|
on Dynamic General Equilibrium |
| By: | Holter, Hans A.; Krueger, Dirk; Stepanchuk, Serhiy |
| Abstract: | How much additional tax revenue can the government generate by increasing labor income taxes? In this paper we provide a quantitative answer to this question, and study the importance of the progressivity of the tax schedule for the ability of the government to generate tax revenues. We develop a rich overlapping generations model featuring an explicit family structure, extensive and intensive margins of labor supply, endogenous accumulation of labor market experience as well as standard intertemporal consumption-savings choices in the presence of uninsurable idiosyncratic labor productivity risk. We calibrate the model to US macro, micro and tax data and characterize the labor income tax Laffer curve under the current choice of the progressivity of the labor income tax code as well as when varying progressivity. We find that more progressive labor income taxes significantly reduce tax revenues. For the US, converting to a flat tax code raises the peak of the Laffer curve by 6%, whereas converting to a tax system with progressivity similar to Denmark would lower the peak by 7%. We also show that, relative to a representative agent economy tax revenues are less sensitive to the progressivity of the tax code in our economy. This finding is due to the fact that labor supply of two earner households is less elastic (along the intensive margin) and the endogenous accumulation of labor market experience makes labor supply of females less elastic (around the extensive margin) to changes in tax progressivity. |
| Keywords: | Fiscal Policy; Government Debt; Laffer Curve; Progressive Taxation |
| JEL: | E62 H20 H60 |
| Date: | 2014–11 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:10259&r=dge |
| By: | Inoue, Atsushi; Kuo, Chun-Hung; Rossi, Barbara |
| Abstract: | In this paper we propose empirical methods for detecting and identifying misspecifications in DSGE models. We introduce wedges in a DSGE model and identify potential misspecification via forecast error variance decomposition (FEVD) and marginal likelihood analyses. Our simulation results based on a small-scale DSGE model demonstrate that our method can correctly identify the source of misspecification. Our empirical results show that the medium-scale New Keynesian DSGE model that incorporates features in the recent empirical macro literature is still very much misspecified; our analysis highlights that the asset and labor markets may be the source of the misspecification. |
| Keywords: | DSGE models; empirical macroeconomics; model misspecification |
| JEL: | C32 E32 |
| Date: | 2014–09 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:10140&r=dge |
| By: | Ghate, Chetan; Gopalakrishnan, Pawan; Tarafdar, Suchismita |
| Abstract: | Emerging market economy business cycles are typically characterized by high consumption and output volatility, strongly counter-cyclical current accounts, and counter-cyclical real interest rates. Evidence from the wider EME and less developed economy business cycle experience suggests however that real interest rates can also be pro-cyclical. We reconcile the pro-cyclicality of real interest rates with the above facts by embedding fiscal policy into a standard emerging market business cycle model. We show that fiscal policy makes real interest rates a-cyclical or pro-cyclical. We use the model to replicate qualitatively some of the key features of the Indian business cycle. |
| Keywords: | Emerging Market Business Cycles, Fiscal Policy in a Small Open Economy, Indian Business Cycle, Interest Rate Shocks, Macroeconomic Stabilization |
| JEL: | E32 F32 F41 H2 |
| Date: | 2014–12–08 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:60449&r=dge |
| By: | Cacciatore, Matteo; Ghironi, Fabio; Stebunovs, Viktors |
| Abstract: | This paper studies the domestic and international effects of national bank market integration in a two-country, dynamic, stochastic, general equilibrium model with endogenous producer entry. Integration of banking across localities reduces the degree of local monopoly power of financial intermediaries. The economy that implements this form of deregulation experiences increased producer entry, real exchange rate appreciation, and a current account deficit. The foreign economy experiences a long-run increase in GDP and consumption. Less monopoly power in financial intermediation results in less volatile business creation, reduced markup countercyclicality, and weaker substitution effects in labor supply in response to productivity shocks. Bank market integration thus contributes to moderation of firm-level and aggregate output volatility. In turn, trade and financial ties allow also the foreign economy to enjoy lower GDP volatility in most scenarios we consider. These results are consistent with features of U.S. and international fluctuations after the United States began its transition to interstate banking in the late 1970s. |
| Keywords: | Business cycle volatility; Current account; Deregulation; Interstate banking; Producer entry; Real exchange rate |
| JEL: | E32 F32 F41 G21 |
| Date: | 2014–05 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:9973&r=dge |
| By: | Mendoza, Enrique G. (University of Pennsylvania); Tesar, Linda L. (University of Michigan); Zhang, Jing (Federal Reserve Bank of Chicago) |
