nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2015‒05‒22
nineteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Oil and Unemployment in a New-Keynesian Model By Verónica Acurio Vásconez
  2. Financial Risk and Unemployment By Eckstein, Zvi; Setty, Ofer; Weiss, David
  3. Robustly Strategic Consumption-Portfolio Rules with Informational Frictions By Luo, Yulei
  4. Aggregate demand, idle time, and unemployment By Pascal Michaillat; Emmanuel Saez
  5. A Small Open Economy as a Limit Case of a Two-country New Keynesian DSGE Model: a Bayesian Estimation with Brazilian Data By Marcos Antonio C. da Silveira
  6. How Independent are the South African Reserve Bank’s Monetary Policy Decisions? Evidence from a Global New-Keynesian DSGE Model By Annari De Waal; Rangan Gupta; Charl Jooste
  7. The Impact of Trade on Labor Market Dynamics By Lorenzo Caliendo; Maximiliano Dvorkin; Fernando Parro
  8. Directed Search over the Life Cycle By Guido Menzio (University of Pennsylvania and NBER); Irina A. Telyukova (University of California at San Diego); Ludo Visschers (University of Edinburgh and Universidad Carlos III Madrid
  9. Large Firm Dynamics and the Business Cycle By Carvalho, Vasco M; Grassi, Basile
  10. Macroeconomic Volatility and External Imbalances By Fogli, Alessandra; Perri, Fabrizio
  11. Secondary Market Liquidity and the Optimal Capital Structure By Arseneau, David M.; Rappoport, David; Vardoulakis, Alexandros
  12. What if oil is less substitutable? A New-Keynesian Model with Oil, Price and Wage Stickiness including Capital Accumulation By Verónica Acurio Vásconez
  13. An Over-the-Counter Approach to the FOREX Market By Geromichalos, Athanasios; Jung, Kuk Mo
  14. A Tractable Model of Monetary Exchange with Ex-post Heterogeneity By Guillaume Rocheteau; Pierre-Olivier Weill; Tsz-Nga Wong
  15. Optimal Income, Education, and Bequest Taxes in an Intergenerational Model By Stefanie Stantcheva
  16. Optimal Social Assistance and Unemployment Insurance in a Life-Cycle Model of Family Labor Supply and Savings By Peter Haan; Victoria Prowse
  17. Income Insurance and the Equilibrium Term-Structure of Equity By Roberto Marfè
  18. Dynamic Investment with Adverse Selection and Moral Hazard By Miguel Cantillo
  19. Coordination and Crisis in Monetary Unions By Aguiar, Mark; Amador, Manuel; Farhi, Emmanuel; Gopinath, Gita

  1. By: Verónica Acurio Vásconez (Centre d'Economie de la Sorbonne - Paris School of Economics)
    Abstract: The effects of oil shocks in inflation and growth have been widely discussed in the literature, however few have focused on the impact of oil price increases on unemployment. In order to shed some light on this problem, this paper develops a medium scale Dynamic Stochastic General Equilibrium model (DSGE) that allows for oil utilization in production and consumption as in Acurio-Vásconez (2015); unemployment as in Mortensen & Pissarides (1994); and staggered nominal wage contracting as in Gertler & Trigari (2009). It then analyzes the effects of oil price increases on the economy. The model recovers most of the well-known stylized facts observed after the oil shock in the 2000s'. A sensitivity analysis shows that the reduction of the bargaining power of households to negotiate wage contracts reduces the impact of an oil shock in unemployment, without affecting negatively GDP. However, it also shows that the reduction of bargaining power, together with wage flexibility strongly reduces the increase in unemployment after an oil shock, but causes a decrease in real wages, which reduces household income and affects GDP
    Keywords: New-Keynesian model; DSGE; oil; CES; Match & Search Models; Unemployment
    JEL: D58 E24 E32 Q43
    Date: 2015–05
  2. By: Eckstein, Zvi; Setty, Ofer; Weiss, David
    Abstract: There is a strong correlation between the corporate interest rate (BAA rated), and its spread relative to Treasuries, and the unemployment rate. We model how interest rates and potential default rates impact equilibrium unemployment in a Diamond-Mortesen-Pissarides model. We calibrate the model using US data without targeting business cycle statistics. Volatility in the corporate interest rate can explain about 80% of the volatility of unemployment, vacancies, and market tightness. Simulating the Great Recession shows the model can account for much of the rise in unemployment. Without Fed action, unemployment would have been 6% higher.
