nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2015‒01‒19
28 papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Wages and Wedges in an Estimated Labor Search Model By Ryan Chahrour; Sanjay K. Chugh; Tristan Potter
  2. Optimal Taxation with Endogenous Default under Incomplete Markets By Ignacio Presno; Demian Pouzo
  3. Sovereign Risk, Interbank Freezes, and Aggregate Fluctuations By Philipp Engler; Christoph Große Steffen
  4. Exchange rates dynamics with long-run risk and recursive preferences By Kollmann, Robert
  5. Land Collateral and Labor Market Dynamics in France. By L. Kaas; P. A. Pintus; S. Ray
  6. Inflation dynamics in a model with firm entry and (some) heterogeneity By Javier Andrés; Pablo Burriel
  7. Tax Reforms in Search-and-Matching Models with Heterogeneous Agents By Wei Jiang
  8. Sovereign Defaults and Banking Crises By Cesar Sosa-Padilla
  9. Intertemporal equilibrium with financial asset and physical capital. By Cuong Le Van; Ngoc-Sang Pham
  10. General Equilibrium Analysis of Conditional Cash Transfers By Nikita Céspedes
  11. Addressing Household Indebtedness: Monetary, Fiscal or Macroprudential Policy? By Sami Alpanda; Sarah Zubairy
  12. Fiscal Multipliers in the 21st Century By Pedro Brinca; Hans Holter; Per Krusell; Laurence Malafry
  13. Post-Crisis Slow Recovery and Monetary Policy By Daisuke Ikeda; Takushi Kurozumi
  14. Optimal Financial Repression By Olga A. Norkina; Sergey E. Pekarski
  15. Majority Voting: A Quantitative Investigation By Carroll, Daniel R.; Dolmas, James; Young, Eric R.
  16. Credit Supply and the Housing Boom By Justiniano, Alejandro; Primiceri, Giorgio E.; Tambalotti, Andrea
  17. Constrained Discretion and Central Bank Transparency By Bianchi, Francesco; Melosi, Leonardo
  18. Optimal Policy with Endogenous Signal Extraction By Andrea Lanteri; Albert Marcet; Esther Hauk
  19. Heterogeneity, Selection and Labor Market Disparities By Gino Gancia; Alessandra Bonfiglioli
  20. Equity Extraction and Mortgage Default By Steven Laufer
  21. Bargaining over Babies By Fabian Kindermann; Matthias Doepke
  22. A Duality Approach to Continuous-Time Contracting Problems with Limited Commitment By Yuzhe Zhang; Jianjun Miao
  23. The retail bank interest rate pass-through: The case of the euro area during the financial and sovereign debt crisis By Darracq Pariès, Matthieu; Moccero, Diego; Krylova, Elizaveta; Marchini, Claudia
  24. Trade and the Geographic Spread of the Great Recession By Sebastian Stumpner
  25. Why Doesn't Technology Flow from Rich to Poor Countries? By Harold L Cole; Jeremy Greenwood; Juan M Sanchez
  26. Banking panics and protracted recessions By Sanches, Daniel R.
  27. International Credit Flows and Pecuniary Externalities By Markus K. Brunnermeier; Yuliy Sannikov
  28. Peculiar Results and Theoretical Inconsistency of New Keynesian Models By Kim, Minseong

  1. By: Ryan Chahrour (Boston College); Sanjay K. Chugh (Boston College); Tristan Potter (Boston College)
    Abstract: We estimate a search-based real business cycle economy using quantity data and a broad set of wage indicators, allowing the latent wage to follow a non-structural ARMA process. Under the estimated process, wages adjust immediately to most shocks and induce substantial variation in labor's share of surplus. These results are not consistent with either a rigid real wage or Nash bargaining. The model fit is excellent, and smoothed realizations of the wage are consistent with empirical measures. According to the model, shocks to intertemporal preferences are the primary cause of inefficient fluctuations in the labor market and the driver of variation in labor's share of surplus.