| Abstract: | What are the macroeconomic effects of tax adjustments in response to large public debt shocks in highly integrated economies? The answer from standard closed-economy models is deceptive, because they underestimate the elasticity of capital tax revenues and ignore cross-country spillovers of tax changes. Instead, we examine this issue using a two-country model that matches the observed elasticity of the capital tax base by introducing endogenous capacity utilization and a partial depreciation allowance. Tax hikes have adverse effects on macro aggregates and welfare, and trigger strong cross-country externalities. Quantitative analysis calibrated to European data shows that unilateral capital tax increases cannot restore fiscal solvency, because the dynamic Laffer curve peaks below the required revenue increase. Unilateral labor tax hikes can do it, but have negative output and welfare effects at home and raise welfare and output abroad. Large spillovers also imply that unilateral capital tax hikes are much less costly under autarky than under free trade. Allowing for one-shot Nash tax competition, the model predicts a “race to the bottom” in capital taxes and higher labor taxes. The cooperative equilibrium is preferable, but capital (labor) taxes are still lower (higher) than initially. Moreover, autarky can produce higher welfare than both Nash and Cooperative equilibria. |
| Keywords: | European debt crisis; tax competition; capacity utilization; fiscal austerity |
| JEL: | E61 E62 E66 F34 F42 |
| Date: | 2014–10–06 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedhwp:wp-2014-13&r=dge |
| By: | Hassan, Tarek; Mertens, Thomas M. |
| Abstract: | We introduce the information microstructure of a canonical noisy rational expectations model (Hellwig, 1980) into the framework of a conventional real business cycle model. Each household receives a private signal about future productivity. In equilibrium, the stock price serves to aggregate and transmit this information. We find that dispersed information about future productivity affects the quantitative properties of our real business cycle model in three dimensions. First, households' ability to learn about the future affects their consumption-savings decision. The equity premium falls and the risk-free interest rate rises when the stock price perfectly reveals innovations to future productivity. Second, when noise trader demand shocks limit the stock market's capacity to aggregate information, households hold heterogeneous expectations in equilibrium. However, for a reasonable size of noise trader demand shocks the model cannot generate the kind of disagreement observed in the data. Third, even moderate heterogeneity in the equilibrium expectations held by households has a sizable effect on the level of all economic aggregates and on the correlations and standard deviations produced by the model. For example, the correlation between consumption and investment growth is 0.29 when households have no information about the future, but 0.41 when information is dispersed. |
| Keywords: | Asset Prices; Business Cycles; Dispersed Information; Investment; Noisy Rational Expectations; Portfolio Choice |
| JEL: | C63 D83 E2 E3 E44 G11 |
| Date: | 2014–06 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:10020&r=dge |
| By: | Javier Andrés (University of Valencia); Pablo Burriel (Banco de España) |
| Abstract: | We analyse the incidence of endogenous entry and firm TFP-heterogeneity on the response of aggregate inflation to exogenous shocks. We build up an otherwise standard DSGE model in which the number of firms is endogenously determined and firms differ in their steady state level of productivity. This splits the industry structure into firms of different sizes. Calibrating the different transition rates, across firm sizes and out of the market we reproduce the main features of the distribution of firms in Spain. We then compare the inflation response to technology, interest rate and entry cost shocks, among others. We find that structures in which large (more productive) firms predominate tend to deliver more muted inflation responses to exogenous shocks. |
| Keywords: | firm dynamics, industrial structure, inflation, business cycles. |
| JEL: | E31 E32 L11 L16 |
| Date: | 2014–12 |
| URL: | http://d.repec.org/n?u=RePEc:bde:wpaper:1429&r=dge |
| By: | Alice Fabre; Stéphane Pallage; Christian Zimmermann |
| Abstract: | In this paper we compare the welfare effects of unemployment insurance (UI) with an universal basic income (UBI) system in an economy with idiosyncratic shocks to employment. Both policies provide a safety net in the face of idiosyncratic shocks. While the unemployment insurance program should do a better job at protecting the unemployed, it suffers from moral hazard and substantial monitoring costs, which may threaten its usefulness. The universal basic income, which is simpler to manage and immune to moral hazard, may represent an interesting alternative in this context. We work within a dynamic equilibrium model with savings calibrated to the United States for 1990 and 2011, and provide results that show that UI beats UBI for insurance purposes because it is better targeted towards those in need. |
