSGE literature, but all are consistent with reduced form evidence. The model presented here offers a structural interpretation of the results. |
| Keywords: | DSGE, small open economy, international business cycles, Bayesian estimation |
| JEL: | C11 F41 F44 |
| Date: | 2014–04 |
| URL: | http://d.repec.org/n?u=RePEc:bny:wpaper:0022&r=dge |
| By: | Stylianos Asimakopoulos; James Malley; Konstantinos Angelopoulos |
| 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 and endogenous skill acquisition under technology and public expenditure shocks. We fiÂ…nd that skilled and unskilled labour tax smoothing maintain quantitatively under externalities and exogenous shocks in skill acquisition, as well as when the relative skill supply is exogenously determined. We further Â…nd that the government Â…nds it optimal to reduce both the size of the wedge between the marginal rates of substitution and transformation in skill attainment in the long-run and the standard deviation of this wedge over the business cycle. This is achieved by subsidising skill creation and taxing both types of labour income. |
| Keywords: | skill premium, tax smoothing, optimal Â…scal policy |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:not:notcfc:14/11&r=dge |
| By: | Croushore, Dean (University of Richmond); Sill, Keith (Federal Reserve Bank of Philadelphia) |
| Abstract: | We use a structural dynamic stochastic general equilibrium model to investigate how initial data releases of key macroeconomic aggregates are related to final revised versions and how identified aggregate shocks influence data revisions. The analysis sheds light on how well preliminary data approximate final data and on how policy makers might condition their view of the preliminary data when formulating policy actions. The results suggest that monetary policy shocks and multifactor productivity shocks lead to predictable revisions to the initial release data on output growth and inflation. |
| Keywords: | Real-time data; DSGE models; Bayesian analysis; Data revisions; |
| JEL: | C11 C32 C53 E27 E47 |
| Date: | 2014–09–23 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedpwp:14-29&r=dge |
| By: | Wei Jiang |
| Abstract: | In this paper, we develop heterogeneous agent models with equilibrium unemployment to study the optimal taxation and labour wedge. We find that the the presence of profits plays an important role in the determination of both optimal tax policy and labour wedge. Judd-Chamley optimal zero capital tax result can still hold in the model without profits. The optimal labour wedge is zero in the long run. This results in welfare gains of all agents and there is no conflict of interests between agents. But the Benthamite government chooses to subsidise the capital income in the long run in the model with profits due to the presence of productive public investment. The resulting labour wedge is non-zero which generates welfare losses of workers despite welfare gains of capitalists. The government also faces a trade-off between efficiency and equity in this model. |
| Keywords: | household heterogeneity; equilibrium unemployment; optimal taxation; labour wedge |
| JEL: | E13 E22 E62 |
| Date: | 2014–09 |
| URL: | http://d.repec.org/n?u=RePEc:ukc:ukcedp:1407&r=dge |
| By: | Marco Del Negro (Federal Reserve Bank of New York); Raiden B. Hasegawa (Wharton School, University of Pennsylvania); Frank Schorfheide (Department of Economics, University of Pennsylvania) |
| Abstract: | We provide a novel methodology for estimating time-varying weights in linear prediction pools, which we call Dynamic Pools, and use it to investigate the relative forecasting performance of DSGE models with and without financial frictions for output growth and inflation from 1992 to 2011. We find strong evidence of time variation in the pool's weights, reflecting the fact that the DSGE model with financial frictions produces superior forecasts in periods of financial distress but does not perform as well in tranquil periods. The dynamic pool's weights react in a timely fashion to changes in the environment, leading to real-time forecast improvements relative to other methods of density forecast combination, such as Bayesian Model Averaging, optimal (static) pools, and equal weights. We show how a policymaker dealing with model uncertainty could have used a dynamic pools to perform a counterfactual exercise (responding to the gap in labor market conditions) in the immediate aftermath of the Lehman crisis. |
| Keywords: | Bayesian estimation, DSGE Models, Financial Frictions, Forecasting, Great Recession, Linear Prediction Pools |
| JEL: | C53 E31 E32 E37 |
| Date: | 2014–10–03 |
| URL: | http://d.repec.org/n?u=RePEc:pen:papers:14-034&r=dge |
| By: | Kuan-Jen Chen (Institute of Economics, Academia Sinica, Taipei, Taiwan); Angus C. Chu (University of Liverpool); Ching-Chong Lai (Institute of Economics, Academia Sinica, Taipei, Taiwan) |