    Keywords: business cycles; corporate interest rates; equilibrium unemployment; Great Recession; interest rate spread; search and matching models
    JEL: E22 E24 E32 E44 J41 J63 J64
    Date: 2015–05
  3. By: Luo, Yulei
    Abstract: This paper provides a tractable continuous-time constant-absolute-risk averse (CARA)-Gaussian framework to explore how the interactions of fundamental uncertainty, model uncertainty due to a preference for robustness (RB), and state uncertainty due to information-processing constraints (rational inattention or RI) affect strategic consumption-portfolio rules and precautionary savings in the presence of uninsurable labor income. Specifically, after solving the model explicitly, I compute and compare the elasticities of strategic asset allocation and precautionary savings to risk aversion, robustness, and inattention. Furthermore, for plausibly estimated and calibrated model parameters, I quantitatively analyze how the interactions of model uncertainty and state uncertainty affect the optimal share invested in the risky asset, and show that they can provide a potential explanation for the observed stockholding behavior of households with different education and income levels.
    Keywords: Robustness, Model Uncertainty, Rational Inattention, Uninsurable Labor Income, Strategic Asset Allocation, Precautionary Savings
    JEL: E21 G00 G11
    Date: 2015
  4. By: Pascal Michaillat; Emmanuel Saez
    Abstract: This article develops a model of unemployment fluctuations. The model keeps the architecture of the general-disequilibrium model of Barro and Grossman (1971) but takes a matching approach to the labor and product markets instead of a disequilibrium approach. On the product and labor markets, both price and tightness adjust to equalize supply and demand. Since there are two equilibrium variables but only one equilibrium condition on each market, a price mechanism is needed to select an equilibrium. We focus on two polar mechanisms: fixed prices and competitive prices. When prices are fixed, aggregate demand affects unemployment as follows. An increase in aggregate demand leads firms to find more customers. This reduces the idle time of their employees and thus increases their labor demand. This in turn reduces unemployment. We combine the predictions of the model and empirical measures of product market tightness, labor market tightness, output, and employment to assess the sources of labor market fluctuations in the United States. First, we find that product market tightness and labor market tightness fluctuate a lot, which implies that the fixed-price equilibrium describes the data better than the competitive-price equilibrium. Next, we find that labor market tightness and employment are positively correlated, which suggests that the labor market fluctuations are mostly due to labor demand shocks and not to labor supply or mismatch shocks. Last, we find that product market tightness and output are positively correlated, which suggests that the labor demand shocks mostly reflect aggregate demand shocks and not technology shocks.
    JEL: E10 E24 E30 J2 J64
    Date: 2015–05
  5. By: Marcos Antonio C. da Silveira
    Abstract: We build a two-country version of the DSGE model in Gali & Monacelli (2005), which extends for a small open economy the new Keynesain model used as tool for monetary policy analysis in closed economies. A distinctive feature of the model is that the terms of trade enters directly into the new Keynesian Phillips curve as a new pushing-cost variable feeding the inflation, so that there is no more the direct relationship between marginal cost and output gap that characterizes the closed economies. Unlike most part of the literature, we derive the small domestic open economy as a limit case of the two-coutry model, rather than assuming exogenous processes for the foreign variables. This procedure preserves the role played by foreign nominal frictions in the way as international monetary policy shocks are conveyed into the small domestic economy. Using the Bayesian approach, the small-economy case is estimated with Brazilian data and impulse-response functions are build to analyse the dynamic effects of structural shocks. O artigo desenvolve uma versão para dois países do modelo de equilíbrio geral dinâmico e estocástico em Gali & Monacelli (2005), o qual estende para uma pequena economia aberta o modelo novo keynesiano usado como ferramenta para análise de política monetária em economias fechadas. Uma importante característica do modelo é que os termos de troca entram diretamente na curva de Phillips novo Keynesiana como uma segunda variável pressionando os custos e a inflação, de forma que não mais existe a relação direta entre custo marginal e hiato do produto encontrada nas economias fechadas. Diferente da maior parte da literatura, a pequena economia aberta é derivada como um caso-limite do modelo para dois países, em vez de supor que as variáveis externas seguem processos exógenos. Este procedimento preserva o papel desempenhado pelas fricções nominais do resto do mundo na transmissão dos choques externos sobre a economia pesquena. Usando uma abordagem bayesiana, o caso-limite do modelo para uma pequena economia é estimado com dados brasileiros e funções impulso-resposta são construídas para análise dos efeitos dinâmicos dos choques estruturais.