| Keywords: | Universal basic income, Idiosyncratic shocks, Unemployment insurance, Heterogeneous agents, Moral hazard |
| JEL: | E24 D7 J65 |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:lvl:lacicr:1427&r=dge |
| By: | Tito Boeri; Pietro Garibaldi; Espen R. Moen |
| Abstract: | The Great Recession has indicated that firms' leverage and access to finance are important for hiring and firing decisions. It is now empirically established that bank lending is correlated to employment losses when credit conditions deteriorate. We provide further evidence of this drawing on a new dataset that we assembled on employment adjustment and financial positions of European firms. Yet, in the Diamond Mortensen Pissarides (DMP) model there is no role for finance. All projects that display positive net present values are realized and financial markets are assumed to be perfect. What if financial markets are not perfect? Does a different access to finance influence the firm's hiring and firing decisions? The paper uses the concept of limited pledgeability proposed by Holmstrom and Tirole to integrate financial imperfections and labor market imperfections. A negative shock wipes out the firm's physical capital and leads to job destruction unless internal cash was accumulated by firms. If firms hold liquid assets they may thus protect their search capital, defined as the cost of attracting and hiring workers. The paper explores the trade-off between size and precautionary cash holdings in both partial and general equilibrium. We find that if labor market frictions disappear, so does the motive for firms to hold liquidity. This suggests a fundamental complementarity between labor market frictions and holding of liquid assets by firms. |
| Keywords: | Pledgeability, war chest, leverage, liquidity, labor and finance |
| JEL: | G01 J64 |
| Date: | 2014–12 |
| URL: | http://d.repec.org/n?u=RePEc:cep:cepdps:dp1317&r=dge |
| By: | Ercolani, Valerio; Pavoni, Nicola |
| Abstract: | We study a largely neglected channel through which government expenditures boost private consumption. We set up a lifecycle model in which households are subject to health shocks. We estimate a negative impact of public health care on household consumption dispersion, wealth and saving. According to our model, this result is explained by a change in the level of precautionary saving, with public health care acting as a form of consumption insurance. We compute the implied consumption multipliers by simulating the typical government consumption shock within a calibrated general equilibrium version of our model, with flexible prices. The impact consumption multiplier generated by the decrease in the level of precautionary saving is positive and sizable. When we include the effect of taxation, the sign of the impact multiplier depends on a few features of the model, such as the persistence of the health shocks. The long-run cumulative multiplier is negative across all calibrations. |
| Keywords: | consumption multipliers; government expenditure by function; precautionary saving |
| JEL: | E21 E32 E62 |
| Date: | 2014–07 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:10067&r=dge |
| By: | Nukic, Senada |
| Abstract: | The recent sovereign debt crisis has renewed the interest in fiscal consolidation policies and the associated output losses they entail. However, countries that adopted such policies are also plagued by persistent unemployment, and debt reduction ought to magnify the problem. This paper extends the standard neoclassical growth model to (i) the presence of public debt and (ii) the search and matching frictions in the labor market and quantifies the output and employment losses associated with fiscal consolidation episodes. The main results indicate that these losses can be substantially high. For instance, a 25% debt reduction yields a 50% increase in unemployment along the adjustment path. The paper also shows that policymakers need to carefully consider the intertemporal trade-off between short-run losses and long-run gains from the lower debt in their design of fiscal consolidation plans. Its timing, its size, the choice of fiscal instruments used to achieve it, and the role of monetary policy, also matter. |
| Keywords: | fiscal consolidation; (un)employment; search and matching frictions; sovereign debt |
| JEL: | E24 E32 E62 |
| Date: | 2014–11 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:60224&r=dge |
| By: | Gadatsch, Niklas; Stähler, Nikolai; Weigert, Benjamin |
| Abstract: | In this paper,we assess the impact ofmajor German structural reforms from1999 to 2008 on key macroeconomic variables within a two-country monetary union DSGE model. Bymany, these reforms, especially the Hartz reforms on the labormarket, are considered to be the root of thereafter observed imbalances in the Euro Area. We find that, in terms of German GDP, consumption, investment and (un)employment, the reforms were a clear success albeit the impact on the German trade balance and the current account was onlyminor. Most importantly, the rest of the Euro Area benefited frompositive spillover effects. Hence, our analysis suggests that the reforms cannot be held responsible for the currently observed macroeconomic imbalances within the Euro Area. |
| Keywords: | Fiscal Policy,Labor Market Reforms,DSGE modeling,Macroeconomics |
