nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2014‒12‒08
23 papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. The term structure of interest rates in a small open economy DSGE model with Markov switching By Horváth, Roman; Maršál, Aleš
  2. Applications and Interviews: Firms' Recruiting Decisions in a Frictional Labor Market By Ronald Wolthoff
  3. Employment, hours and optimal monetary policy By Dossche, Maarten; Lewis, Vivien; Poilly, Céline
  4. A Search-Theoretic Approach to Efficient Financial Intermediation By Fabien Tripier
  5. Financial Frictions and Optimal Monetary Policy in a Small Open Economy By Jesús A. Bejarano; Luisa F. Charry
  6. Labor Market Dynamics: a Time-varying Analysis By Francesco Zanetti; Haroon Mumtaz
  7. Financial Frictions, Financial Shocks, and Aggregate Volatility By Fuentes-Albero, Cristina
  8. Microeconomic Uncertainty, International Trade, and Aggregate Fluctuations By George Alessandria; Horag Choi; Joseph P. Kaboski; Virgiliu Midrigan
  9. What Should I Be When I Grow Up? Occupations and Unemployment over the Life Cycle By Martin Gervais; Nir Jaimovich; Henry E. Siu; Yaniv Yedid-Levi
  10. Intertemporal equilibrium with production: bubbles and efficiency By Stefano Bosi; Cuong Le Van; Ngoc-Sang Pham
  11. Monetary Policy Regime Shifts Under the Zero Lower Bound: An Application of a Stochastic Rational Expectations Equilibrium to a Markov Switching DSGE Model By IIBOSHI Hirokuni
  12. Exchange Rates Dynamics with Long-Run Risk and Recursive Preferences By Robert Kollmann
  13. Education and growth with learning by doing By Marconi G.; Grip A. de
  14. Capital Income Taxation with Household and Firm Heterogeneity By Orhan Atesagaoglu; Eva Carceles-Poveda; Alexis Anagnostopoulos
  15. Marginalized predictive likelihood comparisons of linear Gaussian state-space models with applications to DSGE, DSGEVAR, and VAR models By Warne, Anders; Coenen, Günter; Christoffel, Kai
  16. Endogenous grids in higher dimensions: Delaunay interpolation and hybrid methods By Ludwig, Alexander; Schön, Matthias
  17. Does Public Education Expansion Lead to Trickle-Down Growth? By Böhm, Sebastian; Grossmann, Volker; Steger, Thomas M.
  18. Competitive Pressure and the Decline of the Rust Belt: A Macroeconomic Analysis By Simeon Alder; David Lagakos; Lee Ohanian
  19. Household Finance over the Life-Cycle: What does Education Contribute? By Russell Cooper; Guozhong Zhu
  20. Pre-crisis credit standards: monetary policy or the savings glut? By A. Penalver
  21. Macroeconomic Policy Games By Bodenstein, Martin; Guerrieri, Luca; LaBriola, Joe
  22. Bank capital, the state contingency of banks' assets and its role for the transmission of shocks By Kühl, Michael
  23. Positive Long Run Capital Taxation: Chamley-Judd Revisited By Ludwig Straub; Iván Werning

  1. By: Horváth, Roman; Maršál, Aleš
    Abstract: We lay out a small open economy dynamic stochastic general equilibrium (DSGE) model with Markov switching to study the term structure of interest rates. We extend the previous models by opening up the economy and adding a foreign demand channel. As a result, we explain the term structure of Czech interest rates and that the open economy version of the model fits reasonably well the period after the adoption of inflation targeting, which was characterized by two regimes: 1) a disinflation regime and 2) a price stability regime.
    Keywords: DSGE small open economy model,term structure of interest rates,regime switching
    JEL: G12 E17
    Date: 2014
  2. By: Ronald Wolthoff
    Abstract: I develop a directed search model of the labor market in which firms choose a recruiting intensity, determining the number of applicants they will interview. Interviewing applicants is costly but reveals their productivity, allowing the firm to hire better workers. I characterize the equilibrium and find that the uniqueness and cyclicality of recruiting intensity crucially depend on parameter values. Calibration of the model to the US labor market indicates a multiplicity of the equilibrium. An increase in aggregate productivity---given selection of a particular equilibrium---causes recruiting intensity to move counter to unemployment, while a shock to the equilibrium selection rule predicts the opposite pattern.