    Keywords: Search and Matching, Wage Determination, DSGE, Bayesian Estimation
    JEL: E32 E24
    Date: 2014–12–17
  2. By: Ignacio Presno (Federal Reserve Bank of Boston); Demian Pouzo (UC Berkeley)
    Abstract: In a dynamic economy, we characterize the fiscal policy of the government when it levies distortionary taxes and issues defaultable bonds to finance its stochastic expenditure. Households predict the possibility of default, generating endogenous debt limits that hinder the government's ability to smooth shocks using debt. Default is followed by temporary financial autarky. The government can only exit this state by paying a fraction of the defaulted debt. Since this payment may not occur immediately, in the meantime, households trade the defaulted debt in secondary markets; this device allows us to price the government debt before and during the default.
    Date: 2014
  3. By: Philipp Engler; Christoph Große Steffen
    Abstract: This paper studies the bank-sovereign link in a dynamic stochastic general equilibrium set-up with strategic default on public debt. Heterogeneous banks give rise to an interbank market where government bonds are used as collateral. A default penalty arises from a breakdown of interbank intermediation that induces a credit crunch. Government borrowing under limited commitment is costly ex ante as bank funding conditions tighten when the quality of collateral drops. This lowers the penalty from an interbank freeze and feeds back into default risk. The arising amplification mechanism propagates aggregate shocks to the macroeconomy. The model is calibrated using Spanish data and is capable of reproducing key business cycle statistics alongside stylized facts during the European sovereign debt crisis.
    Keywords: Sovereign default, interbank market, bank-sovereign link, Non-Ricardian effects, secondary markets, domestic debt, occasionally binding constraint
    JEL: E43 E44 F34 H63
    Date: 2014
  4. By: Kollmann, Robert (ECARES, Universite Libre de Bruxelles)
    Abstract: Standard macro models cannot explain why real exchange rates are volatile and disconnected from macro aggregates. Recent research argues that models with persistent growth rate shocks and recursive preferences can solve that puzzle. I show that this result is highly sensitive to the structure of financial markets. When just a bond is traded internationally, then long-run risk generates insufficient exchange rate volatility. A long-run risk model with recursive-preferences can generate realistic exchange rate volatility, if all agents efficiently share their consumption risk by trading in complete financial markets; however, this entails massive international wealth transfers, and excessive swings in net foreign asset positions. By contrast, a long-run risk, recursive-preferences model in which only a fraction of households trades in complete markets, while the remaining households lead hand-to-mouth lives, can generate realistic exchange rate and external balance volatility.
    JEL: F31 F36 F41 F43 F44
    Date: 2014–11–01
  5. By: L. Kaas; P. A. Pintus; S. Ray
    Abstract: The value of land in the balance sheet of French firms correlates positively with their hiring and investment flows. To explore the relationship between these variables, we develop a macroeconomic model with firms that are subject to both credit and labor market frictions. The value of collateral is driven by the forward-looking dynamics of the land price which reacts endogenously to fundamental and non-fundamental (sunspot) shocks. We calibrate the model to French data and find that land price shocks give rise to significant amplification and hump-shaped responses of investment, vacancies and unemployment that are in line with the data. We show that both the endogenous movements in the firms’ discount factor and the sluggish response of the land price are key elements that drive the results.
    Keywords: Financial shocks; Labor market frictions.
    JEL: E24 E32 E44
    Date: 2014
  6. 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
  7. By: Wei Jiang
    Abstract: Using a Mortensen-Pissarides search-and-matching framework, this paper investigates the importance of search frictions in determining the welfare and distributional effects of tax reforms that re-allocate the tax burden from capital to labour income. Calibrating the model to the UK economy, we find that the tax reforms are Pareto improving but increase inequality in the long run, despite welfare losses for at least one segment of the population in the short run. The results are robust to the variations in the relative bargaining power of workers and different specifications of unemployment benefit. But the welfare gains are higher for all agents if the relative bargaining power of workers is reduced or we assume that unemployment benefit depends on past wages.