    Date: 2015–01
  6. By: Annari De Waal (Department of Economics, University of Pretoria); Rangan Gupta (Department of Economics, University of Pretoria); Charl Jooste (Department of Economics, University of Pretoria)
    Abstract: We study the response of South African monetary policy decisions to foreign monetary policy shocks. We estimate the extent of foreign monetary policy pass-through by augmenting standard Taylor rules and comparing the results within the context of a Global New-Keynesian Dynamic Stochastic General Equilibirum (DSGE) model. The general equilibrium model captures important spill-over effects that would otherwise have been ignored in a single equation setup. The results show that the relationship between foreign monetary policy shocks and South African interest rates is complicated - South Africa does not import foreign monetary policy directly, but is still affected. Except for the U.S. an increase in foreign interest rates lead to a decrease in South African interest rates - highlighting the complex channels that monetary policy authorities have to monitor outside of its economy.
    Keywords: Monetary policy, Contagion, Global New-Keynesian DSGE model
    JEL: C20 C30 E43
    Date: 2015–05
  7. By: Lorenzo Caliendo; Maximiliano Dvorkin; Fernando Parro
    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 difficult 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.
    JEL: E24 F16 J62 R13 R23
    Date: 2015–05
  8. By: Guido Menzio (University of Pennsylvania and NBER); Irina A. Telyukova (University of California at San Diego); Ludo Visschers (University of Edinburgh and Universidad Carlos III Madrid
    Abstract: We develop a life-cycle model of the labor market in which different worker-firm matches have different quality and the assignment of the right workers to the right firms is time consuming because of search and learning frictions. The rate at which workers move between unemployment, employment and across different firms is endogenous because search is directed and, hence, workers can choose whether to seek low-wage jobs that are easy to find or high-wage jobs that are hard to find. We calibrate our theory using data on labor market transitions aggregated across workers of different ages. We validate our theory by showing that it predicts quite well the pattern of labor market transitions for workers of different ages. Finally, we use our theory to decompose the age profiles of transition rates, wages and productivity into the effects of age variation in work-life expectancy, human capital and match quality.
    Keywords: Directed Search, Labor Reallocation, Lifecycle
    Date: 2015–01
  9. By: Carvalho, Vasco M; Grassi, Basile
    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 for aggregate output and productivity dynamics display: (i) persistence, (ii) volatility and (iii) 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: aggregate fluctuations; firm size distribution; large firm dynamics; random growth
    JEL: E32 L11
    Date: 2015–05
  10. By: Fogli, Alessandra (Federal Reserve Bank of Minneapolis); Perri, Fabrizio (Federal Reserve Bank of Minneapolis)
    Abstract: Does macroeconomic volatility/uncertainty affect accumulation of net foreign assets? In OECD economies over the period 1970-2012, changes in country specific aggregate volatility are, after controlling for a wide array of factors, significantly positively associated with net foreign asset position. An increase in volatility (measured as the standard deviation of GDP growth) of 0.5% over period of 10 years is associated with an increase in the net foreign assets of around 8% of GDP. A standard open economy model with time varying aggregate uncertainty can quantitatively account for this relationship. The key mechanism is precautionary motive: more uncertainty induces residents to save more, and higher savings are in part channeled into foreign assets. We conclude that both data and theory suggest uncertainty/volatility is an important determinant of the medium/long run evolution of external imbalances in developed countries.
    Keywords: Business cycles; Current account; Global imbalances; Precautionary saving; Uncertainty
    JEL: F32 F34 F41
    Date: 2015–05–11
  11. By: Arseneau, David M. (Board of Governors of the Federal Reserve System (U.S.)); Rappoport, David (Board of Governors of the Federal Reserve System (U.S.)); Vardoulakis, Alexandros (Board of Governors of the Federal Reserve System (U.S.))
    Abstract: We present a model where endogenous liquidity generates a feedback loop between secondary market liquidity and firms' financing decisions in primary markets. The model features two key frictions: a costly state verification problem in primary markets, and search frictions in over-the-counter secondary markets. Our concept of liquidity depends endogenously on illiquid assets put up for sale relative to the resources available for buying those assets in the secondary market. Liquidity determines the liquidity premium, which affects issuance in the primary market, and this effect feeds back into secondary market liquidity by changing the composition of investors' portfolios. We show that the privately optimal allocations are inefficient because investors and firms fail to internalize how their behavior affects secondary market liquidity. These inefficiencies are established analytically through a set of wedge expressions for key efficiency margins. Our analysis provide s a rationale for the effect of quantitative easing on secondary and primary capital markets and the real economy.
