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on Dynamic General Equilibrium |
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Issue of 2015‒05‒09
eighteen papers chosen by Christian Zimmermann Federal Reserve Bank of St. Louis |
| By: | Atsushi Inoue; Chun-Huong 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 misspecification 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 misspecification. 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 misspecification. |
| Keywords: | DSGE models, empirical macroeconomics, model misspecification |
| JEL: | C32 E32 |
| Date: | 2015–02 |
| URL: | http://d.repec.org/n?u=RePEc:bge:wpaper:821&r=dge |
| By: | Luo, Yulei; Nie, Jun; Young, Eric |
| Abstract: | This paper provides a tractable continuous-time constant-absolute-risk averse (CARA)-Gaussian framework to quantitatively explore how the preference for robustness (RB) affects the interest rate, the dynamics of consumption and income, and the welfare costs of model uncertainty in general equilibrium. We show that RB significantly reduces the equilibrium interest rate, and reduces (increases) the relative volatility of consumption growth to income growth when the income process is stationary (non-stationary). Furthermore, we find that the welfare costs of model uncertainty are nontrivial for plausibly estimated income processes and calibrated RB parameter values. Finally, we extend the benchmark model to consider the separation of risk aversion and intertemporal substitution, incomplete information about income, and regime-switching in income growth. |
| Keywords: | Robustness, Model Uncertainty, Precautionary Savings, the Permanent Income Hypothesis, Low Interest Rates, Consumption Inequality, General Equilibrium. |
| JEL: | C6 D5 D52 E2 E21 |
| Date: | 2015–04–29 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:63985&r=dge |
| By: | Caliendo, Lorenzo (Yale University and NBER); Dvorkin , Maximiliano (Federal Reserve Bank of St. Louis); Parro, Fernando (Federal Reserve Board.) |
| Abstract: | We develop a dynamic labor search model where production and consumption take place in spatially distinct labor markets with varying exposure to domestic and international trade. The model recognizes the role of labor mobility frictions, goods mobility frictions, geographic factors, and input-output linkages in determining equilibrium allocations. We show how to solve the equilibrium of the model without estimating productivities, reallocation frictions, or trade frictions, which are usually di¢ cult to identify. We use the model to study the dynamic labor market outcomes of aggregate trade shocks. We calibrate the model to 38 countries, 50 U.S. states and 22 sectors and use the rise in China’s import competition to quantify the aggregate and disaggregate employment and welfare effects on the U.S. economy. We find that China’s import competition growth resulted in 0.6 percentage point reduction in the share of manufacturing employment, approximately 1 million jobs lost, or about 60% of the change in the manufacturing employment share not explained by a secular trend. Overall, China’s shock increases U.S. welfare by 6.7% in the long-run and by 0.2% in the short-run with very heterogeneous effects across labor markets. |
| Keywords: | Migration; labor reallocation; dynamic discrete choice; manufacturing employment; intersectoral trade; interregional trade; international trade |
| JEL: | E24 F16 J62 R13 R23 |
| Date: | 2015–05–01 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2015-009&r=dge |
| By: | Vasco Carvalho; Basile Grassi |
| Abstract: | Do large firm dynamics drive the business cycle? We answer this question by developing a quantitative theory of aggregate fluctuations caused by firm-level disturbances alone. We show that a standard heterogeneous firm dynamics setup already contains in it a theory of the business cycle, without appealing to aggregate shocks. We offer a complete analytical characterization of the law of motion of the aggregate state in this class of models – the firm size distribution – and show that the resulting closed form solutions imply aggregate output and productivity dynamics which are: (i) persistent, (ii) volatile and (iii) exhibit time-varying second moments. We explore the key role of moments of the firm size distribution – and, in particular, the role of large firm dynamics – in shaping aggregate fluctuations, theoretically, quantitatively and in the data. |
| Keywords: | large firm dynamics, firm size distribution, random growth, aggregate fluctuations |
| Date: | 2015–04 |
| URL: | http://d.repec.org/n?u=RePEc:bge:wpaper:824&r=dge |
| By: | Mitsuru Katagiri (Bank of Japan); Hideki Konishi (Faculty of Political Science and Economics, Waseda University); Kozo Ueda (Faculty of Political Science and Economics, Waseda University) |
| Abstract: | Negative correlations between inflation and demographic aging were observed across developed nations recently. To understand the phenomenon from a politico-economic perspective, we embed the fiscal theory of the price level into an overlapping-generations model. In the model, successive short-lived governments choose income tax rates and bond issues considering the political influence of existing generations and the policy response of future governments. The model sheds new light on the traditional debate about the burden of national debt. Because of price adjustments, the accumulation of government debt does not become a burden on future generations. Our analysis reveals that the effects of aging depend on its causes. Aging is deflationary when caused by an increase in longevity but inflationary when caused by a decline in birth rate. Numerical simulation shows that aging over the past 40 years in Japan generated deflation of about 0.6 percentage points annually. |
