nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2015‒04‒02
fourteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Fiscal Policy Matters A New DSGE Model for Slovakia By Zuzana Mucka; Michal Horvath
  2. Self-Fulfilling Credit Cycles By Azariadis, Costas; Kaas, Leo; Wen, Yi
  3. Capital Controls, Monetary Policy, and Balance Sheets in a Small Open Economy By Shigeto Kitano; Kenya Takaku
  4. Can a data-rich environment help identify the sources of model misspecification? By Monti, Francesca
  5. House Prices and Job Losses By Gabor Pinter
  6. The Housing Sector over Business Cycles: Empirical Analysis and DSGE Modelling By Jan Bruha; Jiri Polansky
  7. Dynamic Directed Search By Gabriele Camera; Jaehong Kim
  8. Cross-Border Banking and Business Cycles in Asymmetric Currency Unions By Lena Dräger; Christian R. Proaño
  9. Wealth Inequality, Family Background, and Estate Taxation By Mariacristina De Nardi; Fang Yang
  10. The labor market effects of reducing the number of illegal immigrants By Andri Chassamboulli; Giovanni Peri
  11. Indeterminacy and Sunspots in Two-Sector RBC Models with Generalized No-Income-Effect Preferences By Frédéric Dufourt; Kazuo Nishimura; Alain Venditti
  12. Optimal carbon abatement in a stochastic equilibrium model with climate change By Hambel, Christoph; Kraft, Holger; Schwartz, Eduardo S.
  13. Consumption Risk Sharing with Private Information and Limited Enforcement By Tobias Broer; Marek Kapièka; Paul Klein
  14. Fast Bellman Iteration: An Application of Legendre-Fenchel Duality to In nite-Horizon Dynamic Programming in Discrete Time By Ronaldo Carpio; Takashi Kamihigashi

  1. By: Zuzana Mucka (Council for Budget Responsibility); Michal Horvath (Council for Budget Responsibility)
    Abstract: The paper sets out a DSGE model designed and calibrated to match key stylized facts about the Slovak economy. The model includes a detailed fiscal policy block that allows a thorough analysis of fiscal policy measures. To evaluate the performance of the model, the response of the economy to a technology shock and to a foreign demand shock is considered under alternative fiscal adjustment scenarios. We find that a well-designed programme involving increases in transfers as well as taxes can stabilize the economy in the short run and improve longer-term growth prospects following a shock with adverse fiscal implications. We study the consequences of fiscal policy shocks in and away from the steady state of the model. The exercise yields implied fiscal multipliers that are large in spite of Slovakia being a small open economy. Cutting infrastructure spending or raising taxes on consumption and employment are particularly bad for the real economy in a recession.
    Keywords: dynamic stochastic general equilibrium model, simulations, fiscal rules, fiscal multipliers, fiscal consolidation
    JEL: E32 C61 C63 D58 E62 H63 H5
    Date: 2015–03
  2. By: Azariadis, Costas (Federal Reserve Bank of St. Louis); Kaas, Leo (University of Konstanz); Wen, Yi (Federal Reserve Bank of St. Louis)
    Abstract: In U.S. data 1981–2012, unsecured firm credit moves procyclically and tends to lead GDP, while secured firm credit is acyclical; similarly, shocks to unsecured firm credit explain a far larger fraction of output fluctuations than shocks to secured credit. In this paper we develop a tractable dynamic general equilibrium model in which unsecured firm credit arises from self-enforcing borrowing constraints, preventing an efficient capital allocation among heterogeneous firms. Unsecured credit rests on the value that borrowers attach to a good credit reputation which is a forward-looking variable. We argue that self-fulfilling beliefs over future credit conditions naturally generate endogenously persistent business cycle dynamics. A dynamic complementarity between current and future borrowing limits permits uncorrelated sunspot shocks to unsecured debt to trigger persistent aggregate fluctuations in both secured and unsecured debt, factor productivity and output. We show that these sunspot shocks are quantitatively important, accounting for around half of output volatility.
