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on Dynamic General Equilibrium |
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Issue of 2014‒11‒12
25 papers chosen by |
| By: | Kyle Herkenhoff (UCLA) |
| Abstract: | Unemployed households' access to unsecured revolving credit (credit cards) nearly quadrupled from about 12 percent to about 45 percent over the last three decades. This paper analyzes how this large increase in revolving credit has impacted the business cycle. The paper develops a general equilibrium business cycle model with search in both the labor market and in the credit market. This generates a very rich and empirically plausible level of heterogeneity in work and credit histories while at the same time permitting a tractable model solution. Calibrating to the observed path of credit use between 1974 and 2012, I find that the large growth in credit access leads to deeper and longer recessions as well as moderately slower recoveries. Relative to an economy with credit fixed at 1970s levels, employment reaches its trough about 1 quarter later and remains depressed by up to .8 percentage points three years after the typical recession in this time period (e.g. employment is depressed by 2.8% rather than 2%). The mechanism is that when borrowing opportunities are easy to find, households optimally search for better-paying but harder-to-find jobs knowing that if the job search fails they can obtain credit to smooth consumption. Despite longer recessions and slower recoveries, increased credit card use enhances welfare by reducing consumption volatility and improving job-match quality. |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed014:448&r=dge |
| By: | Yasuo Hirose (Faculty of Economics, Keio University and Institute for Monetary and Economic Studies, Bank of Japan (E-mail:yhirose@econ.keio.ac.jp)); Atsushi Inoue (Department of Economics, Vanderbilt University (E-mail: atsushi.inoue@vanderbilt.edu)) |
| 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. |
| Keywords: | Zero lower bound, DSGE model, Parameter bias, Bayesian estimation |
| JEL: | C32 E30 E52 |
| Date: | 2014–10 |
| URL: | http://d.repec.org/n?u=RePEc:ime:imedps:14-e-09&r=dge |
| By: | Güneş Kamber (Reserve Bank of New Zealand and CAMA.); Konstantinos Theodoridis (Bank of England); Christoph Thoenissen (Department of Economics, University of Sheffield) |
| Abstract: | The focus of this paper is on news-driven business cycles in small open economies. We make two significant contributions. First, we develop a small open economy model where the presence of financial frictions permits the replication of business cycle co-movements in response to news shocks. Second, we use VAR analysis to identify news shocks using data on four advanced small open economies. We find that expected shocks about the future Total Factor Productivity generate business cycle co-movements in output, hours, consumption and investment. We also find that news shocks are associated with countercyclical current account dynamics. Our findings are robust across a number of alternative identification schemes. |
| Keywords: | News shocks, business cycles, open economy macroeconomics, financial frictions, VAR |
| JEL: | E32 F4 |
| Date: | 2014–10 |
| URL: | http://d.repec.org/n?u=RePEc:shf:wpaper:2014017&r=dge |
| By: | Roy Zilberman; William Tayler |
| Abstract: | This paper studies the interactions between loan loss provisioning rules, business cycle fluctuations and monetary policy in a model with nominal price rigidities, a borrowing cost channel and endogenous risk of default. We show that an empirically relevant backward-looking provisioning rule induces financial accelerator mechanisms and results in financial, price and macroeconomic instability. Forward-looking provisioning systems, set to cover for expected losses over the whole business cycle, reduce significantly procyclicality in prices and output, and in addition moderate the (otherwise optimal) anti-inflationary response in the monetary policy rule. The optimal policy response to financial shocks calls for a combination of forward-looking provisions and a mildly credit augmented monetary policy rule. |
| Keywords: | Loan loss provisions, procyclicality, borrowing cost channel, Basel III, forward-looking provisions, monetary policy |
| JEL: | E32 E44 E52 E58 G28 |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:lan:wpaper:68464009&r=dge |
| By: | Dale Mortensen (Northwestern University); Melvyn Coles |