| JEL: | H2 J6 E32 E62 |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:svrwwp:052014&r=dge |
| By: | Buera, Francisco J. (Federal Reserve Bank of Chicago); Nicolini, Juan Pablo (Federal Reserve Bank of Minneapolis) |
| Abstract: | We study a model with heterogeneous producers that face collateral and cash in advance constraints. These two frictions give rise to a non-trivial financial market in a monetary economy. A tightening of the collateral constraint results in a credit-crunch generated recession. The model can suitable be used to study the effects on the main macroeconomic variables - and on welfare of each individual - of alternative monetary - and fiscal - policies following the credit crunch. The model reproduces several features of the recent financial crisis, like the persistent negative real interest rates, the prolonged period at the zero bound for the nominal interest rate, the collapse in investment and low inflation, in spite of the very large increases of liquidity adopted by the government. The policy implications are in sharp contrast with the prevalent view in most Central Banks, based on the New Keynesian explanation of the liquidity trap. |
| Keywords: | Liquidity; monetary policy; interest rate |
| JEL: | E12 E42 E43 E51 |
| Date: | 2014–05–14 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedhwp:wp-2014-14&r=dge |
| By: | Garibaldi, Pietro; Moen, Espen R; Sommervoll, Dag Einar |
| Abstract: | The paper proposes a model of on-the-job search and industry dynamics in which search is directed. Firms permanently differ in productivity levels, their production function features constant returns to scale, and search costs are convex in search intensity. Wages are determined in a competitive manner, as firms advertise wage contracts (expected discounted incomes) so as to balance wage costs and search costs (queue length). An important assumption is that a firm is able to sort out its coordination problems with their employees in such a way that the on-the-job search behavior of workers maximizes the match surplus. Our model has several novel features. First, it is close in spirit to the competitive model, with a tractable and unique equilibrium, and is therefore useful for empirical testing. Second, the resulting equilibrium gives rise to an efficient allocation of resources. Third, the equilibrium is characterized by a job ladder, where unemployed workers apply to low productivity firms offering low wages, and then gradually move on to more productive, higher-paying firms. Finally, the equilibrium offers different implications for the dynamics of job-to-job transitions than existing models of random search. |
| Keywords: | competitive search equilibrium; directed search; efficiency; firm dynamics |
| JEL: | C62 J60 |
| Date: | 2014–09 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:10175&r=dge |
| By: | Haroon Mumtaz (Queen Mary University of London); Konstantinos Theodoridis (Bank of England) |
| Abstract: | This paper investigates if the impact of uncertainty shocks on the US economy has changed over time. To this end, we develop an extended Factor Augmented VAR model that simultaneously allows the estimation of a measure of uncertainty and its time-varying impact on a range of variables. We find that the impact of uncertainty shocks on real activity and financial variables has declined systematically over time. In contrast, the response of inflation and the short-term interest rate to this shock has remained fairly stable. Simulations from a non-linear DSGE model suggest that these empirical results are consistent with an increase in the monetary authorities' anti-inflation stance and a 'flattening' of the Phillips curve. |
| Keywords: | FAVAR, Stochastic volatility, Uncertainty shocks, DSGE model |
| JEL: | C15 C32 E32 |
| Date: | 2014–12 |
| URL: | http://d.repec.org/n?u=RePEc:qmw:qmwecw:wp735&r=dge |
| By: | Fiorella De Fiore; Harald Uhlig |
| Abstract: | We present a DSGE model where firms optimally choose among alternative instruments of external finance. The model is used to explain the evolving composition of corporate debt during the financial crisis of 2008-09, namely the observed shift from bank finance to bond finance, at a time when the cost of market debt rose above the cost of bank loans. We show that the flexibility offered by banks on the terms of their loans and firm's ability to substitute among alternative instruments of debt finance are important to shield the economy from adverse real effects of a financial crisis. |
| JEL: | E22 E32 E44 E5 |
| Date: | 2014–12 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:20730&r=dge |
| By: | Fève, Patrick; Sahuc, Jean-Guillaume |
| Abstract: | Hand-to-mouth consumers and Edgeworth complementarity between private consumption and public expenditures are two competing mechanisms that were put forward by the literature to investigate the effects of government spending. Using Bayesian prior and posterior analysis and several econometric experiments, we find that a model with Edgeworth complementarity is a better representation for the transmission mechanism of fiscal policy in the euro area. We also show that a small change in the degree of Edgeworth complementarity has a large impact on the estimated share of hand-to-mouth consumers. These findings are robust to a number of perturbations. |
