nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2015‒01‒14
twenty-one papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. An estimated DSGE model with search and matching frictions in the credit market By Danilo Liberati
  2. Sources of the Great Recession:A Bayesian Approach of a Data-Rich DSGE model with Time-Varying Volatility Shocks By IIBOSHI Hirokuni; MATSUMAE Tatsuyoshi; NISHIYAMA Shin-Ichi
  3. Generational Risk--Is it a Big Deal?: Simulating an 80-Period OLG Model With Aggregate Shocks By Laurence Kotlikoff; Jasmina Hasanhodzic
  4. Capital Regulation in a Macroeconomic Model with Three Layers of Default. By L. Clerc; A. Derviz; C. Mendicino; S. Moyen; K. Nikolov; L. Stracca; J. Suarez; A. P. Vardoulakis
  5. Corporate Cash and Employment By Philippe Bacchetta; Kenza Benhima; Céline Poilly
  6. Taxing Fossil Fuels under Speculative Storage By Semih Tumen; Deren Unalmis; Ibrahim Unalmis; D. Filiz Unsal
  7. Sovereign Risk and Bank Balance Sheets: The Role of Macroprudential Policies By Pablo D'Erasmo; Bora Durdu; Emine Boz
  8. What if you were German? - DSGE approach to the Great Recession on labour markets By Marek Antosiewicz; Piotr Lewandowski
  9. Fiscal Multipliers in the 21st Century By Per Krusell and Laurence Malafry
  10. More on Middlemen: Equilibrium Entry and Efficiency in Intermediated Markets By Nosal, Ed; Wong, Yuet-Yee; Wright, Randall
  11. Migrant Wages, Human Capital Accumulation and Return Migration By Joseph-Simon Gorlach; Christian Dustmann; Jerome Adda
  12. Entry and shakeout in dynamic oligopoly By Hünermund, Paul; Schmidt-Dengler, Philipp; Takahashi, Yuya
  13. Quantitative Easing in Joseph's Egypt with Keynesian Producers By Campbell, Jeffrey R.
  14. Advertisement versus Motivation in Competitive Search Equilibrium By Katsuya Takii
  15. The Effects Of Robo-Signing On The Economy And Unconventional Monetary Policy By Egor S. Malkov
  16. Superneutrality of Money under Open Market Operations By Homburg, Stefan
  17. The allocation of talent: finance versus entrepreneurship By Shakhnov, Kirill
  18. A Fair Wage Explanation of Labour Market Volatility By Robert Jump
  19. Forecast combinations in a DSGE-VAR lab By Costantini, Mauro; Gunter, Ulrich; Kunst, Robert M.
  20. Macroeconomic effects of simultaneous implementation of reforms after the crisis By Andrea Gerali; Alessandro Notarpietro; Massimiliano Pisani
  21. The Long Run Effect of Growth on Employment in a Labor Market with Matching Frictions: The Role of Labor Market Institutions. By Valeri Sorolla

  1. By: Danilo Liberati (Bank of Italy)
    Abstract: Financial frictions have become fundamental for studying the business cycle and credit market dynamics. This work adds to the existing literature by introducing a search and matching scheme in the financial market into a cash in advance New Keynesian DSGE theoretical model. We provide an alternative explanation of the degree of incompleteness in the pass-through from policy rate to loan rates depending on credit market tightness, the search costs sustained by banks, and the relative powers of the agents in loan interest rate bargaining. The model is able to reproduce the countercyclical behaviour of the credit spread with respect to a positive technology shock. It also proposes a scenario in which a credit shock hits the economy. The model is estimated by using the Bayesian procedures. Finally, since there is still some disagreement about the theoretical mechanism by which the interest rate on loans is derived, we survey and compare these theoretical devices with that proposed by this paper.