| Abstract: | This paper considers a labor market employers differ in productivity, which is private information, and face hiring costs. Each employer sets its current wage but does not commit to future wages. Workers search on the job for better paid employment. A signalling equilibrium is show to exist and characterized in which more productive firms pay higher wages in every state of the market and workers transit from less to more productive employers. There is firm turnover: new small start-up firms are created while some existing firms die. Consistent with Gibrat's law, firm growth rates are size independent but increase with firm productivity (which evolves stochastically). With endogenous aggregate job creation rates and job-to-job transitions, the model provides a rich, coherent, non-steady state framework of equilibrium wage formation and worker flows. Existence of a steady state equilibrium for any finite number of firm productivity types is established. Steady state is unique when firm productivity is permanent and there are many firm types. A unique non-steady state equilibrium exists in the case of one type. In the general case, a unique equilibrium can be established when the elasticity of the hire rate with respect to productivity is sufficiently small. |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed014:462&r=dge |
| By: | Brito, Paulo |
| Abstract: | This paper presents a uncertain-lifetime overlapping-generations continuous time model for an Arrow-Debreu economy with endogenous fertility, in which age-dependent variables are explicitly introduced. The general equilibrium paths for the discount factor and newborns are derived from a system of two coupled forward-backward integral equations. The forward mechanism is related to aggregation between cohorts and the backward mechanism to life-cycle decisions. We study changes in the age-dependent profiles of age-dependent distributions for productivity and time use. We show that high maximum ages of productivity and child-rearing fitness increase the long run interest and growth rates, and low maximum ages can lead to asset pricing bubbles and negative population growth rates. |
| Keywords: | OLG, endogenous fertility, Arrow-Debreu, integral equations |
| JEL: | C6 E2 J1 |
| Date: | 2014–03–27 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:58656&r=dge |
| By: | Verona, Fabio (Bank of Finland Research); Martins, Manuel M. F. (University of Porto,); Drumond , Inês (Banco de Portugal) |
| Abstract: | We assess the performance of optimal Taylor-type interest rate rules, with and without reaction to financial variables, in stabilizing the macroeconomy following financial shocks. We use a DSGE model that comprises both a loan and a bond market, which best suits the contemporary structure of the U.S. financial system and allows for a wide set of financial shocks and transmission mechanisms. Overall, we find that targeting financial stability – in particular credit growth, but in some cases also financial spreads and asset prices – improves macroeconomic stabilization. The specific policy implications depend on the policy regime, and on the origin and the persistence of the financial shock. |
| Keywords: | financial shocks; optimal monetary policy; Taylor rules; DSGE models; bond market; loan market |
| JEL: | E32 E44 E52 |
| Date: | 2014–07–25 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:bofrdp:2014_021&r=dge |
| By: | Jason DeBacker (Department of Economics, Middle Tennessee State University); Richard W. Evans (Department of Economics, Brigham Young University); Evan Magnusson (Department of Economics, Brigham Young University); Kerk L. Phillips (Department of Economics, Brigham Young University); Shanthi P. Ramnath (U.S. Department of the Treasury, Office of Tax Analysis); Isaac Swift (Department of Economics, Brigham Young University) |
| Abstract: | This paper constructs a large scale overlapping generations model with heterogeneity across the lifecycle and over earnings ability types. The model is calibrated to the U.S. economy and includes realistic demographics, earnings distribution, taxes, and mortality risk. We consider the effects of two policies: an increase in income tax rates and a progressive wealth tax. We find that a more progressive income tax does not change inequality in consumption, income, or wealth across the life cycle, but it does reduce inequality across ability types. In contrast, a wealth tax reduces inequality over the life cycle, but slightly increases inequality across ability types. Inequality over ability types is greater concern than changes in equality over the lifecycle. |
| Keywords: | inequality, Piketty, wealth tax, income tax, overlapping generations |
| JEL: | D51 H21 H23 H30 P16 |
| Date: | 2014–10 |
| URL: | http://d.repec.org/n?u=RePEc:byu:byumcl:201408&r=dge |
| By: | Alessandria, George (Federal Reserve Bank of Philadelphia); Choi, Horag (Monash University); Kaboski, Joseph P. (University of Notre Dame and NBER); Midrigan, Virgiliu (New York University and NBER) |
