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on Dynamic General Equilibrium |
|
Issue of 2015‒04‒19
twenty-two papers chosen by Christian Zimmermann Federal Reserve Bank of St. Louis |
| By: | Alan Finkelstein-Shapiro; Andrés González Gómez |
| Abstract: | This paper builds a small open economy business cycle model with labor and financial market frictions that incorporates frictional, endogenous self-employment entry and a link between formal credit markets, informal credit, and the labor market. The paper then shows that the model is consistent with the cyclical behavior of both labor and credit markets in Latin American economies and analyzes the aggregate consequences of cyclical macroprudential policy for labor market and aggregate dynamics. It is found that a policy that reduces credit fluctuations successfully reduces consumption, investment, and output volatility, but generates substantially higher unemployment fluctuations in response to productivity shocks. Moreover, the policy increases the volatility of all these variables in response to net worth shocks. The link between formal credit markets, input credit between firms, and self-employment plays a key role in explaining the adverse impact of macroprudential policy on unemployment dynamics. The findings point to potential gains from policy complementarities between macroprudential regulation and active labor market interventions over the business cycle. |
| Keywords: | Production & Business Cycles, Financial Policy, Labor markets, Labor search, Business cycles, Macroprudential policies, Financial frictions |
| Date: | 2015–03 |
| URL: | http://d.repec.org/n?u=RePEc:idb:brikps:88738&r=dge |
| By: | Ahmat Jidoud |
| Abstract: | This paper investigates the channels through which remittances affect macroeconomic volatility in African countries using a dynamic stochastic general equilibrium (DSGE) model augmented with financial frictions. Empirical results indicate that remittances—as a share of GDP—have a significant smoothing impact on output volatility but their impact on consumption volatility is somewhat small. Furthermore, remittances are found to absorb a substantial amount of GDP shocks in these countries. An investigation of the theoretical channels shows that the stabilization impact of remittances essentially hinges on two channels: (i) the size of the negative wealth effect on labor supply induced by remittances and, (ii) the strength of financial frictions and the ability of remittances to alleviate these frictions. |
| Keywords: | Remittances;Africa;Business cycles;Private consumption;Labor supply;Economic stabilization;General equilibrium models;Macroeconomic Volatility, Remittances, African Economies, Financial Frictions. |
| Date: | 2015–03–02 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:15/49&r=dge |
| By: | Lorenza Rossi (Department of Economics and Management, University of Pavia) |
| Abstract: | I consider a NK-DSGE model with endogenous firms' exit and entry together with a monopolistic competitive banking sector, where defaulting firms do not repay loans to banks. I show that the exit margin is an important shock trans- mission channel. It implies: i) an endogenous countercyclical number of fi rms destruction; ii) an endogenous countercyclical bank markup and spread. The interaction between i) and ii) generates a stronger propagation mechanism with respect to a model with efficient banks. Compared to a model with exogenous exit the model generates a correlation between output and firms'entry closer to the data. |
| Keywords: | firms' endogenous exit, firms dynamics, monopolistic banking, inefficient financial markets, countercyclical bank markup, interest rate spread. |
| JEL: | E32 E44 E52 E58 |
| Date: | 2015–03 |
| URL: | http://d.repec.org/n?u=RePEc:pav:demwpp:demwp0099&r=dge |
| By: | Alan Finkelstein Shapiro; Andres Gonzalez |
| Abstract: | Emerging economies have high shares of self-employed individuals running owner-only firms who, in contrast to many salaried firms, have little access to formal financing and therefore rely on informal financing (input credit) from other firms. We build a small open economy real business cycle model with labor and financial market frictions where formal credit markets, informal credit, and the structure of the labor market interact. The model successfully replicates the cyclical behavior of sectoral employment, formal credit, and the main macroeconomic aggregates in emerging economies. We show that a countercyclical macroprudential policy that reduces formal credit fluctuations has positive though quantitatively limited effects on consumption and output volatility, but generates larger unemployment fluctuations in response to productivity shocks; the same policy increases labor market and aggregate volatility in response to net worth shocks. The link between input credit and the labor market structure---key for capturing the cyclical dynamics of labor and credit markets in the data---plays a crucial role for these results. |
| Keywords: | Macroprudential policies and financial stability;Latin America;Emerging markets;Labor markets;Business cycles;Small open economies;Labor market friction;Econometric models;Business cycles, self-employment, labor search frictions, financial frictions, macroprudential policy. |
