nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2015‒04‒25
twenty-two papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. News Shocks and Labor Market Dynamics in Matching Models By Francesco Zanetti; Konstantinos Theodoridis
  2. The zero lower bound and parameter bias in an estimated DSGE model By Yasuo Hirose; Atsushi Inoue
  3. Financial Conditions and Slow Recoveries By Kevin x.d. Huang; Jie Chen; Zhe Li; Jianfei Sun
  4. An Empirical Equilibrium Model of a Decentralized Asset Market By Gavazza, Alessandro
  5. From real business cycle and new Keynesian to DSGE Macroeconomics: facts and models in the emergence of a consensus By Pedro Garcia Duarte
  6. Optimal Taxation with Risky Human Capital By Marek Kapicka; Julian Neira
  7. Can indeterminacy and self-fulfilling expectations help explain international business cycles? By Stephen McKnight; Laura Povoledo
  8. Quantitative Models of Wealth Inequality: A Survey By Mariacristina De Nardi
  9. On-the-Job Search and City Structure By Aico van Vuuren
  10. The Pass-Through of Sovereign Risk By Bocola, Luigi
  11. Currency Risk and Business Cycle Risk in the Geography of Debt Flows to Peripheral Europe By Eylem Ersal Kiziler; Ha Nguyen
  12. Inflation Dynamics During the Financial Crisis By Gilchrist, Simon; Schoenle, Raphael; Sim, Jae W.; Zakrajsek, Egon
  13. Penalized Indirect Inference By Francisco Blasques; Artem Duplinskiy
  14. Banking panics and deflation in dynamic general equilibrium By Carapella, Francesca
  15. Indeterminacy, Misspecification and Forecastability: Good Luck in Bad Policy? By Luca Fanelli; Marco M. Sorge
  16. State Dependency in Price and Wage Setting By Shuhei Takahashi
  17. Reconciling Consumption Inequality with Income Inequality By Vadym Lepetyuk; Christian A. Stoltenberg
  18. Intensive and Extensive Margins of Fertility, Capital Accumulation, and Economic Welfare By Akira Momota
  19. Deterministic Dynamic Programming in Discrete Time: A Monotone Convergence Principle By Takashi Kamihigashi; Masayuki Yao
  20. Debt and Deficit Fluctuations in a Time-Consistent Setup By Grechyna, Daryna
  21. A dynamic North-South model of demand-induced product cycles By Reto Foellmi; Sandra Hanslin; Andreas Kohler
  22. Existence and uniqueness of equilibrium in Lucas' asset pricing model when utility is unbounded By Brogueira, Joao; Schuetze, Fabian

  1. By: Francesco Zanetti; Konstantinos Theodoridis
    Abstract: We enrich a baseline RBC model with search and matching frictions on the labor market and real frictions that are helpful in accounting for the response of macroeconomic aggregates to shocks.  The analysis allows shocks to have an unanticipated and a new (i.e. anticipated) component.  The Bayesian estimation of the model reveals that the model which includes news shocks on macroeconomic aggregates produces a remarkable fit of the data.  News shocks in stationary and non-stationary TFP, investment-specific productivity and preference shocks significantly affect labor market variables and explain a sizeable fraction of macroeconomic fluctuations at medium- and long-run horizons.  Historically, news shocks have played a relevant role for output, but they have had a limited influence on unemployment.
    Keywords: Anticipated productivity shocks, Bayesian SVAR methods, labour market search frictions
    JEL: E32 C32 C52
    Date: 2015–04–17
  2. By: Yasuo Hirose (Keio University); Atsushi Inoue (Vanderbilt University)
    Abstract: This paper examines how and to what extent parameter estimates can be biased in a dynamic stochastic general equilibrium (DSGE) model that omits the zero lower bound (ZLB) constraint on the nominal interest rate. Our Monte Carlo experiments using a standard sticky-price DSGE model show that no significant bias is detected in parameter estimates and that the estimated impulse response functions are quite similar to the true ones. However, as the probability of hitting the ZLB increases, the parameter bias becomes larger and therefore leads to substantial differences between the estimated and true impulse responses. It is also demonstrated that the model missing the ZLB causes biased estimates of structural shocks even with the virtually unbiased parameters.
