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on Dynamic General Equilibrium |
| By: | Carla La Croce (Department of Economics and Management, University of Pavia); Lorenza Rossi (Department of Economics and Management, University of Pavia) |
| Abstract: | We consider a DSGE model with monopolistic competitive banks together with endogenous ?firms entry. We ?find that our model implies higher volatilities of both real and fi?nancial variables than those implied by a DSGE model with monopolistic banking sector and a ?fixed number of ?firms. The response of the economic activity is also more persistent in response to all shocks. Furthermore, we show that inefficient banks enhance the endogenous propagation of the shocks in respect to a model where banks compete under perfect competition and can fully ensure against the risk of ?firms default. |
| Date: | 2015–06 |
| URL: | http://d.repec.org/n?u=RePEc:pav:demwpp:demwp0104&r=dge |
| By: | Lorenzo Burlon (Bank of Italy); Andrea Gerali (Bank of Italy); Alessandro Notarpietro (Bank of Italy); Massimiliano Pisani (Bank of Italy) |
| Abstract: | This paper evaluates the macroeconomic effects of purchases of long-term sovereign bonds by a central bank in a monetary union when (1) the private sector faces tight financial conditions and (2) the zero lower bound (ZLB) on the policy rate holds. To this end, we calibrate a dynamic general equilibrium model to the euro area (EA). We assume that households in one member country have a large initial debt position and are subject to a borrowing constraint. We simulate the effects of a negative EA-wide demand shock that induces a decline in inflation. The main results are as follows. First, the reduction in inflation amplifies the domestic and cross-country spillovers of the negative demand shock because of the country-specific borrowing constraint and the ZLB. Second, sovereign bond purchases boost economic activity and, hence, indirectly allow households to reduce their debt and relax the borrowing constraint. Third, the new, lower value of debt allows households to smooth consumption, fostering macroeconomic resilience not only in the member country concerned but also in the rest of the monetary union. |
| Keywords: | DSGE models, financial frictions, open-economy macroeconomics, non-standard monetary policy, zero lower bound |
| JEL: | E43 E44 E52 E58 |
| Date: | 2015–06 |
| URL: | http://d.repec.org/n?u=RePEc:bdi:wptemi:td_1015_15&r=dge |
| By: | Michael Funke (Hamburg University, CESifo, Munich, and Hong Kong Institute for Monetary Research); Petar Mihaylovski (Hamburg University); Haibin Zhu (JP Morgan Chase Bank) |
| Abstract: | The paper sheds light on the interplay between monetary policy, the commercial banking sector and the shadow banking sector in mainland China by means of a nonlinear stochastic general equilibrium (DSGE) model with occasionally binding constraints. In particular, we analyze the impacts of interest rate liberalization on monetary policy transmission as well as the dynamics of the parallel shadow banking sector. Comparison of various interest rate liberalization scenarios reveals that monetary policy results in increased feed-through to the lending and investment under complete liberalization. Furthermore, tighter regulation of interest rates in the commercial banking sector in China leads to an increase in loans provided by the shadow banking sector. |
| Keywords: | DSGE Model, Monetary Policy, Financial Market Reform, Shadow Banking, China |
| JEL: | E32 E42 E52 E58 |
| Date: | 2015–05 |
| URL: | http://d.repec.org/n?u=RePEc:hkm:wpaper:122015&r=dge |
| By: | Yuko Imura; Julia Thomas |
| Abstract: | Many policy-makers and researchers view the recent financial and real economic crises across North America, Europe and beyond as a global phenomenon. Some have argued that this global recession has a common source: the U.S. financial crisis. This paper investigates the extent to which a credit shock in one country is transmitted to its trade partners. To this end, we develop a quantitative two-country dynamic stochastic general equilibrium model wherein intermediate-good producers face persistent idiosyncratic productivity shocks and occasionally binding collateralized borrowing constraints for investment loans. We find that a negative credit shock to one country induces a sharp contraction in that country’s economy, whereas the resulting recession in the economy of its trading partner is quantitatively minor. Transmission through goods trade is limited by the calibrated average trade share, which we find insufficient to deliver a sizable recession abroad. The degree of credit-shock transmission depends on the home bias in international trade and the type of goods countries trade with each other. We show that lower home bias dampens the domestic recession following a credit shock, but it amplifies international transmission. Similarly, when traded goods are less substitutable, the domestic recession is less severe, while real consequences abroad are greater. Our model also predicts that credit shocks cause larger declines in international trade than do productivity shocks. These results shed light on the great trade collapse over 2008-09, suggesting that tightened financial constraints may have been a contributing factor. |