| Keywords: | Fiscal multipliers, DSGE Models, Hand-to-Mouth, Edgeworth Complementarity, Euro Area, Bayesian Econometrics. |
| JEL: | C32 E32 E62 |
| Date: | 2014–11–07 |
| URL: | http://d.repec.org/n?u=RePEc:ide:wpaper:28761&r=dge |
| By: | Clancy, Daragh (European Stability Mechanism); Merola, Rossana (International Labour Office) |
| Abstract: | The financial sector played a key role in triggering the recent crisis. Negative feedback loops between the financial sector and the real economy have further increased the persistence and amplitude of the downturn. We examine such macrofinancial linkages through the lens of the housing market. We develop a model capable of replicating some key stylised facts from the bursting of the Irish property bubble. We show that expectations of future favourable events may accelerate credit growth and potentially result in a more vulnerable economy susceptible to downward revisions to the original expectations. We find that macro-prudential policy, in particular counter-cyclical capital requirements and larger capital buffers, can play a role in insulating the economy from these risks. |
| Keywords: | DSGE, macro-prudential policy, macro-financial linkages, capital requirements, Ireland. |
| JEL: | E44 E51 G10 G28 |
| Date: | 2014–11 |
| URL: | http://d.repec.org/n?u=RePEc:cbi:wpaper:15/rt/14&r=dge |
| By: | Bacchetta, Philippe; Benhima, Kenza |
| Abstract: | In this paper, we examine theoretically how corporate saving in emerging markets is contributing to global rebalancing. We consider a two-country dynamic general equilibrium model, based on Bacchetta and Benhima (2014), with a Developed and an Emerging country. Firms need to save in liquid assets to finance their production projects, especially in the Emerging country. In this context, we examine the impact of a credit crunch in the Developed country and of a growth slowdown in both countries. These three shocks imply smaller global imbalances and a positive output comovement, but have a different impact on interest rates. Contrary to common wisdom, a slowdown in the Emerging market implies a trade balance improvement in the Developed country. |
| Keywords: | Capital Flows; Credit Constraints; Financial Crisis; Global Imbalances |
| JEL: | E22 F21 F41 F44 |
| Date: | 2014–06 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:10012&r=dge |
| By: | Gregor Bäurle; Daniel Kaufmann |
| Abstract: | We analyse nominal exchange rate and price dynamics after risk premium shocks with short-term interest rates constrained by the zero lower bound (ZLB). In a small-open-economy DSGE model, temporary risk premium shocks lead to shifts of the exchange rate and the price level if a central bank implements an inflation target by means of a traditional Taylor rule. These shifts are strongly amplified and become more persistent once the ZLB is included in the model. We also provide empirical support for this finding. Using a Bayesian VAR for Switzerland, we find that responses of the exchange rate and the price level to a temporary risk premium shock are larger and more persistent when the ZLB is binding. Our theoretical discussion shows that alternative monetary policy rules that stabilise price-level expectations are able to dampen exchange rate and price fluctuations when the ZLB is binding. This stabilisation can be achieved by including either the price level or, alternatively, the nominal exchange rate in the policy rule. |
| Keywords: | Exchange rate and price dynamics, zero lower bound on short-term interest rates, small-open-economy DSGE model, monetary policy regimes, monetary transmission, Bayesian VAR, sign restrictions |
| JEL: | C11 C32 E31 E37 E52 E58 F31 |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:snb:snbwpa:2014-10&r=dge |
| By: | Ozge Akinci (Board of Governors of the Federal Reserve System); Ryan Chahrour (Boston College) |
| Abstract: | We show that a model with imperfectly forecastable changes in future productivity and an occasionally-binding collateral constraint can match a set of stylized facts about Sudden Stop events. "Good" news about future productivity raises leverage during times of expansions, increasing the probability that the constraint binds, and a Sudden Stop occurs, in future periods. During the Sudden Stop, the nonlinear effects of the constraint induce output, consumption and investment to fall substantially below trend, as they do in the data. Also consistent with data, the economy exhibits a boom period prior to the Sudden Stop, with output, consumption, and investment all above trend. |
| Keywords: | News Shocks, Sudden Stops, Leverage, Boom-Bust Cycle |
| JEL: | E32 F41 F44 G15 |
| Date: | 2014–12–05 |
| URL: | http://d.repec.org/n?u=RePEc:boc:bocoec:866&r=dge |
| By: | Uras, R.B. (Tilburg University, Center For Economic Research) |
| Abstract: | The paper develops a dynamic general equilibrium model of financial markets and macroeconomy. In the model, long-term debt is extended to firms in a primary market and then traded in a secondary market among financiers. Two financial frictions that are ex-ante and ex-post with respect to the secondary market trading date raise the cost of debt finance. In stationary equilibrium, while ex-ante frictions are always counterproductive, financing costs that are ex-post could promote macroeconomic growth. I show that a model consistent with the U.S. financial development experience of the last 30 years is likely to exhibit declining ex-post frictions |