| Date: | 2015–04–03 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:15/78&r=dge |
| By: | Michael Brei; Almira Buzaushina |
| Abstract: | The present paper investigates how an emerging market economy is affected when it suddenly faces a higher risk premium on international capital markets. We study this question empirically for five Latin American economies over the period 1994-2007 within a structural panel vector autoregression and analyze theoretically the transmission mechanism using a dynamic stochastic general equilibrium model (DSGE) of a small open economy. The financial shock is modeled by an unexpected increase in the risk premium of firms’ foreign-currency debt. In response, the adverse shock is amplified by a feedback mechanism between currency depreciation, adverse balance sheet and risk premium effects. The theoretical model is used to study different monetary policy responses. We find that an exchange rate targeting rule that strikes a balance between exchange rate and inflation targeting allows the monetary authority to stabilize inflation and output more effectively than under a pure inflation targeting rule. |
| Keywords: | CGEM, EPA, Gender inequalities, Trade opening, SenEmerging Markets, Financial Crises, International Capital Markets. |
| JEL: | F34 F36 G21 |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:drm:wpaper:2015-11&r=dge |
| By: | Mitsuhiro OKANO (Asia Pacific Institute of Research) |
| Abstract: | Using a dynamic stochastic general equilibrium model, this study empirically examines Japan’s Kansai Region to ascertain causes of its long-run economic stagnation. Simulations and the empirical investigation demonstrate that stagnant private residential and equipment investments and productivity persistency are structural problems responsible for Kansai’s unique economic fluctuations. |
| Keywords: | Kansai economy, Area DSGE, productivity, residential investment |
| Date: | 2015–04 |
| URL: | http://d.repec.org/n?u=RePEc:aps:wpaper:1004265&r=dge |
| 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 con- straint 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 re- gional 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 |
| URL: | http://d.repec.org/n?u=RePEc:hep:macppr:201503&r=dge |
| By: | Hisahiro Naito |
| Abstract: | The eect of accepting more immigrants on welfare in the presence of a pay-asyou-go social security system is analyzed theoretically and quantitatively in this study. First, it is shown that if intergenerational government transfers initially exist from the young to the old, the government can lead an economy to the (modied) golden rule level within a nite time in a Pareto-improving way by increasing the percentage of immigrants to natives (PITN). Second, by using the computational overlapping generation model, I calculate both the welfare gain of increasing the PITN from 15.5 percent to 25.5 percent in 80 years and the years needed to reach the (modied) golden rule level in a Pareto-improving way in a model economy. The simulation results show that the present discounted value of the Pareto-improving welfare gain of increasing the PITN is 23 percent of initial GDP. It takes 112 years for the model economy to reach the golden rule level in a Pareto-improving way. |
| Date: | 2015–04 |
| URL: | http://d.repec.org/n?u=RePEc:tsu:tewpjp:2015-002&r=dge |
| By: | Carlos Carvalho; Nilda Pasca; Laura Souza; Eduardo Zilberman |
| Abstract: | This paper augments a relatively standard dynamic general equilibrium model with financial frictions in order to quantify the macroeconomic effects of the credit deepening process observed in many Latin American (LA) countries in the last decade, most notably in Brazil. In the model, a stylized banking sector intermediates credit from patient households to impatient households and firms. The key novelty of the paper, motivated by the Brazilian experience, is to model the credit constraint faced by (impatient) households as a function of future labor income. In the calibrated model, credit deepening generates only modest abovetrend growth in consumption, investment, and GDP. Since Brazil has experienced one of the most intense credit deepening processes in Latin America, it is argued that the quantitative effects for other LA economies are unlikely to be sizeable. |
| Keywords: | Public finance, Financial Policy, Microbusinesses & Microfinance, Credit deepening, Financial frictions, Consignado credit, Payroll lending, Financial frictions |
| Date: | 2015–01 |
| URL: | http://d.repec.org/n?u=RePEc:idb:brikps:87893&r=dge |
| By: | Andrés Fernández Martín; Felipe Meza |
| Abstract: | This paper documents how informal employment in Mexico is countercyclical, lags the cycle and is negatively correlated to formal employment. This contributes to explaining why total employment in Mexico displays low cyclicality and variability over the business cycle when compared to Canada, a developed economy with a much smaller share of informal employment. To account for these empirical findings, a business cycle model is built of a small, open economy that incorporates formal and informal labor markets, and the model is calibrated to Mexico. The model performs well in terms of matching conditional and unconditional moments in the data. It also sheds light on the channels through which informal economic activity may affect business cycles. Introducing informal employment into a standard model amplifies the effects of productivity shocks. This is linked to productivity shocks being imperfectly propagated from the formal to the informal sector. It also shows how imperfect measurement of informal economic activity in national accounts can translate into stronger variability in aggregate economic activity. |
