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on Dynamic General Equilibrium |
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Issue of 2015‒08‒07
nineteen papers chosen by Christian Zimmermann Federal Reserve Bank of St. Louis |
| By: | Marcelo Veracierto (Federal Reserve Bank of Chicago) |
| Abstract: | I consider a real business cycle model in which agents have private information about an idiosyncratic shock to their value of leisure. I consider the mechanism design problem for this economy and describe a computational method to solve it. This is an important contribution of the paper since the method could be used to solve a wide class of models with heterogeneous agents and aggregate uncertainty. Calibrating the model to U.S. data I find a striking result: That the information frictions that plague the economy have no effects on business cycle fluctuations. |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed015:232&r=dge |
| By: | Jun Nie (Federal Reserve Bank of Kansas City); Gaowang Wang (Shandong University); Eric Young (University of Virginia); Yulei Luo (The University of Hong Kong) |
| Abstract: | This paper derives the general equilibrium effects of rational inattention (or RI; Sims 2003, 2010) in a model of incomplete income insurance (Huggett 1993, Wang 2003). We show that, under the assumption of CARA utility with Gaussian shocks, the permanent income hypothesis (PIH) arises in steady state equilibrium due to a balancing of precautionary savings and impatience. We then explore how RI affects the equilibrium joint dynamics of consumption, income and wealth, and find that elastic attention can make the model fit the data better. We finally show that the welfare costs of incomplete information are even smaller due to general equilibrium adjustments in interest rates. |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed015:280&r=dge |
| By: | Lucas Herrenbrueck (Simon Fraser University) |
| Abstract: | This paper is the first to describe a monetary general equilibrium model that features; (i) search frictions in the goods market, which create market power; (ii) endogenously chosen search effort by consumers, which mitigates this market power; (iii) heterogeneous firms and free entry; and (iv) an open economy, i.e. an arbitrary number of countries that trade goods and, potentially, assets. The model is flexible and well suited to studying questions in international macroeconomics, including the effects of monetary policy on production, firm entry, markups, trade, and welfare, at home or abroad. As part of this effort, I characterize a general class of matching processes which provide a novel approach to modeling firm sales: the number of customers per firm follows a bounded Pareto distribution with shape parameter less than or equal to one. |
| Keywords: | Monetary policy, optimal inflation, search frictions, search effort, price dispersion, open economy |
| JEL: | D43 E40 F12 |
| Date: | 2015–07–01 |
| URL: | http://d.repec.org/n?u=RePEc:sfu:sfudps:dp15-06&r=dge |
| By: | Enrique Mendoza (University of Pennsylvania); Javier Bianchi (Federal Reserve Bank of Minneapolis) |
| Abstract: | Collateral constraints widely used in models of financial crises feature a pecuniary externality, because agents do not internalize how collateral prices respond to collective borrowing decisions, particularly when binding collateral constraints trigger a crisis. We study a production economy in which physical assets serve as collateral for debt and working capital loans, and show that agents in a competitive equilibrium borrow ``too much" during credit expansions compared with a financial regulator who internalizes this externality. Under commitment, however, this regulator faces a time inconsistency problem: It promises low future consumption to prop up current asset prices when collateral constraints bind, but this is not optimal ex post. Instead, we examine the optimal, time-consistent policy of a regulator who cannot commit to future policies. Quantitative analysis shows that this policy reduces the incidence and magnitude of crises, removes fat tails from the distribution of returns and reduces risk premia. A key element of this policy is a state-contingent macro-prudential debt tax (i.e. a tax imposed in normal times when a financial crisis has positive probability next period) of about 1 percent on average. Constant debt taxes also reduce the frequency of crises but are less effective at reducing their severity and reduce welfare when credit constraints bind. |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed015:289&r=dge |
| By: | Eric Swanson (University of California, Irvine) |
| Abstract: | Linkages between the real economy and financial markets can be very important, as evidenced by the 2007-09 financial crisis and European sovereign debt crisis. This paper develops a simple, structural macroeconomic model that is consistent with a wide variety of asset pricing facts, such as the size and variability of risk premia on equities, real and nominal government bonds, and corporate bonds, commonly referred to as the equity premium puzzle, bond premium puzzle, and credit spread puzzle, respectively. The paper makes two main contributions: First, it unifies a variety of asset pricing puzzles in a simple, structural asset pricing framework. Second, it shows how standard dynamic macroeconomic models can be brought into agreement with a range of asset prices, making it possible to use these models to study the linkages between risk premia in financial markets and the real economy. |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed015:273&r=dge |