| Keywords: | microfoundations of financial frictions; long-term investment,; secondary |
| JEL: | E44 G2 O16 O47 |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:tiu:tiucen:9665351e-faf9-4baa-95d7-a88415543408&r=dge |
| By: | Guangyu Nie |
| Abstract: | This paper develops a life-cycle model with multi-dimensional matching in a frictionless marriage market where a single man's rank is determined by his age and wealth relative to others'. Using stable matching patterns, we analyze how people's marital age and saving behavior jointly respond to marriage market shocks. In particular, with wealth as a status good for mating competition, an otherwise standard age profile of savings exhibits an unusual pattern with younger households having relatively high saving rates compared to the middle-aged. This result is consistent with recent empirical findings from China. In addition, both the age gap between spouses and the aggregate saving rate rise when the sex ratio increases. Neglecting the response in marital ages will lead to an overstatement of the effect of the sex ratio imbalance on the increase of the aggregate saving rate. |
| JEL: | J11 J12 D10 E21 |
| Date: | 2014–11–29 |
| URL: | http://d.repec.org/n?u=RePEc:jmp:jm2014:pni317&r=dge |
| By: | Elisa Faraglia; Albert Marcet; Rigas Oikonomou; Andrew Scott |
| Abstract: | Our aim is to provide insights into some basic facts of US government debt management by introducing simple financial frictions in a Ramsey model of fiscal policy. We find that the share of short bonds in total U.S. debt is large, persistent, and highly correlated with total debt. A well known literature argues that optimal debt management should behave very differently: long term debt provides fiscal insurance, hence short bonds should not be issued and the position on short debt is volatile and negatively correlated with total debt. We show that this result hinges on the assumption that governments buy back the entire stock of previously issued long bonds each year, which is very far from observed debt management. We document how the U.S. Treasury rarely has repurchased bonds before 10 years after issuance. When we impose in the model that the government does not buy back old bonds the puzzle disappears and the optimal bond portfolio matches the facts mentioned above. The reason is that issuing only long term debt under no buyback would lead to a lumpiness in debt service payments, short bonds help offset this by smoothing out interest payments and tax rates. The same reasoning helps explain why governments issue coupon-paying bonds. <br><br>Solving dynamic stochastic models of optimal policy with a portfolio choice is computationally challenging. A separate contribution of this paper is to propose computational tools that enable this broad class of models to be solved. In particular we propose two significant extensions to the PEA class of computational methods which overcome problems due to the size of the model. These methods should be useful to many applications with portfolio problems and large state spaces. |
| Keywords: | computational methods, debt management, fiscal policy, incomplete markets, maturity structure, tax smoothing |
| JEL: | C63 E43 E62 H63 |
| Date: | 2014–11 |
| URL: | http://d.repec.org/n?u=RePEc:bge:wpaper:799&r=dge |
| By: | Sînâ T. Ateş (Department of Economics, University of Pennsylvania); Felipe E. Saffie (Department of Economics, University of Maryland) |
| Abstract: | We combine the real business cycle small open economy framework with the endogenous growth literature to study the productivity cost of a sudden stop. In this economy, productivity growth is determined by successful implementation of business ideas, yet the quality of ideas is heterogeneous and good ideas are scarce. A representative financial intermediary screens and selects the most promising ideas, which gives rise to a trade-off between mass (quantity) and composition (quality) in the entrant cohort. Chilean plant-level data from the sudden stop triggered by the Russian sovereign default in 1998 confirms the main mechanism of the model, as firms born during the credit shortage are fewer, but better. A calibrated version of the economy shows the importance of accounting for heterogeneity and selection, as otherwise the permanent loss of output generated by the forgone entrants doubles, which increases the welfare cost by 30%. |
| Keywords: | Financial Selection, Sudden Stop, Endogenous Growth, Firm Entry, Firm Heterogeneity |
| JEL: | F40 F41 F43 O11 O16 |
| Date: | 2014–11–17 |
| URL: | http://d.repec.org/n?u=RePEc:pen:papers:14-043&r=dge |
| By: | Xiaoshan Chen; Tatiana Kirsanova; Campbell Leith |
