nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2015‒09‒18
forty papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Time-Consistent Fiscal Policy in a Debt Crisis By Morten Ravn; Neele Balke
  2. Search-Based Endogenous Illiquidity and the Macroeconomy By Soren Radde; Wei Cui
  3. Sovereign risk, interbank freezes, and aggregate fluctuations By Engler, Philipp; Grosse Steffen, Christoph
  4. Uncertainty shocks, banking frictions and economic activity By Bonciani, Dario; van Roye, Björn
  5. Capital Requirements, Risk Choice, and Liquidity Provision in a Business Cycle Model By Juliane Begenau
  6. Firm Dynamics and the Granular Hypothesis By Basile Grassi; Vasco Carvalho
  7. Credit Search and Credit Cycles By Dong, Feng; Wang, Pengfei; Wen, Yi
  8. Capital regulation in a macroeconomic model with three layers of default By Derviz, Alexis; Mendicino, Caterina; Moyen, Stéphane; Nikolov, Kalin; Stracca, Livio; Clerk, Laurent; Suarez, Javier; Vardoulakis, Alexandros P.
  9. Saving Europe? By Jing Zhang
  10. Optimal Automatic Stabilizers By Ricardo Reis; Alisdair McKay
  11. Optimal capital requirements over the business and financial cycles By Malherbe, Frederic
  12. Pareto Efficient Taxation with Learning by Doing By Marek Kapicka
  13. Approximating time varying structural models with time invariant structures By Canova, Fabio; Ferroni, Filippo; Matthes, Christian
  14. On the Optimal Provision of Social Insurance: Progressive Taxation versus Education Subsidies in General Equilibrium By Dirk Krueger; Alexander Ludwig
  15. Directed Search with Phantom Vacancies By Susan Vroman
  16. Financial Shocks and Job Flows By Dmitriy Sergeyev; Neil Mehrotra
  17. Growth, Unemployment, and Fiscal Policy: A Political Economy Analysis By Tetsuo Ono
  18. Aggregate implications of innovation policy By Ariel Burstein; Andrew Atkeson
  19. Unemployment (Fears) and Deflationary Spirals By Wouter Den Haan; Pontus Rendahl; Markus Riegler
  20. Innovation and growth with financial, and other, frictions By Chiu, Jonathan; Meh, Cesaire; Wright, Randall
  21. Functional finance and intergenerational distribution in a Keynesian OLG model By Skott, Peter; Soon, Ryoo
  22. Liquidity trap and secular stagnation By Yannick Kalantzis; Kenza Benhima; Philippe Bacchetta
  23. A Small Open Economy with the Balassa-Samuelson Effect By Robert Ambrisko
  24. Optimally Sticky Prices By William (Bill) Zame; Jean-Paul L'Huillier
  25. Trading Down and the Business Cycle By Jaimovich, Nir; Rebelo, Sérgio; Wong, Arlene
  26. Indeterminacy in Sovereign Debt Markets: An Empirical Investigation By Alessandro Dovis; Luigi Bocola
  27. Monetary Shocks and Bank Balance Sheets By Sebastian Di Tella; Pablo Kurlat
  28. Does Calvo Meet Rotemberg at the Zero Lower Bound? By Phuong Ngo; Jianjun Miao
  29. Job Ladders and Earnings of Displaced Workers By krolikowski, Pawell
  30. Learning and the effectiveness of central bank forward guidance By Cole, Stephen
  31. What hides behind the German labor market miracle? A macroeconomic analysis By Moritz Kuhn; Philip Jung
  32. Luxury Consumption, Precautionary Savings and Wealth Inequality By Claudio Campanale
  33. Wholesale Transactions under Economies and Diseconomies of Scope in Search Activities in a Model of Search and Match By Shigeru Makioka