    Keywords: Unsecured firm credit; Credit cycles; Sunspots
    JEL: D92 E32
    Date: 2015–03–20
  3. By: Shigeto Kitano (Research Institute for Economics & Business Administration (RIEB), Kobe University, Japan); Kenya Takaku (Faculty of Business, Aichi Shukutoku University)
    Abstract: We develop a small open economy, New Keynesian model that incorporates a financial accelerator in combination with liability dollarization. Applying a Ramsey-type analysis, we compare the welfare implications of an optimal monetary policy under flexible exchange rates and an optimal capital control policy under fixed exchange rates. In an economy without the financial accelerator, an optimal monetary policy under flexible exchange rates is superior to an optimal capital control policy under fixed exchange rates. In contrast, in an economy with the financial accelerator, an optimal capital control under fixed exchange rates yields higher welfare than an optimal monetary policy under flexible exchange rates.
    Keywords: Capital control, Monetary policy, Balance sheets, Ramsey policy, Exchange rate regimes, Small open economy, Nominal rigidities, New keynesian, DSGE, Welfare comparison, Incomplete markets, Financial accelerator, Financial frictions
    JEL: E44 E52 F32 F41
    Date: 2015–03
  4. By: Monti, Francesca (Bank of England)
    Abstract: This paper proposes a method for detecting the sources of misspecification in a dynamic stochastic general equilibrium (DSGE) model based on testing, in a data-rich environment, the exogeneity of the variables of the DSGE with respect to some auxiliary variables. Finding evidence of non-exogeneity implies misspecification, and finding that some specific variables help predict certain shocks can shed light on the dimensions along which the model is misspecified. Forecast error variance decomposition analysis then helps assess the relevance of the missing channels. The paper puts the proposed methodology to work both in a controlled experiment - by running a Monte Carlo simulation with a known data-generating process - and using a state-of-the-art model and US data up to 2011.
    Keywords: DSGE Models; Model Misspecification; Bayesian Analysis
    JEL: C32 C52
    Date: 2015–03–27
  5. By: Gabor Pinter (Bank of England; Centre for Macroeconomics (CFM))
    Abstract: Why are house prices -80% correlated with job losses over the UK business cycle? My paper studies this striking fact together with the strong comovements between house prices and labour market variables in general. First, a regional panel is estimated to quantify the impact of house prices on the unemployment, job finding and job separation rates, whereby rejection rates of planning applications are used as instruments to find exogenous variation in house prices. Second, an orthogonalised VAR is used to estimate the aggregate impact of house price shocks. Both methods confirm the large impact of house price shocks on labour market variables and credit supply. To understand the mechanism, a general equilibrium model with collateral constraints, endogenous job separation and housing shocks is confronted with macroeconomic data via Bayesian methods. The results suggest that shocks to house prices (i) explain about 10% of output fluctuations and about 20% of fluctuations in corporate credit, unemployment and job separation rates via the collateral channel over the forecast horizon, and (ii) were a major cause in triggering the 1990 and 2008 recessions in the UK.
    Keywords: business cycle, house prices, financial frictions, labour market frictions
    Date: 2015–03
  6. By: Jan Bruha; Jiri Polansky
    Abstract: In this paper, we analyse the dynamics of the housing sector over business cycles. First, we provide an empirical analysis of the relationships between housing sector data and the main macroeconomic variables both on Czech data and on a sample of advanced economies. We document that in most countries the housing sector co-moves with the rest of the economy. In the past, the Czech housing market showed temporary episodes during which the housing sector was seemingly disconnected, but since 2005 the housing sector has become more cyclical. Second, we develop a cascade of increasingly complex DSGE models to assess the relative merits of each additional mechanism. Contrary to the popular framework with collateral constraints, we concentrate on the housing sector as an additional production sector via the standard supply and demand mechanisms. Our results confirm that these standard mechanisms are sufficient to replicate the observed comovements of housing market variables.