| Keywords: | Business fluctuations and cycles, Economic models, Financial markets, Financial stability, International topics |
| JEL: | E E2 E22 E3 E32 E4 E44 F F4 F41 F44 |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocawp:15-19&r=dge |
| By: | Luca Guerrieri; Matteo Iacoviello |
| Abstract: | Using Bayesian methods, we estimate a nonlinear general equilibrium model where occasionally binding collateral constraints on housing wealth drive an asymmetry in the link between housing prices and economic activity. The estimated model shows that, as collateral constraints became slack during the housing boom of 2001-2006, expanding housing wealth made a small contribution to consumption growth. By contrast, the housing collapse that followed tightened the constraints and sharply exacerbated the recession of 2007-2009. The empirical relevance of this asymmetry is corroborated by evidence from state- and MSA-level data. |
| Keywords: | Housing; Collateral Constraints; Occasionally Binding Constraints; Nonlinear Estimation of DSGE Models; Great Recession |
| JEL: | E32 E44 E47 R21 R31 |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:nbp:nbpmis:202&r=dge |
| By: | Huiyu Li (Stanford University) |
| Abstract: | Financial frictions can reduce aggregate productivity, in particular when firms with high productivity cannot borrow against their profits. This paper investigates the quantitative importance of this form of borrowing constraint using a large panel of firms in Japan. The firms are young and unlisted, precisely the firms for which credit frictions are expected to be the most severe. In this data, I find that firm leverage (asset-to-equity ratio) and firm output-to-capital ratios rise with firm productivity, both over time in a firm and across firms of the same age and cohort. I use these facts in indirect inference to estimate a standard general equilibrium model where financial frictions arise from the limited pledgeability of profits and capital. In this model more financially constrained firms have higher output-to- capital ratios. The model matches the two facts the best when firms can pledge half of their one-year-ahead profits and one-fifth of their assets. Compared to the common assumption that firms can pledge only assets, aggregate productivity loss due to financing frictions is one-third smaller when profits are also pledgeable to the degree seen in Japan. |
| Date: | 2015–06 |
| URL: | http://d.repec.org/n?u=RePEc:sip:dpaper:15-015&r=dge |
| By: | Gabriela Castro (Economics and Research Department, Banco de Portugal); Ricardo M. Felix (Economics and Research Department, Banco de Portugal); Paulo Julio (Economics and Research Department, Banco de Portugal; and CEFAGE-UE, Portugal); Jose R. Maria (Economics and Research Department, Banco de Portugal) |
| Abstract: | Using PESSOA, a medium-scale DSGE model for a small euro-area economy, we evaluate how fiscal adjustments impact short- and medium-term debt dynamics and output for alternative policy options, and budgetary and economic conditions. Fiscal adjustments may increase the public debt-to-GDP ratio in the short run, even for consolidations carried out in normal times in economies characterized by moderate indebtedness levels. Financial turmoils and hikes in the nationwide risk premia, coupled with high indebtedness levels and stiff fiscal measures, boost the output costs of scal consolidations and severely aect their eectiveness in bringing the public debtto-GDP ratio down in the short term. In the medium run credible fiscal adjustments entail a decline in the public debt ratio, though at potentially very large output losses when carried out under unfavorable budgetary and economic conditions. |
| Keywords: | Fiscal policy; Fiscal consolidation; Debt ratio; Crisis; DSGE model; Euro Area; Small open economy. |
| JEL: | E12 E30 E62 H60 |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:cfe:wpcefa:2015_06&r=dge |
| By: | Thierry BETTI; Thomas COUDERT (LaRGE Research Center, Université de Strasbourg) |
| Abstract: | We develop a new-Keynesian model with a two-sector search and matching labor market framework. We investigate the first and second order effects of fiscal policy on labor market and on output. The model includes four fiscal instruments: a labor income tax, a social protection tax paid by firms, public wage and public vacancies. First-order simulations of the model indicate that whatever instrument is used, fiscal expansion significantly increases total employment and reduce unemployment. We explicit the different transmission channels at work. The main contribution is to use a second-order approximation of the model to investigate the effects of fiscal shocks for two states of the economy: a low unemployment state (6%) and a high unemployment state (12%). For the four fiscal instruments, response of employment is greater when the steady-state unemployment rate is high. We also emphasize a new channel for explaining a larger output fiscal multiplier in periods of economic downturn: the wage channel that plays a crucial role for explaining the non-linear effects of fiscal policy. |
| Keywords: | Labor Market Search, Wage Bargaining, Public Wage, Business Cycle, Fiscal Policy, Second Order. |