  34. Monetary Policy and Controlling Asset Bubbles By Masaya Sakuragawa
  35. Interest on Reserves, Interbank Lending, and Monetary Policy By Williamson, Stephen D.
  36. Economic Growth and the Politics of Intergenerational Redistribution By Tetsuo Ono
  37. Gender Equality and Economic Growth in India: A Quantitative Framework By Pierre-Richard Agénor; Jan Mares; Piritta Sorsa
  38. Choice of market in the monetary economy By Ryoji Hiraguchi; Keiichiro Kobayashi
  39. Investment, speculation, and financial regulation By Viktor Tsyrennikov
  40. Reconciling Hayek's and Keynes' views of recessions By Franck Portier; Dana Galizia; Paul Beaudry

  1. By: Morten Ravn (University College London); Neele Balke (University College London)
    Abstract: The financial crisis led to severe crises in much of Southern Europe that generated deep economic problems that still have not been resolved. Many of these economies (Greece, Italy, Spain and Portugal) witnessed not only large drops in aggregate activity but also rising levels of debt and falling debt prices which made financing of deficits very costly and triggered concerns about sovereign defaults. A large literature has considered environments in which large negative shocks can generate risk of default because sovereign governments lack commitment to debt. However, much of this literature either assumes that government has commitment to all other fiscal instruments or that these are exogenously determined. Therefore, it is unclear whether adjustments of other instruments - for example cuts in public spending or tax hikes - may not be preferable to default. Moreover, this literature typically does not allow for feedback from the fiscal instruments to the state of the economy beyond those triggered by punishment mechanisms in case of a sovereign default. Thus, these models are not useful for understanding richer questions regarding the adjustment of fiscal policy in crisis times. This paper takes a first step in addressing these issues. We study a small open economy model in which a benevolent government aims at maximizing social welfare but lacks commitment to all its fiscal instruments. The economy consists of a government, households, firms and foreign lenders. Households derive utility from consumption of private goods, leisure and from government provided public goods. They differ in their labor market status because of matching frictions. Some households work and earn labor income. The government imposes a payroll tax on these households. Other households are unemployed but choose search effort. Households cannot purchase unemployment insurance contracts but receive government financed unemployment transfers. Firms post vacancies to hire workers and there is free entry. There is an aggregate productivity shock and wages are determined by a non-cooperative Nash bargaining game between firms and households. The government chooses payroll taxes, unemployment benefits, government spending and may be able to smooth the budget by international borrowing and lending. International lenders are risk neutral and charge an interest rate which takes into account that governments may choose to default. If a government defaults it is excluded from international financial markets for a stochastic number of periods and it may suffer a loss of productivity whilst excluded from international lending. The government in this economy faces several trade-offs. It would like to insure households against unemployment risk and against wage risk which occurs due to productivity shocks. However, more generous unemployment insurance gives households less incentive to search for jobs and therefore produces higher unemployment and a smaller tax base. In order to smooth employed households against wage risk, the government would like to cut payroll taxes when productivity falls but this implies rising debt. The government also attempts to equalize the marginal utility of private and public consumption but cannot do so perfectly because of household heterogeneity. In this economy, falling productivity produces difficult choices since it puts a pressure on the government budget due to rising unemployment and a smaller tax base which produces an incentive for increasing government borrowing. However, rising debt levels may eventually impact on the price of debt because lenders perceive a risk of a sovereign default. For that reason, the government will eventually have to make a hard choice about whether to default on its debt which means it will have to balance its budget (and possibly suffer a drop in productivity), cut unemployment transfers which harms the unemployed, increase payroll taxes which harms the employed and produces higher unemployment, or cut government spending which lowers utility of households. We derive optimal fiscal policies in this environment by studying Markov perfect equilibria. The model is calibrated to emulate the conditions of a typical Southern European economy. We show that the time-consistent policies involve countercyclical payroll taxes, constant unemployment benefits, and mildly procyclical government spending in 'normal' times when the risk of default is negligible. In crisis times, the government is willing to further distort the economy by providing less insurance against unemployment, increasing payroll taxes and cutting public goods provision to limit rising debt. However, once a default becomes inevitable, the government partially lifts such austerity measures since it ceases to be concerned about honouring its outstanding debt.
    Date: 2015
  2. By: Soren Radde (European Central Bank); Wei Cui (University College London)
    Abstract: We endogenize asset liquidity in a dynamic general equilibrium model with search frictions on asset markets. In the model, asset liquidity is tantamount to the ease of issuance and resaleability of private financial claims, which is driven by investors' participation on the search market. Limited funding ability of private claims creates a role for liquid assets, such as government bonds or fiat money, to ease funding constraints. We show that liquidity and asset prices can positively co-move. When the capacity of the asset market to channel funds to entrepreneurs deteriorates, investment drops while the hedging value of liquid assets increases. Our model is thus able to match the liquidity hoarding observed during recessions, together with the dynamics of key macro variables.