| Abstract: | The extent and direction of causation between micro volatility and business cycles are debated. We examine, empirically and theoretically, the source and effects of fluctuations in the dispersion of producer-level sales and production over the business cycle. On the theoretical side, we study the expect of exogenous first- and second-moment shocks to producer-level productivity in a two-country DSGE model with heterogeneous producers and an endogenous dynamic export participation decision. First-moment shocks cause endogenous fluctuations in producer-level dispersion by reallocating production internationally, while second-moment shocks lead to increases in trade relative to GDP in recessions. Empirically, using detailed product-level data in the motor vehicle industry and industry-level data of U.S. manufacturers, we find evidence that international reallocation is indeed important for understanding cross-industry variation in cyclical patterns of measured dispersion. |
| Keywords: | Sunk cost; Establishment heterogeneity; Exporting; Uncertainty; |
| JEL: | E31 F12 |
| Date: | 2014–09–30 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedpwp:14-30&r=dge |
| By: | Fang, Lei (Federal Reserve Bank of Atlanta); Nie, Jun (Federal Reserve Bank of Kansas City) |
| Abstract: | The high U.S. unemployment rate after the Great Recession is usually considered to be a result of changes in factors influencing either the demand side or the supply side of the labor market. However, no matter what factors have caused the changes in the unemployment rate, these factors should have influenced workers' and firms' decisions. Therefore, it is important to take into account workers' endogenous responses to changes in various factors when seeking to understand how these factors affect the unemployment rate. To address this issue, we estimate a Mortensen-Pissarides style of labor-market matching model with endogenous separation decisions and stochastic changes in workers' human capital. We study how agents' endogenous choices vary with changes in the exogenous shocks and changes in labor-market policy in the context of human capital dynamics. We reach four main findings. First, once workers have accounted for and are able to optimally respond to possible human capital loss, the unemployment rate in an economy with human capital loss during unemployment will not be higher than in an economy with no human capital loss. The reason is that the increase in the unemployment rate led by human capital loss is more than offset by workers' endogenous responses to prevent them from being unemployed. Second, human capital accumulation on the job is more important than human capital loss during unemployment for both the unemployment rate and output. Third, workers' endogenous separation rates will decline when job-finding rates fall. Fourth, taking into account the endogenous responses, unemployment insurance extensions contributed 0.5 percentage point to the increase in the aggregate unemployment rate in the 2008–12 period. |
| Keywords: | unemployment; unemployment insurance benefits; matching model; human capital; labor market |
| JEL: | E24 J08 J24 J45 |
| Date: | 2014–02–01 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedawp:2014-02&r=dge |
| By: | Burcu Eyigungor (Federal Reserve Bank of Philadelphia); Satyajit Chatterjee (Federal Reserve Bank of Philadelphia) |
| Abstract: | We prove that the standard quasi-geometric discounting model used in dynamic consumer theory and political economics does not possess continuous Markov Perfect equilibria if there is a strictly positive lower bound on wealth. We also show that at points of discontinuity, the decision maker strictly prefers lotteries over next period's assets. We then extend the standard model to have lotteries and establish the existence of a MPE with continuous decision rules. The model with and without lotteries are numerically compared and it is shown that the model with lotteries behaves more in accord with economic intuition. |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed014:348&r=dge |
| By: | Naoko Hara (Bank of Japan); Munechika Katayama (Kyoto University); Ryo Kato (Bank of Japan) |
| Abstract: | Empirical studies report a marked dispersion in skill-premium changes across economies over the past few decades. Structural models in early studies successfully replicate the increases in skill premiums in many economies, while some other cases with a decline in the skill premium are yet to be explained. To this end, we develop a two-sector (i.e., manufacturing and non-manufacturing) general equilibrium model with skilled and unskilled labor, in which degrees of capital-skill complementarity differ across sectors. Based on the estimated structural parameters, we show that a decline in capital-skill complementarity in the non-manufacturing sector can provide a consistent explanation for the following aspects of the Japanese data at both the aggregate and industry levels: (i) a decline in the skill premium, (ii) widening of the sectoral wage gap due to a rise in manufacturing wages and decline in non-manufacturing wages, and (iii) an increase in the unskilled labor share in the non-manufacturing sector. We interpret that this change reflects compositional effects and uneven technology adoption of firms within non-manufacturing. |