| JEL: | E62 J38 |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:lar:wpaper:2015-06&r=dge |
| By: | Simona Malovana (Institute of Economic Studies, Faculty of Social Sciences, Charles University in Prague, Smetanovo nábreží 6, 111 01 Prague 1, Czech Republic; Czech National Bank) |
| Abstract: | The paper contributes to understanding the economic dynamics at the zero lower bound and the exchange rate movements under different central bank intervention regimes. It provides a theoretical framework for modeling foreign exchange interventions at the ZLB within a dynamic general equilibrium model. We find a pronounced volatility of real and nominal macroeconomic variables in response to the domestic demand shock, the foreign demand and financial shocks and the terms-of-trade shock at the ZLB. This effects become severe in response to highly persistent shocks which leads to stronger reaction of variables and prolong period of binding constraint. The FX interventions have proven to be effective in mitigating deflationary pressures and recovering the economic activity in response to all examined shocks at the ZLB. In this sense, the central bank achieves the best performance by fixing the nominal exchange rate temporarily at the ZLB. |
| Keywords: | zero lower bound, foreign exchange interventions, dynamic stochastic general equilibrium, Bayesian estimation, exchange rate and price dynamics |
| JEL: | C11 E31 E43 E52 E58 F31 |
| Date: | 2015–05 |
| URL: | http://d.repec.org/n?u=RePEc:fau:wpaper:wp2015_13&r=dge |
| By: | Carlos Arango (Central Bank of Colombia); Oscar Valencia (Central Bank of 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 combinat on 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: | 2015–03–13 |
| URL: | http://d.repec.org/n?u=RePEc:gii:giihei:heidwp06-2015&r=dge |
| By: | Timo Bettendorf; Miguel A. Leon-Ledesma |
| Abstract: | German labor market reforms in the 1990s and 2000s are generally believed to have driven the large increase in the dispersion of current account balances in the Euro Area. We investigate this hypothesis quantitatively. We develop an open economy New Keynesian model with search and matching frictions from which we derive robust sign restrictions for a wage bargaining shock. We then impose these restrictions on a Global VAR consisting of Germany and 8 EMU countries to identify a wage bargaining shock in Germany. Our results show that, although the German current account was significantly affected by wage bargaining shocks, their contribution to European current account imbalances was negligible. We conclude that the reduction in bargaining power of German unions after labor market reforms cannot be the lone driver of European imbalances. |
| Keywords: | European imbalances; German wage moderation; DSGE; Global VAR; sign restrictions |
| JEL: | F10 F32 F41 |
| Date: | 2015–06 |
| URL: | http://d.repec.org/n?u=RePEc:ukc:ukcedp:1510&r=dge |
| By: | Fuhrer, Jeffrey C. (Federal Reserve Bank of Boston) |
| Abstract: | While there is little question that expectations lie at the heart of much economic decision-making, and therefore at the heart of models of the macroeconomy that hope to reflect such decision-making, how such expectations are formed is an open research question. In earlier work, Fuhrer (2015) showed that empirical estimates of a standard dynamic stochastic general equilibrium (DSGE) model preferred inertia in expectations over price indexation or habit formation as a mechanism to explain the persistence of aggregate time series for output, inflation, and interest rates. A question left open in that paper was why and how expectations might exhibit such inertia. This paper examines the expectations behavior of individual responses in the surveys of the Survey of Professional Forecasters (SPF) and the University of Michigan's Survey Research Center to shed light on that question. |
| Keywords: | persistence; rational expectations; survey expectations |
| JEL: | E32 E52 |
| Date: | 2015–05–18 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedbwp:15-5&r=dge |
| By: | Diego J. Perez (Stanford University) |
| Abstract: | This paper explores two mechanisms through which a sovereign default can disrupt the domestic economy via its banking system. First, a sovereign default creates a negative balance-sheet effect on banks, which reduces their ability to raise funds and prevents the flow of resources to productive investments. Second, default undermines internal liquidity as banks replace government securities with less productive investments. I quantify the model using Argentinean data and find that these two mechanisms can generate a deep and persistent fall in output post-default, which accounts for the government’s commitment necessary to explain observed levels of external public debt. The balance-sheet effect is more important because it generates a larger output cost of default and a stronger ex-ante commitment for the government. Post-default bailouts of the banking system, although desirable ex-post, are welfare reducing ex-ante since they weaken government’s commitment. Imposing a minimum public debt requirement on banks is welfare improving as it enhances commitment by increasing the output cost of default. |
| Keywords: | Sovereign default, public debt, banks, liquidity. |
| Date: | 2015–06 |