    Keywords: Capital structure; market liquidity; quantitiative easing; secondary markets
    JEL: E44 G18 G30
    Date: 2015–05–12
  12. By: Verónica Acurio Vásconez (Centre d'Economie de la Sorbonne - Paris School of Economics)
    Abstract: The recent literature on fossil energy has already stated that oil is not perfectly substitutable to other inputs, considering fossil fuel as a critical production factor in different combinations. However, the estimations of substitution elasticity are in a wide range between 0.004 and 0.64. This paper addresses this phenomenon by enlarging the DSGE model developed in Acurio-Vásconez et al. (2015) by changing the Cobb-Douglas production and consumption functions assumed there, for composite Constant Elasticity of Substitution (CES) functions. Additionally, the paper introduces nominal wage and price rigidities through a Calvo setting. Finally, using Bayesian methods, the model is estimated on quarterly U.S. data over the period 1984:Q1-2007:Q3 and then analyzed. The estimation of oil's elasticity of substitution are 0.14 in production and 0.51 in consumption. Moreover, thanks to the low substitutability of oil, the model recovers and explains four well-known stylized facts after the oil price shock in the 2000's: the absent of recession, coupled with a low persistent increase in inflation rate, a decrease in real wages and a low price elasticity of oil demand in the short run. Furthermore, ceteris paribus, the reduction of nominal wage rigidity amplifies the increase in inflation and the decrease in consumption. Thus in this model more wage flexibility does not seem to attenuate the impact of an oil shock
    Keywords: New-Keynesian model; DSGE; oil; CES; stickiness; oil substitution
    JEL: D58 E32 E52 Q43
    Date: 2015–05
  13. By: Geromichalos, Athanasios; Jung, Kuk Mo
    Abstract: The FOREX market is an over-the-counter market (in fact, the largest in the world) characterized by bilateral trade, intermediation, and significant bid-ask spreads. The existing international macroeconomics literature has failed to account for these stylized facts largely due to the fact that it models the FOREX as a standard Walrasian market, therefore overlooking some important institutional details of this market. In this paper, we build on recent developments in monetary theory and finance to construct a dynamic general equilibrium model of intermediation in the FOREX market. A key concept in our approach is that immediate trade between ultimate buyers and sellers of foreign currencies is obstructed by search frictions (e.g., due to geographic dispersion). We use our framework to compute standard measures of FOREX market liquidity, such as bid-ask spreads and trade volume, and to study how these measures are affected both by macroeconomic fundamentals and the FOREX market microstructure. We also show that the FOREX market microstructure critically affects the volume of international trade and, consequently, welfare. Hence, our paper highlights that modeling the FOREX as a frictionless Walrasian market is not without loss of generality.
    Keywords: FOREX market, over-the-counter markets, search frictions, bargaining, monetary-search models
    JEL: D4 E31 E52 F31
    Date: 2015
  14. By: Guillaume Rocheteau; Pierre-Olivier Weill; Tsz-Nga Wong
    Abstract: We construct a continuous-time, pure currency economy with the following three key features. First, our modelled economy incorporates idiosyncratic uncertainty—households receive infrequent and random opportunities of lumpy consumption—and displays an endogenous, non-degenerate distribution of money holdings. Second, the model is tractable: properties of equilibria can be obtained analytically, and equilibria can be solved in closed form in a variety of cases. Third, it admits as a special, limiting case the quasi-linear economy of Lagos and Wright (2005) and Rocheteau and Wright (2005). We use our modeled economy to obtain new insights into the effects of anticipated inflation on individual spending behavior, the social benefits and output effects of inflationary transfer schemes, and transitional dynamics following unanticipated monetary shocks.
    JEL: E0 E41 E52
    Date: 2015–05
  15. By: Stefanie Stantcheva
    Abstract: This paper considers dynamic optimal income, education, and bequest taxes in a Barro-Becker dynastic setup. Parents can transfer resources to their children in two ways: First, through education investments, which have heterogeneous and stochastic returns for children, and, second, through financial bequests, which yield a safe, uniform return. Each generation's productivity and preferences are subject to idiosyncratic shocks. I derive optimal linear formulas for each tax, as functions of estimable sufficient statistics, robust to underlying heterogeneities in preferences, and at any given level of all other taxes. It is in general not optimal to make education expenses fully tax deductible and the optimal education subsidy, income tax and bequest tax can, but need not, move together at the optimum. I also show how to derive optimal formulas using “reform-specific elasticities” that can be targeted to empirical estimates from existing reforms. I extend the model to an OLG model with altruism to study the effects of credit constraints on optimal policies. Finally, I solve for the fully unrestricted policies and show that, if education is highly complementary to children's ability, it is optimal to distort parents' trade-off between education and bequests and to tax education investments relative to bequests.
