nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2015‒07‒04
fifteen 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. The Welfare Cost of Inflation Risk Under Imperfect Insurance By Olivier Allais; Yann Algan; Edouard Challe; Xavier Ragot
  3. Cross-country co-movement in long-term interest rates: a DSGE approach By Chin, Michael; Filippeli, Thomai; Theodoridis, Konstantinos
  4. Mortgage Defaults By Juan Carlos Hatchondo; Leonardo Martinez; Juan M. Sanchez
  5. Optimal Fiscal Policy with Endogenous Product Variety By Chugh, Sanjay; Ghironi, Fabio
  6. Debt Dilution and Sovereign Default Risk By Juan Carlos Hatchondo; Leonardo Martinez; Cesar Sosa-Padilla
  7. Lending Efficiency Shocks By Kaiji Chen; Tao Zha
  8. Pension Reform and Individual Retirement Accounts in Japan By KITAO Sagiri
  9. What if oil is less substitutable? A New-Keynesian Model with Oil, Price and Wage Stickiness including Capital Accumulation By Verónica Acurio Vásconez
  10. Capital Tax as a Consequence of Bargaining By Saito, Yuta
  11. 'Human capital and income distribution in a model of corruption' By Humna Ahsan; Keith Blackburn
  12. Money and Credit Redux By Chao Gu; Fabrizio Mattesini; Randall Wright
  13. 'Are human and social capital linked? Evidence from India' By Baris Alpaslan
  14. Fiscal rules and the Sovereign Default Premium By Juan Carlos Escaniano; Leonardo Martinez; Francisco Roch
  15. 'Lucas' In The Laboratory (forthcoming in Journal of Finance) By Asparouhova, Elena; Bossaerts, Peter; Roy, Nilanjan; Zame, William

  1. By: Verónica Acurio Vásconez (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS)
    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.
    Abstract: Les effets des chocs pétroliers sur l'inflation et la croissance ont été largement étudiés dans la littérature, cependant peu d'études ont traité l'impact de l'augmentation du prix du pétrole sur le chômage. Afin de faire la lumière sur la question, cet article développe un modèle d'équilibre général dynamique stochastique (DSGE) de taille moyenne où : le pétrole est utilisé en production et consommation comme dans Acurio-Vásconez (2015) ; le chômage est introduit comme dans Mortensen & Pissarides (1994) ; et les salaires nominales sont construits comme dans Gertler & Trigari (2009). On analyse ensuite les effets de l'augmentation du prix du pétrole dans l'économie. Le modèle récupère la plupart des effets stylisés observés après le choc pétrolier des années 2000. L'étude de sensibilité montre que la réduction du pouvoir de négociation salariale des ménages permet d'atténuer l'impact positif du choc pétrolier sur le chômage, sans affecter négativement le PIB. Cependant, il montre aussi que la réduction du pouvoir de négociation ensemble avec la flexibilisation des salaires réduit l'augmentation du chômage après un choc pétrolier, mais il provoque une diminution des salaires réels, ce qui réduit le revenu des ménages et impacte le PIB.
    Date: 2015–05
  2. By: Olivier Allais (Laboratoire de Recherche sur la Consommation); Yann Algan (Département d'économie); Edouard Challe (Department of Economics, Ecole Polytechnique); Xavier Ragot (OFCE)
    Abstract: What are the costs of inflation fluctuations and who bears those costs? In this paper, we investigate this question by means of a quantitative incomplete-market, heterogenous-agent model wherein households hold real and nominal assets and are subject to both idiosyncratic labor income shocks and aggregate inflation risk. A key feature of our analysis is a nonhomothetic specification for households' preferences towards money and consumption goods. Unlike traditional specifications, ours allows the model to reproduce the broad features of the distribution of monetary assets (in addition to being consistent with the distribution of nonmonetary assets). Inflation risk is found to generate significant welfare losses for most households, i.e., between 1 and 1.5 percent of permanent consumption. The loss is small or even negative for households at the very top of the productivity and/or wealth distribution.