| URL: | http://d.repec.org/n?u=RePEc:sip:dpaper:15-016&r=dge |
| By: | Ashima Goyal (Indira Gandhi Institute of Development Research); Shruti Tripathi (Indira Gandhi Institute of Development Research) |
| Abstract: | Conditions for stability in an open economy dynamic stochastic general equilibrium model adapted to a dualistic labor market (SOEME) are the same as for a mature economy. But the introduction of monetary policy transmission lags makes it deviate from the Taylor Principle. Under rational expectation a policy rule is unstable, but under adaptive expectations traditional stabilization gives a determinate path, with weights on the objective of less than unity. Estimation of a Taylor rule for India and optimization in the SOEME model itself, all confirm the low weights. The results imply that under rational expectations optimization is better than following a rule. If backward looking-behavior dominates, however, a policy rule can prevent overshooting and instability. Economy-specific rigidities must inform policy design, and the appropriate design will change as the economy develops. |
| Keywords: | DSGE; emerging market; rigidities; stability; optimization; Taylor rule |
| JEL: | E26 E52 |
| Date: | 2015–02 |
| URL: | http://d.repec.org/n?u=RePEc:ind:igiwpp:2015-003&r=dge |
| By: | Sephorah Mangin |
| Abstract: | How do labor market conditions such as the unemployment rate influence the labor share? To answer this question, I develop a search-theoretic model of the labor market that generates a simple relationship between unemployment, workers' reservation wage, and the labor share. I derive expressions for the dynamic evolution of factor shares and present some comparative statics results regarding factor shares in the steady state equilibrium. I simulate the model and compare its predictions for factor shares to the U.S. data from 1951-2012. The results suggest that labor market conditions – specifically, unemployment fluctuations and changes in workers' reservation wage – can account for much of the variation in the U.S. labor share at an annual frequency during this period. |
| Date: | 2015–05 |
| URL: | http://d.repec.org/n?u=RePEc:mos:moswps:2015-28&r=dge |
| By: | Hevia, Constantino (Universidad Di Tella); Nicolini, Juan Pablo (Federal Reserve Bank of Minneapolis) |
| Abstract: | We study a model of a small open economy that specializes in the production of commodities and that exhibits frictions in the setting of both prices and wages. We study the optimal response of monetary and exchange rate policy following a positive (negative) shock to the price of the exportable that generates an appreciation (depreciation) of the local currency. According to the calibrated version of the model, deviations from full price stability can generate welfare gains that are equivalent to almost 0.5% of lifetime consumption, as long as there is a significant degree of rigidity in nominal wages. On the other hand, if the rigidity is concentrated in prices, the welfare gains can be at most 0.1% of lifetime consumption. We also show that a rule - formally defined in the paper - that resembles a "dirty floating" regime can approximate the optimal policy remarkably well. |
| Keywords: | Dutch disease; Inflation targeting; Foreign exchange intervention |
| JEL: | F31 F41 |
| Date: | 2015–06–08 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedmwp:726&r=dge |
| By: | Sephorah Mangin |
| Abstract: | This paper presents a unified approach to production, matching, and distribution in an environment with labor market frictions. I use competing auctions as both a wage determination mechanism and a microfoundation for an aggregate production and matching technology. For any well-behaved distribution of firm productivities, I show that the aggregate production function exhibits standard neoclassical properties and an elasticity of substitution between capital and labor that is always less than or equal to one. If the distribution is Pareto or power law, this function is particularly tractable. In general, factor income shares vary with the degree of competition between firms to hire workers, the value of non-market activity, and characteristics of the underlying firm productivity distribution. Unlike Diamond-Mortensen-Pissarides style search models with Nash bargaining, production and distribution are endogenously tightly connected: the economy satisfies a generalized version of the Hosios condition. |
| Date: | 2015–05 |
| URL: | http://d.repec.org/n?u=RePEc:mos:moswps:2015-27&r=dge |
| By: | Stephen J. Terry (Stanford University) |
| Abstract: | There is a long concern in economics that investor pressure can induce managerial short-termism, which I examine through the lens of analyst earnings targets. Managers face a tradeoff between short-run profits and long-run investment. This paper starts empirically by showing that firms that just meet earnings targets lower their investment in R&D and intangibles. Firms that just miss their earnings targets cut CEO pay and face drops in stock-market valuation. The paper then builds and structurally estimates a quantitative general equilibrium endogenous growth model with heterogeneous firms, R&D and accounting manipulation choices, and endogenous earnings forecasts. In the model, the short-run pressure to meet earnings forecasts cuts growth because R&D is misallocated across firms, responding too much to short-run profit shocks. This effect cuts growth rates by almost 0.1%, costing the US economy around 6% of output each century. Extending the model to include managerial shirking and empire-building reveals that earnings targets can improve firm value but may still reduce long-run growth and consumer welfare. |