    JEL: E3 E5
    Date: 2014–09–09
  3. By: Kevin x.d. Huang (Vanderbilt University); Jie Chen (Shanghai University of Finance and Economics); Zhe Li (Shanghai University of Finance and Economics); Jianfei Sun (Shanghai Jiao Tong University)
    Abstract: We argue that financial frictions and financial shocks can be an important factor behind the slow recoveries from the three most recent recessions. To illustrate this point, we augment a simple RBC model with a collateral constraint whose tightness is randomly disturbed by a shock that prescribes the general financial condition in the economy. We present evidence that such financial shock has become more persistent since the mid 1980s. We show that this can be an important contributor to the recent slow recoveries, and that a main mechanism may have to do with just-in-time-uses of capital and labor in the face of tight credit conditions during the recoveries. To assess the importance of such financial shock relative to other shocks in contributing to the slow recoveries, we enrich a New Keynesian model, which features various structural shocks and frictions widely considered in the literature, with the financial frictions and financial shocks studied in our parsimonious model. Our structural estimates of this comprehensive model indicate that financial shocks can play a dominant role in accounting for the slow recoveries, especially in employment growth rate.
    Keywords: Collateral constraint; Financial shock; Slow recovery; Capital shortage; Extensive margin; Intensive margin
    JEL: E2 E3
    Date: 2014–06–06
  4. By: Gavazza, Alessandro
    Abstract: I estimate a search-and-bargaining model of a decentralized market to quantify the effects of trading frictions on asset allocations, asset prices and welfare, and to quantify the effects of intermediaries that facilitate trade. Using business-aircraft data, I find that, relative to the Walrasian benchmark, 18.3 percent of the assets are misallocated; prices are 19.2-percent lower; and the aggregate welfare losses equal 23.9 percent. Dealers play an important role in reducing trading frictions: In a market with no dealers, a larger fraction of assets would be misallocated, and prices would be higher. Moreover, dealers reduce aggregate welfare because their operations are costly, and they impose a negative externality by decreasing the number of agents' direct transactions.
    Keywords: bargaining; intermediaries; search markets
    JEL: C78 D83 G12
    Date: 2015–04
  5. By: Pedro Garcia Duarte
    Abstract: Macroeconomists have emphasized the force of facts in forging a consensus understanding of business cycle fluctuations. According to this view, rival economists could no longer hold disparate views on the topic because “facts have a way of not going away” (Blanchard 2009). But how can macroeconomists observe the workings of an economy? Essentially through building and manipulating models. Thus the construction of macroeconomic facts –or “stylized facts”–, empirical regularities that come to be widely accepted, opens up technical spaces where macroeconomists negotiated their theoretical commitments and eventually allowed a consensus to emerge. I argue that this is an important element in the history of the DSGE macroeconomics.
    Keywords: DSGE models; history of macroeconomics; new Keynesian macroeconomics; real business cycles
    JEL: B22 B23 E32
    Date: 2015–04–17
  6. By: Marek Kapicka (U.C. Santa Barbara and CERGE-EI); Julian Neira (Department of Economics, University of Exeter)
    Abstract: We study optimal tax policies in a life-cycle economy with risky human capital and permanent ability differences, where both ability and learning effort are private information of the agents. The optimal policies balance several goals: redistribution across agents, insurance against human capital shocks, incentives to accumulate human capital, and incentives to work. We show that, in the optimum, i) high-ability agents face risky consumption in order to elicit learning effort while low-ability agents are insured, ii) high-ability agents face a higher savings tax to discourage them from self-insuring, iii) under certain conditions, the inverse marginal labor income tax rate follows a random walk, and iv) the “no distortion at the top” result does not apply if discouraging labor supply increases incentives to invest in human capital. Quantitatively, we find large welfare gains for the U.S. from switching to an optimal tax system.
    Keywords: optimal taxation, income taxation, human capital
    JEL: E6 H2
    Date: 2015
  7. By: Stephen McKnight (El Colegio de México); Laura Povoledo (University of the West of England, Bristol)
    Abstract: We introduce equilibrium indeterminacy into a two-country incomplete asset model with imperfect competition and analyze whether self-fulfilling, belief-driven fluctuations (i.e., sunspot shocks) can help resolve the major puzzles of international business cycles. We find that a combination of productivity and sunspot shocks can account for the observed counter-cyclical behavior in international relative prices and quantities, while simultaneously generating volatilities that match the data. The indeterminacy model can also resolve the Backus-Smith puzzle without requiring a low value of the trade elasticity.
