nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2015‒08‒30
seventeen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Aggregate Consequences of Dynamic Credit Relationships By Verani, Stephane
  2. Financial Fragmentation Shocks By Paulo Júlio; Ricardo Mourinho Félix; Gabriela Lopes de Castro; José R. Maria
  3. The Joint Labor Supply Decision of Married Couples and the Social Security Pension System By Shinichi Nishiyama
  4. Housing, Capital Taxation and Bequests in a Simple OLG Model By Gary-Bobo, Robert J.; Nur, Jamil
  5. Can a DSGE Model Explain a Costly Disinflation? By Maria Ferrara; Patrizio Tirelli
  6. The Role of Shadow Banking in the Monetary Transmission Mechanism and the Business Cycle By Falk Mazelis; ; ;
  7. Distributional Effects of Monetary Policy in Emerging Market Economies By Prasad, Eswar; Zhang, Boyang
  8. Can active labor market policy be counter-productive? By Gilles Saint-Paul
  9. Incomplete Markets and Aggregate Demand By Iván Werning
  10. Mortgages and Monetary Policy By Carlos Garriga; Finn E. Kydland; Roman Šustek
  11. Unemployment Fluctuations, Match Quality, and the Wage Cyclicality of New Hires By Christopher Huckfeldt; Antonella Trigari; Mark Gertler
  12. Population ageing and prices in an OLG model with money created by credits By Fedotenkov, Igor
  13. Capital Allocation and Productivity in South Europe By Gopinath, Gita; Kalemli-Ozcan, Sebnem; Karabarbounis, Loukas; Villegas-Sanchez, Carolina
  14. Collateral constraints and rental markets By Hippolyte D'Albis; Eleni Iliopulos
  15. Fiscal Policy Effects in a Heterogeneous-Agent OLG Economy with an Aging Population By Shinichi Nishiyama
  16. Comparing Indirect Inference and Likelihood testing: asymptotic and small sample results By Meenagh, David; Minford, Patrick; Wickens, Michael; Xu, Yongdeng
  17. Comparing Indirect Inference and Likelihood testing: asymptotic and small sample results By Meenagh, David; Minford, Patrick; Wickens, Michael R.; Xu, Yongdeng

  1. By: Verani, Stephane (Board of Governors of the Federal Reserve System (U.S.))
    Abstract: Which financial frictions matter in the aggregate? This paper presents a general equilibrium model in which entrepreneurs finance a firm with a long-term contract. The contract is constrained efficient because firm revenue is costly to monitor and entrepreneurs may default. The cost of monitoring firms and the entrepreneurs' outside options determine the significance of moral hazard relative to limited enforcement for financial contracting. Calibrating the model to the U.S. economy, I find that the relative welfare loss from financial frictions is about 5 percent in terms of aggregate consumption with moral hazard, while it is 1 percent with limited enforcement. Reforms designed to strengthen contract enforcement increase aggregate consumption in the short-run, but their long-run effects are modest when monitoring costs are high. Weak contract enforcement contributes to aggregate fluctuations by amplifying the effect of aggregate technological shocks, but moral hazard does not.
    Keywords: Business cycles; financial contracting; financial development; firm dynamics; limited enforcement; private information
    JEL: D82 E32 G32 L14
    Date: 2015–08–14
  2. By: Paulo Júlio; Ricardo Mourinho Félix; Gabriela Lopes de Castro; José R. Maria
    Abstract: We define "financial fragmentation shocks" as fluctuations in credit market frictions in a small euro area economy. The shock changes the financial integration status quo of the monetary union, given its negligible international spillover. An increase in credit market frictions triggers a recession in the small economy. Perfect competition and the absence of nominal rigidities attenuate output volatility. Expectations also matter: real impacts weaken when long fragmentation time spans are perceived to be short lived. Contrarily to ""risk shocks", defined as fluctuations in borrowers' riskiness, fragmentation shocks do not imply strongly countercyclical bankruptcy rates. The results are based on PESSOA, a general equilibrium model with a Bernanke-Gertler-Gilchrist financial accelerator mechanism.
