nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2015‒03‒13
sixteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Notes on Business Cycle Theory from a Dynamic Stochastic General Equilibrium Perspective By Solomon, Bernard Daniel
  2. Household Borrowing Constraints and Monetary Policy in Emerging Economies By ARRUDA, Gustavo; LIMA, Daniela; TELES, Vladimir K.
  3. Firms entry, oligopolistic competition and labor market dynamics By Andrea Colciago; Lorenza Rossi
  4. Leaning Against the Credit Cycle By Paolo Gelain; Kevin J. Lansing; Gisle J. Natvik
  5. Assessing bankruptcy reform in a model with temptation and equilibrium default By Nakajima, Makoto
  6. A DSGE Model for China’s Monetary and Macroprudential Policies By Sinclair, Peter; Sun, Lixn
  7. Household Debt and Fiscal Multipliers By J. Andrés; J.E. Boscá; J. Ferri
  8. Real Rigidity, Nominal Rigidity, and the Social Value of Information By George-Marios Angeletos; Luigi Iovino; Jennifer La?'o
  9. Worker Search Effort as an Amplification Mechanism By Paul Gomme; Damba Lkhagvasuren
  10. The informal sector in contemporary models of the aggregate economy By Leal-Ordoñez Julio C.
  11. Monetary policy implications for an oil-exporting economy of lower long-run international oil prices By Franz Hamann; Jesús Bejarano; Diego Rodríguez
  12. Cross-subsidies, and the elasticity of informality to social expenditures By Alonso-Ortiz Jorge; Leal-Ordoñez Julio C.
  13. Can international macroeconomic models explain low-frequency movements of real exchange rates? By Pau Rabanal; Juan F. Rubio-Ramirez
  14. Financial Development and International Trade By Fernando Leibovici
  15. Liquidity Constraints of the Middle Class By Campbell, J.R.; Hercowitz, Zvi
  16. Appropriate Macroeconomic Model Support for the Ministry of Finance and the National Institute of Economic Research: A Pilot Study By Hjelm, Göran; Bornevall, Helena; Fromlet, Pia; Nilsson, Jonny; Stockhammar , Pär; Wiberg, Magnus

  1. By: Solomon, Bernard Daniel
    Abstract: In these notes I go over some basic aspects of the analysis of business cycles and aggregate fluctuations from a dynamic stochastic general equilibrium (DSGE) perspective. I build a cannonical DSGE model with a small number of representative agents and a large set of distortionnary wedges standing for various frictions as an organising framework. I use this model to discuss fundamental properties of business cycle dynamics. I start with some of the basic assumptions common to most applied DSGE models, and the modeling of household and firm behaviour. Then I discuss general equilibrium and the response of the economy to various shocks with flexible prices and wages, as well as ways of applying DSGE models with actual data. Finally I add nominal price rigidities to get the standard New Keynesian model, and discuss some open economy issues, fiscal policy and unconventional monetary policy.
    Keywords: Business cycles, dynamic stochastic general equilibrium
    JEL: E0 E12 E13 E32 E37 E44
    Date: 2015–02–16
  2. By: ARRUDA, Gustavo; LIMA, Daniela; TELES, Vladimir K.
    Abstract: Credit markets in emerging economies can be distinguished from those in advanced economies in many respects, including the collateral required for households to borrow. This work proposes a DSGE framework to analyze one peculiarity that characterizes the credit markets of some emerging markets: payroll-deducted personal loans. We add the possibility for households to contract long-term debt and compare two different types of credit constraints with one another, one based on housing and the other based on future income. We estimate the model for Brazil using a Bayesian technique. The model is able to solve a puzzle of the Brazilian economy: responses to monetary shocks at first appear to be strong but dissipate quickly. This occurs because income – and the amount available for loans – responds more rapidly to monetary shocks than housing prices. To smooth consumption, agents (borrowers) compensate for lower income and for borrowing by working more hours to repay loans and erase debt in a shorter time. Therefore, in addition to the income and substitution effects, workers consider the effects on their credit constraints when deciding how much labor to supply, which becomes an additional channel through which financial frictions affect the economy.
