nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2015‒02‒11
29 papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Fiscal Stimulus and Unemployment Dynamics By Chun-Hung Kuo; Hiroaki Miyamoto
  2. Inventories and the role of goods-market frictions for business cycles By Wouter J. Den Haan
  3. Modeling Labor Markets in Macroeconomics: Search and Matching By Lubik, Thomas A.; Krause, Michael U.
  4. Sentiment and the U.S. Business Cycle By Fabio Milani
  5. Capital Regulation in a Macroeconomic Model with Three Layers of Default By Clerc, Laurent; Derviz, Alexis; Mendicino, Caterina; Moyen, Stéphane; Nikolov, Kalin; Stracca, Livio; Suarez, Javier; Vardoulakis, Alexandros
  6. Optimal unemployment insurance over the business cycle By Camille Landais; Pascal Michaillat; Emmanuel Saez
  7. Unconventional monetary policy in an open economy By Gieck, Jana
  8. Mortgages and monetary policy By Carlos Garriga; Finn E. Kydland; Roman Šustek
  9. The Effects of Oil Price Shocks in a New-Keynesian Framework with Capital Accumulation. By Verónica Acurio Vasconez; Gaël Giraud; Florent Mc Isaac; Ngoc Sang Pham
  10. Capital structure and investment dynamics with fire sales By Douglas Gale; Piero Gottardi
  11. Sovereign Debt vs Redistributive Taxes: Financing Recoveries in Unequal and Uncommitted Economies By Mikhail Golosov; Ali Shourideh; Alessandro Dovis
  12. Buying First or Selling First in Housing Markets By Moen, Espen R; Nenov, Plamen T.; Sniekers, Florian
  13. External Equity Financing Costs, Financial Flows, and Asset Prices By Xiaoji Lin; Fan Yang; Frederico Belo
  14. Trends and cycles in small open economies: making the case for a general equilibrium approach By Chen, Kan; Crucini, Mario J.
  15. Firm turnover and inflation dynamics By Lenno Uusküla
  16. The Power of Forward Guidance Revisited By Alisdair McKay; Emi Nakamura; Jón Steinsson
  17. Rehypothecation By Andolfatto, David; Martin, Fernando M.; Zhang, Shengxing
  18. Impulse Response Matching Estimators for DSGE Models By Guerron-Quintana, Pablo A.; Inoue, Atsushi; Kilian, Lutz
  19. Explaining the boom-bust cycle in the U.S. housing market: a reverse-engineering approach By Gelain, Paolo; Lansing, Kevin J.; Natvik, Gisele J.
  20. Social Security Benefits, Life Expectancy and Early Retirement By Qi Li; Juan Pantano; Daifeng He; Maria Casanova
  21. Dynamic equilibrium with rare events and heterogeneous Epstein-Zin investors By Georgy Chabakauri
  22. Pensions, Savings and Housing: A Life-cycle Framework with Policy Simulations By Creedy, John; Gemmell, Norman; Scobie, Grant
  23. The transmission of monetary policy operations through redistributions and durable purchases By Vincent Sterk; Silvana Tenreyro
  24. A Model of Market and Political Power Interactions for Southern Europe By Kollintzas, Tryphon; Papageorgiou, Dimitris; Vassilatos, Vanghelis
  25. Housing over time and over the life cycle: a structural estimation By Li, Wenli; Liu, Haiyong; Yang, Fang; Yao, Rui
  26. International Credit Flows and Pecuniary Externalities By Brunnermeier, Markus K; Sannikov, Yuliy
  27. Costly Search with Adverse Selection: Solicitation Curse vs. Accelerating Blessing By Marilyn Pease; Kyungmin Kim
  28. Time-varying disaster risk models: An empirical assessment of the Rietz-Barro hypothesis By Alfonso Irarrazabal; Juan Carlos Parra-Alvarez
  29. On the Welfare Cost of Consumption Fluctuations in the Presence of Memorable Goods, Second Version By Rong Hai; Dirk Krueger; Andrew Postlewaite

  1. By: Chun-Hung Kuo (International University of Japan); Hiroaki Miyamoto (The University of Tokyo)
    Abstract: Focusing on both hiring and firing margins, this paper revisits effects of fiscal expansion on unemployment. We develop a DSGE model with search frictions where job separation is endogenously determined. The predictions of the model are in contrast with earlier studies that assume exogenous separation. Our model can capture the empirical pattern of responses of the job finding, separation, and unemployment rates to a government spending shock, obtained from estimating a structural VAR model with the U.S. data. However, our model fails to capture the response of vacancies and the volatility of unemployment.