| Abstract: | This paper incorporates home production into a real business cycle (RBC) model of a small open economy to provide a parsimonious explanation of the empirical pattern of international business cycles in developed economies and emerging markets. It is well known in the literature that in order for the RBC model to replicate quantita- tively plausible empirical moments of small open economies, the model needs to feature counterfactually a small income effect on labor supply. This paper provides a plausible solution to this puzzle by considering home production that introduces substitutability between market consumption and home consumption, which in turn generates a high volatility in market consumption in accordance with the data, even in the presence of a sizable income effect on labor supply. Furthermore, the model with estimated parameter values based on the simulated method of moments is able to match other empirical moments, such as the standard deviations of output, investment and the trade balance and the correlations between output and other standard macroeconomic variables. Given that home production is more prevalent in emerging markets than in developed economies, the model is also able to replicate empirical differences between emerging markets and developed economies in the volatility of market consumption and the volatility/countercyclicality of the trade balance. JEL Classification-JEL: D13, E32, F41, O16 |
| Keywords: | small open economy, home production, emerging markets, business cycles |
| Date: | 2014–09 |
| URL: | http://d.repec.org/n?u=RePEc:sin:wpaper:14-a011&r=dge |
| By: | Tetsuo Ono (Graduate School of Economics, Osaka University) |
| Abstract: | This paper analyzes the political economy of public education and in-cash trans- fer in an overlapping generations model of a two-class society in which the dynamics of inequality is driven by the accumulation of human capital. The two redistributive policies are determined by voting, while private education that supplements public education is purchased individually. The model, which includes two-dimensional voting, demonstrates either of the following two types of stable steady-state equilib- ria, which are in line with the evidence: a high-inequality equilibrium with govern- ment expenditure favoring lump-sum transfer, or a low-inequality equilibrium with that favoring public education. |
| Keywords: | Public education, political economy, inequality |
| JEL: | D72 D91 I24 |
| Date: | 2013–10 |
| URL: | http://d.repec.org/n?u=RePEc:osk:wpaper:1209r2&r=dge |
| By: | Junichi Fujimoto (National Graduate Institute for Policy Studies); Ko Munakata (Bank of Japan); Koji Nakamura (Bank of Japan); Yuki Teranishi (Keio University and CAMA, ANU) |
| Abstract: | This paper introduces financial market frictions into a standard New Keynesian model through search and matching in the credit market. Under such financial mar- ket frictions, a second-order approximation of social welfare includes a term involv- ing credit, in addition to terms for inflation and consumption. As a consequence, the optimal monetary and macroprudential policies must contribute to both finan- cial and price stability. This result holds for various approximated welfares that can change corresponding to macroprudential policy variables. The key features of opti- mal policies are as follows. The optimal monetary policy requires keeping the credit market countercyclical against the real economy. Commitment in monetary and macro- prudential policy, rather than approximated welfare, justifies history dependence and pre-emptiveness. Appropriate combinations of macroprudential and monetary policy achieve perfect financial and price stability. |
| Keywords: | optimal macroprudential policy; optimal monetary policy; financial market friction |
| JEL: | E44 E52 E61 |
| Date: | 2014–09 |
| URL: | http://d.repec.org/n?u=RePEc:upd:utppwp:030&r=dge |
| By: | Carlstrom, Charles T. (Federal Reserve Bank of Cleveland); Fuerst, Timothy S. (University of Notre Dame); Paustian, Matthius (Bank of England) |
| Abstract: | This paper derives the optimal lending contract in the financial accelerator model of Bernanke, Gertler and Gilchrist (1999), hereafter BGG. The optimal contract includes indexation to the aggregate return on capital, household consumption, and the return to internal funds. This triple indexation results in a dampening of fluctuations in leverage and the risk premium. Hence, compared with the contract originally imposed by BGG, the privately optimal contract implies essentially no financial accelerator. |
| Keywords: | Agency costs; CGE models; optimal contracting |
| JEL: | C68 E44 E61 |
| Date: | 2014–10–16 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedcwp:1420&r=dge |
| By: | Arseneau, David M. (Board of Governors of the Federal Reserve System (U.S.)); Epstein, Brendan (Board of Governors of the Federal Reserve System (U.S.)) |
| Abstract: | We study the role of labor market mismatch in the adjustment to a trade liberalization that results in the offshoring of high-tech production. Our model features two-sided heterogeneity in the labor market: high- and low-skilled workers are matched in a frictional labor market with high- and low-tech firms. Mismatch employment occurs when high-skilled workers choose to accept a less desirable job in the low-tech industry. The main result is that--perhaps counter-intuitively--this type of job displacement is actually beneficial for the labor market in the country doing the offshoring. Mismatch allows the economy to reallocate domestic high-skilled labor across both high- and low-tech industries. In doing so, mismatch dampens both the increase in the aggregate unemployment rate and the decline in aggregate wages that come as a consequence of shifting domestic production abroad. |
| Keywords: | Labor market frictions; globalization; trade liberalization; heterogeneous workers; search and matching |
| Date: | 2014–09–08 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgif:1118&r=dge |
| By: | Yaprak Tavman |