    Date: 2015–03–02
  3. By: Andrea Colciago; Lorenza Rossi
    Abstract: Using U.S. quarterly data we provide VAR evidence showing that a positive productivity shock leads to a persistent decrease in the unemployment rate and in the price markup, together with an increase in aggregate profits. In response to the shock the labor share of income decreases on impact and overshoots its long run trend before reverting to equilibrium. To address these facts, we propose a model where Cournot competition and firms' entry in the goods market interact with search and matching frictions in the labor market. The price markup countercyclicality delivered by our model is a key factor to jointly account for the empirical facts we documented.
    Keywords: Firms' Entry; Oligopolistic competition
    JEL: L11 E32
    Date: 2015–03
  4. By: Paolo Gelain (Norges Bank (Central Bank of Norway)); Kevin J. Lansing (Federal Reserve Bank of San Francisco); Gisle J. Natvik (Norges Bank (Central Bank of Norway) and Department of Economics, BI Norwegian Business School)
    Abstract: We study the interaction between monetary policy and household debt dynamics. To this end, we develop a dynamic stochastic general equilibrium model where household debt is amortized gradually, and only new loans are constrained by the current value of collateral. Long-term debt implies that swings in leverage do not simply reect shifts in borrowing, and brings model implied debt dynamics closer to their empirical counterparts. The model implies that contractive monetary policy has muted inuence on household debt, increasing debt-to-GDP in the short run, while reducing it only in the medium run. If the interest rate is systematically raised whenever the debt-to-GDP ratio or the real debt level is high, equilibrium indeterminacy and greater volatility of debt itself follows. Responding to debt growth does not cast this destabilizing influence.
    Keywords: Monetary policy, Credit, Long-term debt.
    JEL: E52 E32 E44
    Date: 2015–02–27
  5. By: Nakajima, Makoto (Federal Reserve Bank of Philadelphia)
    Abstract: A life-cycle model with equilibrium default in which consumers with and without temptation coexist is constructed to evaluate the 2005 bankruptcy law reform and other counterfactual reforms. The calibrated model indicates that the 2005 bankruptcy reform achieves its goal of reducing the number of bankruptcy filings, as seen in the data, but at the cost of loss in social welfare. The creditor-friendly reform provides borrowers with a stronger commitment to repay and thus yields lower default premia and better consumption smoothing. However, those who borrow and default due to temptation or unavoidable large expenditures suffer more under the reform due to higher costs or means-testing requirement. Moreover, those who borrow due to temptation suffer from overborrowing when the borrowing cost declines. The model indicates that the negative welfare effects dominate.
    Keywords: Consumer bankruptcy; Debt; Default; Borrowing constraint; Temptation and self-control; Hyperbolic discounting; Heterogeneous agents; Incomplete markets
    JEL: D91 E21 E44 G18 K35
    Date: 2015–03–09
  6. By: Sinclair, Peter; Sun, Lixn
    Abstract: This paper develops a calibrated DSGE model for simulating China’s monetary policy and macroprudential policy. The empirical results show, first, that the interest rate is a better instrument for China’s monetary policy than the required reserve ratio when the central bank is solely concerned by the price stability; second, that the loan-to-value (LTV) ratio is a very useful macroprudential tool for China’s financial stability, and the required reserve ratio could be used as an instrument for both objectives. Whether macroprudential policy complements or conflicts with monetary policy depends upon the instruments choices of two policies. Our policy experiments suggest three combination choices of instruments for China’s monetary and macroprudential policies.
    Keywords: DSGE Model, Monetary Policy, Macroprudental Policy, China’s Economy
    JEL: E5 E6 G1
    Date: 2014–05
  7. By: J. Andrés; J.E. Boscá; J. Ferri
    Abstract: We study the size of government spending multipliers in a general equilibrium model with search and matching frictions in which we allow for different levels of household indebtedness. The main results of the paper are: (a) the presence of impatient households and private debt helps generate government spending multipliers greater than 1; (b) as financial conditions worsen and impatient consumers find it more difficult to borrow (i.e. in a credit crunch), the size of the government spending multiplier falls; (c) conversely, employment, vacancies and unemployment multipliers are larger when access to credit becomes more difficult; and (d) the model explains the observed pattern of responses of labour market variables, housing prices and private debt to a fiscal shock reasonably well. On these grounds it outperforms the standard model with Rule-of-Thumb consumers whose predictions for the labour market are at odds with the data.