    Keywords: Interest rate pass-through, Credit Spread, Search and Matching, Credit Market Frictions, Bayesian techniques
    JEL: C78 E13 E43 E44
    Date: 2014–10
  2. By: IIBOSHI Hirokuni; MATSUMAE Tatsuyoshi; NISHIYAMA Shin-Ichi
    Abstract: In order to investigate sources of the Great Recession (Dec. 2007 to Jun. 2009) of the US economy in the latter portion of the first decade of the 2000s, we modified the standard New Keynesian dynamic stochastic general equilibrium (DSGE) model by embedding financial frictions in both the banking and the corporate sectors. Furthermore, the structural shocks in the model are assumed to possess stochastic volatility (SV) with a leverage effect. Then, we estimated the model using a data-rich estimation method and utilized up to 40 macroeconomic time series in the estimation. In light of a DSGE model, we suggest the following three empirical evidences in the Great Recession:(1) the negative bank net-worth shock gradually spread before the corporate net worth shock burst ; (2) the data-rich approach and the structural shocks with SV found the contribution of the corporate net worth shock to a substantial portion of the macroeconomic fluctuations after the Great Recession, which is unlike the standard DSGE model; and (3) the Troubled Asset Relief Program (TARP) would work to bail out financial institutions, whereas balance sheets in the corporate sector would still not have stopped deteriorating. Incorporating time-varying volatilities of shocks into the DSGE model makes their credible bands narrower than half of the constant volatilities, which result implies that it is a realistic assumption based on the dynamics of the structural shocks. It is plausible that tiny volatilities (or uncertainty) in ordinary times change to an extraordinary magnitude at the turning points of business cycles. Keywords: New Keynesian DSGE model, Data-rich approach, Bayesian estimation, financial friction, stochastic volatility, leverage effect. JEL Classification: E32, E37, C32, C53.
    Date: 2014–12
  3. By: Laurence Kotlikoff (Boston University); Jasmina Hasanhodzic (Boston University)
    Abstract: We calibrate and simulate 80, 40, and 20-period OLG models with aggregate shocks to assess generational risk. We overcome the curse of dimensionality by building on the Judd, Maliar, and Maliar algorithm, which limits a model's solution to its ergodic states, with no reliance on sparse grids, state-variable aggregation, or local approximations. We find that intrinsic generational risk is quite small, that government policies can produce generational risk, and that bond markets can share generational risk, including risks generated by policy. Our results hold with rare disasters, high risk aversion, persistent shocks, and stochastic depreciation.
    Date: 2014
  4. By: L. Clerc; A. Derviz; C. Mendicino; S. Moyen; K. Nikolov; L. Stracca; J. Suarez; A. P. Vardoulakis
    Abstract: We develop a dynamic general equilibrium model for the positive and normative analysis of macroprudential policies. Optimizing financial intermediaries allocate their scarce net worth together with funds raised from saving households across two lending activities, mortgage and corporate lending. For all borrowers (households, firms, and banks) external financing takes the form of debt which is subject to default risk. This “3D model” shows the interplay between three interconnected net worth channels that cause financial amplification and the distortions due to deposit insurance. We apply it to the analysis of capital regulation.
    Keywords: Macroprudential policy; Financial frictions; Default risk.
    JEL: E3 E44 G01 G21
    Date: 2014
  5. By: Philippe Bacchetta; Kenza Benhima; Céline Poilly
    Abstract: In the aftermath of the U.S. financial crisis, both a sharp drop in employment and a surge in corporate cash have been observed. In this paper, based on U.S. data, we document that the negative relationship between the corporate cash ratio and employment is systematic, both over time and across firms. We develop a dynamic general equilibrium model where heterogenous firms need cash in their production process and where financial shocks are made of both credit and liquidity shocks. We show that external liquidity shocks generate a negative comovement between the cash ratio and employment. We analyze the dynamic impact of aggregate shocks and the cross-firm impact of idiosyncratic shocks. With a calibrated version of the model, the model yields a negative comovement that is close to the data.
    Keywords: Liquidity; Financial Shocks; Working Capital
    JEL: E44 G32 E24
    Date: 2014–12
  6. By: Semih Tumen; Deren Unalmis; Ibrahim Unalmis; D. Filiz Unsal
    Abstract: This paper investigates the mechanisms through which environmental taxes on fossil fuel usage can affect the main macroeconomic variables in the short-run. We concentrate on a particular mechanism: speculative storage. The existence of forward-looking speculators in the model improves the effectiveness of tax policies in reducing fossil fuel usage. Improved policy effectiveness, however, is costly: it drives inflation and interest rates up, while impeding output. Based on this tradeoff, we seek an answer to the question how monetary policy should interact with environmental tax policies in our DSGE model of fossil fuel storage.