| By: | Küçük, Hande; Sutherland, Alan |
| Abstract: | This paper aims to account for the Backus-Smith puzzle in a two-country DSGE model with endogenous portfolio choice in bonds and equities. Utility is non-separable across consumption and leisure and across time. This model is shown to imply almost zero correlation between relative consumption and the real exchange rate while generating portfolio positions that broadly match the data. Furthermore, the cross-country correlation of consumption is lower than the correlation of output, which has previously been a difficult fact to match. Non-separable preferences are found to be crucial to generating these results but financial market structure plays only a minor role. |
| Keywords: | Backus-Smith puzzle; consumption-real exchange rate anomaly; incomplete markets; international risk sharing; non-separable preferences; portfolio choice |
| JEL: | F31 F41 |
| Date: | 2015–07 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:10724&r=dge |
| By: | Roberto Duncan (Ohio University) |
| Abstract: | The canonical neoclassical model is insufficient to understand business cycle fluctuations in emerging market and developing economies (EMDEs). I reformulate the models proposed by Aguiar and Gopinath (2007) and Neumeyer and Perri (2005) in simple settings that can be used to do back-of-the-envelope analysis and teach business cycle macroeconomics for EMDEs at the undergraduate level. The simplified models are employed for qualitatively explaining facts such as the countercyclicality of the trade balance and the real interest rate, and the higher volatility of output, consumption, and real wages compared with those observed in advanced countries. Simple extensions can be used to understand other empirical facts such as large capital outflows and output drops, small government spending multipliers, the cyclical behavior of prices, and the negative association between currency depreciations and output. |
| Keywords: | Emerging market economies, economic education, undergraduate macroeconomics, business cycles |
| JEL: | A22 E32 F32 |
| Date: | 2015–07 |
| URL: | http://d.repec.org/n?u=RePEc:apc:wpaper:2015-049&r=dge |
| By: | Gregory Phelan (Williams College); Alexis Akira Toda (University of California-San Diego) |
| Abstract: | We derive a parsimonious returns-based stochastic discount factor that is robust to model misspecification. We consider a general equilibrium model with heterogeneous agents who can invest their wealth in many assets. As long as (i) agents have (individual-, time-, and state-dependent) recursive preferences that are homothetic in current consumption and continuation value with a common relative risk aversion coefficient "gamma" and (ii) asset returns and individual state variables are conditionally independent (e.g., GARCH processes), we prove that the (minus "gamma")-th power of market return is a valid stochastic discount factor. Within this class of models, asset prices are determined by relative risk aversion and technology alone, and "returns-based asset pricing" is robust to model misspecification as opposed to the consumption-based approach. We recast the equity premium puzzle as a consumption/saving puzzle, not as an asset pricing puzzle. |
| Keywords: | Asset pricing puzzles, heterogeneous-agent model, model misspecification, recursive preferences |
| JEL: | D53 D58 D91 G11 G12 |
| Date: | 2015–07 |
| URL: | http://d.repec.org/n?u=RePEc:wil:wileco:2015-10&r=dge |
| By: | Yongsung Chang (University of Rochester / Yonsei Univ.); Sun-Bin Kim (Yonsei University); Bo Hyun Chang (University of Rochester) |
| Abstract: | We develop a quantitative, heterogeneous-agents general equilibrium model that reproduces the income inequalities of 31 countries in the Organization for Economic Co-operation and Development. Using this model, we compute the optimal income tax rate for each country under the equal-weight utilitarian social welfare function. We simulate the voting outcome for the utilitarian optimal tax reform for each country. Finally, we uncover the Pareto weights in the social welfare functions of each country that justify the current redistribution policy. |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed015:224&r=dge |
| By: | Marcin Kolasa (Narodowy Bank Polski and Warsaw School of Economics) |