    Keywords: Money-in-the-utility; Incomplete Markets; Inflation Risks; Welfare
    JEL: E21 E32 E41
    Date: 2015–05
  3. By: Chin, Michael (Bank of England); Filippeli, Thomai (Queen Mary University of London); Theodoridis, Konstantinos (Bank of England)
    Abstract: Long-term interest rates in a number of small open inflation-targeting economies co-move more strongly with US long-term rates than with short-term rates in those economies. We augment a standard small open economy model with imperfectly substitutable government bonds and time-varying term premia, that captures this phenomenon. The estimated model fits a range of US and UK data remarkably well, and produces term premium estimates that are comparable to estimates from the affine term structure model literature. We find that the strong co-movement between US and UK long-term interest rates arises primarily via correlated policy rate expectations, rather than through correlated term premia. This is due to policymakers in both economies responding to foreign productivity and discount factor shocks that cause persistent changes in inflation. We also overcome the common failure of similar models to account for the large influence of foreign disturbances on domestic economies found empirically, where in our model around 40% of the variation in UK GDP can be explained by shocks originating in the US economy.
    Keywords: Open-economy; international; co-movement; yield curve; interest rates
    JEL: F41 F44 G15
    Date: 2015–06–19
  4. By: Juan Carlos Hatchondo (Indiana University); Leonardo Martinez (IMF); Juan M. Sanchez (St. Louis Fed)
    Abstract: We present a model in which households facing income and housing-price shocks use long-term mortgages to purchase houses. Interest rates on mortgages reflect the risk of default. The model accounts for observed patterns of housing consumption, mortgage borrowing, and defaults. We use the model as a laboratory to evaluate default-prevention policies. While recourse mortgages make the penalty for default harsher and thus may lower the default rate, they also lower equity and increase payments and thus may increase the default rate. Introducing loan-to-value (LTV) limits for new mortgages increases equity and thus lowers the default rate, with negligible negative effects on housing demand. The combination of recourse mortgages and LTV limits reduces the default rate while boosting housing demand. Recourse mortgages with LTV limits are also necessary to prevent large increases in the mortgage default rate after large declines in the aggregate price of housing
    Keywords: mortgage, default, life cycle, recourse, LTV, housing price
    Date: 2015–05
  5. By: Chugh, Sanjay; Ghironi, Fabio
    Abstract: We study Ramsey-optimal fiscal policy in an economy in which product creation is the result of forward-looking investment decisions by firms. There are two main results. First, depending on the particular form of variety aggregation, firms' dividend payments may be either subsidized or taxed in the long run. This policy balances monopoly incentives for product creation with the welfare benefit of product variety. In the most empirically relevant form of variety aggregation, socially efficient outcomes entail a substantial tax on dividend income, removing the incentive for over-accumulation of capital, which takes the form of the stock of products. Similar intuitions determine the optimal setting of long-run producer entry subsidies. Second, optimal policy induces dramatically smaller, but efficient, fluctuations of both capital and labor markets than in a calibrated exogenous policy. Decentralization requires zero intertemporal distortions and constant static distortions over the cycle. The results relate to Ramsey theory, which we show by developing welfare-relevant concepts of efficiency that take into account product creation. The results on optimal entry subsidies provide guidance for the study of product market reforms in dynamic macro models.