| Keywords: | Short-Termism, Earnings Manipulation, Heterogeneous Agents, Endogenous Growth, Agency Conflicts, Shirking, Empire Building. |
| Date: | 2015–06 |
| URL: | http://d.repec.org/n?u=RePEc:sip:dpaper:15-022&r=dge |
| By: | O. Loisel |
| Abstract: | In a broad class of locally linearizable dynamic stochastic rational-expectations models, I consider various alternative observation sets for the policy maker, each of them made of the history of some endogenous variables or exogenous shocks until some current or past date. For each observation set, I characterize, within the set of feasible paths (paths that can be obtained as one local equilibrium under a policy-instrument rule consistent with this observation set), the subset of implementable paths (paths that can be obtained, in a minimally robust way, as the unique local equilibrium under such a rule). In two applications, I show that, for relevant observation sets, optimal feasible monetary policy may not be implementable in the basic New Keynesian model, even when the number of observed variables largely exceeds the number of unobserved shocks; while debt-stabilizing feasible tax policy is, contrary to conventional wisdom, implementable in the standard real-business-cycle model, even in the presence of policy-implementation lags of any length. |
| Keywords: | stabilization policy, robust local-equilibrium determinacy, observation set, feasible path, implementable path. |
| JEL: | E52 E61 |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:bfr:banfra:556&r=dge |
| By: | Baker Steven; Hollifield Burton; Osambela Emilio |
| Abstract: | When investors disagree, speculation between them alters equilibrium prices in financial markets. Because managers maximize firm value given financial market prices, disagreement alters firms’ value-maximizing investment policies. Disagreement therefore impacts aggregate investment, consumption, and output. In a production economy with recursive preferences and disasters, we demonstrate that static disagreement among investors generates dynamic aggregate investment that is positively correlated with shocks, leading to stochastic volatility in aggregate consumption, investment and equity returns. The direction of these effects is consistent with business cycle facts, and with several features of the 2008 financial crisis. |
| URL: | http://d.repec.org/n?u=RePEc:cmu:gsiawp:-1790377040&r=dge |
| By: | Joanna Tyrowicz (Faculty of Economic Sciences, University of Warsaw; National Bank of Poland); Krzysztof Makarski (National Bank of Poland; Warsaw School of Economics) |
| Abstract: | In this paper we consider an economy populated by overlapping generations, who vote on abolishing the funded system and replacing it with the pay-as-you-go scheme (i.e. unprivatizing the pension system). We compare politically stable and politically unstable reforms and show that even if the funded system is overall welfare enhancing, the cohort distribution of benefits along the transition path turns unprivatizing social security politically favorable. |
| Keywords: | pension system reform, time inconsistency, welfare |
| JEL: | H55 D72 C68 E17 E27 |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:war:wpaper:2015-21&r=dge |
| By: | Deniz Aydin (Stanford University) |
| Abstract: | This paper presents novel tests of competing models of intertemporal consumption behavior using unique European administrative panel data on income, spending and assets. I estimate the marginal propensity to consume (MPC) out of ‘liquidity’ -the debt response to a change in borrowing capacity- using changes in credit card limits in a randomized controlled trial implemented in September 2014 involving fifty-five thousand individuals. I obtain four empirical results: First, borrowing constraints change consumption dynamics even when they are not strictly binding. Two-thirds of the population accumulate a significant average of 20 cent of debt per dollar limit increase, relative to the control group. Second, the heterogeneity of the MPC is exclusively in line with precautionary models, a decreasing function of cash-on-hand. Third, the debt response to liquidity and credit card utilization are stationary. Fourth, additional liquidity is spent mostly on durables and services using installments, with a smaller fraction spent on non-durables and taken out as cash advances. I then use a workhorse Bewley model with realistic income risk and show that the joint dynamics of consumption, debt and the balance sheet in response to a change in borrowing constraints can be used to calibrate and test intertemporal models. Debt response to liquidity shocks identifies preference parameters via a simulated moments estimator. Hump-shaped debt response and mean-reverting credit card utilization are not consistent with myopia as the underlying preferences. |