    Date: 2015–03
  8. By: George-Marios Angeletos; Luigi Iovino; Jennifer La?'o
    Abstract: Does welfare improve when ?firms are better informed about the state of the economy and can better coordinate their decisions? We address this question in an elementary business-cycle model that highlights how the dispersion of information can be the source of both nominal and real rigidity. Within this context we develop a taxonomy for how the social value of information depends on the two rigidities, on the sources of the business cycle, and on the conduct of monetary policy. JEL codes: C7, D6, D8. Keywords: Fluctuations, informational frictions, strategic complementarity, coordination, beauty contests, central-bank transparency.
    Date: 2015
  9. By: Paul Gomme (Concordia University and CIREQ); Damba Lkhagvasuren (Concordia University and CIREQ)
    Abstract: It is well known that the Diamond-Mortensen-Pissarides model exhibits a strong trade-off between cyclical unemployment fluctuations and the size of rents to employment. Introducing endogenous job search effort reduces the strength of the trade-off while bringing the model closer to the data. Ignoring worker search effort leads to a large upward bias in the elasticity of matches with respect to vacancies. Merging the American Time Use Survey and the Current Population Survey, new evidence in support of procyclical search effort is presented. Average search effort of the unemployed is subject to cyclical composition biases.
    Keywords: Variable Search Effort, Unemployment and Vacancies, Beveridge Curve, Search Intensity, Time Use
    JEL: E24 E32 J63 J64
    Date: 2015–02
  10. By: Leal-Ordoñez Julio C.
    Abstract: I review a contemporary branch of the informal sector literature that focus on understanding the way firm behavior is affected by the presence of informality and how such distortions have an impact on aggregate variables. The authors in this group all make use of dynamic general equilibrium (DGE) models. I focus on models with heterogeneous firms and a cost of informality that is increasing with firm size: reducing informality entails a tradeoff because there are some distortions associated with the formal sector and some others with the informal. Quantitative evaluations of this tradeoff using these models show that, in general, reducing informality brings gains. In conclusion, substantial progress has been made in understanding informality and its consequences through the use of DGE models with heterogeneous firms. More research is needed to understand how informality affects the economy when other sources of heterogeneity are considered.
    Keywords: informality, literature survey, dynamic general equilibrium, heterogeneous firms, distortions, productivity.
    JEL: E26 O17 O40
    Date: 2014–11
  11. By: Franz Hamann (Banco de la República de Colombia); Jesús Bejarano (Banco de la República de Colombia); Diego Rodríguez (Banco de la República de Colombia)
    Abstract: The sudden collapse of oil prices poses a challenge to inflation targeting central banks in oil exporting economies. This paper illustrates that challenge and conducts a quantitative assessment of the impact of permanent changes in oil prices in a small and open economy, in which oil represents an important fraction of its exports. We calibrate and estimate a variety of real and monetary dynamic stochastic general equilibrium models using Colombian historical data. We find that, in these artificial economies the macroeconomic effects can be large but vary depending on the structure of the economy. The main channels through which the shock passes to the economy come from the increased country risk premium, the real exchange rate depreciation, the sectoral reallocation of resources from nontradables to tradables and the sluggish adjustment of prices. Contrary to the conventional findings in the literature of the financial accelerator mechanism for single-good closed economies, in multiple-goods small open economies the financial accelerator does not play a significant role in magnifying macroeconomic fluctuations. The sectoral reallocation from nontradable to tradables diminishes the financial amplification mechanism. Classification JEL: C61, E31, E37, E52, F41
    Keywords: oil prices, precautionary savings, monetary policy, credit, leverage, financial accelerator, Colombia