    Keywords: Endogenous product variety; Optimal taxation; Producer entry; Wedge smoothing; Zero intertemporal distortions
    JEL: E20 E21 E22 E32 E62
    Date: 2015–06
  6. By: Juan Carlos Hatchondo (Indiana University); Leonardo Martinez (IMF); Cesar Sosa-Padilla (McMaster University)
    Abstract: We measure the effects of debt dilution on sovereign default risk and study debt covenants that could mitigate these effects. We calibrate a baseline model with en- dogenous debt duration and default risk (in which debt can be diluted) using data from Spain. We find that debt dilution accounts for 78 percent of the default risk in the baseline economy and that eliminating dilution increases the optimal duration of sovereign debt by almost two years. Eliminating dilution also increases consumption volatility, but still produces welfare gains. The debt covenants we study could help enforcing fiscal rules
    Date: 2015–06
  7. By: Kaiji Chen; Tao Zha
    Abstract: This paper develops a theory in which shocks to the efficiency of information acquisition by financial intermediation translate into business cycle fluctuations via capital reallocation. In our theory, under costly verification, the bank chooses to only monitor the returns of those entrepreneurs with insufficient net worth. This distorts the existing capital allocation among entrepreneurs of different sizes. A crucial ingredient of the model is that the outcome of monitoring is random and depends on both the efficiency of monitoring and the resources devoted to policing the returns of a project. As a consequence, a negative shock to monitoring efficiency forces bank to increase monitoring intensity and reduce the loan toward small entrepreneurs. This results in an increase in productivity dispersion and a recession. Using the COMPUSTAT dataset, we find a significant countercyclical pattern for the relative capital productivity of small to large firms, and a procyclical capital allocation between them. Such an empirical observation distinguishes the lending efficiency shocks from other aggregate shocks as the sources of business cycles.
    Date: 2015–06
  8. By: KITAO Sagiri
    Abstract: The paper studies the effects of introducing individual retirement accounts (IRA) as an alternative to the employer-based, pay-as-you-go public pension system in Japan. Without any reform, the projected demographic transition implies a massive increase in government expenditures in the magnitude of 40% of total consumption expenditures at the peak. Gradually shifting the earnings-related part of pension towards self-financed IRA, expenditures can be reduced by 20% of total consumption, providing a major relief for the government budget. The reform generates a significant rise in capital, as individuals save more for retirement, which is invested over many years. As a result, wage, output, and consumption are also higher, leading to a sizeable welfare gain in the intermediate and long run. Current generations, however, can face a large welfare loss depending on how the transition is financed.
    Date: 2015–06
  9. By: Verónica Acurio Vásconez (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS)
    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.
    Abstract: La littérature récente sur énergie a déjà établit que le pétrole n'est pas parfaitement substituable aux autres facteurs, en considérant l'énergie fossile comme étant un facteur de production critique en différentes combinaisons. Cependant, les valeurs estimées de l'élasticité de substitution se trouvent dans un large rang, entre 0.004 et 0.64. Cet article évoque ce phénomène en élargissant le modèle DSGE développe en Acurio Vásconez et al. (2015) en modifiant les fonctions de production et consommation supposées Cobb-Douglas par des fonctions à élasticité de substitution constante (CES). Cet article introduit aussi des rigidités de salaire et des prix à la Calvo. Finalement, en utilisant des techniques Bayésiennes, le modèle est estimé sur les données trimestrielles aux Etats-Unis, pour la période 1984:Q1 - 2007:Q3 et après analysé. L'estimation de l'élasticité de substitution du pétrole est 0.14 dans le secteur productif et 0.51 pour les ménages. De plus, grâce à la faible substituabilité du pétrole, ce modèle récupère et explique quatre fait stylisés observés après le choc pétrolier des années 2000 : l'absence de récession, jumelée avec une faible mais persistante augmentation du taux d'inflation, une décroissance des salaires réels et une faible élasticité de prix de la demande de pétrole dans le court terme. En outre, le modèle montre que, ceteris paribus, la réduction de la rigidité des salaires nominales amplifie l'augmentation de l'inflation et la diminution de la consommation. Donc dans ce modèle, plus de flexibilité de salaires ne semble pas atténuer l'impact d'un choc pétrolier.
    Date: 2015–05
  10. By: Saito, Yuta
    Abstract: We study an OLG model in which heterogenous agents bargain over capital taxation. In our model, both of the balance of bargaining power and threat point, that standard median voter models have not considered, are endogenized. We show that the two key features are crucial determinants for political as well as economic outcomes.