    Keywords: Indeterminacy; Sunspots; International Business Cycles; Net Exports; Terms of Trade; Real Exchange Rate; Backus-Smith Puzzle
    JEL: E32 F41 F44
    Date: 2015–01–04
  8. By: Mariacristina De Nardi
    Abstract: In the data, wealth is very unequally distributed, even more so than labor earnings and income, and the saving rate of wealthy people is high. Many dynamic models used for quantitative policy evaluation imply that once households get rich, they dissave. As a result, these models generate too little wealth concentration in the hands of the wealthiest compared with the observed data. This raises the question of the robustness of the policy lessons that we learn from environments in which key aspects of saving behavior in the model are not consistent with those in the observed data. Mechanisms that raise the saving rate of richer people, and thus generate more realistic saving behavior and wealth concentration in dynamic quantitative models, have been proposed. These mechanisms include heterogeneity in patience, transmission of human capital and voluntary bequests across generations, entrepreneurship or high returns to capital coupled with borrowing constraints, and high earnings risk for the top earners. More work is needed to evaluate these explanations both individually and jointly and to quantitatively assess their importance. Additionally, more work to explore alternative or complementary mechanisms is warranted.
    JEL: D14 D31 E21 H2
    Date: 2015–04
  9. By: Aico van Vuuren (VU University Amsterdam)
    Abstract: We investigate an equilibrium search model in which the search frictions are increasing with the distance to the central business district allowing for on-the-job search and endogenous (monopsony) wage formation and land allocation. We find that there are many different possible outcomes with respect to the location of unemployed workers within a metropolitan area. The city structure of the decentralized market is only efficient when commuting costs of the employed workers are large. Policies reducing the rental costs of unemployed workers for locations close to the central business district can potentially increase welfare.
    Keywords: Search, city structure, urban economics
    JEL: J42 J60 J64 R10
    Date: 2015–02–02
  10. By: Bocola, Luigi (Federal Reserve Bank of Minneapolis)
    Abstract: This paper examines the macroeconomic implications of sovereign credit risk in a business cycle model where banks are exposed to domestic government debt. The news of a future sovereign default hampers financial intermediation. First, it tightens the funding constraints of banks, reducing their available resources to finance firms (liquidity channel). Second, it generates a precautionary motive for banks to deleverage (risk channel). I estimate the model using Italian data, finding that i) sovereign credit risk was recessionary and that ii) the risk channel was sizable. I then use the model to evaluate the effects of subsidized long term loans to banks, calibrated to the ECB’s longer-term refinancing operations. The presence of strong precautionary motives at the time of policy enactment implies that bank lending to firms is not very sensitive to these credit market interventions.
    Keywords: Sovereign debt crises; Financial constraints; Risk; Credit policies
    JEL: E32 E44 G01 G21
    Date: 2015–04–16
  11. By: Eylem Ersal Kiziler (Department of Economics, University of Wisconsin - Whitewater); Ha Nguyen (Development Research Group, World Bank)
    Abstract: Since the start of the Eurozone, the pattern of debt ows to Peripheral Europe seems puzzling: they were mostly indirect and intermediated by the large countries of the euro area. This paper examines the euro currency risk and the business cycle risk as two opposing forces: while the currency risk favors Core Europe in lending to Peripheral Europe, business cycle risk favors outsider lenders. We explain the mechanisms and show that both forces are strong. In a 3-country DSGE model with endogenous portfolio choices, without the business cycle risk, currency risk completely pushes outside lenders out of the Peripheral bond market. With both types of risk, Core Europe and outside lenders hold 40 and 60 percents of Peripheral bonds respectively. The results suggest that other factors such as asymmetric information or bailout discrimination are also at play.
    Keywords: Debt Flows, Business Cycle Risk
    JEL: F4
    Date: 2014–08
  12. By: Gilchrist, Simon (Boston University); Schoenle, Raphael (Brandeis University); Sim, Jae W. (Board of Governors of the Federal Reserve System (U.S.)); Zakrajsek, Egon (Board of Governors of the Federal Reserve System (U.S.))
    Abstract: Firms with limited internal liquidity significantly increased prices in 2008, while their liquidity unconstrained counterparts slashed prices. Differences in the firms' price-setting behavior were concentrated in sectors likely characterized by customer markets. We develop a model, in which firms face financial frictions, while setting prices in a customer-markets setting. Financial distortions create an incentive for firms to raise prices in response to adverse demand or financial shocks. These results reflect the firms' reaction to preserve internal liquidity and avoid accessing external finance, factors that strengthen the countercyclical behavior of markups and attenuate the response of inflation to fluctuations in output.