    Keywords: Fiscal Policy, Unemployment, Labor market, Search and matching, Endogenous separation
    JEL: E24 E62 J64
    Date: 2015–01
  2. By: Wouter J. Den Haan
    Abstract: Changes in the stock of inventories are important for �fluctuations in aggregate output. However, the possibility that firms do not sell all produced goods and inventory accumulation are typically ignored in business cycle models. This paper captures this with a goods-market friction. Using US data, "goods-market efficiency" is shown to be strongly procyclical. By including both a goods-market friction and a standard labor-market search friction, the model developed can substantially magnify and propagate shocks. Despite its simplicity, the model can also replicate key inventory facts. However, when these inventory facts are used to discipline parameter values, then goods-market frictions are quantitatively not very important.
    Keywords: matching models; search frictions; magnification propagation
    JEL: E12 E24 E32
    Date: 2013–12–30
  3. By: Lubik, Thomas A. (Federal Reserve Bank of Richmond); Krause, Michael U. (Universityof Cologne)
    Abstract: We present and discuss the simple search and matching model of the labor market against the background of developments in modern macroeconomics. We derive a simple representation of the model in a general equilibrium context and how the model can be used to analyze various policy issues in labor markets and monetary policy.
    JEL: E24 E32 J23 J64
    Date: 2014–12–15
  4. By: Fabio Milani (University of California, Irvine)
    Abstract: Psychological factors are commonly believed to play a role on cyclical economic fluctuations, but they are typically omitted from state-of-the-art macroeconomic models. This paper introduces “sentiment†in a medium-scale DSGE model of the U.S. economy and tests the empirical contribution of sentiment shocks to business cycle fluctuations. The assumption of rational expectations is relaxed. The paper exploits, instead, observed data on expectations in the estimation. The observed expectations are assumed to be formed from a near-rational learning model. Agents are endowed with a perceived law of motion that resembles the model solution under rational expectations, but they lack knowledge about the solution’s reduced- form coefficients. They attempt to learn those coefficients over time using available time series at each point in the sample and updating their beliefs through constant-gain learning. In each period, however, they may form expectations that fall above or below those implied by the learning model. These deviations capture excesses of optimism and pessimism, which can be quite persistent and which are defined as sentiment in the model. Different sentiment shocks are identified in the empirical analysis: waves of undue optimism and pessimism may refer to expected future consumption, future investment, or future inflationary pressures. The results show that exogenous variations in sentiment are responsible for a sizable (about forty percent) portion of historical U.S. business cycle fluctuations. Sentiment shocks related to investment decisions, which evoke Keynes' animal spirits, play the largest role. When the model is estimated imposing the rational expectations hypothesis, instead, the role of structural investment-specific and neutral technology shocks significantly expands to capture the omitted contribution of sentiment.