    JEL: E27 E44
    Date: 2015
  3. By: Shinichi Nishiyama
    Abstract: The current U.S. Social Security program redistributes resources from high-wage workers to low-wage workers through its progressive benefit schedule and from two-earner couples and singles to one-earner couples through its spousal and survivors benefits. This paper extends a standard general-equilibrium overlapping-generations model with uninsurable wage shocks to analyze the effect of the spousal and survivors benefits on the labor supply of married households and the overall economy. The heterogeneousagent model calibrated to the current U.S. economy predicts that, in the long run, removing spousal and survivors benefits would increase the female labor participation rate by 1.4%, the total working hours of women by 1.6–1.7%, and the total output of the economy by 0.5–0.6%. Under the balanced-budget assumption, a phased-in cohort-by-cohort removal of these benefits would make all age cohorts, on average, better off, although the policy change would make a majority of young married households worse off in the short run.
    Keywords: dynamic general equilibrium, heterogeneous agents, overlapping generations, female labor supply
    JEL: D91 E62 H55
    Date: 2015
  4. By: Gary-Bobo, Robert J.; Nur, Jamil
    Abstract: We study the allocation of housing capital in an overlapping generations economy with competitive property and housing rental markets. In this economy, consumers inherit property from their parents when they retire. Agents have paternalistic bequest motives. All agents are identical and there is no redistribution problem. The stationary competitive equilibrium of such a model is inefficient, since old agents consume too much perishable goods and too much housing. We then show that the golden rule stationary optimum can be achieved by means of a simple system of proportional taxes. The optimal allocation is characterized by the fact that the young agents rent their homes and that the old agents own the entire stock of housing capital. An optimal tax system has the following features: the young agents' rents must be subsidized. Housing capital and rents are both taxed. But bequests must be subsidized. Bequest and rent subsidies are financed by labor income tax and property tax revenues. Rent subsidies are financed by the tax on rents. The government's budget is balanced. The negative tax on bequests can be interpreted as a pension benefit, paid out of a public pension fund, based on the market value of the housing-capital stock.
    Keywords: bequests; capital taxation; housing; overlapping generation; real estate; rents
    JEL: H2 H3 H6
    Date: 2015–08
  5. By: Maria Ferrara; Patrizio Tirelli
    Abstract: This paper shows that a medium-scale DSGE model is able to explain a contemporaneous reduction of output and consumption during a disinflation policy, as it is in the empirical evidence. To this aim, we introduce Rotemberg (1982) adjustment costs and the limited asset market participation assumption.
    Keywords: Disináation, Rotemberg price adjustment, Monetary Policy
    JEL: E31 E5
    Date: 2015–08
  6. By: Falk Mazelis; ; ;
    Abstract: This paper investigates the heterogeneous impact of monetary policy shocks on nancial in- termediaries. I distinguish between banks and shadow banks based on their funding constraints. Because credit creation by banks responds to economy-wide productivity endogenously, bank reaction to shocks corresponds to the balance sheet channel. Shadow banks are constrained by their available funding and their behavior is better explained by the lending channel. In line with empirical observations, shadow bank lending moves in the opposite direction to bank lending following monetary policy shocks, which mitigates aggregate credit responses. The propagation of real and nancial shocks is likewise altered when shadow banks are identied as a distinct sector among nancial intermediaries. Following estimation of the model using Bayesian methods, a historical shock decomposition highlights the roles of banks and shadow banks in the run-up to the 2007 - 08 nancial crisis.
    Keywords: Shadow Banking, Monetary Policy Transmission, Credit Channel, Bayesian Methods, Search Frictions
    JEL: E32 E44 E51 G20
    Date: 2015–08
  7. By: Prasad, Eswar (Cornell University); Zhang, Boyang (Cornell University)
    Abstract: We develop a two-sector, heterogeneous-agent model with incomplete financial markets to study the distributional effects and aggregate welfare implications of alternative monetary policy rules in emerging market economies. Relative to inflation targeting, exchange rate management benefits households in the tradable goods sector but in the long run these households are worse off due to higher consumption volatility. A fixed exchange rate reduces the welfare of these households and aggregate welfare when the economy is hit by positive shocks to nontradable goods productivity or foreign interest rates. Fiscal policy can more efficiently achieve similar short-run distributional objectives as exchange rate management.