    Keywords: Fossil fuels;Environmental taxes;Tax policy;General equilibrium models;Fossil fuel; environmental taxes; speculative storage; DSGE
    Date: 2014–12–18
  7. By: Pablo D'Erasmo (University of Maryland / FRB Philadelphi); Bora Durdu (Federal Reserve Board); Emine Boz (International Monetary Fund)
    Abstract: This paper explores the role of bank balance sheets, sovereign default risk, and capital adequacy requirements in amplifying aggregate fluctuations. The paper, first, proposes a unified model of defaultable sovereign debt and bank balance sheets to capture regularities on bank credit to firms, banks' holdings of sovereign bonds, and the behavior of sovereign debt and default. The model captures the procyclical bank credit and countercyclical bank holdings of sovereign bonds. Since the sovereign defaults indiscriminately, bank losses due to a default hampers its lending to firms, thereby, generating an endogenous cost of default. The paper then conducts counterfactual policy experiments in line with Basel III. Our preliminary findings suggest that the introduction of leverage ratios is superior to increasing the capital requirement on risk weighted assets where sovereign bonds are assigned a zero weight.
    Date: 2014
  8. By: Marek Antosiewicz; Piotr Lewandowski
    Abstract: In this paper we utilize an open economy DSGE model to analyse factors behind the Great Recession and its transmission into labour markets of selected Southern European countries. We introduce a number of shocks which form potential sources of macroeconomic disturbances, in particular: foreign demand, productivity, bargaining power, labour demand, labour supply, government spending, and job destruction shocks. Using quarterly data for the 1995-2013 period, we estimate the model for Germany, Greece, Italy, Portugal and Spain. We identify shocks determining macroeconomic and labour market fluctuations in each of the countries studied. We also conduct experiments allowing us to assess to what extent differences between countries with regard to macroeconomic and labour market fluctuations resulted from different shocks affecting them, and to what extent from different resilience of particular economies.
    Keywords: Unemployment, Rigidities, Great Recession, DSGE
    JEL: E32 J20 J60
    Date: 2014–08
  9. By: Per Krusell and Laurence Malafry
    Abstract: The recent experience of a Great Recession has brought the effectiveness of fiscal policy back into focus. Fiscal multipliers do, however, vary greatly over time and place. between wealth inequality and the magnitude of fiscal multipliers. To explain this finding, we develop a life-cycle, overlapping generations economy with uninsurable labor market risk. We calibrate our model to match key characteristics of a number of OECD economies, including the distribution of wages and wealth, social security, taxes and debt and study the effects of changing policies and various forms of inequality on the fiscal multiplier. We find that the fiscal multiplier is highly sensitive to the fraction of the population who face binding credit constraints and also negatively related to the average wealth level in the economy. This explains the correlation between wealth inequality and fiscal multipliers.
    Date: 2014–12–05
  10. By: Nosal, Ed (Federal Reserve Bank of Chicago); Wong, Yuet-Yee (Binghamton University); Wright, Randall (University of Wisconsin-Madison)
    Abstract: This paper generalizes Rubinstein and Wolinsky’s model of middlemen (intermediation) by incorporating production and search costs, plus more general matching and bargaining. This allows us to study many new issues, including entry, efficiency and dynamics. In the benchmark model, equilibrium exists uniquely, and involves production and intermediation for some parameters but not others. Sometimes intermediation is essential: the market operates iff middlemen are active. If bargaining powers are set correctly equilibrium is efficient; if not there can be too much or too little economic activity. This is novel, compared to the original Rubinstein-Wolinsky model, where equilibrium is always efficient.
    Keywords: Middlemen; intermediation; search; bargaining; entry
    JEL: D83 G24
    Date: 2014–11–01
  11. By: Joseph-Simon Gorlach (University College London); Christian Dustmann (University College London); Jerome Adda (European University Institute)
    Abstract: This paper analyses the wage dynamics of migrants focussing on their human capital accumulation and how it is affected by potential return migration. We develop a life-cycle model describing labor market participation, wages, return decisions as well as two forms of human capital, work experience and cultural integration. The model is estimated using panel data and exploits elicited return intentions as well as realised ones. We show that return intentions are key to understand the decision to invest in various forms of human capital and to explain differential wage paths. We show that conventional estimation methods overstate returns to work experience, as they fail to take into account selective return migration but also selective investment in human capital.