    Date: 2014
  5. By: Clerc, Laurent; Derviz, Alexis; Mendicino, Caterina; Moyen, Stéphane; Nikolov, Kalin; Stracca, Livio; Suarez, Javier; Vardoulakis, Alexandros
    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: Default risk; Financial frictions; Macroprudential policy
    JEL: E3 E44 G01 G21
    Date: 2014–12
  6. By: Camille Landais; Pascal Michaillat; Emmanuel Saez
    Abstract: This paper analyzes optimal unemployment insurance (UI) over the business cycle. We consider a general matching model of the labor market. For a given UI, the economy is efficient if tightness satisfies a generalized Hosios condition, slack if tightness is too low, and tight if tightness is too high. The optimal UI formula is the sum of the standard Baily-Chetty term, which trades off search incentives and insurance, and an externality-correction term, which is positive if UI brings the economy closer to efficiency and negative otherwise. Our formula therefore deviates from the Baily-Chetty formula when the economy is inefficient and UI affects labor market tightness. In a model with rigid wages and concave production function, UI increases tightness; hence, UI should be more generous than in the Baily-Chetty formula when the economy is slack, and less generous otherwise. In contrast, in a model with linear production function and Nash bargaining, UI increases wages and reduces tightness; hence, UI should be less generous than in the Baily-Chetty formula when the economy is slack, and more generous otherwise. Deviations from the Baily-Chetty formula can be quantitatively large using realistic empirical parameters.
    JEL: N0 R14 J01
    Date: 2013–08–19
  7. By: Gieck, Jana
    Abstract: The impact of unconventional monetary policies on exchange rates and its spillovers to other economies is not yet fully understood. In this paper I develop a two-country DSGE model with interbank markets and endogenous default probabilities to analyze the cross-border impacts of unconventional monetary policy. I examine the impact of two unconventional measures commonly used: central bank liquidity injections and asset swaps. I find that liquidity injections lead to a short run appreciation of domestic currency, but a mild long run depreciation. In contrast, asset swaps cause a short run depreciation of domestic currency, but a long run appreciation. Lastly, when both countries coordinate on the implementation of unconventional policies, the model yields the following results: Non-coordinated liquidity injections lead to higher increases with respect to output and inflation variation, but have negative spillovers on the other economy in terms of lower growth. By contrast, coordinating asset swaps leads to higher increases in output and lower fluctuation in inflation in both countries. The results of this paper suggest that coordination in unconventional monetary policy may not always yield an optimal outcome, and macroeconomic outcomes in both countries depend crucially on the choice of instrument.
    Keywords: Unconventional Monetary Policy,Quantitative Easing,Asset Swaps,Open Economy DSGE,Currency Wars,Policy Coordination
    JEL: E02 E44 E52 G21 G28
    Date: 2014
  8. By: Carlos Garriga; Finn E. Kydland; Roman Šustek
    Abstract: Mortgage loans are a striking example of a persistent nominal rigidity. As a result, under incomplete markets, monetary policy affects decisions through the cost of new mortgage borrowing and the value of payments on outstanding debt. Observed debt levels and payment to income ratios suggest the role of such loans in monetary transmission may be important. A general equilibrium model is developed to address this question. The transmission is found to be stronger under adjustable- than fixed-rate contracts. The source of impulse also matters: persistent inflation shocks have larger effects than cyclical fluctuations in inflation and nominal interest rates.
    Keywords: mortgages; debt servicing costs; monetary policy; transmission mechanism; housing investment
    JEL: E32 E52 G21 R21
    Date: 2013–12–05
  9. By: Verónica Acurio Vasconez (Centre d'Economie de la Sorbonne); Gaël Giraud (Centre d'Economie de la Sorbonne - Paris School of Economics); Florent Mc Isaac (Centre d'Economie de la Sorbonne); Ngoc Sang Pham (Centre d'Economie de la Sorbonne)
    Abstract: The economic implications of oil price shocks have been extensively studied since the 1970s'. Despite this huge literature, no dynamic stochastic general equilibrium model was available that captures two well-known stylized facts: 1) the stagflationary impact of an oil price shock, together with 2) the influence of the energy productivity of capital on the depth and length of this impact. We build, estimate and simulate a New-Keynesian model with capital accumulation, which takes the case of an economy where oil is imported from abroad, and where these stylized facts can be accounted for. Moreover, the Bayesian estimation of the model on the US economy (1984-2007) suggests that the output elasticity of oil might have been above 10%, stressing the role of oil use in US growth at this time. Finally, our simulations confirm that an increase in energy efficiency significantly attenuates the effects of an oil shock —a possible explanation of why the third oil shock (1999-2008) did not have the same macro-economic impact as the first two ones.