    Keywords: monetary policy rules, exchange rate management, interest rate smoothing, distributional effects, emerging markets, financial frictions, inflation targeting
    JEL: E25 E52 E58 F41
    Date: 2015–08
  8. By: Gilles Saint-Paul (New York University Abu Dhabi - Abu Dhabi, PSE - Paris-Jourdan Sciences Economiques - CNRS - Institut national de la recherche agronomique (INRA) - EHESS - École des hautes études en sciences sociales - ENS Paris - École normale supérieure - Paris - École des Ponts ParisTech (ENPC), EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics)
    Abstract: We study active labor market policies (ALMP) in a matching model. ALMPs are modelled as a subsidy to job search. Workers di¤er in their productivity, and search takes place along an extensive margin. An additional job seeker a¤ects the quality of unemployed workers. As a result, the Hosios conditions are no longer valid. To replicate the optimum the worker share in bargaining must exceed the Hosios level, and one must impose a tax on job search activity. The coalition in favor of ALMP is also studied.
    Date: 2014–11
  9. By: Iván Werning
    Abstract: I study aggregate consumption dynamics under incomplete markets, focusing on the relationship between consumption and the path for interest rates. I first provide a general aggregation result under extreme illiquidity (no borrowing and no outside assets), deriving a generalized Euler relation involving the real interest rate, current and future aggregate consumption. This provides a tractable way of incorporating incomplete markets in macroeconomic models, dealing only with aggregates. Although this relation does not necessarily coincide with the standard representative-agent Euler equation, I show that it does for an important benchmark specification. When this is the case, idiosyncratic uncertainty and incomplete markets leave their imprint by affecting the discount factor in this representation, but the sensitivity of consumption to current and future interest rates is unaffected. An immediate corollary is that “forward guidance” (lower future interest rates) is as powerful as in representative agent models. I show that the same representation holds with positive liquidity (borrowing and outside assets) when utility is logarithmic. I show that away from these benchmark cases, consumption is likely to become more sensitive to interest rate, and especially future interest rates. Finally, I apply my approach to a real business cycle economy, providing an exact analytical aggregation result that complements existing numerical results.
    JEL: D52 E0
    Date: 2015–08
  10. By: Carlos Garriga (Federal Reserve Bank of St. Louis); Finn E. Kydland (University of California–Santa Barbara and NBER); Roman Šustek (Queen Mary University of London and Centre for Macroeconomics)
    Abstract: Mortgages are prime examples of long-term nominal loans. As a result, under incomplete asset markets, monetary policy can affect household decisions through the cost of new mortgage borrowing and the value of payments on outstanding debt. These channels are distinct from the transmission through real interest rates. A stylized general equilibrium model in corporating these features is developed. Persistent monetary policy shocks, resembling the level factor in the nominal yield curve, have larger real effects than transitory shocks. The transmission is stronger under adjustable-than fixed-rate mortgages. Higher, persistent, inflation benefits homeowners under FRMs but hurts them under ARMs.
    Keywords: Mortgages, Debt servicing costs, Monetary policy, Residential investment
    JEL: E32 E52 G21 R21
    Date: 2015–08
  11. By: Christopher Huckfeldt (Cornell University); Antonella Trigari (Università Bocconi); Mark Gertler (New York University)
    Abstract: Recent papers interpret micro-level findings of greater cyclicality in the wages of job-changers as evidence for flexible wages of new hires, thus concluding that wage rigidity is not an empirically plausible mechanism for resolving the unemployment volatility puzzle. We analyze data from the Survey of Income and Program Participation (SIPP) to argue that greater cyclicality of wages for job changers reflects cyclicality in the composition of match quality across new hires. After introducing controls for the cyclicality of job-to-job flows, we find no evidence for greater wage flexibility among new hires. In light of our empirical findings, we study an equilibrium model of unemployment with staggered Nash bargaining, heterogeneous match quality, and on-the-job search. Workers in bad matches vary their search intensity according to the probability of finding a better match, generating cyclicality in the contribution of bad-to-good transitions to total job-to-job flows. Using simulated data from our model, we compute measures of new hire wage cyclicality analogous to those found in the literature and show that cyclical match composition in our model generates spurious evidence of new hire wage flexibility of comparable in magnitude to what we estimate from the SIPP. The model is also successful in accounting for the cyclicality of job creation and the dynamics of aggregate unemployment.
    Date: 2015
  12. By: Fedotenkov, Igor
    Abstract: This paper provides an explanation of why population ageing is associated with deflationary processes. For this reason, we create an overlapping-generations model (OLG) with money created by credits (inside money) and intergenerational trade. In other words, we combine a neoclassical OLG model, with post-Keynesian monetary theory. The model links demographic factors, such as fertility rates and longevity, to prices. We show that lower fertility rates lead to a smaller demand for credits, and lower money creation, which causes a decline in prices. Changes in longevity affect prices via real savings and capital market. Furthermore, we address a few links between interest rates and inflation, which arise in the general equilibrium, and are not thoroughly discussed in the literature. Long-run results are derived analytically; short-run dynamics is simulated numerically.