| Keywords: | Capital-skill Complementarity; Skill Premium; Two-sector DSGE Model; Bayesian Estimation |
| JEL: | E22 E24 J31 |
| Date: | 2014–10–28 |
| URL: | http://d.repec.org/n?u=RePEc:boj:bojwps:wp14e09&r=dge |
| By: | Antonia Díaz; Luis Franjo |
| Abstract: | This paper reconciles two, apparently, contradictory facts about the Spanish economy: real GDP per working age person has grown at 2.4 percent during the period 1996-2007, on average, whereas Total Factor Productivity has been stagnant during that period. Here we argue that the Spanish economy has grown, in spite of stagnant TFP, because investment in structures has been heavily subsidized. This inefficiently high rate of investment in structures is the main reason for the increase in hours worked observed during that period. We use a three sector model economy where we distinguish between equipment and structures to quantify the sources of changes in measured TFP in Spain. We find that measured TFP is low because Investment- Specific Technical Change in Spain is very low. A calibrated version of this model is able to reproduce very well the growth experience of Spain for the period 1970-2007. We use the model economy to quantify the cost of direct and indirect subsidies to structures and the gains of eliminating them in terms of TFP and income growth. Our three sector model economy also allows us to quantify the cost in measured TFP of the housing price boom experienced during the 2000s. |
| Keywords: | Spain , TFP , growth accounting , ISTC , applied general equilibrium |
| JEL: | E01 E13 E32 |
| Date: | 2014–10 |
| URL: | http://d.repec.org/n?u=RePEc:cte:werepe:we1422&r=dge |
| By: | Foerster, Andrew T. (Federal Reserve Bank of Kansas City); Rubio-Ramirez, Juan F. (Duke University); Waggoner, Daniel F. (Federal Reserve Bank of Atlanta); Zha, Tao (Federal Reserve Bank of Atlanta) |
| Abstract: | Markov-switching DSGE (MSDSGE) modeling has become a growing body of literature on economic and policy issues related to structural shifts. This paper develops a general perturbation methodology for constructing high-order approximations to the solutions of MSDSGE models. Our new method, called "the partition perturbation method," partitions the Markov-switching parameter space to keep a maximum number of time-varying parameters from perturbation. For this method to work in practice, we show how to reduce the potentially intractable problem of solving MSDSGE models to the manageable problem of solving a system of quadratic polynomial equations. We propose to use the theory of Gröbner bases for solving such a quadratic system. This approach allows us to first obtain all the solutions and then determine how many of them are stable. We illustrate the tractability of our methodology through two examples. |
| Keywords: | partition principle; naive perturbation; uncertainty; Taylor series; high-order expansion; time-varying coefficients; nonlinearity; Gröbner bases |
| JEL: | C6 E3 G1 |
| Date: | 2014–08–01 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedawp:2014-16&r=dge |
| By: | Pierre-Olivier Weill (UCLA); Benjamin Lester (Federal Reserve Bank of Philadelphia); Julien Hugonnier (EPFL) |
| Abstract: | We consider a decentralized market for an asset (or durable good) where the valuations of the agents in the market are heterogeneous and drawn from a continuous distribution. Agents can hold either zero or one unit of the asset, and they choose whether or not to search for a trading partner, which is costly. We provide a full characterization of the steady-state equilibrium, which allows us to study market composition (i.e., who searches and who doesn’t), the joint distribution of valuations and asset holdings (i.e., the degree of misallocation), trading volume and asset turnover (i.e., the amount of endogenous intermediation), asset prices and dispersion across trades, and several other important properties of over-the-counter markets. We also provide closed-form solutions as trading frictions vanish. We show that, while prices and allocations converge to those of the frictionless counterpart, excess trading volume persists in the asymptotic limit. |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed014:427&r=dge |
| By: | Pedros Silos (Federal Reserve Bank of Atlanta); Eric Smith (University of Essex) |
| Abstract: | Online appendix for the Review of Economic Dynamics article |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:red:append:13-132&r=dge |
| By: | Richard McManus; F. Gulcin Ozkan; Dawid Trzeciakiewicz |
| Abstract: | This paper presents a comprehensive assessment of fiscal austerity, with special emphasis on its distributional consequences, which are surprisingly ignored in the existing literature. Using amedium scale DSGE model we find that both the aggregate and distributional consequences of fiscal consolidation are shaped by its composition much more than by its speed. A trade-off emerges between effciency and equality; spending-based austerity leads to smaller net movements in output, incomes and welfare, but also to larger inequality between agents who vary by their access and use of credit markets. Given the severity of the recent downturn in most advanced economies that had adopted austerity, this trade-off between growth and distributional consequences of fiscalconsolidation is likely to pose serious challenges to policymakers in many countries. |