| Keywords: | consumption, debt, borrowing con- straints, precautionary saving, permanent income hypothesis, field experiment. |
| JEL: | C93 D12 D14 D91 E21 E44 E51 G21 |
| Date: | 2015–06 |
| URL: | http://d.repec.org/n?u=RePEc:sip:dpaper:15-010&r=dge |
| By: | Das, Abhishek; Gupta, Gautam |
| Abstract: | In this paper we use a heterogeneously endowed Overlapping Generation model (OLG) in an experimental framework. . In our experimental OLG economy young subjects are asked either to predict the inflation rate for the next period or to decide his/her savings for the current period. We find that for both the decisions neither higher amount of government expenditure nor the higher amount of money supply by monetary authority will move inflation rate towards equilibrium. We also find that that if there is much uncertainty, Friedman Conjecture will not work. |
| Keywords: | OLG-model; Expectations; Inflation; Stability; Monetary policy; Experiments |
| JEL: | C92 E21 E31 E52 |
| Date: | 2015–06–12 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:65007&r=dge |
| By: | Mordecai Kurz (Stanford University) |
| Abstract: | A rapid recovery from deflationary shocks that result in transition to the Zero Lower Bound (ZLB) requires that policy generate an inflationary counter-force. Monetary policy cannot achieve it and the lesson of the 2007-2015 Great Recession is that growing debt give rise to a political gridlock which prevents restoration to full employment with deficit financed public spending. Even optimal investments in needed public projects cannot be undertaken at a zero interest rate. Hence, failure of policy to arrest the massive damage of eight year’s Great Recession shows the need for new policy tools. I propose such policy under the ZLB called "Stabilizing Wage Policy" which requires public intervention in markets instead of deficit financed expenditures. Section 1 develops a New Keynesian model with diverse beliefs and inflexible wages. Section 2 presents the policy and studies its efficacy. The integrated New Keynesian (NK) model economy consists of a lower s ub-economy under a ZLB and upper sub-economy with positive rate, linked by random transition between them. Household-firm-managers hold heterogenous beliefs and inflexible wage is based on a four quarter staggered wage structure so that mean wage is a relatively inflexible function of inflation, of unemployment and of a distributed lag of productivity. Equilibrium maps of the two sub-economies exhibit significant differences which emerge from the relative rates at which the nominal rate, prices and wage rate adjust to shocks. Two key results: first, decline to the ZLB lower sub- economy causes a powerful debt-deflation spiral. Second, output level, inflation and real wages rise in the lower sub-economy if all base wages are unexpectedly raised. Unemployment falls. This result is explored and explained since it is the key analytic result that motivates the policy. A Stabilizing Wage Policy aims to repair households' balance sheets, expedite recovery and exit from the ZLB. It raises base wages for policy duration with quarterly cost of living adjustment and a prohibition to alter base wages in order to nullify the policy. I use demand shocks to cause recession under a ZLB and a deleveraging rule to measure recovery. The rule is calibrated to repair damaged balance sheets of US households in 2007-2015. Sufficient deleveraging and a positive rate in the upper sub-economy without a wage policy are required for exit hence at exit time inflation and output in the lower sub-economy are irrelevant for exit decision. Simulations show effective policy selects high policy intensity at the outset and given the 2007-2015 experience, a constant 10% increased base wages raises equilibrium mean wage by about 5.5%, generates a controlled inflation of 5%-6% at exit time and attains recovery in a fraction of the time it takes for recovery without policy. Under a successful policy inflation exceeds the target at exit time and when policy terminates, inflation abates rapidly if the inflation target is intact. I suggest that a stabilizing wage policy with a constant 10% increased base wages could have been initiated in September 2008. If controlled inflation of 5% for 2.25 years would have been politically tolerated, the US would have recovered and exited the ZLB in 9 quarters and full employment restored by 2012. Lower policy intensity would have resulted in smaller increased mean wage, lower inflation but increased recession’s duration. The policy would not have required any federal budget expenditures, it would have reduced public deficits after 2010 and the US would have reached 2015 with a lower national debt. The policy negates the effect of demand shocks which cause the recession and the binding ZLB. It attains it’s goal with strong temporary intervention in the market instead of generating demand with public expenditures. It does not solve other long term structural problems that persist after exit from the ZLB and which require other solutions. |
| Keywords: | New Keynesian Model; wage scale; reference wage; inflexible wages; sticky prices; heterogenous beliefs; market belief; Rational Belie fs; Great Recession; Depression; monetary policy; Stabilizing Wage Policy |
| JEL: | D21 E12 E24 E3 E4 E52 E6 H3 J3 J6 |