    Keywords: search frictions; agent heterogeneity; unemployment benefits; tax reforms
    JEL: E21 E24 E62
    Date: 2014–12
  8. By: Cesar Sosa-Padilla (McMaster University)
    Abstract: Episodes of sovereign default feature three key empirical regularities in connection with the banking systems of the countries where they occur: (i) sovereign defaults and banking crises tend to happen together, (ii) commercial banks have substantial holdings of government debt, and (iii) sovereign defaults result in major contractions in bank credit and production. This paper provides a rationale for these phenomena by extending the traditional sovereign default framework to incorporate bankers that lend to both the government and the corporate sector. When these bankers are highly exposed to government debt a default triggers a banking crisis, which leads to a corporate credit collapse and subsequently to an output decline. When calibrated to Argentina's 2001 default episode the model produces default on equilibrium with a frequency in line with actual default frequencies, and when it happens credit experiences a sharp contraction which generates an output drop similar in magnitude to the one observed in the data. Moreover, the model also matches several moments of the cyclical dynamics of macroeconomic aggregates.
    Date: 2014
  9. By: Cuong Le Van (Centre d'Economie de la Sorbonne - Paris School of Economics, IPAG Business School and VCREME); Ngoc-Sang Pham (Centre d'Economie de la Sorbonne)
    Abstract: We build an infinite-horizon dynamic deterministic general equilibrium model with imperfect markets (because of borrowing constraints), in which heterogeneous agents invest in capital or/and financial asset, and consume. There is a representative firm who maximizes its profit. Firstly, the existence of intertemporal equilibrium is proved even if aggregate capital is not uniformly bounded. Secondly, we study the interaction between the financial market and the productive sector. We also give conditions to have no bubbles on the financial asset market and the physical asset market as well.
    Keywords: Infinite horizon, intertemporal equilibrium, financial friction, productivity, efficiency, fluctuation.
    JEL: C62 D31 D91 G10 E44
    Date: 2014–08
  10. By: Nikita Céspedes (Banco Central de Reserva del Perú)
    Abstract: Conditional Cash Transfer (CCT) program is one of the most important anti-poverty policies worldwide. In this document, I study the economic effects of this program by using a stylized dynamic general equilibrium model. I look at the program’s impact on output, human capital, poverty and income inequality. I also study its welfare implications and its effects on the intergenerational transmission of poverty. The quantitative analysis reveals that a long-term implementation of this anti-poverty program helps to reduce the intergenerational transmission of poverty. In aggregate terms the welfare gain is small, but varies across agents; the winners are those who are in the lower tail of the income distribution and the losers are those located in the upper tail. Finally, this program increases the human capital of households and, through this channel, induces a consistent reduction of both poverty and income inequality.
    Keywords: Poverty, Welfare, Cash Transfer, General Equilibrium, Inequality, Overlapping Generations
    JEL: D52 D58 D62 D64 I30 I32 I38
    Date: 2014–12
  11. By: Sami Alpanda; Sarah Zubairy
    Abstract: In this paper, we build a dynamic stochastic general-equilibrium model with housing and household debt, and compare the effectiveness of monetary policy, housing-related fiscal policy, and macroprudential regulations in reducing household indebtedness. The model features long-term fixed-rate borrowing and lending across two types of households, and differentiates between the flow and the stock of household debt. We use Bayesian methods to estimate parameters related to model dynamics, while level parameters are calibrated to match key ratios in the U.S. data. We find that monetary tightening is able to reduce the stock of real mortgage debt, but leads to an increase in the household debt-toincome ratio. Among the policy tools we consider, tightening in mortgage interest deduction and regulatory loan-to-value (LTV) are the most effective and least costly in reducing household debt, followed by increasing property taxes and monetary tightening. Although mortgage interest deduction is a broader tool than regulatory LTV, and therefore potentially more costly in terms of output loss, it is effective in reducing overall mortgage debt, since its direct reach also extends to home equity loans.