    Date: 2015–03
  12. By: Alonso-Ortiz Jorge; Leal-Ordoñez Julio C.
    Abstract: How is the size of the informal sector affected when the distribution of social expenditures across formal and informal workers changes? Given this distribution, how is it affected when the generosity of these transfers changes? We use a search frictions model with informality, (ex post) heterogeneous workers, and conditional taxes and transfers. In the model, formal jobs are "better" than informal jobs, but harder to get. Taxes are proportional to the wage, while transfers are lump sum, implying a cross-subsidy from high-income to low-income workers. As a result, the marginal worker weighs two opposing forces: changes in taxes vs. changes in transfers. We calibrate the model to Mexico and perform counterfactuals. We find that informality is quite inelastic due to frictions, and due to the opposing forces of taxes and transfers.
    Keywords: Informality, elasticity of informality, social expenditures, cross-subsidies, taxes and transfers, search frictions.
    JEL: E2 E26 J6
    Date: 2014–12
  13. By: Pau Rabanal; Juan F. Rubio-Ramirez
    Abstract: Real exchange rates exhibit important low-frequency fluctuations. This makes the analysis of real exchange rates at all frequencies a more sound exercise than the typical business cycle one, which compares actual and simulated data after the Hodrick-Prescott …lter is applied to both. A simple two-country, two-good, international real business cycle model can explain the volatility of the real exchange rate when all frequencies are studied. The puzzle is that the model generates too much persistence of the real exchange rate instead of too little, as the business cycle analysis asserts. We show that the introduction of input adjustment costs in production, cointegrated productivity shocks across countries, and lower home bias allows us to reconcile theory and this feature of the data.
    Keywords: Economic Analysis, Global, Research, Working Paper
    JEL: E32 F32 F33 F41
    Date: 2015–01
  14. By: Fernando Leibovici (Department of Economics, York University, Toronto, Canada)
    Abstract: This paper studies the industry-level and aggregate implications of financial development on international trade. I set up a multi-industry general equilibrium model of international trade with heterogeneous firms subject to export entry costs and financial frictions, in which industries differ in their dependence on external finance. The model is parametrized to match key features of plant-level data. I find that financial frictions have a large effect on the extent of international trade across industries, but a negligible impact at the aggregate-level. I show that these findings are consistent with estimates from cross-country industry- and aggregate-level data.
    Date: 2015–03–05
  15. By: Campbell, J.R.; Hercowitz, Zvi
    Abstract: Among U.S. middle-class households, the marginal propensity to consume is either invariant to household wealth or a U-shaped function thereof. In contrast, precautionary savings models predict that wealth reduces the marginal propensity to consume. We bridge this gap between theory and data with term saving, households' savings for large forecastable expenditures. Household data indicate that term saving is widespread. Once incorporated into a calibrated precautionary savings model, it generates marginal propensities to consume like those from the data. This is because the approaching expenditure simultaneously motivates saving and raises the marginal propensity to consume by shortening the effective planning horizon.
    Keywords: fiscal policy; tax rebates; marginal propensity to consume; term saving; precautionary saving
    JEL: E21
    Date: 2015
  16. By: Hjelm, Göran (National Institute of Economic Research); Bornevall, Helena (National Institute of Economic Research); Fromlet, Pia (National Institute of Economic Research); Nilsson, Jonny (National Institute of Economic Research); Stockhammar , Pär (National Institute of Economic Research); Wiberg, Magnus (National Institute of Economic Research)
    Abstract: We analyse model choices of various international institutions and find that the majority of the studied central banks have chosen so-called DSGE-models. Ministry of finances have chosen to continue using so-called Semi-Structural Models (SSM) while international organisations such as the IMF and the OECD have “a suite of models” including both DSGE and SSM. Based on these international experiences and the specific institutional set up in Sweden we list a number of criteria and rank different modelling strategies. We propose that a DSGE-model for both forecast and policy analysis including a rich modelling of fiscal policy would be appropriate for the Ministry of finance and the National Institute of Economic Research in Sweden.
    Keywords: Macroeconomic modelling; model criteria; forecast; policy analysis; semi-structural models; DSGE; BVAR; SVAR; VAR
    JEL: E00
    Date: 2015–03–05

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