    Keywords: Business cycles, DSGE, housing sector
    JEL: E32 R21 R31
    Date: 2014–12
  7. By: Gabriele Camera (Chapman University, University of Basel); Jaehong Kim (Chapman University)
    Abstract: The directed search model (Peters, 1984) is static; its dynamic extensions typically restrict strategies, often assuming price or match commitments. We lift such restrictions to study equilibrium when search can be directed over time, without constraints and at no cost. In equilibrium trade frictions arise endogenously, and price commitments, if they do exist, are self-enforcing. In contrast to the typical model, there exists a continuum of equilibria that exhibit trade frictions. These equilibria support any price above the static price, including monopoly pricing in arbitrarily large markets. Dispersion in posted prices can naturally arise as temporary or permanent phenomenon despite the absence of pre-existing heterogeneity.
    Keywords: frictions, matching, price dispersion, search
    JEL: C70 D39 D49 E39
    Date: 2015
  8. By: Lena Dräger (Universität Hamburg (University of Hamburg)); Christian R. Proaño (The New School for Social Research)
    Abstract: Against the background of the recent housing boom and bust in countries such as Spain and Ireland, we investigate in this paper the macroeconomic consequences of cross-border banking in monetary unions such as the euro area. For this purpose, we incorporate in an otherwise standard two-region monetary union DSGE model a banking sector module along the lines of Gerali et al. (2010), accounting for borrowing constraints of entrepreneurs and an internal constraint on the bank’s leverage ratio. We illustrate in particular how different lending standards within the monetary union can translate into destabilizing spill-over effects between the regions, which can in turn result in a higher macroeconomic volatility. This mechanism is modelled by letting the loan-to-value (LTV) ratio that banks demand of entrepreneurs depend on either regional productivity shocks or on the productivity shock from one dominating region. Thereby, we demonstrate a channel through which the financial sector may have exacerbated the emergence of macroeconomic imbalances within the euro area. Additionally, we show the effects of a monetary policy rule augmented by the loan rate spread as in Cúrdia and Woodford (2010) in a two-country monetary union context.
    Keywords: Cross-border banking, euro area, monetary unions, DSGE
    JEL: F41 F34 E52
    Date: 2015–03
  9. By: Mariacristina De Nardi; Fang Yang
    Abstract: This paper provides two main contributions. First, it provides a new theory of wealth inequality that merges two forces generating inequality: bequests motives and inheritance of ability of across generations; and an earnings process that allows for more earnings risk for the richest. Second, it uses a calibrated framework to study the effects of changing estate taxation on inequality, aggregate capital accumulation and output, the economic advantage of being born to a given parental background, and welfare. Our calibrated model generates realistically skewed distributions for wealth, earnings, and bequests, and implies that parental background is a crucial determinant of one’s expected lifetime utility. We find that increasing the estate tax rate would significantly reduce wealth concentration in the hands of the richest few, and would reduce the economic advantage of being born to a super-rich family, but also would lower aggregate capital and output. Lastly, it would also generate a significant welfare gain from the ex-ante standpoint of a newborn under the veil of ignorance.
    JEL: D1 D14 D31 E21 E6 H2
    Date: 2015–03
  10. By: Andri Chassamboulli; Giovanni Peri
    Abstract: A controversial issue in the US is how to reduce the number of illegal immigrants and what effect this would have on the US economy. To answer this question we set up a two-country model with search in labor markets and featuring legal and illegal immigrants among the low skilled. We calibrate it to the US and Mexican economies during the period 2000-2010. As immigrants, especially illegal ones, have a worse outside option than natives their wages are lower. Hence their presence reduces the labor cost of employers who, as a consequence, create more jobs per unemployed when there are more immigrants. Because of such effect our model shows that increasing deportation rates and tightening border control weakens the low-skilled labor markets, increasing unemployment of native low skilled. Legalization, instead decreases the unemployment rate of low-skilled natives and it increases income per native.