| Abstract: | This paper considers a canonical New Keynesian macrofinancial model to analyze how macroprudential policy tools can help the monetary authority in reaching a selection of dual stabilization objectives. We show that using the loan-to-value ratio as an additional policy instrument does not allow to resolve the standard inflation-output volatility tradeoff. Simultaneous stabilization of inflation and either credit or house prices with monetary and macroprudential policy is possible only if the role of credit in the economy is very small. Overall, our results suggest that macroprudential policy has important limits as a complement to monetary policy. |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed015:207&r=dge |
| By: | Assaf Razin (tel aviv university) |
| Abstract: | We develop a dynamic political-economic theory of welfare state and immigration policies, featuring three distinct voting groups: skilled work- ers, unskilled workers, and old retirees. The essence of inter - and intra- generational redistribution of a typical welfare system is captured with a proportional tax on labor income to nance a transfer in a balanced- budget manner. We provide an analytical characterization of political- economic equilibrium policy rules consisting of the tax rate, the skill com- position of migrants, and the total number of migrants. When none of these groups enjoy a majority (50 percent of the voters or more), political coalitions will form. With overlapping generations and policy-determined influx of immigrants, the formation of the political coalitions changes over time. These future changes are taken into account when policies are shaped. |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed015:215&r=dge |
| By: | Hakki Yazici (Sabanci University); Nicola Pavoni (Bocconi University) |
| Abstract: | We study optimal taxation of bequests and inter vivos transfers in a model where altruistic parents and their offspring disagree on intertemporal trade-offs. We show that laissez-faire equilibrium is Pareto inefficient, and whenever offspring are impatient from their parents' perspective, optimal policy involves a positive tax on parental transfers. Cautioned by the technical complications present in this class of models, our normative prescriptions do not rely on the assumption of differentiability of the agents’ policy functions. |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed015:250&r=dge |
| By: | Rosch, Stephanie D; Zhang, Cathy; Preckel, Paul; Ortega, David L. |
| Abstract: | We estimate the effect of search frictions on Kenyan farmers' decisions to supply French beans for export under contract. To do so, we create a model of competitive wage search in posted offer markets with imperfect contract enforcement using the frameworks of Moen (1997) and Mortensen and Wright (2002). Then we employ two novel empirical methodologies to test our model using data from Kenya's French bean export industry. The first methodology measures search frictions based on the spatial density of firms and farmers in the market. The second uses preferences measured in a choice experiment to quantify the impact of search frictions on farmers’ entry and exit decisions under different contract enforcement scenarios. We find that search frictions are present in the market which primarily limit farmers' abilities to match with potential buyers and not vice versa. We also find that increasing buyer concentration has a negative impact on the maximum bid received by farmers, suggesting that buyers tend to target areas where farmers have fewer profitable alternatives to French bean production. Lastly, we find that search frictions can provide a potential causal explanation for why farmers do not enter the fresh market, and also why they do not transition from supplying the less lucrative processed market to the more lucrative fresh market. These findings are important for designing more effective programs to connect small-scale producers to French bean markets. |
| Keywords: | search theory, empirical contract theory, development, contract enforcement, Industrial Organization, Institutional and Behavioral Economics, International Development, Labor and Human Capital, J64, L14, D86, O13, |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:ags:aaea15:205779&r=dge |
| By: | David Andolfatto; Aleksander Berentsen; Christopher Waller |
| Abstract: | We study the use of asset-backed money in a neoclassical growth model with illiquid capital. A mechanism is delegated control of productive capi- tal and issues claims against the revenue it earns. These claims constitute a form of asset-backed money. The mechanism determines (i) the number of claims outstanding, (ii) the dividends paid to claim holders, and (iii) the structure of redemption fees. We find that for capital-rich economies, the first-best allocation can be implemented and price stability is optimal. However, for sufficiently capital-poor economies, achieving the first-best allocation requires a strictly positive rate of inflation. In general, the minimum infiation necessary to implement the first-best allocation is above the Friedman rule and varies with capital wealth. |
| Keywords: | Limited commitment, asset-backed money, optimal monetary policy |
| JEL: | D82 D83 E61 G32 |
| Date: | 2015–06 |
| URL: | http://d.repec.org/n?u=RePEc:zur:econwp:198&r=dge |
| By: | Roberto Steri (University of Lausanne) |