    Keywords: New-Keynesian model, DSGE, oil, capital accumulation, stagflation, energy productivity.
    JEL: C68 E12 E23 Q43
    Date: 2014–12
  10. By: Douglas Gale; Piero Gottardi
    Abstract: We study a general equilibrium model in which firms choose their capital structure optimally, trading off the tax advantages of debt against the risk of costly default. The costs of default are endogenous: bankrupt firms are forced to liquidate their assets, resulting in a fire sale if there is insufficient liquidity in the market. When the corporate income tax rate is zero, the optimal capital structure is indeterminate, there are no fire sales, and the equilibrium is Pareto efficient. When the tax rate is positive, the optimal capital structure is uniquely determined, default occurs with positive probability, firms’ assets are liquidated at fire-sale prices, and the equilibrium is constrained inefficient. More precisely, firms’ investment is too low and, although the capital structure is chosen optimally, in equilibrium too little debt is used. We also show that introducing more liquidity into the system can be counter-productive: although it reduces the severity of fire sales, it also reduces welfare.
    Keywords: debt; equity; capital structure; default; market liquidity; constrained inefficient; incomplete markets
    JEL: F3 G3
    Date: 2013–10–30
  11. By: Mikhail Golosov (Princeton University); Ali Shourideh (University of Pennsylavnia); Alessandro Dovis (Penn State)
    Abstract: In this paper, we study optimal design of taxes and debt in the medium term in presence of domestic inequality and lack of commitment. We study an OLG economy in which individuals work and save for retirement when young. Government of the small open economy provides transfers to both the young and the old while it can decide to finance its spending via taxation of labor income as well as borrowing from the rest of the world. We show that in such environment, government has two different motives to renege on its past promises: 1. `Domestic default' to reduce domestic wealth inequality, 2. `Sovereign default' to reduce transfers to foreign lenders. We show that episodes of high income inequality create strong incentive for sovereign default. We show that this interaction between the domestic and sovereign default motive leads to oscillatory dynamics in the model. That is, it is optimal for such economies to periodically raise taxes above and below its long-run levels during an episode of economic recovery. Moreover, the level of after tax income inequality is time-varying: When the government is repaying foreign debt it is optimal to allow for more inequality.
    Date: 2014
  12. By: Moen, Espen R; Nenov, Plamen T.; Sniekers, Florian
    Abstract: Housing transactions by owner-occupiers take two steps, purchase of a new property and sale of the old housing unit. This paper shows how the transaction sequence decision of owner-occupiers depends on, and in turn, affects housing market conditions in an equilibrium search-and-matching model of the housing market. We show that home-owners prefer to buy first whenever there are more buyers than sellers in the market. This behavior leads to multiple steady state equilibria and to self-fulfilling fluctuations in prices and time-on-market. Equilibrium switches creates large fluctuations in the housing market, which are broadly consistent with stylized facts on the housing cycle.
    Keywords: housing market; order of transactions; search frictions; strategic complementarities
    JEL: R21 R31
    Date: 2015–01
  13. By: Xiaoji Lin (The Ohio State University); Fan Yang (University of Hong Kong); Frederico Belo (University of Minnesota and NBER)
    Abstract: The recent financial crisis in 2007-2008 suggests that financial shocks, the aggregate disturbances that originate directly in the financial sector, can play an important role as a source of business cycle fluctuations. In this paper, we explore the impact of aggregate shocks to the cost of equity issuance on asset prices in the cross section. We document that an empirical proxy of equity issuance cost shocks forecast future economic activity (output, consumption, and investment), and is a source of systematic risk: exposure to this shock helps price the cross section of stock returns including book-to-market, size, investment, and cash-flow portfolios. We propose a dynamic investment-based model that features an aggregate shock to the firms’ cost of external equity issuance, and a collateral constraint. Our central finding is that time-varying external ï¬nancing costs are crucial for the model to quantitatively capture the joint dynamics of firms’ real quantities, financing flows, and asset prices. Furthermore, the model also replicates the failure of the unconditional CAPM in pricing the cross-sectional expected returns.