| Keywords: | fiscal austerity; welfare; redistribution |
| JEL: | E65 H2 H3 |
| Date: | 2014–07 |
| URL: | http://d.repec.org/n?u=RePEc:yor:yorken:14/22&r=dge |
| By: | Gregory Thwaites (Centre for Macroeconomics (CFM)) |
| Abstract: | Over the past four decades, real interest rates have risen then fallen across the industrialised world. Over the same period, nominal investment rates are down, while house prices and household debt are up. I explain these four trends with a fifth - the widespread fall in the relative price of investment goods. I present a simple closed-economy OLG model in which households finance retirement in part by selling claims on the corporate sector (capital goods) accumulated over their working lives. As capital goods prices fall, the interest rate must fall to re ect capital losses. And in the long run, a given quantity of saving buys more capital goods. This has ambiguous effects on interest rates in the long run: if the production function is inelastic, in line with most estimates in the literature, interest rates stay low even after relative prices have stopped falling. Lower interest rates reduce the user cost of housing, raising house prices and, given that housing is bought early in life, increasing household debt. I extend the model to allow for a heterogeneous bequest motive, and show that wealth inequality rises but consumption inequality falls.I test the model on cross-country data and find support for its assumptions and predictions. The analysis in this paper shows recent debates on macroeconomic imbalances and household and government indebtedness in a new light. In particular, low real interest rates may be the new normal. The debt of the young provides an alternative outlet for the retirement savings of the old; preventing the accumulation of debt, for example through macroprudential policy, leads to a bigger fall in interest rates. |
| Date: | 2014–08 |
| URL: | http://d.repec.org/n?u=RePEc:cfm:wpaper:1428&r=dge |
| By: | Bhattacharya, Joydeep; Qiao, Xue; Wang, Min |
| Abstract: | This paper studies the evolution of wealth inequality in an economy with endogenousborrowing constraints. In the model economy, agents need to borrow to finance humancapital investments but cannot commit to repaying their loans. Creditors can punishdefaulters by banishing them permanently from the credit market. In equilibrium, loandefault is prevented by imposing a borrowing limit tied to the borrower’s inheritance.The heterogeneity in inheritances translates into heterogeneity in the borrowing limits:endogenously, some young borrowers face a zero borrowing limit, some are partlyconstrained, while others are unconstrained. Depending on the initial distribution ofinheritances, it is possible all lineages are attracted to either the zero-borrowing-limitsteady state or to the unconstrained-borrowing steady state — long-run equality. It isalso possible some lineages end up at one steady state and the rest at the other — completepolarization. Interestingly, the wealth dynamics in the model closely resemblethat in the seminal work of Galor and Zeira (1993). |
| Keywords: | wealth inequality; endogenous borrowing constraints; exclusion |
| JEL: | E25 E44 E62 O23 O41 |
| Date: | 2014–10–22 |
| URL: | http://d.repec.org/n?u=RePEc:isu:genres:38181&r=dge |
| By: | Bandopadhyay, Titas Kumar |
| Abstract: | We extend the benchmark model of DMP in a two-sector general equilibrium framework by introducing a frictionless segment of the labour market. We also examine the effects of trade reforms and labour market reforms on equilibrium rate of unemployment and wage inequality in our stylitzed economy. We find that both these reforms reduce equilibrium rate of unemployment. However, trade reforms raise wage inequality but labour market reforms reduce it. These results provide a strong theoretical basis for labour market reform in a small open economy characterized by frictional labour market. |
| Keywords: | Job-searching, Job-matching, General equilibrium, Trade liberalization |
| JEL: | J6 |
| Date: | 2014–10–02 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:59039&r=dge |
| By: | Michael Lim |