| Abstract: | We estimate a New Keynesian DSGE model for the Euro area under alternative descriptions of monetary policy (discretion, commitment or a simple rule) after allowing for Markov switching in policy maker preferences and shock volatilities. This reveals that there have been several changes in Euro area policy making, with a strengthening of the anti-inflation stance in the early years of the ERM, which was then lost around the time of German reunification and only recovered following the turnoil in the ERM in 1992. The ECB does not appear to have been as conservative as aggregate Euro-area policy was under Bundesbank leadership, and its response to the financial crisis has been muted. The estimates also suggest that the most appropriate description of policy is that of discretion, with no evidence of commitment in the Euro-area. As a result although both ‘good luck’ and ‘good policy’ played a role in the moderation of inflation and output volatility in the Euro-area, the welfare gains would have been substantially higher had policy makers been able to commit. We consider a range of delegation schemes as devices to improve upon the discretionary outcome, and conclude that price level targeting would have achieved welfare levels close to those attained under commitment, even after accounting for the existence of the Zero Lower Bound on nominal interest rates. |
| Keywords: | Bayesian Estimation, Interest Rate Rules, Optimal Monetary Policy, Great Moderation, Commitment, Discretion, Zero Lower Bound, Financial Crisis, Great Recession |
| JEL: | E58 E32 C11 C51 C52 C54 |
| Date: | 2014–11 |
| URL: | http://d.repec.org/n?u=RePEc:gla:glaewp:2014_20&r=dge |
| By: | Shuhei Takahashi (Institute of Economic Research, Kyoto University) |
| Abstract: | The frequency of nominal wage adjustments varies with macroeconomic conditions. Existing macroeconomic analyses exclude such state dependency in wage setting, as- suming exogenous timing and constant frequency of wage adjustments under time- dependent setting (e.g., Calvo- and Taylor-style setting). To investigate how state dependency in wage setting influences the transmission of monetary shocks, this paper develops a New Keynesian model in which the timing and frequency of wage changes are endogenously determined in the presence of fixed wage-setting costs. I find that state-dependent wage setting reduces the real impacts of monetary shocks compared to time-dependent setting. Further, with state dependency, monetary nonneutralities decrease with the elasticity of demand for differentiated labor, while the opposite holds under time-dependent setting. Next, this paper examines the empirical importance of state dependency in wage setting. To this end, I augment the model with habit formation, capital accumula- tion, capital adjustment costs, and variable capital utilization. When parameterized to reproduce the fluctuations in wage rigidity observed in the U.S. data, the state- dependent wage-setting model shows a response to monetary shocks quite similar to that of the time-dependent counterpart. The result suggests that for the U.S. economy, state dependency in wage setting is largely irrelevant to the monetary transmission. |
| Keywords: | Nominal wage stickiness, state-dependent setting, time-dependent set- ting, monetary nonneutralities, New Keynesian models. |
| JEL: | E31 E32 |
| Date: | 2014–11 |
| URL: | http://d.repec.org/n?u=RePEc:upd:utppwp:034&r=dge |
| By: | Bianchi, Francesco; Kung, Howard |
| Abstract: | We consider a network game with strategic complementarities where the individual reward or the strength of interactions is only partially known by the agents. Players receive different correlated signals and they make inferences about other players' information. We demonstrate that there exists a unique Bayesian-Nash equilibrium. We characterize the equilibrium by disentangling the information effects from the network effects and show that the equilibrium effort of each agent is a weighted combinations of different Katz-Bonacich centralities where the decay factors are the eigenvalues of the information matrix while the weights are its eigenvectors. We then study the impact of incomplete information on a network policy which aim is to target the most relevant agents in the network (key players). Compared to the complete information case, we show that the optimal targeting may be very different. |
| Keywords: | Bayesian methods; business cycles; DSGE model; endogenous growth; technology diffusion |
| Date: | 2014–12 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:10291&r=dge |
| By: | Richard Harrison (Centre for Macroeconomics (CFM); Bank of England) |
| Abstract: | Simulations of forward guidance in rational expectations models should be assessed using the “modest interventions” framework introduced by Eric Leeper and Tao Zha. That is, the estimated effects of a policy intervention should be considered reliable only if that intervention is unlikely to trigger a revision in private sector beliefs about the way that policy will be conducted. I show how to constrain simulations of forward guidance to ensure that they are regarded as modest policy interventions and illustrate the technique using a medium-scale DSGE model estimated on US data. I find that, in many cases, experiments that generate the large responses of macroeconomic variables that many economists deem implausible – the so-called “forward guidance puzzle” – would not be viewed as modest policy interventions by the agents in the model. Those experiments should therefore be treated with caution, since they may prompt agents to believe that there has been a change in the monetary policy regime that is not accounted for within the model. More reliable results can be obtained by constraining the experiment to be a modest policy intervention. The quantitative effects on macroeconomic variables are more plausible in these cases. |
