nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2014‒11‒28
eighteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Welfare Cost of Fluctuations: when Labor Market Search Interacts with Financial Frictions By Eleni Iliopulos; François Langot; Thepthida Sopraseuth
  2. High Marginal Tax Rates on the Top 1%? Lessons from a Life Cycle Model with Idiosyncratic Income Risk By Fabian Kindermann; Dirk Krueger
  3. Financial Frictions and Macroeconomic Fluctuations in Emerging Economies By Akinci, Ozge
  4. Revisiting the Matching Function By Kohlbrecher, Britta; Merkl, Christian; Nordmeier, Daniela
  5. Policy and Spillover Analysis in the World Economy: A Panel Dynamic Stochastic General Equilibrium Approach By Francis Vitek
  6. Maturity and Repayment Structure of Sovereign Debt By Seon Tae Kim; Gabriel Mihalache; Yan Bai
  7. A Theory of Targeted Search By Cheremukhin, Anton A.; Restrepo-Echavarria, Paulina; Tutino, Antonella
  8. Dynamic Prediction Pools: An Investigation of Financial Frictions and Forecasting Performance By Marco Del Negro; Raiden B. Hasegawa; Frank Schorfheide
  9. Credit, Bankruptcy, and Aggregate Fluctuations By Makoto Nakajima; José-Víctor Ríos-Rull
  10. When are There Natural Limits on Inequality? By Scott S. Condie; Richard W. Evans; Kerk L. Phillips
  11. EIRE Mod- A DSGE Model for Ireland By Clancy, Daragh; Merola, Rossana
  12. Top Income Inequality, Aggregate Saving and the Gains from Trade By Lixin Tang
  13. Collateral amplification under complete markets By Nikolov, Kalin
  14. Working Less and Bargain Hunting More:Macro Implications of Sales during Japan's Lost Decades By Nao Sudo; Kozo Ueda; Kota Watanabe; Tsutomu Watanabe
  15. Over-aging: Are present human populations too old? By Stelter, Robert
  16. The Impact of Intangible Investments on the Macroeconomy By Ellen McGrattan
  17. Trade Dynamics in the Market for Federal Funds By Gara Afonso; Ricardo Lagos
  18. Social Insurance, Information Revelation, and Lack of Commitment By Mikhail Golosov; Luigi Iovino

  1. By: Eleni Iliopulos (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon-Sorbonne, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris, CEPREMAP - Centre pour la recherche économique et ses applications - Centre pour la recherche économique et ses applications); François Langot (EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris, GAINS-TEPP - Université du Maine, Banque de france - Banque de France, IZA - Institute for the Study of Labor); Thepthida Sopraseuth (CEPREMAP - Centre pour la recherche économique et ses applications - Centre pour la recherche économique et ses applications, THEMA - Théorie économique, modélisation et applications - CNRS : UMR8184 - Université de Cergy Pontoise)
    Abstract: We provide a quantitative assessment of welfare costs of fluctuations in a search model with financial frictions. The matching process in the labor market leads positive shocks to reduce unemployment less than negative shocks increase it. We show that the magnitude of this non-linearity is magnified frictions. This asymmetric effect of the business cycle leads to sizable welfare costs. The model also accounts for the responsiveness of the job finding rate to the business cycle as financial frictions endogenously generate counter-cyclical opportunity costs of opening a vacancy and wage sluggishness.
    Keywords: Welfare; business cycle; financial friction; labor market search
    Date: 2014–06
  2. By: Fabian Kindermann; Dirk Krueger
    Abstract: In this paper we argue that very high marginal labor income tax rates are an effective tool for social insurance even when households have preferences with high labor supply elasticity, make dynamic savings decisions, and policies have general equilibrium effects. To make this point we construct a large scale Overlapping Generations Model with uninsurable labor productivity risk, show that it has a wealth distribution that matches the data well, and then use it to characterize fiscal policies that achieve a desired degree of redistribution in society. We find that marginal tax rates on the top 1% of the earnings distribution of close to 90% are optimal. We document that this result is robust to plausible variation in the labor supply elasticity and holds regardless of whether social welfare is measured at the steady state only or includes transitional generations.
    JEL: E62 H21 H24
    Date: 2014–10
  3. By: Akinci, Ozge (Board of Governors of the Federal Reserve System (U.S.))
    Abstract: Estimated dynamic models of business cycles in emerging markets deliver counterfactual predictions for the country risk premium. In particular, the country interest rate predicted by these models is acyclical or procyclical, whereas it is countercyclical in the data. This paper proposes and estimates a small open economy model of the emerging-market business cycle in which a time-varying country risk premium emerges endogenously. In the proposed model, a firm's borrowing rate adjusts countercyclically as the default threshold of the firm depends on the state of the macroeconomy. I econometrically estimate the proposed model and find that it can account for the volatility and the countercyclicality of country risk premium as well as for other key emerging market business cycle moments. Time varying uncertainty in firm specific productivity contributes to delivering a countercyclical default rate and explains 70 percent of the variances in the trade balance and in the country risk premium. Finally, I find the predicted contribution of nonstationary productivity shocks in explaining output variations falls between the extremely high and extremely low values reported in the literature.