| Keywords: | Workforce & Employment, Production & Business Cycles, Emerging economies, Business cycles, Informal employment, IDB-TN-515 |
| Date: | 2015–01 |
| URL: | http://d.repec.org/n?u=RePEc:idb:brikps:87694&r=dge |
| By: | Sarolta Laczó (Bank of England; Centre for Macroeconomics (CFM)); Raffaele Rossi (Department of Economics Management School Lancaster University) |
| Abstract: | We characterise optimal fiscal policies in a Real Business Cycle model when the government has access to consumption taxation but cannot credibly commit to future policies. Contrary to the case where only labour and capital income are taxed, the optimal time-consistent policies are remarkably similar to their Ramsey counterparts, as long as the capital income tax causes some distortion within the period. The welfare gains from commitment are negligible, while they are substantial without consumption taxation. Further, the welfare gains from taxing consumption are much higher without commitment. These results suggest that the policy-maker's ability to commit is of secondary importance if consumption is taxed optimally. |
| Keywords: | fiscal policy, Markov-perfect policies, consumption taxation, variable capital utilisation, endogenous government spending |
| JEL: | E62 H21 |
| Date: | 2015–01 |
| URL: | http://d.repec.org/n?u=RePEc:cfm:wpaper:1508&r=dge |
| By: | Atsushi Inoue; Chun-Hung Kuo; Barbara Rossi |
| Abstract: | The Great Recession has challenged the adequacy of existing models to explain key macroeconomic data, and raised the concern that the models might be misspecified. This paper investigates the importance of misspecification in structural models using a novel approach to detect and identify the source of the misspecification, thus guiding researchers in their quest for improving economic models. Our approach formalizes the common practice of adding "shocks" in the model and identifies potential mis-specification via forecast error variance decomposition and marginal likelihood analyses. Simulation results based on a small-scale DSGE model demonstrate that the method can correctly identify the source of mis-specification. Our empirical results show that state-of-the-art medium-scale New Keynesian DSGE models remain mis-specified, pointing to asset and labor markets as the sources of the mis-specification. |
| Date: | 2015–02 |
| URL: | http://d.repec.org/n?u=RePEc:upf:upfgen:1479&r=dge |
| By: | Carlos A. Arango (Banco de la República de Colombia); Oscar M. Valencia (Banco de la República de Colombia) |
| Abstract: | This paper presents a DSGE model with banks that face moral hazard in management. Banks receive demand deposits and fund investment projects. Banks are subject to potential withdrawals by depositors which may force them into early liquidation of their investments. The likelihood of this happening depends on the bank management efforts to keep the bank financially sound and the degree of bank leverage. We study the properties of this model under different monetary and macro-prudential policy arrangements. Our model is able to replicate the pro-cyclicality of leverage, and provides insights on the interplay between bank leverage and bank management incentives as a result of monetary, productivity and financial shocks. We find that a combination of pro-cyclical capital requirements and a standard monetary policy are well suited to contain the effects on output and prices of a downturn, keeping the financial system in check. Yet, in an expansionary phase (i.e. a productivity shock) this policy combination may produce desirable results for some macro-variables but at the expense of a deterioration in other macro-financial indicators. Classification JEL: G11, 033, D86. |
| Keywords: | DSGE modeling, Financial frictions, Moral hazard, Macro-prudential policies. |
| Date: | 2015–04 |
| URL: | http://d.repec.org/n?u=RePEc:bdr:borrec:878&r=dge |
| By: | Jakub Mateju (CERGE-EI, Prague, Czech Republic; Czech National Bank, Prague, Czech Republic) |
| Abstract: | This paper suggests that non-fundamental component in asset prices is one of the drivers of financial and credit cycle. Presented model builds on the financial accelerator literature by including a stock market where limitedly-liable investors trade stocks of productive firms with stochastic productivities. Investors borrow funds from the banking sector and can go bankrupt. Their limited liability induces a moral hazard problem which shifts demand for risk and drives prices of risky assets above fundamental value. Embedding the contracting problem in a New Keynesian general equilibrium framework, the model shows that loose monetary policy induces loose credit conditions and leads to a rise in both fundamental and non-fundamental components of stock prices. Positive shock to non-fundamental component triggers a financial cycle: collateral values rise, lending rate and default rate decreases. These effects reverse after several quarters, inducing a credit crunch. The credit boom lasts only while stock market growth maintains sufficient momentum. However, monetary policy does not reduce volatility of inflation and output gap by reacting to asset prices. |