    Keywords: Population ageing, inflation, OLG model, inside money, credits
    JEL: E12 E31 J10
    Date: 2015–07–10
  13. By: Gopinath, Gita (Harvard University); Kalemli-Ozcan, Sebnem (University of Maryland); Karabarbounis, Loukas (Federal Reserve Bank of Minneapolis); Villegas-Sanchez, Carolina (ESADE - Universitat Ramon Llull)
    Abstract: Following the introduction of the euro in 1999, countries in the South experienced large capital inflows and low productivity. We use data for manufacturing firms in Spain to document a significant increase in the dispersion of the return to capital across firms, a stable dispersion of the return to labor across firms, and a significant increase in productivity losses from misallocation over time. We develop a model of heterogeneous firms facing financial frictions and investment adjustment costs. The model generates cross-sectional and time-series patterns in size, productivity, capital returns, investment, and debt consistent with those observed in production and balance sheet data. We illustrate how the decline in the real interest rate, often attributed to the euro convergence process, leads to a decline in sectoral total factor productivity as capital inflows are misallocated toward firms that have higher net worth but are not necessarily more productive. We conclude by showing that similar trends in dispersion and productivity losses are observed in Italy and Portugal but not in Germany, France, and Norway.
    Keywords: Misallocation; Productivity; Dispersion; Capital flows; Europe
    JEL: D24 E22 F41 O16 O47
    Date: 2015–07–31
  14. By: Hippolyte D'Albis (EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics); Eleni Iliopulos (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics)
    Abstract: We study a benchmark model with collateral constraints and heterogeneous discounting. Contrarily to a rich literature on borrowing limits, we allow for rental markets. By incorporating this missing market, we show that impatient agents choose to rent rather than to own the collateral in the neighborhood of the deterministic steady state. Consequently, impatient agents are not indebted and borrowing constraints play no role in local dynamics.
    Date: 2013–12–01
  15. By: Shinichi Nishiyama
    Abstract: This paper incorporates the aging population projected by the U.S. Social Security Administration to a heterogeneous-agent OLG model with idiosyncratic wage shocks and analyzes its effects on individual households, the government budget, and the overall economy. The fiscal gap caused by the demographic change is 2.94% of GDP under the intermediate projection. The effect of the aging population is large by itself and depends significantly on how the government finances the cost of the demographic change. There is a strong trade-off between efficiency and equity, and this paper quantitatively assesses the pros and cons of stylized fiscal reform plans.
    Keywords: dynamic general equilibrium, heterogeneous agents, overlapping generations, aging population, fiscal policy
    JEL: D91 E62 H31
    Date: 2015
  16. By: Meenagh, David (Cardiff Business School); Minford, Patrick (Cardiff Business School); Wickens, Michael (Cardiff Business School); Xu, Yongdeng
    Abstract: Indirect Inference has been found to have much greater power than the Likelihood Ratio in small samples for testing DSGE models. We look at asymptotic and large sample properties of these tests to understand why this might be the case. We find that the power of the LR test is undermined when reestimation of the error parameters is permitted; this offsets the effect of the falseness of structural parameters on the overall forecast error. Even when the two tests are done on a like-for-like basis Indirect Inference has more power because it uses the distribution restricted by the DSGE model being tested.
    Keywords: Indirect Inference; Likelihood Ratio; DSGE model; structural parameters; error processes
    JEL: C12 C32 C52 E1
    Date: 2015–07
  17. By: Meenagh, David; Minford, Patrick; Wickens, Michael R.; Xu, Yongdeng
    Abstract: Indirect Inference has been found to have much greater power than the Likelihood Ratio in small samples for testing DSGE models. We look at asymptotic and large sample properties of these tests to understand why this might be the case. We find that the power of the LR test is undermined when re-estimation of the error parameters is permitted; this offsets the effect of the falseness of structural parameters on the overall forecast error. Even when the two tests are done on a like-for-like basis Indirect Inference has more power because it uses the distribution restricted by the DSGE model being tested.
    Keywords: DSGE model; error processes; indirect inference; likelihood ratio; structural parameters
    JEL: C12 C32 C52 E1
    Date: 2015–08

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