    Keywords: labor market, search, frictions, recruiting, efficiency
    JEL: J64 E24
    Date: 2014–11–10
  3. By: Dossche, Maarten; Lewis, Vivien; Poilly, Céline
    Abstract: We characterize optimal monetary policy in a New Keynesian search-and-matching model where multiple-worker firms satisfy demand in the short run by adjusting hours per worker. Imperfect product market competition and search frictions reduce steady state hours per worker below the efficient level. Bargaining results in a convex ‘wage curve’ linking wages to hours. Since the steady-state real marginal wage is low, wages respond little to hours. As a result, firms overuse the hours margin at the expense of hiring, which makes hours too volatile. The Ramsey planner uses inflation as an instrument to dampen inefficient hours fluctuations. JEL Classification: E30, E50, E60
    Keywords: employment, hours, optimal monetary policy, wage curve
    Date: 2014–08
  4. By: Fabien Tripier
    Abstract: This article develops a search-theoretic model of financial intermediation to study the efficiency condition of the banking sector. Competitive financial intermediation is determined by the search decisions of both households (to find adequate financial products) and banks (to attract depositors through marketing and to select borrowers through auditing) and by the interest rate setting mechanism. The efficiency of the competitive economy requires that interest rates are posted by banks or are bargained under a specific Hosios (1990) condition, which addresses the hold-up problem induced by search frictions on the credit and deposit markets. Interbank market frictions are introduced to show how an interbank market crisis leads to inefficient financial intermediation characterized by credit rationing and high net interest margin.
    Keywords: Banking;Search;Search;Matching;Switching Costs;Efficiency
    JEL: C78 D83 G21
    Date: 2014–11
  5. By: Jesús A. Bejarano; Luisa F. Charry
    Abstract: In this paper we set up a small open economy model with financial frictions, following Curdia and Woodford (2010)’s model. Unlike other results in the literature such as Curdia and Woodford (2010), McCulley and Ramin (2008) and Taylor (2008), we find that optimal monetary policy should not respond to changes in domestic interest rate spreads when the source of fluctuations are exogenous financial shocks. A novel result here is that the optimal size of policy responses to changes in the credit spread is large when the disturbance source are shocks to the foreign interest rate. Our results suggest that such a response is welfare enhancing.
    Keywords: Financial frictions, optimal interest rate rules, interest rate spreads, welfare, small open economy, second order approximation
    JEL: E44 E50 E52 E58 F41
    Date: 2014–11–13
  6. By: Francesco Zanetti; Haroon Mumtaz
    Abstract: This paper studies how key labor market stylized facts and the responses of labor market variables to technology shocks vary over the US postwar period.  It uses a benchmark DSGE model enriched with labor market frictions and investment specific technological progress that enables a novel identification scheme based on sign restrictions on a SVAR with time-varying coefficients and stochastic volatility.  Key findings are: i) the volatility in job finding and separation rates has declined over time, while their correlation varies across time; ii) the job finding rate plays an important role for unemployment, and the two series are strongly negatively correlated over the sample period; iii) the magnitude of the response of labor market variables to technology shocks varies across the sample period.
    Keywords: Technology shocks, labor market frictions, Bayesian SVAR methods, sign restrictions
    JEL: E32 C32
    Date: 2014–10–29
  7. By: Fuentes-Albero, Cristina (Board of Governors of the Federal Reserve System (U.S.))
    Abstract: I revisit the Great Inflation and the Great Moderation. I document an immoderation in corporate balance sheet variables so that the Great Moderation is best described as a period of divergent patterns in volatilities for real, nominal and financial variables. A model with time-varying financial frictions and financial shocks allowing for structural breaks in the size of shocks and the institutional framework is estimated. The paper shows that (i) while the Great Inflation was driven by bad luck, the Great Moderation is mostly due to better institutions; (ii) the slowdown in credit spreads is driven by an easier access to credit, while a higher exposure to financial risk determines the immoderation of balance sheet variables; and (iii) financial shocks arise as relevant drivers of U.S. business cycle uctuations.
    Keywords: Great Inflation; Great Moderation; immoderation; financial frictions; financial shocks; structural breaks; Bayesian methods
    JEL: C11 C13 E32 E44
    Date: 2014–09–19
  8. By: George Alessandria; Horag Choi; Joseph P. Kaboski; Virgiliu Midrigan
    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 effect of exogenous first- and second-moment shocks to producer-level productivity in a two-country DSGE model with heterogenous 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.