    Keywords: Housing; Transmission of monetary policy; Financial system regulation and policies; Economic models
    JEL: E52 E62 R38
    Date: 2014
  12. By: Pedro Brinca; Hans Holter; Per Krusell; 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. Running VARs for a large number of countries, we document a strong correlation 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.
    JEL: E21 E62 H50
    Date: 2014–12–23
  13. By: Daisuke Ikeda (Director and Senior Economist, Institute for Monetary and Economic Studies, Bank of Japan (E-mail:; Takushi Kurozumi (Director and Senior Economist, Institute for Monetary and Economic Studies, Bank of Japan (E-mail:
    Abstract: In the aftermath of the recent financial crisis and subsequent recession, slow recoveries have been observed and slowdowns in total factor productivity (TFP) growth have been measured in many economies. This paper develops a model that can describe a slow recovery resulting from an adverse financial shock in the presence of an endogenous mechanism of TFP growth, and examines how monetary policy should react to the financial shock in terms of social welfare. It is shown that in the face of the financial shocks, a welfare-maximizing monetary policy rule features a strong response to output, and the welfare gain from output stabilization is much more substantial than in the model where TFP growth is exogenously given. Moreover, compared with the welfare-maximizing rule, a strict inflation or price-level targeting rule induces a sizable welfare loss because it has no response to output, whereas a nominal GDP growth or level targeting rule performs well, although it causes high interest-rate volatility. In the presence of the endogenous TFP growth mechanism, it is crucial to take into account a welfare loss from a permanent decline in consumption caused by a slowdown in TFP growth.
    Keywords: Financial shock, Endogenous TFP growth, Slow recovery, Monetary policy, Welfare cost of business cycle
    JEL: E52 O33
    Date: 2014–12
  14. By: Olga A. Norkina (National Research University Higher School of Economics); Sergey E. Pekarski (National Research University Higher School of Economics)
    Abstract: Modern financial repression in advanced economies does not rely on increasing seigniorage revenue, but mostly rests upon regulatory measures to enlarge the demand for public debt that delivers extremely low or negative real interest rate. In this paper we propose the extension of the overlapping generations model to question the optimality of financial repression in the form of non-market placement of the public debt in the captive pension fund. We show that financial repression and capital income taxation are not perfect substitutes. The optimal degree of financial repression depends on the growth rate of population. Moreover, the benevolent government makes a decision to confiscate some part of the pension wealth
    Keywords: financial repression; fully-funded pension system; public debt; overlapping generations.
    JEL: E62 G28 H21 H55 H63
    Date: 2014
  15. By: Carroll, Daniel R. (Federal Reserve Bank of Cleveland); Dolmas, James (Federal Reserve Bank of Dallas); Young, Eric R. (University of Virginia)
    Abstract: We study the tax systems that arise in a once-and-for-all majority voting equilibrium embedded within a macroeconomic model of inequality. We find that majority voting delivers (i) a small set of outcomes, (ii) zero labor income taxation, and (iii) nearly zero transfers. We find that majority voting, contrary to the literature developed in models without idiosyncratic risk, is quite powerful at restricting outcomes; however, it also delivers predictions inconsistent with observed tax systems.
    Keywords: Political Economy; Essential Set; Voting; Inequality; Incomplete Markets
    JEL: D52 D72 E62
    Date: 2015–01–07
  16. By: Justiniano, Alejandro (Federal Reserve Bank of Chicago); Primiceri, Giorgio E. (Northwestern University); Tambalotti, Andrea (Federal Reserve Bank of New York)
    Abstract: The housing boom that preceded the Great Recession was due to an increase in credit supply driven by looser lending constraints in the mortgage market. This view on the fundamental drivers of the boom is consistent with four empirical observations: the unprecedented rise in home prices and household debt, the stability of debt relative to house values, and the fall in mortgage rates. These facts are difficult to reconcile with the popular view that attributes the housing boom to looser borrowing constraints associated with lower collateral requirements. In fact, a slackening of collateral constraints at the peak of the lending cycle triggers a fall in home prices in our framework, providing a novel perspective on the possible origins of the bust.