| Abstract: | Recent corporate finance studies show that hedging is a first-order driver of corporate decisions. I use firms' hedging behavior to build a novel asset pricing model, the Corporate CAPM. I propose a dynamic contracting framework in which collateral constraints induce a tradeoff between hedging and immediate needs for funding. Firms hedge by transferring resources to future states that are most important for firm's value. In the model, firms' hedging behavior is informative of the shareholders' stochastic discount factor, which measures the value of each state. As a consequence, discount rates can be inferred from firm's observed investment, financing, and hedging policies. On the corporate finance side, a calibrated version of the model is broadly consistent with observed corporate policies of US listed firms. On the asset pricing side, the Corporate CAPM is successful in pricing different test assets, also in comparison to leading asset pricing models. |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed015:293&r=dge |
| By: | Aleksander Berentsen; Samuel Huber; Alessandro Marchesiani |
| Abstract: | In the United Kingdom, money demand deviates from the convex relationship suggested by monetary theory. Limited commitment of borrowers via banks can explain this observation. Our finding is based on a microfounded monetary model, where a money market provides insurance against idiosyncratic liquidity shocks by offering short-term loans and by paying interest on money market deposits. We calibrate the model to U.K. data and show that limited commitment significantly improves the fit between the theoretical money demand function and the data. Limited commitment can also explain the "liquidity trap"; i.e., why the ratio of credit to Ml is currently so low, despite the fact that nominal interest rates are at their lowest recorded levels. |
| Keywords: | Money demand, money markets, financial intermediation, limited commitment |
| JEL: | E4 E5 D9 |
| Date: | 2015–07 |
| URL: | http://d.repec.org/n?u=RePEc:zur:econwp:199&r=dge |
| By: | Rouhi-Rad, Mani; Brozovic, Nicholas; Mieno, Taro |
| Abstract: | This study develops a framework of search with frictions in the context of tradeable permit markets to explain the trading behavior and search effort of the participants. The study area is the groundwater market of the Twin Platte Natural Resources District, in Nebraska. The results show that overall the market is moving towards Pareto efficiency as irrigation rights are moving from lower value users to higher value users. The results also suggest that quantity of the rights traded affects the search effort of the participants positively. |
| Keywords: | Tradeable permit markets, transaction costs, search costs, groundwater markets, Environmental Economics and Policy, Resource /Energy Economics and Policy, |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:ags:aaea15:205798&r=dge |
| By: | Nicolas Werquin (Yale University); Aleh Tsyvinski (Yale University); Mikhail Golosov (Princeton University) |
| Abstract: | We develop a general method to study the effects of non-linear taxation in dynamic settings using variational arguments. We first derive general theoretical formulas that characterize the welfare effects of local tax reforms and, in particular, the optimal tax system, potentially restricted within certain classes (e.g., age-independent, linear, separable). These formulas are expressed in terms of intuitive parameters, such as the labor and capital income elasticities and the hazard rates of the income distributions. Second, we apply these formulas to various specific settings. In particular, we decompose the gains arising from each element of tax reform, starting from a simple baseline system, as the available tax instruments become more sophisticated. We further show that the design of tax systems obeys a common general principle, namely that more sophisticated tax instruments (e.g., age-dependent, non-linear, non-separable) allow the government to fine-tune the tax rates by targeting higher distortions to the segments of the population whose behavior responds relatively little to those taxes. |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed015:244&r=dge |
| By: | Eduardo Morales (Princeton University); Kamran Bilir (University of Wisconsin - Madison) |
| Abstract: | What is the private return to innovation? When firms operate production sites in multiple countries, improvements developed at one site may be shared across others for efficiency gain. We develop a dynamic model that explicitly accounts for such transfer within the firm, and apply it to measure innovation returns for a comprehensive panel of U.S. multinationals during 1989--2009. We find that the data, which include detailed measures of affiliate production and innovation, are consistent with innovation generating returns at firm locations beyond the innovating site. Accounting for cross-plant effects of innovation, our estimates indicate the average firm realizes between 10 and 30 percent of the return to its U.S. parent R&D abroad, suggesting single-plant estimates may understate firms' gain from innovation. |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed015:238&r=dge |