| Keywords: | Fiscal theory of the price level, Politico-economic equilibrium |
| JEL: | D72 E30 E62 E63 H60 |
| Date: | 2014–11 |
| URL: | http://d.repec.org/n?u=RePEc:wap:wpaper:1413&r=dge |
| By: | Ferrante, Francesco (Board of Governors of the Federal Reserve System (U.S.)) |
| Abstract: | I develop a macroeconomic model with a financial sector, in which banks can finance risky projects (loans) and can affect their quality by exerting a costly screening effort. Informational frictions regarding the observability of loan characteristics limit the amount of external funds that banks can raise. In this framework I consider two possible types of financial intermediation, traditional banking (TB) and shadow banking (SB), differing in the level of diversification across projects. In particular, shadow banks, by pooling different loans, improve on the diversification of their idiosyncratic risk and increase the marketability of their assets. Due to their ability to pledge a larger share of the return on their projects, shadow banks will have a higher endogenous leverage compared to traditional banks, despite choosing a lower screening level. As a result, on the one hand, the introduction of SB will imply a higher amount of capital intermediated. On the other han d it will make the economy more fragile via three channels. First, by being highly leveraged and more exposed to risky projects, shadow banks will amplify exogenous negative shocks. Second, during a recession, the quality of projects intermediated by shadow banks will endogenously deteriorate even further, causing a slower recovery of the financial sector. A final source of instability is that the SB-system will be vulnerable to runs. When a run occurs, shadow banks will have to sell their assets to traditional banks, and this fire sale, because of the limited leverage capacity of the TB-system, will depress asset prices, making the run self-fulfilling and negatively affecting investment. In this framework I study how central bank credit intermediation helps reduce the impact of a crisis and the likelihood of a run. |
| Keywords: | Bank Runs; Financial Frictions; Shadow Banking; Unconventional Monetary Policy |
| JEL: | E44 E58 G23 G23 G24 |
| Date: | 2015–03–04 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgfe:2015-21&r=dge |
| By: | Guo, Yanling |
| Abstract: | In this paper, the author considers the sovereign debt in the form of one-period government bonds with default risk, which can be purchased by and traded among domestic and foreign investors. She shows that the weight assigned to the lenders' interest by the borrowing government at the time of debt repayment, which captures the lenders' trust in the government's propensity to repay the debt and is denoted as », also determines the default risk: a higher » means a lower default risk ceteris paribus which leads to a lower risk premium, and vice versa. Since this relationship only holds in the "good equilibrium", the author further shows that the "good equilibrium" is the only stable equilibrium under some quite general assumptions while the "bad equilibrium" is an unstable one - a possible reason why in practice rather a negative correlation between » and the default risk as well as the corresponding risk premium is observed. |
| Keywords: | Public debt,sovereign debt,sovereign default,domestic debt,external debt,fiscal policy,government bond,government borrowing |
| JEL: | F34 H63 H74 H62 H6 H87 |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:ifwedp:201530&r=dge |
| By: | Arias, Jonas E. (Board of Governors of the Federal Reserve System (U.S.)); Ascari, Guido (University of Oxford); Branzoli, Nicola (Bank of Italy); Castelnuovo, Efrem (University of Melbourne) |
| Abstract: | Working with a small-scale calibrated New-Keynesian model, Coibion and Gorodnichenko (2011) find that the reduction in trend inflation during Volcker's mandate was a key factor behind the Great Moderation. We revisit this finding with an estimated New-Keynesian model with trend inflation and no indexation based on Christiano, Eichenbaum and Evans (2005). First, our simulations confirm Coibion and Gorodnichenko's (2011) main finding. Second, we show that a trend inflation-immune Taylor rule based on economic theory can avoid indeterminacy even at high levels of trend inflation such as those observed in the 1970s. |
| Keywords: | Trend inflation; determinacy; and monetary policy |
| JEL: | C22 E30 E52 |
| Date: | 2014–10–29 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgif:1127&r=dge |
| By: | Alberto Martín; Jaume Ventura |
| Abstract: | We study a dynamic economy where credit is limited by insufficient collateral and, as a result, investment and output are too low. In this environment, changes in investor sentiment or market expectations can give rise to credit bubbles, that is, expansions in credit that are backed not by expectations of future profits (i.e. fundamental collateral), but instead by expectations of future credit (i.e. bubbly collateral). Credit bubbles raise the availability of credit for entrepreneurs: this is the crowding-in effect. But entrepreneurs must also use some of this credit to cancel past credit: this is the crowding-out effect. There is an "optimal" bubble size that trades off these two effects and maximizes long-run output and consumption. The equilibrium bubble size depends on investor sentiment, however, and it typically does not coincide with the "optimal" bubble size. This provides a new rationale for macroprudential policy. A credit management agency (CMA) can replicate the "optimal" bubble by taxing credit when the equilibrium bubble is too high and subsidizing credit when the equilibrium bubble is too low. This leaning-against-the-wind policy maximizes output and consumption. Moreover, the same conditions that make this policy desirable guarantee that a CMA has the resources to implement it. |