    Keywords: Legislative bargaining; wealth inequality; capital taxation
    JEL: E62 H20 H30 P48
    Date: 2015–06–30
  11. By: Humna Ahsan; Keith Blackburn
    Abstract: This paper studies the role of corruption in determining the distribution of income and, with this, the degree of poverty and inequality. The analysis is based on an overlapping generations model in which individuals may seek to improve their productive e¢ ciency by supplementing or substituting publicly-provided services (education and health care) with their own expenditures on human capital formation. Financial market imperfections mean that their ability to do this depends on their initial wealth status, implying the possibility of persistent inequality in multiple long-run equilibria. We show how corruption may exacerbate this by compromising public service provision. This occurs through the double whammy of both reducing the earnings and increasing the population of those who rely most on such services. Higher levels of corruption are associated with higher levels of poverty and may result in a complete polarisation between the rich and poor through the elimination of any middle class.
    Date: 2015
  12. By: Chao Gu (University of Missouri-Columbia); Fabrizio Mattesini; Randall Wright
    Abstract: We analyze money and credit as competing payment instruments in decentralized exchange. In natural environments, we show the economy does not need both: if credit is easy, money is irrelevant; if credit is tight, money can be essential, but then credit is irrelevant. Changes in credit conditions are neutral because real balances respond endogenously to keep total liquidity constant. This is true for exogenous or endogenous policy and debt limits, secured or unsecured lending, and a general class of pricing mechanisms. While we show how to overturn some results, the benchmark model suggests credit might matter less than people think.
    Keywords: Money, Credit, Debt, Essentiality, Neutrality
    JEL: E42 E51
    Date: 2015–03–29
  13. By: Baris Alpaslan
    Abstract: This paper develops a two-period Overlapping Generations (OLG) model of endogenous growth in which a two-way relationship between social capital and human capital is studied. In order to illustrate the impact of public policies, the model is calibrated using the data for a low-income country, India and a sensitivity analysis is reported under di¤erent parameter con...gurations. Based on the numerical analysis, this paper focuses on possible trade-offs in the allocation of government spending between two productive components, that is, social capital-related activities and education. The results of this paper show that a higher share of spending on education promotes growth despite an offsetting cut in social capital-related activities; however, the reverse entails trade-o¤s. In other words, an increase in the share of spending on social capital-related activities through a concomitant cut in education is detrimental to long-run growth.
    Date: 2015
  14. By: Juan Carlos Escaniano (Indiana University); Leonardo Martinez (IMF); Francisco Roch (IMF)
    Abstract: We use a sovereign default model to study the eects of introducing limits to the decision- making capabilities of governments|scal rules. We show that optimal limits to the debt level vary greatly across parameterizations of the model that deliver dierent levels of debt tolerance. In contrast, optimal limits to the sovereign premium paid by the government are very similar across parameterizations. Since levels of debt tolerance are dicult to identify and vary both across countries and over time, and political constraints often force common scal rule targets across countries, these ndings indicate that sovereign-premium limits may be preferable to debt limits
    Keywords: Fiscal Rules, Debt Limit, Spread Limit, Default, Sovereign Default Pre- mium, Countercyclical Policy, Endogenous Borrowing Constraints, Long-term Debt, Debt Dilution, Debt Tolerance
    Date: 2015–03
  15. By: Asparouhova, Elena (University of Utah); Bossaerts, Peter (University of Utah and University of Melbourne); Roy, Nilanjan (City University of Hong Kong); Zame, William (University of California, Los Angeles)
    Abstract: The Lucas asset pricing model is studied here in a controlled setting. Participants could trade two long-lived securities in a continuous open-book system. The experimental design emulated the stationary, infinite-horizon setting of the model and incentivized participants to smooth consumption across periods. Consistent with the model, prices aligned with consumption betas, and they co-moved with aggregate dividends, more strongly so when risk premia were higher. Trading significantly increased consumption smoothing compared to autarky. Nevertheless, as in field markets, prices were excessively volatile. The noise corrupted traditional GMM tests. Choices displayed substantial heterogeneity: no subject was representative for pricing.
    Date: 2015–06

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