| Date: | 2014–11 |
| URL: | http://d.repec.org/n?u=RePEc:cfm:wpaper:1429&r=dge |
| By: | VARDAR, N. Baris (Paris School of Economics, France; Université catholique de Louvain, CORE & Chair Lhoist Berghmans in Environmental Economics and Management, Belgium) |
| Abstract: | This paper investigates the optimal taxation path of a non-renewable resource in the presence of an imperfect substitute renewable resource. We present an optimal growth model and characterize the social optimum and the decentralized equilibrium. We show that the economy gradually reduces the share of non-renewable resource and converges to a steady state in which it uses only the renewable resource. The decentralized economy converges to the same steady state as the social optimum in terms of capital stock and consumption whether there is a regulator intervention or not. What matters for welfare, however, is the speed at which the economy approaches the clean state - the energy transition, which determines the level of environmental damages. We obtain the optimal taxation rule and show that its time profile can be either always increasing, decreasing or U-shaped depending on the initial state of the economy. Finally we provide some simulation results to illustrate these theoretical findings. |
| Keywords: | energy, optimal taxation, non-renewable resource, renewable resource, imperfect substitution, simultaneous resource use |
| JEL: | Q43 Q38 Q30 Q20 |
| Date: | 2014–07–03 |
| URL: | http://d.repec.org/n?u=RePEc:cor:louvco:2014021&r=dge |
| By: | Jonathan Temple; Huikang Ying |
| Abstract: | We examine whether structural transformation leads to a Kuznets curve. We present a dynamic general equilibrium model with heterogeneous workers, occupational self-selection and selective migration, and calibrate the model to survey data for Malawi. We show that structural transformation raises living standards unevenly. As development proceeds, the movement of workers from agriculture is associated with rising wage inequality, rather than a Kuznets curve. The increase in sectoral wage inequality is pronounced for agriculture. At the same time, structural transformation is associated with major reductions in rural poverty, and eventually in urban poverty. |
| Keywords: | Structural transformation, inequality, Kuznets curve, Roy Model. |
| JEL: | D31 O15 O41 |
| Date: | 2014–11–28 |
| URL: | http://d.repec.org/n?u=RePEc:bri:uobdis:14/650&r=dge |
| By: | Koeniger, Winfried; Prat, Julien |
| Abstract: | We characterize optimal redistribution in a dynastic family model with human capital. We show how a government can improve the trade-off between equality and incentives by changing the amount of observable human capital. We provide an intuitive decomposition for the wedge between human-capital investment in the laissez faire and the social optimum. This wedge differs from the wedge for bequests because human capital carries risk: its returns depend on the non-diversifiable risk of children's ability. Thus, human capital investment is encouraged more than bequests in the social optimum if human capital is a bad hedge for consumption risk. |
| Keywords: | human capital,optimal taxation |
| JEL: | E24 H21 I22 J24 |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:cfswop:497&r=dge |
| By: | Chiara Fratto; Harald Uhlig |
| Abstract: | What accounts for inflation after 2008? We use the prominent pre-crisis Smets-Wouters (2007) model to address this question. We find that due to price markup shocks alone inflation would have been 1% higher than observed and 0.5% higher that the long-run average. Their standard deviation is similar to its pre-crisis level. Price markup shocks were also responsible for the slow recovery of employment, though not for the initial drop. Monetary policy shocks predict an inflation rate 0.5% below average. Government expenditure innovations do not contribute much either to inflation or to employment dynamics. |
| JEL: | E31 E32 E52 |
| Date: | 2014–11 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:20707&r=dge |
| By: | Adema, Y. (Tilburg University, Center For Economic Research); Bonenkamp, J. (Tilburg University, Center For Economic Research); Meijdam, A.C. (Tilburg University, Center For Economic Research) |
| Abstract: | Abstract: This paper studies the redistribution and welfare effects of increasing the flexibility of individual pension take-up. We use an overlapping-generations model with Beveridgean pay-as-you-go pensions, where individuals differ in ability and life span. We find that introducing flexible pension take-up can induce a Pareto improvement when the initial pension scheme contains within-cohort redistribution and induces early retirement. Such a Pareto-improving reform entails the application of uniform actuarial adjustment of pension entitlements based on average life expectancy. Introducing actuarial non-neutrality that stimulates later retirement further improves such a flexibility reform. |
| Keywords: | redistribution; retirement; flexible pensions |
| JEL: | H55 H23 J26 |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:tiu:tiucen:7abc7392-6626-4677-b457-a9798d95539a&r=dge |