| Keywords: | bubbles, credit, business cycles, economic growth, financial frictions, pyramid schemes |
| JEL: | E32 E44 O40 |
| Date: | 2015–03 |
| URL: | http://d.repec.org/n?u=RePEc:bge:wpaper:823&r=dge |
| By: | Gregory Phelan (Williams College) |
| Abstract: | This paper investigates how financial-sector leverage affects macroeconomic instability and household welfare. In the model, banks use leverage to allocate resources to productive projects and provide liquidity. When banks do not actively issue new equity, aggregate outcomes depend on the level of equity in the financial sector. Equilibrium is inefficient because agents do not internalize how their decisions affect volatility, aggregate leverage, and the returns on assets. Leverage creates systemic risk and macroeconomic instability, increasing the frequency and duration of crises. Regulating leverage changes asset-price volatility and the likelihood that the financial sector is undercapitalized. |
| Keywords: | Leverage, Macroeconomic Instability, Borrowing Constraints, Banks, Macroprudential Regulation, Financial Crises |
| Date: | 2015–04 |
| URL: | http://d.repec.org/n?u=RePEc:wil:wileco:2015-02&r=dge |
| By: | Doniger, Cynthia L. (Board of Governors of the Federal Reserve System (U.S.)) |
| Abstract: | I study a labor market in which identical workers search on- and off-the-job and heterogeneous firms employ using either posted wages or wage contracts contingent on outside options. Firm level costs for contingent contracts generate a separating equilibrium in which less productive firms post wages. The model with heterogeneous contracts can achieve wage dispersion, labor share, employment transitions, and flow value of unemployment that are simultaneously consistent with empirical observations even when most firms post wages. Using German employee-level administrative data, I estimate roughly 70 percent of firms post wages and employ nearly 50 percent of workers under such contracts. |
| Keywords: | Labor supply and demand; Market structure and pricing; Wages and compensation |
| Date: | 2015–03–26 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgfe:2015-23&r=dge |
| By: | Gregory Phelan (Williams College) |
| Abstract: | This paper uses a general equilibrium model with collateralized borrowing to show that increases in risk can have ambiguous effects on leverage, loan margins, loan amounts, and asset prices. Increasing risk about future payoffs can lead to riskier loans with larger balances and lower spreads even when lenders are risk-averse and borrowers can default. As well, increasing endowment risk for either agent can have ambiguous consequences for equilibrium. Though the effects are ambiguous, two key determinants of how increased risk translate into changes in prices and allocations are the correlation of agents' endowments with the asset payoff and agents' risk-aversion, even when marginal utilities are exogenous. When lender's endowments become more risky in a restricted way, the effects on margins and prices depend asymmetrically on the likelihood of loan repayment. When borrowers' endowments become more risky in the tails, the effects depend asymmetrically on whether upside or downside states are affected. |
| Keywords: | Leverage, risk, collateral constraints, asset prices |
| Date: | 2015–04 |
| URL: | http://d.repec.org/n?u=RePEc:wil:wileco:2015-03&r=dge |
| By: | Nekoei, Arash; Weber, Andrea |
| Abstract: | Contrary to standard search model predictions, prior studies failed to estimate a positive effect of unemployment insurance (UI) on reemployment wages. This paper estimates a positive UI wage effect exploiting an age-based regression discontinuity in Austrian administrative data. A search model incorporating duration dependence determines the UI wage effect as the balance between two offsetting forces: UI causes agents to seek higher-wage jobs, but also reduces wages by lengthening unemployment. This implies a negative relationship between the UI unemployment duration and wage effects, which holds empirically both in our sample and across studies, reconciling disparate wage-effect estimates. Empirically, UI raises wages by improving reemployment firms’ quality and attenuating wage drops. |
| Keywords: | job search; regression discontinuity design; unemployment insurance; wages |
| JEL: | H5 J3 J6 |
| Date: | 2015–05 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:10568&r=dge |
| By: | Etienne Lalé |
| Abstract: | This paper studies the secular behavior of worker reallocation across occupations in the US labor market. In the empirical analysis, we use 45 years of microdata to construct consistent time-series and document that the fraction of employment reallocated annually across occupations is remarkably stable in the long run. We go beyond description and use an equilibrium model to uncover potential changes in the factors that affect worker reallocation, namely productivity shocks and mobility costs. We uncover their joint evolution by deriving a simple mapping between data and the model. We find little changes overall, except in the period surrounding the Great Recession where both the volatility of productivity shocks and the cost of switching occupations are found to increase. |