    Date: 2015
  3. By: Engler, Philipp; Grosse Steffen, Christoph
    Abstract: This paper studies the bank-sovereign link in a dynamic stochastic general equilibrium set-up with strategic default on public debt. Heterogeneous banks give rise to an interbank market where government bonds are used as collateral. A default penalty arises from a breakdown of interbank intermediation that induces a credit crunch. Government borrowing under limited commitment is costly ex ante as bank funding conditions tighten when the quality of collateral drops. This lowers the penalty from an interbank freeze and feeds back into default risk. The arising amplification mechanism propagates aggregate shocks to the macro-economy. The model is calibrated using Spanish data and is capable of reproducing key business cycle statistics alongside stylized facts during the European sovereign debt crisis. JEL Classification: E43, E44, F34, H63
    Keywords: Bank-sovereign link, Domestic debt, Interbank market, Non-Ricardian effects, Occasionally binding constraint, Secondary markets, Sovereign default
    Date: 2015–08
  4. By: Bonciani, Dario; van Roye, Björn
    Abstract: In this paper we investigate the effects of uncertainty shocks on economic activity in the euro area by using a Dynamic Stochastic General Equilibrium (DSGE) model with heterogeneous agents and a stylized banking sector. We show that frictions in credit supply amplify the effects of uncertainty shocks on economic activity. This amplification channel stems mainly from the stickiness in banking retail interest rates. This stickiness reduces the effectiveness in the transmission mechanism of monetary policy. JEL Classification: E32, E52
    Keywords: Financial frictions, Perturbation Methods, Stochastic Volatility, Third-order approximation, Uncertainty Shocks
    Date: 2015–07
  5. By: Juliane Begenau (Harvard Business School)
    Abstract: This paper presents a quantitative dynamic general equilibrium model in which households' liquidity preference change the standard intuition of how higher bank capital requirements affect the economy. The mechanism is that a reduction in the supply of safe and liquid assets in the form of bank debt increases bank lending through a general equilibrium effect. I embed this mechanism in a two-sector business cycle model in which banks provide liquidity and have excessive risk-taking incentives. I quantify this model using data from the National Income and Product Accounts and banks' regulatory filings. Welfare is maximized at 14% equity as a share of risk-weighted assets. This level of capital requirement trades-off a reduction in the provision of safe and liquid assets against an increase in lending and a reduction in risk-taking by banks.
    Date: 2015
  6. By: Basile Grassi (University of Oxford); Vasco Carvalho (University of Cambridge and CREi)
    Abstract: Building on the standard firm dynamics setup of Hopenhayn (1992), we develop a quantitative theory of aggregate fluctuations arising from idiosyncratic shocks to firm level productivity. This allows us to generalize the theoretical results in Gabaix (2011) to account for persistent micro-level shocks, optimal size decisions as well as endogenous firm entry and exit. We then use our model to provide a quantitative evaluation of Gabaix's "granular hypothesis" and find that it yields aggregate fluctuations of the same order of magnitude as a standard representative-firm real business cycle model. A calibration of our model to the US economy with a large number of firms leads to sizable aggregate fluctuations: the standard deviation of aggregate TFP (respectively output) is 0.8% (respectively 1.7%). We use this calibration to explore firms' comovement over the business cycle. The model predicts that the differential growth between large and small firms is pro-cyclical as it is in the data.
    Date: 2015
  7. By: Dong, Feng (Shanghai Jiao Tong University); Wang, Pengfei (Hong Kong University of Science and Technology); Wen, Yi (Federal Reserve Bank of St. Louis)
    Abstract: The supply and demand of credit are not always well aligned and matched, as is reflected in the countercyclical excess reserve-to-deposit ratio and interest spread between the lending rate and the deposit rate. We develop a search-based theory of credit allocations to explain the cyclical fluctuations in both bank reserves and the interest spread. We show that search frictions in the credit market can not only naturally explain the countercyclical bank reserves and interest spread, but also generate endogenous business cycles driven primarily by the cyclical utilization rate of credit resources, as long conjectured by the Austrian school of the business cycle. In particular, we show that credit search can lead to endogenous local increasing returns to scale and variable capital utilization in a model with constant returns to scale production technology and matching functions, thus providing a micro-foundation for the indeterminacy literature of Benhabib and Farmer (1994) and Wen (1998).