    JEL: E31 F12
    Date: 2014–10
  9. By: Martin Gervais; Nir Jaimovich; Henry E. Siu; Yaniv Yedid-Levi
    Abstract: Why is unemployment higher for younger individuals? We address this question in a frictional model of the labor market that features learning about occupational fit. In order to learn the occupation in which they are most productive, workers sample occupations over their careers. Because young workers are more likely to be in matches that represent a poor occupational fit, they spend more time in transition between occupations. Through this mechanism, our model can replicate the observed age differences in unemployment which, as in the data, are due to differences in job separation rates.
    JEL: E0 J0
    Date: 2014–10
  10. By: Stefano Bosi (EPEE, University of Evry); Cuong Le Van (IPAG Business School, CNRS, Paris School of Economics); Ngoc-Sang Pham (EPEE, University of Evry)
    Abstract: We consider a general equilibrium model with heterogeneous agents, borrowing constraints, and exogenous labor supply. First, the existence of intertemporal equilibrium is proved even if the aggregate capitals are not uniformly bounded above and the production functions are not time invariant. Second, we call by physical capital bubble a situation in which the fundamental value of physical capital is lower than its market price. We show that there is a physical capital bubble if and only if the sum (over time) of capital returns is finite. We also point out that there is no causal relationship between physical capital bubble and the fact that the present value of output is finite. Last, with linear technologies, every intertemporal equilibrium is efficient in sense of Malinvaud (1953). Moreover, there is a room for both efficiency and bubble.
    Keywords: Intertemporal equilibrium, physical capital bubble, efficiency, infinite horizon
    JEL: C62 D31 D91 G10
    Date: 2014
  11. By: IIBOSHI Hirokuni
    Abstract: I extend a simple new Keynesian model with the Markov-switching-type Taylor rule introduced by Davig and Leeper (2007 ) by incorporating the constraint of the zero lower bound (ZLB), using the concept and algorithms of the stochastic rational expectations equilibrium proposed by Billi (2013). According to the calibration, when an economy does not face the ZLB constraint, there is no gap in the fluctuation of output and inflation between stochastic expectations and perfect foresight because of the linear policy functions. In contrast, once negative aggregate demand shocks make the nominal interest rate hit the ZLB under stochastic expectations, unlike perfect foresight, intensifying uncertainty plays an important role in further declines of the output and price level even in response to the same shock, regardless of the monetary policy regime adopted. The calibration also indicates the possibility that the steady states of a model, in the absence of the ZLB, are underestimated in periods of deflation, since the means often used as estimates of the steady states are biased downward from these. The analysis sheds light on an exit strategy from the zero interest rate policy, since a passive policy regime reduces the expected interest rate and induces both the expected output and the inflation to increase under the ZLB.
    Date: 2014–11
  12. By: Robert Kollmann
    Abstract: Standard macro models cannot explain why real exchange rates are volatile anddisconnected from macro aggregates. Recent research argues that models with persistentgrowth rate shocks and recursive preferences can solve that puzzle. I show that this resultis highly sensitive to the structure of financial markets. When just a bond is tradedinternationally, then long-run risk generates insufficient exchange rate volatility. A longrunrisk model with recursive-preferences can generate realistic exchange rate volatility,if all agents efficiently share their consumption risk by trading in complete financialmarkets; however, this entails massive international wealth transfers, and excessiveswings in net foreign asset positions. By contrast, a long-run risk, recursive-preferencesmodel in which only a fraction of households trades in complete markets, while theremaining households lead hand-to-mouth lives, can generate realistic exchange rate andexternal balance volatility.
    Keywords: exchange rate; long-run risk; recursive preferences; complete financial markets; financial frictions; international risk sharing
    JEL: F31 F36 F41 F43
    Date: 2014–11
  13. By: Marconi G.; Grip A. de (ROA)
    Abstract: In this paper, we develop a general equilibrium overlapping generations model which is based on the view that education makes workers more productive by increasing their ability to learn from work experience, rather than providing skills that directly increase productivity. This assumption is discussed and compared with the dominant Mincerian view on the education-productivity relationship. One important implication of the model is that the enrolment rate to education has a negative effect on the GDP in the medium term and a positive effect in the long term. This could be an explanation for the weak empirical relationship between education and economic growth that has been found in the empirical macroeconomic literature. Conversely, for a given enrolment rate, the quality of education, as measured by workers ability to learn, has a positive effect on the GDP both in the medium and in the long term.