| Date: | 2015–05 |
| URL: | http://d.repec.org/n?u=RePEc:sip:dpaper:15-007&r=dge |
| By: | Andrew Binning; Junior Maih |
| Abstract: | In this paper we take three well known Sigma Point Filters, namely the Unscented Kalman Filter, the Divided Difference Filter, and the Cubature Kalman Filter, and extend them to allow for a very general class of dynamic nonlinear regime switching models. Using both a Monte Carlo study and real data, we investigate the properties of our proposed filters by using a regime switching DSGE model solved using nonlinear methods. We find that the proposed filters perform well. They are both fast and reasonably accurate, and as a result they will provide practitioners with a convenient alternative to Sequential Monte Carlo methods. We also investigate the concept of observability and its implications in the context of the nonlinear filters developed and propose some heuristics. Finally, we provide in the RISE toolbox, the codes implementing these three novel filters. |
| Keywords: | Regime Switching, Higher-order Perturbation, Sigma Point Filters, Nonlinear DSGE estimation, Observability |
| Date: | 2015–04 |
| URL: | http://d.repec.org/n?u=RePEc:bny:wpaper:0032&r=dge |
| By: | Romain Baeriswyl (Swiss National Bank, Boersenstrasse 15, 8022 Zurich, Switzerland); Camille Cornand (Université de Lyon, Lyon, F-69007, France ; CNRS, GATE Lyon Saint-Etienne, Ecully, F-69130, France; Université Lyon 2, Lyon, F-69007, France) |
| Abstract: | In an experimental monetary general equilibrium economy, we assess two processes of monetary injection : credit expansion vs. lump-sum monetary transfers. In theory, both processes are neutral and exert no real effect on allocation. In the experiment, however, credit expansion leads to substantial distortions of real allocation and relative prices, and exerts a redistributive effect across subjects. By contrast, an increase in money through lump-sum transfers does not distort real allocation. |
| Keywords: | laboratory experiment, money neutrality, credit expansion, lump-sum monetary transfers |
| JEL: | C92 E52 E58 |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:gat:wpaper:1516&r=dge |
| By: | Hideki Konishi (School of Political Science and Economics, Waseda University) |
| Abstract: | Recently, taxation reforms entailing a “social” valued-added tax (VAT), i.e., a social security reform shifting funding from traditional wage-based taxation to consumption taxation, have been obtaining political support in some developed countries; e.g. Japan, France, Denmark, and Germany. This paper analyzes the political economy of social security funding in an overlapping-generations economy. In particular, we consider how population aging influences the choice of wage or consumption tax financing by focusing on their differential impact on inter- and intragenerational redistribution. Our results show that population aging may drastically alter the political equilibrium, in that if the population growth rate is higher than the interest rate, wage taxation is the only equilibrium choice, but if it is lower, multiple equilibria are likely to emerge, in which the introduction of consumption taxation emerges as an alternative equilibrium choice. |
| Keywords: | political economy of social security, consumption tax, structure-induced equilibrium |
| JEL: | D78 H55 |
| Date: | 2014–04 |
| URL: | http://d.repec.org/n?u=RePEc:wap:wpaper:1402&r=dge |
| By: | Marina Azzimonti |
| Abstract: | American politics have been characterized by a high degree of partisan conflict in recent years. Combined with a divided government, this has led not only to significant Congressional gridlock, but also to spells of high fiscal policy uncertainty. The unusually slow recovery from the Great Recession during the same period suggests the possibility that the two phenomena may be related. In this paper, I investigate the hypothesis that political discord depresses private investment. To this end, I first present a reduced-form political economy model to illustrate how news about political disagreement affects investment through agents' expectations. I then construct a novel high-frequency indicator of partisan conflict consistent with the model. The index, computed monthly between 1981 and 2015, uses a semantic search methodology to measure the frequency of newspaper articles reporting lawmakers' disagreement about policy. Using a 2SLS approach, I estimate that a 10% increase in the partisan conflict index is associated with a 3.4% decline in aggregate private investment in the US. |
| JEL: | C11 C26 E02 E22 E32 E62 H3 P48 |
| Date: | 2015–06 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:21273&r=dge |
| By: | Schmitt-Grohé, Stephanie; Uribe, Martín |
| Abstract: | According to conventional wisdom, terms of trade shocks represent a major source of business cycles in emerging and poor countries. This view is largely based on the analysis of calibrated business-cycle models. We argue that the view that emerges from empirical SVAR models is strikingly different. We estimate country-specific SVARs using data from 38 poor and emerging countries and find that terms-of-trade shocks explain only 10 percent of movements in aggregate activity. We then build a fully-fledged, open economy model with three sectors, importables, exportables, and nontradables, and use data from each of the 38 countries to obtain country-specific estimates of key structural parameters, including those defining the terms-of-trade process. In the estimated theoretical business-cycle models terms-of-trade shocks explain on average 30 percent of the variance of key macroeconomic indicators, three times as much as in SVAR models. |