    Keywords: Credit; housing prices; mortgages
    JEL: E44 G21 R21
    Date: 2014–07–01
  17. By: Bianchi, Francesco (Duke University); Melosi, Leonardo (Federal Reserve Bank of Chicago)
    Abstract: We develop and estimate a general equilibrium model in which monetary policy can deviate from active inflation stabilization and agents face uncertainty about the nature of these deviations. When observing a deviation, agents conduct Bayesian learning to infer its likely duration. Under constrained discretion, only short deviations occur: Agents are confident about a prompt return to the active regime, macroeconomic uncertainty is low, welfare is high. However, if a deviation persists, agents’ beliefs start drifting, uncertainty accelerates, and welfare declines. If the duration of the deviations is announced, uncertainty follows a reverse path. For the U.S. transparency lowers uncertainty and increases welfare.
    Keywords: Bayesian learning; reputation; uncertainty; expectations; Markov-switching models; impulse response
    JEL: C11 D83 E52
    Date: 2014–07–01
  18. By: Andrea Lanteri (London School of Economics); Albert Marcet (Institut d'Anàlisi Econòmica CSIC, BGS); Esther Hauk (Spanish Research Council)
    Abstract: This paper studies optimal policy in models with multidimensional uncertainty and endogenous observables. We first consider a very general setup where the policy-maker does not observe the realisations of the shocks that hit the economy, but only some aggregate variables that are endogenous with respect to policy, therefore standard first order conditions do not hold. We derive first order conditions of optimality from first principles and we illustrate why the estimation of the state of the economy cannot be separated from the determination of the optimal policy. In an optimal fiscal policy application with incomplete markets and endogenous Partial Information, we find that the optimal policy response to aggregate data can be quite non-linear: it calls for tax smoothing across states in normal times, but in some cases for a strong adjustment of fiscal positions during a slump. We show that policies that disregard the endogeneity of the filtering problem and hence these non-linearities can be quite wrong. Finally, our model can rationalise the fiscal response of some European countries to the Great Recession: a slow reaction, followed by large deficits and a delayed sharp fiscal adjustment that protracts the downturn.
    Date: 2014
  19. By: Gino Gancia (CREI); Alessandra Bonfiglioli (Universitat Pompeu Fabra)
    Abstract: We study the incentives to acquire skill in a model where heterogeneous firms and workers interact in a labor market characterized by matching frictions and costly screening. When effort in acquiring skill raises both the mean and the variance of the resulting ability distribution, multiple equilibria may arise. In the high-effort equilibrium, heterogeneity in ability is sufficiently large to induce firms to select the best workers, thereby confirming the belief that effort is important for finding good jobs. In the low-effort equilibrium, ability is not sufficiently dispersed to justify screening, thereby confirming the belief that effort is not so important. The model has implications for wage inequality, the distribution of firm characteristics, sorting patterns between firms and workers, and unemployment rates that can help explaining observed cross-country variation in socio-economic and labor market outcomes.
    Date: 2014
  20. By: Steven Laufer (Federal Reserve Board)
    Abstract: Using a property-level data set of houses in Los Angeles County, I estimate that 30% of the recent surge in mortgage defaults is attributable to early home-buyers who would not have defaulted had they not borrowed against the rising value of their homes during the boom. I develop and estimate a structural model capable of explaining the patterns of both equity extraction and default observed among this group of homeowners. In the model, most of these defaults are attributable to the high loan-to-value ratios generated by this additional borrowing combined with the expectation that house prices would continue to decline. Only 30% are the result of income shocks and liquidity constraints. I use this model to analyze a policy that limits the maximum size of cash-out refinances to 80% of the current house value. I find that this restriction would reduce house prices by 14% and defaults by 28%. Despite the reduced borrowing opportunities, the welfare gain from this policy for new homeowners is equivalent to 3.2% of consumption because of their ability to purchase houses at lower prices.