    Date: 2014
  12. By: Hünermund, Paul; Schmidt-Dengler, Philipp; Takahashi, Yuya
    Abstract: In many industries, the number of firms evolves non-monotonically over time. A phase of rapid entry is followed by an industry shakeout: a large number of firms exit within a short period. We present a simple timing game of entry and exit with an exogenous technological process governing firm efficiency. We calibrate our model to data from the post World War II penicillin industry. The equilibrium dynamics of the calibrated model closely match the patterns observed in many industries. In particular, our model generates richer and more realistic dynamics than competitive models previously analyzed. The entry phase is characterized by preemption motives while the shakeout phase mimics a war of attrition. We show that dynamic strategic incentives accelerate early entry and trigger the shakeout by comparing a Markov Perfect Equilibrium to an Open-loop Equilibrium.
    Keywords: Life Cycle,Dynamic Oligopoly,Preemption,War of Attrition,Penicillin
    JEL: L11
    Date: 2014
  13. By: Campbell, Jeffrey R. (Federal Reserve Bank of Chicago)
    Abstract: This paper considers monetary and fiscal policy when tangible assets can be accumulated after shocks that increase desired savings, like Joseph's biblical prophecy of seven fat years followed by seven lean years. The model’s flexible-price allocation mimics Joseph’s saving to smooth consumption. With nominal rigidities, monetary policy that eliminates liquidity traps leaves the economy vulnerable to confidence recessions with low consumption and investment. Josephean Quantitative Easing, a fiscal policy that purchases either obligations collateralized by tangible assets or the assets themselves, eliminates both liquidity traps and confidence recessions by putting a floor under future consumption. This requires no commitment to a time-inconsistent plan.
    Keywords: Zero Lower Bound; Liquidity Trap; Confidence Recession; Storage; Equilibrium Multiplicity; Competitive Devaluation
    JEL: E12 E63
    Date: 2014–11–05
  14. By: Katsuya Takii (Osaka School of International Public Policy (OSIPP), Osaka University)
    Abstract: We analyze equilibrium wage contracts in a competitive search model where a firm motivates workers to invest in a match-specific skill. If skill is not critical for production, the contract is first best. If critical, the contract coincides with an efficiency wage contract and cannot attain even second best. Unlike standard efficiency wage models, the wage plays a dual role, advertisement and motivation, which induces a novel source of inefficiency: the competition to attract workers forces a wage to be chosen that increases the ex ante utility of workers at the expense of ex post utility.
    Keywords: Search Theory, Incentive, Advertisement, Specific Skill
    JEL: E24 J64 M50
    Date: 2014–12
  15. By: Egor S. Malkov (National Research University Higher School of Economics)
    Abstract: As Akerlof and Shiller (2009) argue, corruption and bad faith played an important role in determining the severity of the recent recessions in the US. This paper studies the impact of robo-signing, which is a typical example of economic bad faith, on the economy and unconventional monetary policy during the last financial crisis. We modify the DSGE model by Gertler and Karadi (2011) by including the features of robo-signing. The paper concludes that banks’ bad faith magnifies the financial crisis through the transmission channel related to changes in the leverage of financial intermediaries and induces the central bank to conduct a more aggressive unconventional monetary policy. We suggest a theoretical framework for studying cases of economic bad faith during the last financial crisis, and provide a model that well fits the data.
    Keywords: robo-signing, unconventional monetary policy, bad faith, financial crisis.
    JEL: E44 E52 E58 G01 G21
    Date: 2014
  16. By: Homburg, Stefan
    Abstract: Monetary policy is superneutral in an overlapping generations model. Previous authors have argued that superneutrality does not hold in such a setting. However, the standard results rely on the counter-factual premise of helicopter money and are overturned if money creation through open market operations is taken into account.