    Keywords: Financial frictions; country risk premium; international business cycles; Bayesian estimation
    JEL: E32 E44 F44 G15
    Date: 2014–10–24
  4. By: Kohlbrecher, Britta (University of Erlangen-Nuremberg); Merkl, Christian (University of Erlangen-Nuremberg); Nordmeier, Daniela (Deutsche Bundesbank)
    Abstract: This paper shows analytically and numerically that there are two ways of generating an observationally equivalent comovement between matches, unemployment, and vacancies in dynamic labor market models: either by assuming a standard Cobb-Douglas contact function or by combining a degenerate contact function with idiosyncratic productivity shocks for new jobs. Despite this observational equivalence, we provide several reasons for why it is important to understand what happens inside the black box of job creation. We calibrate a combined model with both mechanisms to administrative German wage and labor market flow data. In contrast to the model without idiosyncratic shocks, the combined model is able to replicate the observed negative time trend in estimated matching functions. In addition, the full nonlinear combined model generates highly asymmetric business cycle responses to large aggregate shocks.
    Keywords: matching function, idiosyncratic productivity, job creation, vacancies, time trend, asymmetries
    JEL: E24 E32 J63 J64
    Date: 2014–09
  5. By: Francis Vitek
    Abstract: This paper develops a structural macroeconometric model of the world economy, disaggregated into forty national economies. This panel dynamic stochastic general equilibrium model features a range of nominal and real rigidities, extensive macrofinancial linkages, and diverse spillover transmission channels. A variety of monetary policy analysis, fiscal policy analysis, spillover analysis, and forecasting applications of the estimated model are demonstrated. These include quantifying the monetary and fiscal transmission mechanisms, accounting for business cycle fluctuations, and generating relatively accurate forecasts of inflation and output growth.
    Keywords: Spillovers;Monetary policy;Monetary transmission mechanism;Fiscal policy;Business cycles;Economic forecasting;General equilibrium models;Panel analysis;Monetary policy analysis; Fiscal policy analysis; Spillover analysis; Forecasting; World economy; Panel dynamic stochastic general equilibrium model; Bayesian econometrics
    Date: 2014–10–30
  6. By: Seon Tae Kim (Instituto Tecnológico Autónomo de México); Gabriel Mihalache (University of Rochester); Yan Bai (University of Rochester)
    Abstract: This paper studies the maturity, timing and relative size of repayments for sovereign debt. Using Bloomberg bond data for emerging economies, we document that sovereigns issue debt with shorter maturity but more back-loaded repayments during downturns. To account for this pattern, we study a sovereign-default model of a small open economy which issues a state-uncontingent bond, with a flexible choice of maturity and repayment schedule. In our model, as in the data, during recessions the country prefers its payments to be more back- loaded—delaying relatively larger payments—in order to smooth consumption. However, such back-loaded debt is expensive since payments scheduled later involve higher default risk. To reduce borrowing costs, the country optimally shortens its maturity. We calibrate the model to yearly Brazilian data. The model can rationalize the observed patterns of maturity and repayment structure, as an optimal trade-off between consumption smoothing and endogenous borrowing cost due to lack of enforcement.
    Date: 2014
  7. By: Cheremukhin, Anton A. (Federal Reserve Bank of Dallas); Restrepo-Echavarria, Paulina (Federal Reserve Bank of St. Louis); Tutino, Antonella (Federal Reserve Bank of Dallas)
    Abstract: We present a theory of targeted search, where people with a finite information processing capacity search for a match. Our theory explicitly accounts for both the quantity and the quality of matches. It delivers a unique equilibrium that resides in between the random matching and the directed search outcomes. The equilibrium that emerges from this middle ground is inefficient relative to the constrained Pareto allocation. Our theory encompasses the outcomes of the random matching and the directed search literature as limiting cases.
    Keywords: Matching; assignment; search; efficiency; information
    JEL: C78 D83 E24 J64
    Date: 2013–08–23
  8. By: Marco Del Negro; Raiden B. Hasegawa; Frank Schorfheide
    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.