    Keywords: Search Frictions; Credit Utilization; Credit Rationing; Self-fulfilling Prophecy. Business Cycles.
    JEL: E1 E2 E3 E4
    Date: 2015–08–01
  8. By: Derviz, Alexis; Mendicino, Caterina; Moyen, Stéphane; Nikolov, Kalin; Stracca, Livio; Clerk, Laurent; Suarez, Javier; Vardoulakis, Alexandros P.
    Abstract: We develop a dynamic general equilibrium model for the positive and normative analysis of macroprudential policies. Optimizing financial intermediaries allocate their scarce net worth together with funds raised from saving households across two lending activities, mortgage and corporate lending. For all borrowers (households, firms, and banks) external financing takes the form of debt which is subject to default risk. This “3D model” shows the interplay between three interconnected net worth channels that cause financial amplification and the distortions due to deposit insurance. We apply it to the analysis of capital regulation. JEL Classification: E3, E44, G01, G21
    Keywords: Default risk, Financial frictions, Macroprudential policy
    Date: 2015–07
  9. By: Jing Zhang (Federal Reserve Bank of Chicago)
    Abstract: Europes debt crisis casts doubt on the effectiveness of fiscal austerity in highly-integrated economies. Closed-economy models overestimate its effectiveness, because they underestimate tax-base elasticities and ignore cross-country tax externalities. In contrast, we study tax responses to debt shocks in a two-country model with endogenous utilization that captures those externalities and matches the capital-tax-base elasticity. Quantitative results show that unilateral capital tax hikes cannot restore fiscal solvency in Europe, and have large negative (positive) effects at "home" ("abroad"). Restoring solvency via Nash competition reduces capital taxes sharply but increases labor taxes, and even the Cooperative equilibrium lowers (rises) capital (labor) taxes.
    Date: 2015
  10. By: Ricardo Reis (Columbia University); Alisdair McKay (Boston University)
    Abstract: This paper studies the design of fiscal policies that serve as automatic stabilizers in an incomplete markets economy affected by inefficient business cycle fluctuations. We make three contributions. First, we provide a model that combines nominal rigidities, idiosyncratic income shocks and incomplete markets, but which is sufficiently simple that we can analyze it with an AS-AD diagram to show how sticky prices and incomplete markets interact to determine the effect of and desirability of the automatic stabilizers. Second, we characterize social welfare and show that it depends on the variance of an output gap and inflation as well as on a measure of time-varying inequality. The interaction of nominal rigidities and incomplete markets raises the costs of business cycles making room for stabilization policy to achieve large gains. Third, we calibrate the model to match the main facts about inequality in order to solve for the optimal set of automatic stabilizers. We show that stabilization concerns make the income tax more progressive, unemployment benefits and income support policies more generous.
    Date: 2015
  11. By: Malherbe, Frederic
    Abstract: I study economies where banks do not fully internalize the social costs of default, which distorts their lending decisions. In all these economies, a common general equilibrium effect leads to aggregate over-investment. As a result, under laissez-faire, crises are too frequent and too costly from a social point of view. In response, the regulator sets a capital requirement to trade off expected output against financial stability. The capital requirement that ensures investment efficiency depends on the state of the economy. Because of the general equilibrium effect, the more aggregate banking capital the tighter the optimal requirement. A regulation that fails to take this effect into account exacerbates economic fluctuations and allows for excessive build-up of risk in the financial sector during booms. Government guarantees amplify this mechanism and, at the peak of a boom, even a small adverse shock can trigger a banking sector collapse, followed by an excessively severe credit crunch. JEL Classification: E44, G01, G21, G28
    Keywords: Basel regulation, capital requirement, countercyclical buffers, financial cycles, financial regulation, overinvestment
    Date: 2015–07
  12. By: Marek Kapicka (University of California Santa Barbara)
    Abstract: I provide a general framework for analyzing the Pareto efficient income taxation in a Mirrlees economy with human capital formation. I show that human capital formation effectively makes preferences nonseparable over labor supply, and derive a tax formula that holds in any Pareto efficient allocation. I compare it with the optimal tax formula in a Ramsey economy, and show that both formulas differ because the Ramsey planner does not take into account intertemporal changes in the earnings distribution. Both learning-by-doing and learning-or-doing models are special cases of the general framework. I compare their implications for the efficient tax structure and show that in both models the optimal marginal tax rates decrease with age, despite the fact that both models respond differently to any given tax change. In the learning-by-doing model the result is driven by a decreasing contemporaneous labor elasticity, while in the learning-or-doing model the result is driven by the fact that labor supply is initially a substitute for future labor supply because it crowds out schooling.