    Keywords: Superneutrality, open market operations, seigniorage, monetary policy, overlapping generations
    JEL: E24 E43 E52
    Date: 2015–01
  17. By: Shakhnov, Kirill
    Abstract: The rapid growth of the US financial sector has driven policy debate on whether it is socially desirable. I propose a heterogeneous agent model with asymmetric information and matching frictions that produces a tradeoff between finance and entrepreneurship. By becoming bankers, talented individuals efficiently match investors with entrepreneurs, but do not internalize the negative effect on the pool of talented entrepreneurs. Thus, the financial sector is inefficiently large in equilibrium, and this inefficiency increases with wealth inequality. The model explains the simultaneous growth of wealth inequality and finance in the US, and why more unequal countries have larger financial sectors.
    Keywords: Talent; Financial sector, Matching, Productivity
    JEL: E44 G14 L26 O15
    Date: 2014
  18. By: Robert Jump
    Abstract: This paper proposes an explanation for observed differences in the business cycle volatility of employment and unemployment across a sample of OECD countries. Using an incomplete markets variant of the fair wage real business cycle model, increases in the gross replacement rate of public unemployment insurance are shown to increase the volatility of employment, and decrease the volatility of real wages, ceteris paribus. For a sample of 14 OECD countries over the period 1985-2005, the gross replacement rate is found to be positively correlated with the business cycle volatility of hours worked, lending support to the argument. A secondary contribution, which may be of some use in the incomplete markets literature, is the simple manner in which unemployment is endogenised in the model.
    Keywords: Fair Wages; Unemployment; Incomplete Markets
    JEL: E24 E32 J64 J65
    Date: 2014–09
  19. By: Costantini, Mauro (Department of Economics and Finance, Brunel University); Gunter, Ulrich (Department of Tourism and Service Management, MODUL University Vienna); Kunst, Robert M. (Department of Economics and Finance, Institute for Advanced Studies, Vienna and Department of Economics, University of Vienna)
    Abstract: We explore the benefits of forecast combinations based on forecast-encompassing tests compared to simple averages and to Bates-Granger combinations. We also consider a new combination method that fuses test-based and Bates-Granger weighting. For a realistic simulation design, we generate multivariate time-series samples from a macroeconomic DSGE-VAR model. Results generally support Bates-Granger over uniform weighting, whereas benefits of test-based weights depend on the sample size and on the prediction horizon. In a corresponding application to real-world data, simple averaging performs best. Uniform averages may be the weighting scheme that is most robust to empirically observed irregularities.
    Keywords: Combining forecasts, encompassing tests, model selection, time series, DSGE-VAR model
    Date: 2014–12
  20. By: Andrea Gerali (Bank of Italy); Alessandro Notarpietro (Bank of Italy); Massimiliano Pisani (Bank of Italy)
    Abstract: This paper evaluates the macroeconomic effects of simultaneously implementing fiscal consolidation and competition-friendly reforms in a country of the euro area by simulating a large-scale dynamic general equilibrium model. We find, first, that the joint implementation of reforms has additional expansionary effects on long-run economic activity. Increasing competition in the service sector favors a higher income tax base. Given the targeted public debt-to-GDP ratio, labor and capital income tax rates can be reduced more than with fiscal consolidation alone. Second, fiscal consolidation has non-negligible medium-run costs; however, they are reduced by joint implementation with the services reform. The results are robust to alternative assumptions that capture the impact of financial crisis on the financing conditions of households.
    Keywords: competition, fiscal policy, markups, monetary policy, public debt, spread.
    JEL: C51 E30 E63
    Date: 2014–11
  21. By: Valeri Sorolla
    Abstract: In this paper we analyze the long run effect of exogenous technological growth on the employment rate in a labor market with matching frictions when there is either individual or collective wage setting and different timing for setting wages, labor and capital. We obtain that the effect depends on the timing of setting wages with respect to capital and labor and on the way the unemployment benefit is financed. The type of wage negotiation (individual or collective) does not change really much the effect. The result that appears in most cases is that growth has a negative effect on the long run rate of employment meaning that, in general, growth is bad for employment.
    Keywords: :Matching Frictions Unemployment, Growth, Wage Setting Systems.
    JEL: E24 O41
    Date: 2014–12–22

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