    JEL: C53 E31 E32 E37
    Date: 2014–10
  9. By: Makoto Nakajima; José-Víctor Ríos-Rull
    Abstract: We ask two questions related to how access to credit affects the nature of business cycles. First, does the standard theory of unsecured credit account for the high volatility and procyclicality of credit and the high volatility and countercyclicality of bankruptcy filings found in U.S. data? Yes, it does, but only if we explicitly model recessions as displaying countercyclical earnings risk (i.e., rather than having all households fare slightly worse than normal during recessions, we ensure that more households than normal fare very poorly). Second, does access to credit smooth aggregate consumption or aggregate hours worked, and if so, does it matter with respect to the nature of business cycles? No, it does not; in fact, consumption is 20 percent more volatile when credit is available. The interest rate premia increase in recessions because of higher bankruptcy risk discouraging households from using credit. This finding contradicts the intuition that access to credit helps households to smooth their consumption.
    JEL: D91 E21 E32 E44 K35
    Date: 2014–10
  10. By: Scott S. Condie (Department of Economics, Brigham Young University); Richard W. Evans (Department of Economics, Brigham Young University); Kerk L. Phillips (Department of Economics, Brigham Young University)
    Abstract: This paper examines Thomas Piketty's thesis that there are no natural limits on accumulation of wealth. We undertake our examination in the context of a simple general equilibrium model with infintely-lived dynasties. We show that extreme wealth accumulation does not happen in general equilibrium unless capital and labor are substitutes, an assumption which also leads to unbalanced growth. We also show that even with unbalanced growth, differences in rates of return and effective labor are not sufficient to cause unbounded inequality. Only savings rate differences can lead to extreme wealth concentration. Finally, we show that while a flat wealth tax will not eliminate extreme wealth concentration, both a graduated wealth tax and a flat income tax will.
    Keywords: Piketty, inequality, wealth tax, welfare
    JEL: D51 H21 H23 H30 P16
    Date: 2014–10
  11. By: Clancy, Daragh (Central Bank of Ireland); Merola, Rossana (Economic and Social Research Institute)
    Abstract: We develop ´EIRE Mod (Elementary Irish Real Economy Model), a core DSGE model suitable for policy analysis in Ireland. The model’s underlying structure, with a distinction between the traded and non-traded sectors and an import content of exports component, is designed to replicate the highly open nature of the Irish economy. Ireland’s membership of EMU is accounted for through exogenous nominal interest and exchange rates. New Keynesian features, such as sticky prices and wages, mean the model’s dynamics can replicate the sluggish reaction of economic variables found in the empirical literature. The model is calibrated in order to match key observed ratios in the Irish data. The usefulness of the model as a policy tool is highlighted through the simulation of various structural reforms aimed at boosting efficiency and competitiveness. Our results show that overall, reforms aimed at boosting productivity and price and wage competitiveness lead to the desired increase in output. Nevertheless, particular care should be paid to the effect of domestic reforms on Ireland’s external competitiveness and employment. This work is the first step towards the development of a suite of DSGE models for Ireland. Extensions of the core ´EIRE Mod will be necessary to fully capture key aspects of the economy’s adjustment path following these reforms. Accordingly, the results presented in this initial paper should be treated with caution.
    Keywords: Ireland, corporate liquidations, rm default, survival analysis.
    JEL: E12
    Date: 2014–09
  12. By: Lixin Tang
    Abstract: I study the implications of top income inequality for the gains from trade in a dynamic model. I argue that higher top income inequality among entrepreneurs can increase the gains from trade for workers. In the model, entrepreneurs face uninsurable idiosyncratic productivity risk, and thus save. Since the most productive entrepreneurs have the highest saving rate and are the ones that export, a reduction in trade costs increases their share of total prots and their savings, which leads to a large increase in the aggregate supply of capital. The welfare gains from trade for workers in the model are 6.4%, which are larger than in comparable benchmarks without top income inequality or capital accumulation. While the typical entrepreneur loses in consumption because of higher labor costs, aggregate consumption by entrepreneurs increases by 3.6%. Empirically, I find a strong relationship between trade openness and the national saving rate in a large sample of countries, consistent with the model. I find a much weaker relationship between trade openness and the investment rate.