| Keywords: | credit cycle, limited liability, non-fundamental asset pricing, collateral value, monetary policy |
| JEL: | E32 E44 E52 G10 |
| Date: | 2015–03 |
| URL: | http://d.repec.org/n?u=RePEc:fau:wpaper:wp2015_05&r=dge |
| By: | Carlos A. Arango; Oscar M. Valencia |
| Abstract: | This paper presents a DSGE model with banks that face moral hazard in management. Banks receive demand deposits and fund investment projects. Banks are subject to potential withdrawals by depositors which may force them into early liquidation of their investments. The likelihood of this happening depends on the bank management efforts to keep the bank financially sound and the degree of bank leverage. We study the properties of this model under different monetary and macro-prudential policy arrangements. Our model is able to replicate the pro-cyclicality of leverage, and provides insights on the interplay between bank leverage and bank management incentives as a result of monetary, productivity and financial shocks. We find that a combination of pro-cyclical capital requirements and a standard monetary policy are well suited to contain the effects on output and prices of a downturn, keeping the financial system in check. Yet, in an expansionary phase (i.e. a productivity shock) this policy combination may produce desirable results for some macro-variables but at the expense of a deterioration in other macro-financial indicators. |
| Keywords: | DSGE modeling, Financial frictions, Moral hazard, Macro-prudential policies. |
| JEL: | G11 D86 |
| Date: | 2015–04–10 |
| URL: | http://d.repec.org/n?u=RePEc:col:000094:012695&r=dge |
| By: | Eugeni, Sara |
| Abstract: | Recent empirical studies have highlighted that valuation effects associated with fluctuations of nominal exchange rates are one of the key components that drive the behaviour of the net foreign assets position of a country. In this paper, we propose a two-country overlapping-generations model of nominal exchange rate determination with endogenous portfolio choice in line with this evidence. We show that a country runs a current account deficit when its share of world GDP decreases. As the domestic currency depreciates in equilibrium, a positive wealth effect partially offsets the current deficit and therefore has a stabilizing impact on the net external position of the country. The model rationalizes the deterioration of the US external position over the past 20 years as a consequence of the rise of emerging market countries in the world economy, while being consistent with the fact the US have experienced positive valuation effects. Numerical results indicate that valuation effects are quantitatively relevant as they account for more than half of the cumulated US current account deficits, consistently with the data. |
| Keywords: | portfolio choice; nominal exchange rates; valuation effects; incomplete markets; two-country OLG model |
| JEL: | F30 F31 F32 F40 F41 |
| Date: | 2015–04 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:63549&r=dge |
| By: | Catalina Granda; Franz Hamann |
| Abstract: | The informal sector is an extensive phenomenon in developing countries. While some of its implications have drawn considerable attention in the literature, one relatively unexplored aspect has to do with the saving patterns of workers and firms and how these might influence aggregate savings and wealth inequality. This paper aims to fill that gap by examining both entrepreneurs' and workers' choices regarding whether to perform informally and regarding asset accumulation. Specifically, the paper builds an occupational choice model wherein saving is primarily motivated by precautionary considerations. The model features labor and capital market segmentation, and it is calibrated to replicate the saving rates, wealth inequality and composition of occupations across the formal and informal sectors of Colombia. Computational experiments additionally make it possible to analyze the effects of highly debated formalization policies on wealth redistribution and promotion of saving and entrepreneurship. Alternative frameworks are finally considered. |
| Keywords: | Income, Consumption & Saving, Wealth inequality, Informality, Wealth inequality, Saving, Occupational choice models |
| Date: | 2015–02 |
| URL: | http://d.repec.org/n?u=RePEc:idb:brikps:88196&r=dge |
| By: | Kevin x.d. Huang (Vanderbilt University); Hui He (Shanghai University of Finance and Economics and International Monetary Fund) |
| Abstract: | Empirical evidence suggests that both leisure time and medical care are important for maintaining health. We develop a general equilibrium macroeconomic model in which taxation is a key determinant of the composition of these two inputs in the endogenous accumulation of health capital. In our model, higher taxes lead to using relatively more leisure time and less medical care in maintaining health. We find that difference in taxation between the US and Europe can account for a large fraction of their difference in health expenditure-GDP ratio and almost all of their difference in time input for health production. |