    Date: 2014
  14. By: Chen, Kan (International Monetary Fund); Crucini, Mario J. (Vanderbilt University)
    Abstract: Economic research into the causes of business cycles in small open economies is almost always undertaken using a partial equilibrium model. This approach is characterized by two key assumptions. The first is that the world interest rate is unaffected by economic developments in the small open economy, an exogeneity assumption. The second assumption is that this exogenous interest rate combined with domestic productivity is sufficient to describe equilibrium choices. We demonstrate the failure of the second assumption by contrasting general and partial equilibrium approaches to the study of a cross- section of small open economies. In doing so, we provide a method for modeling small open economies in general equilibrium that is no more technically demanding than the small open economy approach while preserving much of the value of the general equilibrium approach.
    JEL: E32 F41
    Date: 2014–11–01
  15. By: Lenno Uusküla
    Abstract: This paper examines the role of firm turnover in explaining inflation dynamics. I augment a New-Keynesian DSGE model with endogenous entry and exogenous stochastic exit and estimate with the Bayesian full information approach for the US economy. Results show that shocks to the entry cost explain more than half of the inflation variance at the business cycle frequencies. When it is cheap to create firms, the number of new firms goes up and inflation increases as labour intensive creation of firms pushes up the demand for labour. Only gradually, when the number of firms is high and the number of new firms goes down again, does inflation fall, as stressed by the standard mechanism for an increasing number of firms
    Keywords: inflation, New-Keynesian Phillips curve, firm turnover
    JEL: E32 C11 E23
    Date: 2015–02–03
  16. By: Alisdair McKay; Emi Nakamura; Jón Steinsson
    Abstract: In recent years, central banks have increasingly turned to "forward guidance" as a central tool of monetary policy, especially as interest rates around the world have hit the zero lower bound. Standard monetary models imply that far future forward guidance is extremely powerful: promises about far future interest rates have huge effects on current economic outcomes, and these effects grow with the horizon of the forward guidance. We show that the power of forward guidance is highly sensitive to the assumption of complete markets. If agents face uninsurable income risk and borrowing constraints, a precautionary savings effect tempers their responses to far future promises about interest rates. As a consequence, the ability of central banks to combat recessions using small changes in interest rates far in the future, is greatly reduced relative to the complete markets benchmark. We show that the effects of precautionary savings motives can be captured by a simplified version of our model that generates discounting in the representative agent's Euler equation. This discounted Euler equation can be easily included in standard business cycle models.
    JEL: E21 E40 E50
    Date: 2015–01
  17. By: Andolfatto, David (Federal Reserve Bank of St. Louis); Martin, Fernando M. (Federal Reserve Bank of St. Louis); Zhang, Shengxing (London School of Economics)
    Abstract: Rehypothecation refers to the practice of re-using (selling or pledging as collateral) an asset that has already been pledged as collateral for a loan. We develop a dynamic general equilibrium monetary model where an “asset shortage” motivates the rehypothecation of assets. We find that in high inflation-high interest rate economies, rehypothecation improves economic welfare, but that there is generally too much of it. We find that regulatory constraints that limit the practice can improve economic welfare.