    JEL: F1 F4 O1 O4
    Date: 2014–11–06
  13. By: Nikolov, Kalin
    Abstract: This paper examines the robustness of the Kiyotaki-Moore collateral amplification mechanism to the existence of complete markets for aggregate risk. We show that, when borrowers can hedge against aggregate shocks at fair prices, the volatility of endogenous variables becomes identical to the first best in the absence of credit constraints. The collateral amplification mechanism disappears. To motivate the limited use of contingent contracts, we introduce costs of issuing contingent debt and calibrate them to match the liquidity and safety premia the data. We .find that realistic costs of state contingent market participation can rationalize the predominant use of uncontingent debt. Amplification is restored in such an environment. JEL Classification: E32, D52
    Keywords: amplification, collateral constraints
    Date: 2014–08
  14. By: Nao Sudo (Bank of Japan); Kozo Ueda (Waseda University); Kota Watanabe (Meiji University); Tsutomu Watanabe (The University of Tokyo)
    Abstract: Standard New Keynesian models have often neglected temporary sales. In this paper, we ask whether this treatment is appropriate. In the empirical part of the paper, we provide evidence using Japanese scanner data covering the last two decades that the frequency of sales was closely related with macroeconomic developments. Specically, we find that the frequency of sales and hours worked move in opposite directions in response to technology shocks, producing a negative correlation between the two. We then construct a dynamic stochastic general equilibrium model that takes households' decisions regarding their allocation of time for work, leisure, and bargain hunting into account. Using this model, we show that the rise in the frequency of sales, which is observed in the data, can be accounted for by the decline in hours worked during Japan's lost decades. We also nd that the real eect of monetary policy shocks weakens by around 40% due to the presence of temporary sales, but monetary policy still matters.
    Date: 2014–09
  15. By: Stelter, Robert
    Abstract: This paper investigates the problem of an \optimum population" concerning age structures in a 3-period OLG-model with endogenous fertility and longevity. The first-best solution for a number-dampened total social welfare function, including Millian and Benthamite utilitarianism as two extreme cases, identifies the optimal age structure, generally failed in the laissez-faire economy. Individuals over-invest in health expenditures and choose a non-optimal number of offspring. A calibration exercise for 80 countries emphasizes that mean ages in the optimal solution with the highest feasible individual utility exceed the observed in all countries, especially due to a very low first-best number of children. Introducing a preference for the population stock in the social welfare function increases fertility, but reduces individual utility, in the first-best solution. Optimal mean age shrinks and an over-aging of the laissez-faire economy becomes more likely. To decentralize first-best solutions health expenditures are taxed, whereas children are either taxed or subsided.
    Keywords: endogenous fertility,adult mortality,optimal age structure,over-aging,optimal taxation
    JEL: H20 I10 J18
    Date: 2014
  16. By: Ellen McGrattan (University of Minnesota)
    Abstract: As yet, there is no consensus among macroeconomists concerning the main driving forces behind the large declines in economic activity during 2008-2009 and the subsequent slow recovery. This paper seeks to shed light on a measurement issue that confounds analyses of key macrodata during this period. Because firms invest heavily in intangible investments---at a rate close to that of tangible investments---a drop in measured GDP, which does not include all intangible investments, understates the actual decline in total output. As a result, it is possible to have productivity rising during a recession as observed in 2008-2009. The rise in productivity has led many economists to the natural conclusion that this recession was different than most other post-World War II recessions and, as a result, many have been in search of evidence that financial disruptions were the cause of the large declines in real activity. The main objective of the paper is to determine if this time is in fact different by analyzing U.S. data---at the aggregate and micro level---using a model that incorporates intangible investments and multiple sectors, estimating parameters with maximum likelihood techniques, and comparing model predictions to data. Because of the inherent measurement issues, success relies on comparing model predictions to observations that are not used in the estimation of parameters.
    Date: 2014
  17. By: Gara Afonso; Ricardo Lagos
    Abstract: We develop a model of the market for federal funds that explicitly accounts for its two distinctive features: banks have to search for a suitable counterparty, and once they meet, both parties negotiate the size of the loan and the repayment. The theory is used to answer a number of positive and normative questions: What are the determinants of the fed funds rate? How does the market reallocate funds? Is the market able to achieve an efficient reallocation of funds? We also use the model for theoretical and quantitative analyses of policy issues facing modern central banks.
    JEL: E4 E43 E5 E52 E58 G21 G28
    Date: 2014–08
  18. By: Mikhail Golosov; Luigi Iovino
    Abstract: We study the optimal provision of insurance against unobservable idiosyncratic shocks in a setting in which a benevolent government cannot commit. A continuum of agents and the government play an infinitely repeated game. Actions of the government are constrained only by the threat of reverting to the worst perfect Bayesian equilibrium (PBE). We construct a recursive problem that characterizes the resource allocation and information revelation on the Pareto frontier of the set of PBE. We prove a version of the Revelation Principle and find an upper bound on the maximum number of messages that are needed to achieve the optimal allocation. Agents play mixed strategies over that message set to limit the amount of information transmitted to the government. The central feature of the optimal contract is that agents who enter the period with low implicitly-promised lifetime utilities reveal no information to the government and receive no insurance against current period shock, while agents with high promised utilities reveal precise information about their current shock and receive insurance as in economies with full commitment by the government.
    JEL: D82 D86 E61 H3
    Date: 2014–10

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