| Keywords: | Taxation; Relative health care price; Time allocation; Health care expenditure; Macroeconomics |
| JEL: | E2 H2 |
| Date: | 2015–04–08 |
| URL: | http://d.repec.org/n?u=RePEc:van:wpaper:vuecon-15-00003&r=dge |
| By: | Michael C. Huang (National Graduate Institute for Policy Studies); Nobuhiro Hosoe (National Graduate Institute for Policy Studies) |
| Abstract: | We investigate a long-run impact of a compound disaster in northern Taiwan by describing a recovery process from the disaster with a dynamic computable general equilibrium model. After simulating losses of capital and labor in combination with a nuclear power shutdown, we conduct policy experiments that are aimed at recovery of Taiwan’s major industries by subsidizing their output or capital use. We found that the semiconductor industry could recover but need a huge amount of subsidies while the electronic equipment sector could almost recover even without subsidies. Capital-use subsidies would cost less than output subsidies. When we use two-year longer duration for a recovery program of semiconductors, we could save the subsidy costs by 7–10%. |
| Date: | 2015–04 |
| URL: | http://d.repec.org/n?u=RePEc:ngi:dpaper:15-01&r=dge |
| By: | Annamaria Lusardi; Pierre-Carl Michaud; Olivia S. Mitchell |
| Abstract: | Prior studies disagree regarding the effectiveness of financial literacy programs, especially those offered in the workplace. To explain such measurement differences in evaluation and outcomes, we employ a stochastic life cycle model with endogenous financial knowledge accumulation to investigate how financial education programs optimally shape key economic outcomes. This approach permits us to measure how such programs shape wealth accumulation, financial knowledge, and participation in sophisticated assets (e.g. stocks) across heterogeneous consumers. We then apply conventional program evaluation econometric techniques to simulated data, distinguishing selection and treatment effects. We show that the more effective programs provide follow-up in order to sustain the knowledge acquired by employees via the program; in such an instance, financial education delivered to employeees around the age of 40 can raise savings at retirement by close to 10%. By contrast, one-time education programs do produce short-term but few long-term effects. We also measure how accounting for selection affects estimates of program effectiveness on those who participate. Comparisons of participants and non-participants can be misleading, even using a difference-in-difference strategy. Random program assignment is needed to evaluate program effects on those who participate. |
| Keywords: | Life cycle model, financial literacy, financial decision-making, financial education, program evaluation, difference-in-difference |
| JEL: | D91 |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:lvl:criacr:1505&r=dge |
| By: | Sanches, Daniel R. (Federal Reserve Bank of Philadelphia) |
| Abstract: | A primary concern in monetary economics is whether a purely private monetary regime is consistent with macroeconomic stability. I show that a competitive regime is inherently unstable due to the properties of endogenously determined limits on private money creation. Precisely, there is a continuum of equilibria characterized by a self-fulfilling collapse of the value of private money and a persistent decline in the demand for money. I associate these equilibrium allocations with self-fulfilling banking crises. It is possible to formulate a fiscal intervention that results in the global determinacy of equilibrium, with the property that the value of private money remains stable. Thus, the goal of monetary stability necessarily requires some form of government intervention. |
| Keywords: | Private money; Self-fulfilling crises; Macroeconomic stability |
| JEL: | E42 E44 G21 |
| Date: | 2015–04–09 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedpwp:15-18&r=dge |
| By: | Michal Andrle; Patrick Blagrave; Pedro Espaillat; Keiko Honjo; Ben Hunt; Mika Kortelainen; René Lalonde; Douglas Laxton; Eleonara Mavroeidi; Dirk Muir; Susanna Mursula; Stephen Snudden |
| Abstract: | The Flexible System of Global Models (FSGM) is a group of models developed by the Economic Modeling Division of the IMF for policy analysis. A typical module of FSGM is a multi-region, forward-looking semi-structural global model consisting of 24 regions. Using the three core modules focused on the G-20, the euro area, and emerging market economies, this paper outlines the theory under-pinning the model, and illustrates its macroeconomic properties by presenting its responses under a wide range of experiments, including monetary, financial, demand, supply, fiscal and international shocks. |
| Keywords: | Economic theory;Demand;Prices;Commodities;Fiscal policy;Monetary policy;Group of Twenty;General equilibrium models;monetary policy; fiscal policy; dynamic stochastic general equilibrium models; macroeconomic interdependence |
| Date: | 2015–03–20 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:15/64&r=dge |