    Keywords: Human Capital; Skills; Occupational Choice; Labor Productivity; Macroeconomic Analyses of Economic Development; One, Two, and Multisector Growth Models;
    JEL: J24 O11 O41
    Date: 2014
  14. By: Orhan Atesagaoglu (SUNY-Stony Brook); Eva Carceles-Poveda (Stony Brook University); Alexis Anagnostopoulos (Stony Brook University)
    Abstract: The US tax code stipulates taxation of capital income at the firm level (corporate profits) and at the household level (dividends and capital gains). Even though all of those are capital income taxes, they have different effects both on incentives for household savings and firm investment and in terms of distribution. We argue that these effects can work both from the aggregate savings (household) side and from the aggregate investment (firms) side and provide a model that incorporates both aspects. The model features heterogeneous households and heterogeneous firms and is used to: 1. Evaluate the Jobs and Growth Tax Relief Reconciliation Act (JGTRRA) of 2003, which reduced and equalized tax rates on dividends and capital gains and 2. Analyze the optimal mix between the different types of capital income taxes. We find that the JGTRRA reduces investment and capital mainly due to a wealth effect. In particular, the dividend tax cut raises stock prices and, as a result, aggregate wealth held by stockholders. In order to be willing to hold additional wealth, stockholders require a higher return which pushes capital demand and investment down. Interestingly, capital is more efficiently allocated and, as a result, GDP actually rises slightly. On the second question, we search for a tax scheme that provides incentives for investment without the usual negative redistribution side effects.
    Date: 2014
  15. By: Warne, Anders; Coenen, Günter; Christoffel, Kai
    Abstract: The predictive likelihood is of particular relevance in a Bayesian setting when the purpose is to rank models in a forecast comparison exercise. This paper discusses how the predictive likelihood can be estimated for any subset of the observable variables in linear Gaussian state-space models with Bayesian methods, and proposes to utilize a missing observations consistent Kalman filter in the process of achieving this objective. As an empirical application, we analyze euro area data and compare the density forecast performance of a DSGE model to DSGE-VARs and reduced-form linear Gaussian models.
    Keywords: Bayesian inference,density forecasting,Kalman filter,missing data,Monte Carlo integration,predictive likelihood
    JEL: C11 C32 C52 C53 E37
    Date: 2014
  16. By: Ludwig, Alexander; Schön, Matthias
    Abstract: This paper investigates extensions of the method of endogenous gridpoints (ENDGM) introduced by Carroll (2006) to higher dimensions with more than one continuous endogenous state variable. We compare three different categories of algorithms: (i) the conventional method with exogenous grids (EXOGM), (ii) the pure method of endogenous gridpoints (ENDGM) and (iii) a hybrid method (HYBGM). ENDGM comes along with Delaunay interpolation on irregular grids. Comparison of methods is done by evaluating speed and accuracy. We find that HYBGM and ENDGM both dominate EXOGM. In an infinite horizon model, ENDGM also always dominates HYBGM. In a finite horizon model, the choice between HYBGM and ENDGM depends on the number of gridpoints in each dimension. With less than 150 gridpoints in each dimension ENDGM is faster than HYBGM, and vice versa. For a standard choice of 25 to 50 gridpoints in each dimension, ENDGM is 1.4 to 1.7 times faster than HYBGM in the finite horizon version and 2.4 to 2.5 times faster in the infinite horizon version of the model.
    Keywords: Dynamic Models,Numerical Solution,Endogenous gridpoints Method,Delaunay Interpolation
    JEL: C63 E21
    Date: 2014
  17. By: Böhm, Sebastian (University of Leipzig); Grossmann, Volker (University of Fribourg); Steger, Thomas M. (University of Leipzig)
    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
  18. By: Simeon Alder; David Lagakos; Lee Ohanian
    Abstract: No region of the United States fared worse over the postwar period than the "Rust Belt," the heavy manufacturing region bordering the Great Lakes. This paper hypothesizes that the Rust Belt declined in large part due to a lack of competitive pressure in its labor and output markets. We formalize this thesis in a two-region dynamic general equilibrium model, in which productivity growth and regional employment shares are determined by the extent of competition. Quantitatively, the model accounts for much of the large secular decline in the Rust Belt's employment share before the 1980s, and the relative stabilization of the Rust Belt since then, as competitive pressure increased.