| Abstract: | The global financial crisis has clearly shown that macroeconomic stability is not sufficient to guarantee the stability of the financial system. Hence, the recent policy debate has focused on the effectiveness of macroprudential tools and their interaction with monetary policy. This paper aims to contribute to the macroprudential policy literature by presenting a formal comparative analysis of three macroprudential tools: (i) reserve requirements, (ii) capital requirements and (iii) a regulation premium. Utilizing a New Keynesian general equilibrium model with Önancial frictions, we find that capital requirements are the most effective macroprudential tool in mitigating the negative effects of the financial accelerator mechanism. Deriving welfare-maximizing monetary and macroprudential policy rules, we also conclude that irrespective of the type of the shock affecting the economy, use of capital requirements generates the highest welfare gains. |
| Keywords: | financial crises, monetary policy, macroprudential tools, financial system regulation |
| JEL: | E44 E58 G21 G28 |
| Date: | 2014–06 |
| URL: | http://d.repec.org/n?u=RePEc:yor:yorken:14/18&r=dge |
| By: | Claudio Michelacci (EIEF); Joseph Pijoan-Mas (CEMFI and CEPR) |
| Abstract: | We consider a competitive equilibrium growth model where technological progress is embodied into new jobs which are assigned to workers of different skills. In every period workers decide whether to actively participate in the labor market and if so how many hours to work on the job. Balanced growth requires that the job technology is complementary with the worker's total labor input in the job, which is jointly determined by his skill and his working hours. Since lower skilled workers can supply longer hours, we show that the equilibrium features positive assortative matching (higher skilled workers are assigned to better jobs) only if differences in consumption are small relative to differences in worker skills. When the pace of technological progress accelerates, wage inequality increases and workers participate less often in the labor market but supply longer hours on the job. This mechanism can explain why, as male wage inequality has increased in the US, labor force participation of male workers of different skills has fallen while their working hours have increased. |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:eie:wpaper:1410&r=dge |
| By: | Andrew Clausen (The University of Edinburgh); Carlo Strub (University of St. Gallen) |
| Abstract: | Operating overheads are widespread and lead to concentrated bursts of activity. To transfer resources between active and idle spells, agents demand financial assets. Futures contracts and lotteries are unsuitable, as they have substantial overheads of their own. We show that money – under efficient monetary policy – is a liquid asset that leads to efficient allocations. Under all other policies, agents follow inefficient “money cycle” patterns of saving, activity, and inactivity. Agents spend their money too quickly – a “hot potato effect of inflation”. We show that inflation can stimulate inefficiently high aggregate output. |
| Date: | 2014–09–22 |
| URL: | http://d.repec.org/n?u=RePEc:edn:esedps:249&r=dge |
| By: | Carlstrom, Charles T. (Federal Reserve Bank of Cleveland); Fuerst, Timothy S. (University of Notre Dame); Paustian, Matthius (Bank of England) |
| Abstract: | This paper develops a model of segmented financial markets in which the net worth of financial institutions limits the degree of arbitrage across the term structure. The model is embedded into the canonical Dynamic New Keynesian (DNK) framework. We estimate the model using data on the term premium. Our principal results include the following. First, the estimated segmentation coefficient implies a nontrivial effect of central bank asset purchases on yields and real activity. Second, there are welfare gains to having the central bank respond to the term premium, eg., including the term premium in the Taylor rule. Third, a policy that directly targets the term premium sterilizes the real economy from shocks originating in the financial sector. A term premium peg can have signifi cant welfare effects. |
| Keywords: | Agency costs; CGE models; optimal contracting |
| JEL: | C68 E44 E61 |
| Date: | 2014–10–15 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedcwp:1419&r=dge |
| By: | Böhm, Sebastian; Grossmann, Volker; Steger, Thomas M. |
| Abstract: | The paper revisits the debate on trickle-down growth in view of the widely discussed evolution of the earnings and income distribution that followed a massive expansion of higher education. We propose a dynamic general equilibrium model to dynamically evaluate whether economic growth triggered by an increase in public education expenditure on behalf of those with high learning ability eventually trickles down to low-ability workers and serves them better than redistributive transfers. Our results suggest that, in the shorter run, low-skilled workers lose. They are better off from promoting equally sized redistributive transfers. In the longer run, however, low-skilled workers eventually benefit more from the education policy. Interestingly, although the expansion of education leads to sustained increases in the skill premium, income inequality follows an inverted U-shaped evolution. |
| Keywords: | Directed Technological Change; Publicly Financed Education; Redistributive Transfers; Transitional Dynamics; Trickle-Down Growth |
| JEL: | H20 J31 O30 |
| Date: | 2014–10–21 |
| URL: | http://d.repec.org/n?u=RePEc:fri:fribow:fribow00452&r=dge |