    JEL: E31 E32 E44 E51
    Date: 2015–03–03
  13. By: Francisco Blasques (VU University Amsterdam, the Netherlands); Artem Duplinskiy (VU University Amsterdam, the Netherlands)
    Abstract: Parameter estimates of structural economic models are often difficult to interpret at the light of the underlying economic theory. Bayesian methods have become increasingly popular as a tool for conducting inference on structural models since priors offer a way to exert control over the estimation results. This paper proposes a penalized indirect inference estimator that allows researchers to obtain economically meaningful parameter estimates in a frequentist setting. The asymptotic properties of the estimator are established for both correctly and incorrectly specified models. A Monte Carlo study reveals the role of the penalty function in shaping the finite sample distribution of the estimator. The advantages of using this estimator are highlighted in the empirical study of a state-of-the-art dynamic stochastic general equilibrium model.
    Keywords: Penalized estimation, Indirect Inference, Simulation-based methods, DSGE models
    JEL: C15 C13 D58 E32
    Date: 2015–01–19
  14. By: Carapella, Francesca (Board of Governors of the Federal Reserve System (U.S.))
    Abstract: This paper develops a framework to study the interaction between banking, price dynamics, and monetary policy. Deposit contracts are written in nominal terms: if prices unexpectedly fall, the real value of banks' existing obligations increases. Banks default, panics precipitate, economic activity declines. If banks default, aggregate demand for cash increases because financial intermediation provided by banks disappears. When money supply is unchanged, the price level drops, thereby providing incentives for banks to default. Active monetary policy prevents banks from failing and output from falling. Deposit insurance can achieve the same goal but amplifies business cycle fluctuations by inducing moral hazard.
    Keywords: banking panics; deflation; deposit insurance
    JEL: E53 E58 G21 N12
    Date: 2015–03–04
  15. By: Luca Fanelli (University of Bologna); Marco M. Sorge (University of Göttingen and CSEF)
    Abstract: A recent debate in the forecasting literature revolves around the inability of macroecono-metric models to improve on simple univariate predictors, since the onset of the so-called Great Moderation. This paper explores the consequences of equilibrium indeterminacy for quantitative forecasting through standard reduced form forecast models. Exploiting U.S. data on both the Great Moderation and the preceding era, we first present evidence that (i) higher (absolute) forecastability obtains in the former rather than the latter period for all models considered, and that (ii) the decline in volatility and persistence captured by a .nite-order VAR system across the two samples is not associated with inferior (absolute or relative) predictive accuracy. Then, using a small-scale New Keynesian monetary DSGE model as laboratory, we generate arti.cial datasets under either equilibrium regime and investigate numerically whether (relative) forecastability is improved in the presence of indeterminacy. It is argued that forecasting under indeterminacy with e.g. unrestricted VAR models entails misspecification issues that are generally more severe than those one typically faces under determinacy. Irrespective of the occurrence of non-fundamental (sunspot) noise, for certain values of the arbitrary parameters governing solution multiplicity, the pseudo out-of-sample VAR-based forecasts of in.ation and output growth can outperform simple univariate predictors. For other values of these parameters, by contrast, the opposite occurs. In general, it is not possible to establish a one-to-one relationship between indeterminacy and superior forecastability, even when sunspot shocks play no role in generating the data. Overall, our analysis points towards a 'good luck in bad policy' explanation of the (relative) higher forecastability of macroeconometric models prior to the Great Moderation period.
    Keywords: DSGE, Forecasting, Indeterminacy, Misspecification, VAR system
    JEL: C53 C62 E17
    Date: 2015–04–19
  16. By: Shuhei Takahashi (Institute of Economic Research, Kyoto University)
    Abstract: The frequency of nominal wage adjustments varies with macroeconomic conditions, but existing New Keynesian models exclude such state dependency in wage setting, assuming time-dependent setting. This paper develops a New Keynesian model in which fixed wage-setting costs generate state-dependent wage setting. I find that state- dependent wage setting reduces the real impacts of monetary shocks compared to time- dependent setting. However, when parameterized to reproduce the fluctuations in wage rigidity in the U.S., the state- and time-dependent models show similar responses to monetary shocks. The result suggests that state dependency in wage setting is largely irrelevant to the U.S. monetary transmission.