    Keywords: rehypothecation; money; collateral
    JEL: E4 E5
    Date: 2014–12–13
  18. By: Guerron-Quintana, Pablo A.; Inoue, Atsushi; Kilian, Lutz
    Abstract: One of the leading methods of estimating the structural parameters of DSGE models is the VAR-based impulse response matching estimator. The existing asymptotic theory for this estimator does not cover situations in which the number of impulse response parameters exceeds the number of VAR model parameters. Situations in which this order condition is violated arise routinely in applied work. We establish the consistency of the impulse response matching estimator in this situation, we derive its asymptotic distribution, and we show how this distribution can be approximated by bootstrap methods. Our methods of inference remain asymptotically valid when the order condition is satisfied, regardless of whether the usual rank condition for the application of the delta method holds. Our analysis sheds new light on the choice of the weighting matrix and covers both weakly and strongly identified DSGE model parameters. We also show that under our assumptions special care is needed to ensure the asymptotic validity of Bayesian methods of inference. A simulation study suggests that the frequentist and Bayesian point and interval estimators we propose are reasonably accurate infinite samples. We also show that using these methods may affect the substantive conclusions in empirical work.
    Keywords: bootstrap; DSGE; impulse response; nonstandard asymptotics; robust inference; structual estimation; VAR; weak identification
    JEL: C32 C52 E30 E50
    Date: 2014–12
  19. By: Gelain, Paolo (Norges Bank); Lansing, Kevin J. (Federal Reserve Bank of San Francisco); Natvik, Gisele J. (BI Norwegian Business School)
    Abstract: We use a simple quantitative asset pricing model to “reverse-engineer” the sequences of stochastic shocks to housing demand and lending standards that are needed to exactly replicate the boom-bust patterns in U.S. household real estate value and mortgage debt over the period 1995 to 2012. Conditional on the observed paths for U.S. disposable income growth and the mortgage interest rate, we consider four different specifications of the model that vary according to the way that household expectations are formed (rational versus moving average forecast rules) and the maturity of the mortgage contract (one-period versus long-term). We find that the model with moving average forecast rules and long-term mortgage debt does best in plausibly matching the patterns observed in the data. Counterfactual simulations show that shifting lending standards (as measured by a loan-to-equity limit) were an important driver of the episode while movements in the mortgage interest rate were not. Our results lend support to the view that the U.S. housing boom was a classic credit-fueled bubble involving over-optimistic projections about future housing values, relaxed lending standards, and ineffective mortgage regulation.
    Keywords: Housing bubbles; Mortgage debt; Borrowing constraints; Lending standards; macroprudential policy.
    JEL: D84 E32 E44 G12 O40 R31
    Date: 2015–01
  20. By: Qi Li (University of Chicago); Juan Pantano (Washington University in St. Louis); Daifeng He (College of William and Mary); Maria Casanova (UCLA)
    Abstract: The Social Security Administration computes individual pension benefits using the average survival in the population. However, less educated individuals, and those with lower lifetime incomes, have lower life expectancies than their more educated and richer counterparts. We investigate how heterogeneity in longevity interacts with homogenous social security rules in shaping retirement patterns. In particular, the increase in Social Security benefits for each additional year of work after early retirement age is approximately actuarially fair for individuals with the average longevity. Thus, it is less than actuarially fair for individuals whose life expectancy is lower than average. As a result, individuals with below-average longevity have lower incentives to delay retirement past early retirement age. We estimate a structural dynamic programming model of retirement using microdata from the Health and Retirement Study. We then use the estimated model to simulate retirement behavior under a counterfactual social security system in which individual specific survival odds are used to compute individual benefits. This allow us to investigate the role of actuarial unfairness plays in shaping the observed patterns of early retirement.
    Date: 2014
  21. By: Georgy Chabakauri
    Abstract: We consider a general equilibrium Lucas (1978) economy with one consumption good and two heterogeneous Epstein-Zin investors. The output is subject to rare large drops or, more generally, can have non-lognormal distribution with higher cumulants. The heterogeneity in preferences generates excess stock return volatilities, procyclical price-dividend ratios and interest rates, and countercyclical market prices of risk when the elasticity of intertemporal substitution (EIS) is greater than one. Moreover, the latter results cannot be jointly replicated in a model where investors have EIS_ 1 or CRRA preferences. We propose new approach for deriving equilibrium, and extend the analysis to the case of heterogeneous beliefs about probabilities of rare events.