| Keywords: | Occupations, Reallocation, Wages, Equilibrium Search. |
| JEL: | E24 J21 J31 J62 |
| Date: | 2015–05–05 |
| URL: | http://d.repec.org/n?u=RePEc:bri:uobdis:15/657&r=dge |
| By: | Lie, Denny |
| Abstract: | This paper studies optimal monetary policy under precommitment in a state-dependent pricing (SDP) environment, in contrast to the standard assumption of time-dependent pricing(TDP). I show that the endogenous timing of price adjustment under SDP importantly alters the policy tradeoffs faced by the monetary authority, due to lower cost of inflation variation on the relative-price distortion. It is thus desirable under SDP for the monetary authority to put less weight on inflation stabilization, relative to other stabilization goals. The optimal Ramsey policy under SDP delivers a 24 percent higher standard deviation of inflation, but with 26 percent and 6 percent lower standard deviations of output gap and nominal interest rate, respectively. Within a simple, Taylor-like policy rule, the change in the policy tradeoffs is manifested in higher feedback response coefficients on the output gap and the lagged nominal interest rate deviation under SDP. Additionally, this paper studies the optimal policy start-up problem related to the cost of adopting the timeless perspective policy instead of the true Ramsey policy. The SDP assumption leads to different start-up dynamics compared to the dynamics under the TDP assumption in several important ways. In particular, the change in the policy tradeoffs gives rise to much higher start-up inflation under SDP. |
| Keywords: | optimal monetary policy, state-dependent pricing, start-up problem, policy tradeoff, Ramsey policy, simple policy rule |
| Date: | 2015–04 |
| URL: | http://d.repec.org/n?u=RePEc:syd:wpaper:2015-09&r=dge |
| By: | Faberman, R. Jason (Federal Reserve Bank of Chicago) |
| Abstract: | This paper examines the role of home production in estimating life-cycle labor supply. I show that, consistent with previous studies, ignoring an individual’s time spent on home production when estimating the Frisch elasticity of labor supply biases its estimate downwards. I also show, however, that ignoring other ways a household can satisfy the demand for home production biases its estimate upwards. Changes in this demand over the life-cycle have an income effect on labor supply, but the effect can be mitigated through purchases in the market and through the home production of other household members. When accounting all factors related to home production, I find that the "micro" Frisch elasticity is about 0.4 and the "macro" Frisch elasticity, which accounts for extensive margin adjustments, is about 0.9. If I only account for an individual's own home production effort, I find that the "macro" elasticity is about 1.6. |
| Keywords: | Labor; Home production; Frisch elasticity of labor supply; life-cycle time use |
| JEL: | D13 D91 J22 |
| Date: | 2015–05–03 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedhwp:wp-2015-02&r=dge |
| By: | Gregory Phelan (Williams College) |
| Abstract: | Financial intermediation naturally arises when borrowers' payoffs are correlated. I show this using a costly enforcement model in which lenders need ex post incentives to enforce payments from defaulted loans. When projects have correlated outcomes, learning the state of one project (via enforcement) provides information about the states of other projects. A large, correlated portfolio provides ex post incentives for enforcement and as a result borrowers default less frequently. Because borrowers behave differently with large lenders, intermediation dominates direct lending. Intermediaries are financed with risk-free deposits, earn positive profits, and hold systemic default risk. |
| Keywords: | Financial intermediation, systemic risk, default |
| Date: | 2015–04 |
| URL: | http://d.repec.org/n?u=RePEc:wil:wileco:2015-01&r=dge |
| By: | Jung, Kuk Mo; Lee, Seungduck |
| Abstract: | A new monetary theory is set out to resolve the “Uncovered Interest Parity Puzzle (UIP Puzzle)”. It explores the possibility that liquidity properties of money and nominal bonds can account for the puzzle. A key concept in our model is that nominal bonds carry liquidity premium due to their medium of exchange role as either collateral or means of payment. In this framework no-arbitrage condition ensures a positive comovement of real return on money and nominal bonds. Thus, when inflation in one country becomes relatively lower, i.e., real return on this currency is relatively higher, its nominal bonds should also yield higher real return. We show that their nominal returns can also become higher under the economic environment where collateral pledgeability and/or liquidity of nominal bonds and/or collateralized credit based transactions are relatively bigger. Since a currency with lower inflation is expected to appreciate, the high interest currency does indeed appreciate in this case, i.e., the UIP puzzle is no longer an anomaly in our model. Our liquidity based theory in fact has interesting implications on many empirical observations that risk based explanations find difficult to reconcile with. |
| Keywords: | uncovered interest parity puzzle, monetary search models, FOREX market |
| JEL: | E31 E4 E52 F31 |
| Date: | 2015–05 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:64164&r=dge |