    Date: 2014
  21. By: Fabian Kindermann (University of Wuerzburg); Matthias Doepke (Northwestern University)
    Abstract: It takes a woman and a man to make a baby. This observation suggests that for a birth to take place, both parents should agree that they are better off with another child. In this paper, we first show empirically that agreement between the parents indeed makes a birth much more likely. We then build a bargaining model of fertility choice and calibrate the model to data on fertility preferences and realized fertility. The quantitative model can be used to examine how policies such as child subsidies and public provision of child care affect childbearing. Unlike a theory that abstracts from bargaining, our analysis shows that the distribution of benefits among mothers and fathers is the key determinant of a policy’s impact on fertility.
    Date: 2014
  22. By: Yuzhe Zhang (Texas A&M University); Jianjun Miao (Boston University)
    Abstract: We propose a duality approach to solving contracting models with either one-sided or two-sided limited commitment in continuous time. We establish weak and strong duality theorems and provide a dynamic programming characterization of the dual problem. The dual problem gives a linear Hamilton-Jacobi-Bellman equation with a known state space subject to free-boundary conditions, making analysis much more tractable than the primal problem. We provide two explicitly solved examples of a consumption insurance problem. We characterize the optimal consumption allocation in terms of the marginal utility ratio. We find that neither autarky nor full risk sharing can be an optimal contract with two-sided limited commitment, unlike in discrete-time models. We also derive an explicit solution for the unique long-run stationary distribution of consumption relative to income.
    Date: 2014
  23. By: Darracq Pariès, Matthieu; Moccero, Diego; Krylova, Elizaveta; Marchini, Claudia
    Abstract: This paper analyses the cross-country heterogeneity in retail bank lending rates in the euro area and presents newly developed pass-through models that account for the riskiness of borrowers, the balance sheet constraints of lenders and sovereign debt tensions affecting interest rate-setting behaviour. Country evidence for the four largest euro area countries shows that downward adjustments in policy rates and market reference rates have translated into a concomitant reduction in bank lending rates. In the case of Spain and Italy, however, sovereign bond market tensions and a deteriorating macroeconomic environment have put upward pressure on composite lending rates to non-financial corporations and households. At the same time, model simulations suggest that higher lending rates have propagated to the broader economy by depressing economic activity and inflation. As a response to increasing financial fragmentation, the ECB has introduced several standard and non-standard monetary policy measures. These measures have gone a long way towards alleviating financial market tensions in the euro area. However, in order to ensure the adequate transmission of monetary policy to financing conditions, it is essential that the fragmentation of euro area credit markets is reduced further and the resilience of banks strengthened where needed. Simulation analysis confirms that receding financial fragmentation could help to boost economic activity in the euro area in the medium term. JEL Classification: J64
    Keywords: bank lending rates, DSGE models, financial fragmentation, monetary policy, pass-through models
    Date: 2014–09
  24. By: Sebastian Stumpner (UC Berkeley)
    Abstract: I use the large spatial variation in consumer demand shocks at the onset of the Great Recession to study the mechanisms behind the ensuing geographic spread of the crisis. While the initial increase in unemployment was concentrated in areas with housing busts, subsequently unemployment slowly spread across space. By 2009, it was above pre-crisis levels in almost all U.S. counties. I show that trade was an important driver of this geographic spread of the crisis. To identify the trade channel empirically, I make use of heterogeneity in the direction of trade flows across industries in the same state: Industries that sold relatively more to states with housing boom-bust cycles grew by more before the crisis and declined faster from 2007-09. These results cannot be explained by a collapse in credit supply. I then link the reduced form empirical evidence to a formal model of contagion through trade. In a quantitative exercise, the model delivers a cross-sectional effect of similar magnitude as the one found empirically and reveals that the trade channel can explain roughly half of the overall spread.