    JEL: H21 H24 H31 I24
    Date: 2015–05
  16. By: Peter Haan; Victoria Prowse
    Abstract: We analyze empirically the optimal design of social insurance and assistance programs when families obtain insurance by making labor supply choices for both spouses. For this purpose, we specify a structural life-cycle model of the labor supply and savings decisions of singles and married couples. Partial insurance against wage and employment shocks is provided by social programs, savings and the labor supplies of all adult household members. The optimal policy mix focuses mainly on Social Assistance, which provides a permanent universal household income floor, with a minor role for temporary earnings-related Unemployment Insurance. Reflecting that married couples obtain intra-household insurance by making labor supply choices for both spouses, the optimal generosity of Social Assistance decreases in the proportion of married individuals in the population. The link between optimal program design and the family context is strongest in low-educated populations.
    Keywords: Life-cycle labor supply, Family labor supply, Unemployment Insurance, Social Assistance, Design of benefit programs, Intra-household insurance, Household savings, Employment risk, Added worker effect.
    JEL: J18 J68 H21 I38
    Date: 2015
  17. By: Roberto Marfè
    Abstract: This paper documents that GDP, wages and dividends are co-integrated but feature term-structures of risk respectively flat, increasing and decreasing. Income insurance within the firm from shareholders to workers explains those term-structures: distributional risk smooths wages and enhances the short-run risk of dividends. A simple general equilibrium model, where labor rigidity affects dividend dynamics and the price of short-run risk, reconciles standard asset pricing facts with the term-structures of equity premium and volatility and those of macroeconomic variables, at odds in leading models. Income insurance also helps to explain dividend growth predictability, cross-sectional value premia, counter-cyclical Sharpe-ratios, and interest rates term-premia.
    Keywords: term structure of equity, income insurance, dividend strips, distributional risk, equilibrium asset pricing
    JEL: D53 E24 E32 G12
    Date: 2015
  18. By: Miguel Cantillo (Universidad de Costa Rica)
    Abstract: This paper develops a dynamic model of capital structure and investment. In a world with low and high ability managers, the former mask as the latter, but to do so have to overstate both earnings and investment. Debt is a mechanism that eventually separates investors’ abilities, at the cost of intervening unlucky high productivity managers. Immediate separation is counterproductive, as it generates costs and no expected payoff. The security design that asymptotically implements optimal investment includes the use of excess non-operating cash, of proportional cash flow compensation, and of ”golden parachutes”. Relative to a first best case, high ability managers will underinvest. Low ability managers will generally overinvest, except when their firm is close to bankruptcy, in which case they will loot the company by underinvesting and overstating their earnings.
    Date: 2015–03
  19. By: Aguiar, Mark (Princeton University); Amador, Manuel (Federal Reserve Bank of Minneapolis); Farhi, Emmanuel (Harvard University); Gopinath, Gita (Harvard University)
    Abstract: We study fiscal and monetary policy in a monetary union with the potential for rollover crises in sovereign debt markets. Member-country fiscal authorities lack commitment to repay their debt and choose fiscal policy independently. A common monetary authority chooses inflation for the union, also without commitment. We first describe the existence of a fiscal externality that arises in the presence of limited commitment and leads countries to over-borrow; this externality rationalizes the imposition of debt ceilings in a monetary union. We then investigate the impact of the composition of debt in a monetary union, that is the fraction of high-debt versus low-debt members, on the occurrence of self-fulfilling debt crises. We demonstrate that a high-debt country may be less vulnerable to crises and have higher welfare when it belongs to a union with an intermediate mix of high- and low-debt members, than one where all other members are low-debt. This contrasts with the conventional wisdom that all countries should prefer a union with low-debt members, as such a union can credibly deliver low inflation. These findings shed new light on the criteria for an optimal currency area in the presence of rollover crises.
    Keywords: Debt crisis; Coordination failures; Monetary union; Fiscal policy
    JEL: E40 E50 F30 F40
    Date: 2015–05–11

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