    JEL: E0 O3 O4
    Date: 2014–10
  19. By: Russell Cooper; Guozhong Zhu
    Abstract: This paper studies household financial choices: why are these decisions dependent on the education level of the household? A life-cycle model is constructed to understand a rich set of facts about decisions of households with different levels of educational attainment regarding stock market participation, the stock share in wealth, the stock adjustment rate and the wealth-income ratio. Model parameters, including preferences, the cost of stock market participation and portfolio adjustment costs, are estimated to match the financial decisions of different education groups. Based on the estimated model, education affects household finance mainly through increased average income. The estimation also finds evidence that higher educational attainment is associated with a lower stock market entry cost and a larger discount factor. Education specific differences in income risks, medical expenses, mortality risks and the life-cycle pattern of income explain relatively little of the observed differences in household financial choices.
    JEL: E21 G11
    Date: 2014–11
  20. By: A. Penalver
    Abstract: This paper presents a theoretical model of how banks set their credit standards. It examines how a monopoly bank sets its monitoring intensity in order to manage credit risk when it makes long duration loans to borrowers who have private knowledge of their project's stochastic profitability. In contrast to standard models, it has a recursive structure and a general equilibrium. The bank loan contract considered specifies the interest rate, the monitoring intensity and a profitability covenant. Within this class of contract, the bank chooses the terms which maximise steady-state profits subject to the constraint that it must have as many deposits as loans. The model is then used to consider whether the reduction in credit standards and credit spreads observed before the financial crisis could have been caused by low official interest rates or a positive deposit shock. The model rejects a risk-taking channel of monetary policy and endorses the savings glut hypothesis.
    Keywords: credit standards, credit risk, monitoring, risk-taking channel, savings glut.
    JEL: G21
    Date: 2014
  21. By: Bodenstein, Martin (National University of Singapore); Guerrieri, Luca (Board of Governors of the Federal Reserve System (U.S.)); LaBriola, Joe (University of California, Berkeley)
    Abstract: Strategic interactions between policymakers arise whenever each policymaker has distinct objectives. Deviating from full cooperation can result in large welfare losses. To facilitate the study of strategic interactions, we develop a toolbox that characterizes the welfare-maximizing cooperative Ramsey policies under full commitment and open-loop Nash games. Two examples for the use of our toolbox offer some novel results. The first example revisits the case of monetary policy coordination in a two-country model to confirm that our approach replicates well-known results in the literature and extends these results by highlighting their sensitivity to the choice of policy instrument. For the second example, a central bank and a macroprudential regulator are assigned distinct objectives in a model with financial frictions. Lack of coordination leads to large welfare losses even if technology shocks are the only source of fluctuations.
    Keywords: Optimal policy; strategic interaction; welfare analysis; monetary policy cooperation; marcroprudential regulation
    JEL: E44 E61 F42
    Date: 2014–09–23
  22. By: Kühl, Michael
    Abstract: The role of bank capital as a propagation channel of shocks is strongly pronounced in recent macroeconomic models. In this paper, we show how the evolution of bank capital depends on the share of non-state-contingent assets in banks' balance sheets and present the consequences for macroeconomic dynamics. State-contingent securities impact on banks' balance sheets through changes in their returns (and their prices), both of which depend on the current state of the economy. Nonstate-contingent assets are signed before shocks are realized and their repayment is guaranteed. For this reason they insulate banks' balance sheets from recent economic activity in the absence of defaults. Our results show that non-state-contingent assets in banks' balance sheets attenuate the amplification of shocks resulting from financial frictions in the banking sector.
    Keywords: bank capital,state-contingent assets,non-state-contingent assets,monetary policy,financial frictions
    JEL: E44 E58 E61
    Date: 2014
  23. By: Ludwig Straub; Iván Werning
    Abstract: According to the Chamley-Judd result, capital should not be taxed in the long run. In this paper, we overturn this conclusion, showing that it does not follow from the very models used to derive them. For the model in Judd (1985), we prove that the long run tax on capital is positive and significant, whenever the intertemporal elasticity of substitution is below one. For higher elasticities, the tax converges to zero but may do so at a slow rate, after centuries of high capital taxation. The model in Chamley (1986) imposes an upper bound on capital taxation and we prove that the tax rate may end up at this bound indefinitely. When, instead, the bounds do not bind forever, the long run tax is indeed zero; however, when preferences are recursive but non-additive across time, the zero-capital-tax limit comes accompanied by zero private wealth (zero tax base) or by zero labor taxes (first best). Finally, we explain why the equivalence of a positive capital tax with ever rising consumption taxes does not provide a firm rationale against capital taxation.
    JEL: H2 H63
    Date: 2014–08

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