    Date: 2014
  25. By: Harold L Cole (University of Pennsylvania); Jeremy Greenwood (University of Pennsylvania); Juan M Sanchez (Federal Reserve Bank of St. Louis)
    Abstract: What determines the technology that a country adopts? While many factors affect technological adoption, the efficiency of the country's financial system may also play a significant role. To address this question, a dynamic contract model is embedded into a general equilibrium setting with competitive intermediation. The ability of an intermediary to monitor and control the cash flows of a firm plays an important role in the technology adoption decision. Can such a theory help to explain the differences in total factor productivity and establishment-size distributions across India, Mexico, and the United States? A quantitative illustration suggests the answer is yes.
    Keywords: Costly cash-flow control, costly state verification, dynamic contract theory, economic development, establishment-size distributions, finance and development, financial intermediation, India, Mexico, and the United States, monitoring; productivity, self-finance, technology adoption, ventures
    JEL: E13 O11 O16
    Date: 2014–12
  26. By: Sanches, Daniel R. (Federal Reserve Bank of Philadelphia)
    Abstract: This paper develops a dynamic theory of money and banking that explains why banks need to hold an illiquid portfolio to provide socially optimal transaction and liquidity services, opening the door to the possibility of equilibrium banking panics. Following a widespread liquidation of banking assets in the event of a panic, the banking portfolio consistent with the optimal provision of transaction and liquidity services during normal times cannot be quickly reestablished, resulting in an unusual loss of wealth for all depositors. This negative wealth effect stemming from the liquid portion of the consumers' portfolio is strong enough to produce a protracted recession. A key element of the theory is the existence of a dynamic interaction between the ability of banks to offer transaction and liquidity services and the occurrence of panics.
    Keywords: Banking Panics; Medium Of Exchange; Random Matching; Transaction Services; Liquidity Insurance
    JEL: E32 E42 G21
    Date: 2014–12–22
  27. By: Markus K. Brunnermeier; Yuliy Sannikov
    Abstract: This paper develops a dynamic two-country neoclassical stochastic growth model with incomplete markets. Short-term credit flows can be excessive and reverse suddenly. The equilibrium outcome is constrained inefficient due to pecuniary externalities. First, an undercapitalized country borrows too much since each firm does not internalize that an increase in production capacity undermines their output price, worsening their terms of trade. From an ex-ante perspective each firm undermines the natural “terms of trade hedge.” Second, sudden stops and fire sales lead to sharp price drops of illiquid capital. Capital controls or domestic macro-prudential measures that limit short-term borrowing can improve welfare.
    JEL: F32 F43 G15 O41
    Date: 2014–12
  28. By: Kim, Minseong
    Abstract: In this paper, several flaws of the basic no-capital/labor-only New Keynesian model are discussed. Some flaws were left undiscovered because mass of varieties n in Dixit-Stiglitz aggregator is often considered as not affecting overall outcomes. Only when n=1 would ordinary results of the basic New Keynesian model hold. To save the theory, we consider the case where production function exhibits constant return to scale for its input labor, then concludes that linear production function itself leads to other sets of problems. The aforementioned results are proven by checking several limit cases of the basic New Keynesian model, which itself is the limit case model of several New Keynesian models. Then we show some problems with applying transversality condition to consumption Euler equation of the model.
    Keywords: Dixit-Stiglitz aggregator; CES; New Keynesian model; Inconsistency; production function; consumption Euler equation; IS curve; transversality condition; monetary rule
    JEL: E12 E13 E32 E52
    Date: 2014–12–30

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