    Keywords: heterogeneous investors; Epstein-Zin preferences; rare events; equilibrium; portfolio choice
    JEL: D53 G11 G12
    Date: 2015–01–10
  22. By: Creedy, John; Gemmell, Norman; Scobie, Grant
    Abstract: The objective of the paper is to explore the saving and consumption responses of a representative household to a range of policy interventions such as changes in taxes and pension settings. To achieve this, it develops a two-period life-cycle model. The representative household maximises lifetime utility through its choice of optimal levels of consumption, housing and saving. A key feature of the approach is modelling the consumption of housing services as a separate good in retirement along with the implications for saving. Importantly, the model incorporates a government budget constraint involving a pay-as-you-go universal pension. In addition, the model allows for a compulsory private retirement savings scheme. Particular attention in the simulations is given to the potential impact on household saving rates of a range of policy changes. Typically the effect on saving rates is modest. In most instances, it would take very substantial changes in existing policy settings to induce significant increases in household saving rates.
    Keywords: Savings, Housing, Retirement, Intertemporal elasticity of substitution, Rate of interest, Taxation,
    Date: 2015
  23. By: Vincent Sterk; Silvana Tenreyro
    Abstract: A large literature has documented statistically significant effects of monetary policy on economic activity. The central explanation for how monetary policy transmits to the real economy relies critically on nominal rigidities, which form the basis of the New Keynesian (NK) framework. This paper studies a different transmission mechanism that operates even in the absence of nominal rigidities. We show that in an OLG setting, standard open market operations (OMO) carried by central banks have important revaluation effects that alter the level and distribution of wealth and the incentives to work and save for retirement. Specifically, expansionary OMO lead households to front-load their purchases of durable goods and work and save more, thus generating a temporary boom in durables, followed by a bust. The mechanism can account for the empirical responses of key macroeconomic variables to monetary policy interventions. Moreover, the model implies that different monetary interventions (e.g., OMO versus helicopter drops) can have different qualitative effects on activity. The mechanism can thus complement the NK paradigm. We study an extension of the model incorporating labor market frictions.
    JEL: E1 E31 E32 E52 E58
    Date: 2013–11
  24. By: Kollintzas, Tryphon; Papageorgiou, Dimitris; Vassilatos, Vanghelis
    Abstract: In recent years the growth pattern of most Southern European countries has been disturbed, as those countries are suffering from economic crises that go beyond the usual business cycle. In this paper, we develop a dynamic general equilibrium model of market and political power interactions that explains this growth reversal. Moreover, the model is consistent with several stylized facts of those countries, where wages in the public sector relative to the private sector are high and these wage differentials correlate negatively with public sector employment over total employment, total factor productivity, and output growth. The model is a synthesis of the insiders-outsiders labor market structure and the concept of an elite government. Outsiders form a group of workers that supply labor to a competitive private sector. And, insiders form a group of workers that enjoy market power in supplying labor to the public sector and influence the policy decisions of government, including those that affect the development and maintenance of public sector infrastructures.
    Keywords: Growth; Insiders - Outsiders; Politicoeconomic Equilibrium; Public Sector Wage Premium; Southern European Economies
    JEL: J45 O43 O52 P16
    Date: 2015–01
  25. By: Li, Wenli (Federal Reserve Bank of Philadelphia); Liu, Haiyong (East Carolina University); Yang, Fang (Louisiana State University); Yao, Rui (Baruch College)
    Abstract: Supersedes Working Paper 09-7. We estimate a structural model of optimal life-cycle housing and nonhousing consumption in the presence of labor income and house price uncertainties. The model postulates constant elasticity of substitution between housing service and nonhousing consumption and explicitly incorporates a housing adjustment cost. Our estimation fits the cross-sectional and time-series household wealth and housing profies from the Panel Study of Income Dynamics (1984 to 2005) reasonably well and suggests an intratemporal elasticity of substitution between housing and nonhousing consumption of 0.487. The low elasticity estimate is largely driven by moments conditional on state house prices and moments in the latter half of the sample period and is robust to different assumptions of housing adjustment cost. We then conduct policy analyses in which we let house price and income take values as those observed between 2006 and 2011. We show that the responses depend importantly on the housing adjustment cost and the elasticity of sub-stitution between housing and nonhousing consumption. In particular, compared with the benchmark, the impact of the shocks on homeownership rates is reduced, but the impact on nonhousing consumption is magnified when the house selling cost is sizable or when housing service and nonhousing consumption are highly substitutable.