    Keywords: job creation, search costs, illegal immigrants, border controls, deportations, legalization, unemployment, wages
    Date: 2015–03
  11. By: Frédéric Dufourt (Aix-Marseille UniversitÈ (Aix-Marseille School of Economics), CNRS-GREQAM & EHESS and Institut Universitaire de France); Kazuo Nishimura (RIEB, Kobe University & KIER, Kyoto University); Alain Venditti (Aix-Marseille University (Aix-Marseille School of Economics), CNRS-GREQAM, EHESS & EDHEC)
    Abstract: We analyze sunspot-driven fluctuations in the standard two-sector RBC model with moderate increasing returns to scale and generalized no-income-effect preferences à la Greenwood, Hercovitz and Huffman [13]. We provide a detailed theoretical analysis enabling us to derive relevant bifurcation loci and to characterize the steady-state local stability properties as a function of various structural parameters. We show that local indeterminacy occurs through flip and Hopf bifurcations for a large set of values for the elasticity of intertemporal substitution in consumption, provided that the labor supply is sufficiently inelastic. Finally, we provide a detailed quantitative analysis of the model. Computing, on a quarterly basis, a new set of empirical moments related to two broadly defined consumption and investment sectors, we are able to identify, among the set of admissible calibrations consistent with sunspot equilibria, the ones that provide the best fit of the data. The model properly calibrated solves several empirical puzzles traditionally associated with two-sector RBC models.
    Keywords: Indeterminacy, sunspots, two-sector model, sector-specific externalities, real business cycles
    JEL: C62 E32 O41
    Date: 2015–03
  12. By: Hambel, Christoph; Kraft, Holger; Schwartz, Eduardo S.
    Abstract: This paper studies a dynamic stochastic general equilibrium model involving climate change. Our model allows for damages on economic growth resulting from global warming. In the calibration, we capture effects from climate change and feedback effects on the temperature dynamics. We solve for the optimal state-dependent abatement policy. In our simulations, the costs of this policy measured in terms of lost GDP growth are moderate. On the other hand, postponing abatement action could reduce the probability that the climate can be stabilized. For instance, waiting for 10 years reduces this probability from 60% to 30%. Waiting for another 10 years leads to a probability that is less than 10%. Finally, doing nothing opens the risk that temperatures might explode and economic growth decreases significantly.
    Keywords: Climate change economics,Carbon abatement,GDP growth
    JEL: D81 Q5 Q54
    Date: 2015
  13. By: Tobias Broer; Marek Kapièka; Paul Klein
    Abstract: In this paper, we study consumption risk sharing when individual income shocks are persistent and not publicly observable, and individuals can default on contracts at the price of financial autarky. We find that, in contrast to a model where the only friction is limited enforcement, our model has observable implications that are similar to those of an Aiyagari (1994) self-insurance model and therefore broadly consistent with empirical observations. However, some of the implied effects of changes in policy or the economic environment are noticeably different in our model compared to self-insurance.
    Keywords: risk sharing; private information; limited enforcement;
    JEL: D8 E6
    Date: 2015–02
  14. By: Ronaldo Carpio (School of Business and Finance, University of International Business and Economics); Takashi Kamihigashi (Research Institute for Economics & Business Administration (RIEB), Kobe University, Japan)
    Abstract: We propose an algorithm, which we call "Fast Bellman Iteration" (FBI), to compute the value function of an infinite-horizon dynamic programming problem in discrete time. FBI is an extremely efficient linear-time algorithm applicable to a class of multidimensional dynamic programming problems with concave return (or convex cost) functions and linear constraints. In this algorithm, a sequence of functions is generated starting from the zero function by repeatedly applying a simple algebraic rule involving the Legendre-Fenchel transform of the return function. The resulting sequence is guaranteed to converge, and the Legendre-Fenchel transform of the limiting function coincides with the value function.
    Date: 2015–03

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