| Abstract: | Empirical data suggests that the relative price of goods and services may play a role in individual labor supply decisions. Data shows that individuals spend a significant amount of their time at home engaged in activities such as child care, education, and elderly care, among others, which are substitutible with relatively expensive market services. From 2000 and onward, the relative price of services and the labor participation rate have shown a negative relationship. In this paper, the role of relative prices in a frictional, two sector labor market is examined. Adapting the labor search model presented in Garibaldi and Wasmer (2005) to incorporate relative price effects, we show that the introduction of relative prices has both partial and general equilibrium effects on entry and exit margins, which tend to reduce labor market participation. The model is then calibrated and taken to US data from the 2000s (to be done). |
| URL: | http://d.repec.org/n?u=RePEc:cmu:gsiawp:222365889&r=dge |
| By: | Kaiji Chen (Emory University); Alfonso Irarrazabal (Norges Bank) |
| Abstract: | Online appendix for the Review of Economic Dynamics article |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:red:append:13-61&r=dge |
| By: | Claire Reicher |
| Abstract: | While European countries have engaged in a debate about fiscal policy rules, little is known about the ability of these rules to ensure stable debt and output paths when taxes are distortionary, particularly in a small open economy. In this situation, it turns out that the interaction between a fiscal rule and output may affect whether or not fiscal policy is stabilizing, or "passive", in equilibrium. For instance, under moderate debt-multiplier combinations, a debt-GDP targeting rule can result in instability, while a debt-level targeting rule, irrespective of GDP, can result in stability. A primary deficit target may result in instability for the debt but stability for output, while a total deficit target can result in stability for both debt and output. A fiscal reaction function similar to those found in the macro literature may result in stability for certain parameter values, so long as the response of fiscal policy to the past debt level is strong enough to overcome the interactions among fiscal policy, output, and interest rates. Furthermore, under certain conditions, optimal policy mimics a fiscal reaction function with a moderate degree of business cycle stabilization policy |
| Keywords: | fiscal rule, fiscal reaction function, deficits, stability, instability |
| JEL: | E62 E63 H60 |
| Date: | 2014–10 |
| URL: | http://d.repec.org/n?u=RePEc:kie:kieliw:1968&r=dge |
| By: | Shannon Seitz (Boston College); Geoffrey Sanzenbacher (Analysis Group); Andrew Beauchamp (Boston College); Meghan Skira (University of Georgia) |
| Abstract: | Why do some men father children outside of marriage but not provide support? Why are single women willing to have children outside of marriage when they receive little or no support from unmarried fathers? To answer these questions, we develop and estimate a dynamic equilibrium model of marriage, employment, fertility, and child support. We consider the extent to which two explanations account for the prevalence of 'deadbeat dads' and non-marital childbearing: low wages and a shortage of single men relative to single women. Even if women prefer to have children within marriage, when faced with a shortage of high wage spouses it may be optimal to have children with low wage men outside of marriage. In response, some men have incentives to have children and not support them. The model is estimated by efficient method of moments using data from the National Longitudinal Survey of Youth 1979. We conduct several counterfactual experiments including equating black and white population supplies and eliminating the racial gap in wages to explore the implications of the model. We also analyze a counterfactual policy in which child support enforcement is perfect. |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed014:435&r=dge |
| By: | Pedro Gomis-Porqueras; Timothy Kam; Christopher Waller |
| Abstract: | We study the endogenous choice to accept fiat objects as media of exchange and the implications for nominal exchange rate determination. We consider an economy with two currencies which can be used to settle any transactions. However, currencies can be counterfeited at a fixed cost and the decision to counterfeit is private information. This induces equilibrium liquidity constraints on the currencies in circulation. We show that the threat of counterfeiting can pin down the nominal exchange rate even when the currencies are perfect substitutes, thus breaking the Kareken-Wallace indeterminacy result. We also find that with appropriate fiscal policies we can enlarge the set of monetary equilibria with determinate nominal exchange rates. Finally, we show that the threat of counterfeiting can also help determine nominal exchange rates in a variety of different trading environments. These include a two-country setup with tradable and non-tradable goods sectors, and with an alternative timing of money injections. |
| Keywords: | Multiple Currencies, Counterfeiting Threat, Liquidity, Exchange Rates |
| JEL: | D82 D83 F4 |
| Date: | 2014–10–10 |
| URL: | http://d.repec.org/n?u=RePEc:dkn:econwp:eco_2014_7&r=dge |