    Keywords: Life cycle; Housing adjustment costs; Intratemporal substitution
    JEL: E21 R21
    Date: 2015–01–17
  26. By: Brunnermeier, Markus K; Sannikov, Yuliy
    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.
    Keywords: hot money; international capital flows; international credit flows; pecuniary externalities; sudden stops; terms of trade hedge
    JEL: F33 F34 F36 F41 G15
    Date: 2015–01
  27. By: Marilyn Pease (University of Iowa); Kyungmin Kim (University of Iowa)
    Abstract: We study the effects of endogenizing search intensity in sequential search models of trading under adverse selection. Ceteris paribus, the low-type seller obtains more surplus from search and, therefore, searches more intensively than the high-type seller. This has two ramifications for trade. On the one hand, a seller who successfully finds a buyer is more likely to be the low type (solicitation curse). On the other hand, since the low-type seller leaves the market even faster than the high-type seller, a seller who is available is more likely to be the high type (accelerating blessing). We explore the interaction of these two effects in both stationary and non-stationary sequential search environments. In the stationary case, the two effects are balanced, while in the non-stationary case, the relative strengths of the two effects vary over time. We show that reducing search costs can be detrimental to the seller.
    Date: 2014
  28. By: Alfonso Irarrazabal (BI Norwegian Business School); Juan Carlos Parra-Alvarez (Aarhus University and CREATES)
    Abstract: This paper revisits the fit of disaster risk models where a representative agent has recursive preferences and the probability of a macroeconomic disaster changes over time. We calibrate the model as in Wachter (2013) and perform two sets of tests to assess the empirical performance of the model in long run simulations. The model is solved using a two step projection-based method that allows us to find the equilibrium consumption-wealth ratio and dividend-yield for different values of the intertemporal elasticity of substitution. By fixing the elasticity of substitution to one, the first experiment indicates that the overall fit of the model is adequate. However, we find that the amount of aggregate stock market volatility that the model can generate is sensible to the method used to solve the model. We also find that the model generates near unit root interest rates and a puzzling ranking of volatilities between the risk free rate and the expected return on government bills. We later solve the model for values of the elasticity of substitution that differ from one. This second experiment shows that while a higher elasticity of substitution helps to increase the aggregate stock market volatility and hence to reduce the Sharpe Ratio, a lower elasticity of substitution generates a more reasonable level for the equity risk premium and for the volatility of the government bond returns without compromising the ability of the price-dividend ratio to predict excess returns.
    Keywords: Rare events, disaster risk, recursive preferences, intertemporal elasticity of substitution, projection methods, asset pricing.
    JEL: D51 E44 G12
    Date: 2015–02–02
  29. By: Rong Hai (Department of Economics, University of Chicago); Dirk Krueger (Department of Economics, University of Pennsylvania); Andrew Postlewaite (Department of Economics, University of Pennsylvania)
    Abstract: We propose a new category of consumption goods, memorable goods, that generate a flow of utility after consumption. We analyze an otherwise standard consumption model that distinguishes memorable goods from other nondurable goods. Consumers optimally choose lumpy consumption of memorable goods. We empirically document differences between levels and volatilities of memorable and other goods expenditures. Memorable goods expenditures are about twice durable goods expenditures and half the volatility. The welfare cost of consumption fluctuations driven by income shocks are overstated if memorable goods are not accounted for and estimates of excess sensitivity of consumption might be due to memorable goods.
    Keywords: Memorable Goods, Consumption Volatility, Welfare Cost
    JEL: D91 E21
    Date: 2014–04–15

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