    Keywords: Nominal wage stickiness, state-dependent setting, time-dependent setting, monetary nonneutralities, New Keynesian models
    JEL: E31 E32
    Date: 2015–03
  17. By: Vadym Lepetyuk (Bank of Canada, Canada); Christian A. Stoltenberg (University of Amsterdam)
    Abstract: The rise in within-group consumption inequality in response to the increase in within-group income inequality over the last three decades in the U.S. is puzzling to expected-utility-based incomplete market models. The two-sided lack of commitment models exhibit too little consumption inequality while the standard incomplete markets models tend to predict too much consumption inequality. We show that a model with two-sided lack of commitment and chance attitudes, as emphasized by prospect theory, can explain the relationship and can avoid the systematic bias of the expected utility models. The chance attitudes, such as optimism and pessimism, imply that the households attribute a higher weight to high and low outcomes compared to their objective probabilities. For realistic values of risk aversion and of chance attitudes, the incentives for households to share the idiosyncratic risk decrease. The latter effect endogenously amplifies the increase in consumption inequality relative to the expected utility model, thereby improving the fit to the data.
    Keywords: Consumption Inequality, Prospect Theory, Limited Enforcement, Risk Sharing
    JEL: E21 D31 D52
    Date: 2013–08–17
  18. By: Akira Momota (University of Tsukuba)
    Abstract: This paper investigates the impact of low fertility on long-term capital accumulation and economic welfare. We find that the impact differs according to whether the low fertility arises from a decrease in the intensive or extensive margin of fertility. We show that an increase in the intensive margin of fertility decreases the capital stock and economic welfare. Conversely, we identify a U-shaped relationship between the extensive margin of fertility and the capital stock because of the existence of two opposing effects, such that the decline in fertility may reduce economic welfare. Furthermore, we show that an intragenerational income redistribution policy can eliminate the welfare loss resulting from the incomplete market.
    Keywords: Childlessness, Economic growth, Extensive margin of fertility, Income redistribution, Intensive margin of fertility, Overlapping generations.
    JEL: H23 J13 O41
    Date: 2015–03
  19. By: Takashi Kamihigashi (Research Institute for Economics & Business Administration (RIEB), Kobe University, Japan); Masayuki Yao (Graduate School of Economics, Keio University)
    Abstract: We consider infinite-horizon deterministic dynamic programming problems in discrete time. We show that the value function is always a fixed point of a modified version of the Bellman operator. We also show that value iteration monotonically converges to the value function if the initial function is dominated by the value function, is mapped upward by the modified Bellman operator, and satisfies a transversality-like condition. These results require no assumption except for the general framework of infinite-horizon deterministic dynamic programming.
    Keywords: Dynamic Programming, Bellman Operator, Fixed Point, Value Iteration
    Date: 2015–03
  20. By: Grechyna, Daryna
    Abstract: This paper compares the stochastic behavior of fiscal variables under optimal fiscal policy for the cases of full commitment by the government (Ramsey problem) and no commitment by the government (focusing on differentiable Markov perfect equilibrium). It shows that the cyclical properties of fiscal variables are similar for both commitment assumptions. These conclusions are robust to two different specifications of the structure of public bonds (risk-free and state-contingent), and to different sets of the parameters. The cyclical properties of fiscal variables, regardless of commitment assumptions, can be determined by the parameters of the utility function.
    Keywords: optimal taxation; time-consistent policy; market incompleteness.
    JEL: E61 E62 H21 H63
    Date: 2015–03
  21. By: Reto Foellmi; Sandra Hanslin; Andreas Kohler
    Abstract: This paper presents a dynamic North-South general-equilibrium model where households have non-homothetic preferences. Innovation takes place in a rich North while firms in a poor South imitate products manufactured in the North. Introducing non-homothetic preferences delivers a complete international product cycle as described by Vernon (1966), where the different stages of the product cycle are determined not only by supply side factors but also by the distribution of income between North and South. We ask how changes in Southern labour productivity, population size in the South and inequality across regions affect the international product cycle. In line with presented stylised facts about the product cycle we predict a negative correlation between adoption time and per capita incomes.
    Keywords: Product cycles, Inequality, International trade
    JEL: F1 O3
    Date: 2015
  22. By: Brogueira, Joao; Schuetze, Fabian
    Abstract: This note proves existence of a unique equilibrium in a Lucas (1978) economy when the utility function displays constant relative risk aversion and log dividends follow a normally distributed AR(1) process with positive auto-correlation. In particular, the note provides restrictions on the coefficient of relative risk aversion, the discount factor and the conditional variance of the consumption process that ensure existence of a unique equilibrium.
    Keywords: Asset pricing, Exchange economy, Dynamic programming, Equilibrium conditions
    JEL: C61 C62 D51 G12
    Date: 2015

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