| Keywords: | business cycles.; nontradable goods; real exchange rates; Terms of trade |
| JEL: | E32 F41 F44 |
| Date: | 2015–06 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:10655&r=dge |
| By: | Edle von Gaessler A.K.U.; Ziesemer T.H.W. (UNU-MERIT) |
| Abstract: | The increasing share of retirees puts pressure on the shrinking working generation which will need to produce more output per worker to ensure a constant standard of living. We investigate the influence a changing dependency ratio has on the time individuals spend in education and production. Longer education will increase productivity in the future, but will lower production in the short run, whereas an increase in labour input at the cost of education will provide more production immediately. We introduce an age-independent dependency ratio into a discrete-time Uzawa-Lucas model with international capital movements, human capital externalities and decreasing returns to labour in education. The dependency ratio is defined as the fraction between inactive and active individuals in regard to work or education. By calibration of the model, we find multiple steady states indicated by a u-shaped relation between education time-shares and the growth rate of the dependency ratio. Near the stable, high-level steady state, the optimal response to higher growth of the dependency ratio is more education to enhance productivity. We find evidence for this relation for 16 OECD countries. As a model extension, a debt-dependent interest rate has been introduced and estimated. |
| Keywords: | Demographic Trends, Macroeconomic Effects, and Forecasts; Economic Development: Human Resources; Human Development; Income Distribution; Migration; |
| JEL: | O15 J11 |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:unm:unumer:2015020&r=dge |
| By: | Sergey E. Pekarski (National Research University Higher School of Economics) |
| Abstract: | In the celebrated paper “Some unpleasant monetarist arithmetic”, Sargent and Wallace (1981) showed that tight monetary policy is not feasible unless it is supported by appropriate fiscal adjustment. In this paper, we explore a simple forward-looking monetary model to show that an anticipated decrease in the growth rate of base money is not necessarily characterized by “unpleasant arithmetic”. This is due to a possible transitory gain in seigniorage, which keeps public debt on a sustainable path. High interest rates worsen the fiscal stance, but actually support the feasibility of anticipated tighter monetary policy. Thus an increase in the present discounted value of budget deficits does not necessarily have inflationary consequences. |
| Keywords: | public debt sustainability; tight money paradox; unpleasant monetarist arithmetic |
| JEL: | E41 E52 E61 E63 |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:hig:wpaper:95/ec/2015&r=dge |
| By: | Lucy Qian Liu (International Monetary Fund); Liang Wang (University of Hawaii at Manoa); Randall Wright (University of Wisconsin-Madison, FRB Chicago, FRB Minneapolis) |
| Abstract: | We construct a model where money and credit are alternative payment instruments, use it to analyze sluggish nominal prices, and confront the data. Equilibria entail price dispersion, where sellers set nominal terms that they may keep fixed when aggregate conditions change. Buyers use cash and credit, with the former (latter) subject to inflation (transaction costs). We provide strong analytic results and exact solutions for money demand. Calibrated versions match price-change data well, with realistic durations, large average changes, many small and negative changes, a decreasing hazard, and behavior that changes with inflation, while staying consistent with macro and micro data on money and credit. Policy implications are discussed. |
| Keywords: | Money, Credit, Sticky Prices, Price Dispersion |
| JEL: | E31 E51 E52 E42 |
| Date: | 2015–06 |
| URL: | http://d.repec.org/n?u=RePEc:hai:wpaper:201505&r=dge |
| By: | Blume, Lawrence E. (Cornell University and Institute for Advanced Studies); Cogley, Timothy (New York University); Easley, David A. (Cornell University); Sargent, Thomas J. (New York University and Hoover Institution); Tsyrennikov, Viktor (IMF) |
| Abstract: | We propose a new welfare criterion that allows us to rank alternative financial market structures in the presence of belief heterogeneity. We analyze economies with complete and incomplete financial markets and/or restricted trading possibilities in the form of borrowing limits or transaction costs. We describe circumstances under which various restrictions on financial markets are desirable according to our welfare criterion. |
| Keywords: | social welfare, heterogeneous beliefs, spurious unanimity, speculation, pessimism, incomplete markets, financial regulation |
| Date: | 2015–06 |
| URL: | http://d.repec.org/n?u=RePEc:ihs:ihsesp:313&r=dge |