    Date: 2015
  13. By: Canova, Fabio; Ferroni, Filippo; Matthes, Christian
    Abstract: The paper studies how parameter variation affects the decision rules of a DSGE model and structural inference. We provide diagnostics to detect parameter variations and to ascertain whether they are exogenous or endogenous. Identification and inferential distortions when a constant parameter model is incorrectly assumed are examined. Likelihood and VAR-based estimates of the structural dynamics when parameter variations are neglected are compared. Time variations in the financial frictions of a Gertler and Karadi's (2010) model are studied.
    Keywords: endogenous variations; misspecification; Structural model; time varying coefficients
    JEL: C10 E27 E32
    Date: 2015–09
  14. By: Dirk Krueger; Alexander Ludwig
    Abstract: In this paper we compute the optimal tax and education policy transition in an economy where progressive taxes provide social insurance against idiosyncratic wage risk, but distort the education decision of households. Optimally chosen tertiary education subsidies mitigate these distortions. We highlight the quantitative importance of general equilibrium feedback effects from policies to relative wages of skilled and unskilled workers: subsidizing higher education increases the share of workers with a college degree thereby reducing the college wage premium which has important redistributive benefits. We also argue that a full characterization of the transition path is crucial for policy evaluation. We find that optimal education policies are always characterized by generous tuition subsidies, but the optimal degree of income tax progressivity depends crucially on whether transitional costs of policies are explicitly taken into account and how strongly the college premium responds to policy changes in general equilibrium.
    JEL: E62 H21 H24
    Date: 2015–09
  15. By: Susan Vroman (Georgetown University)
    Abstract: Information persistence about already filled vacancies implies that old vacancies are likely to be obsolete or phantom vacancies. When ads for jobs stipulate the vacancy creation date, job-seekers apply for the different jobs so as to equalize matching odds across vacancy age. This search behavior leads them to over-apply to young vacancies. Finding a job of a given age creates phantom vacancy and a negative informational externality that affects all cohorts of vacancies after this age. Thus the magnitude of the externality decreases with the age of the vacancy filled. We calibrate the model on US labor market data. The magnitude of the externality is small, despite the fact that the contribution of phantom vacancies to overall frictions is large.
    Date: 2015
  16. By: Dmitriy Sergeyev (Bocconi University); Neil Mehrotra (Brown University)
    Abstract: The labor market recovery since the end of the Great Recession has been characterized by a marked decline in labor market turnover. In this paper, we provide evidence that the housing crisis and financial nature of the Great Recession account for this decline in job flows. We exploit MSA-level variation in job flows and housing prices to show that a decline in housing prices diminishes job creation and lagged job destruction. Moreover, we document differences across firm size and age categories, with middle-sized firms (20-99 employees) and new and young firms (firms less than 5 years of age) most sensitive to a decline in house prices. We propose a quantitative model of firm dynamics with collateral constraints, calibrating the model to match the distribution of employment by firm size and age. Financial shocks in our firm dynamics model depresses job creation and job destruction and replicates the empirical pattern of the sensitivity of job flows across firm age and size categories.
    Date: 2015
  17. By: Tetsuo Ono (Graduate School of Economics, Osaka University)
    Abstract: This study presents an overlapping-generations model featuring capital accumu- lation, collective wage-bargaining, and probabilistic voting over fiscal policy. We characterize a Markov-perfect political equilibrium of the voting game within and across generations and show the following results. First, greater bargaining power of unions lowers the growth rate of capital and creates a positive correlation between unemployment and public debt. Second, greater political power of the old lowers the growth rate and shifts government expenditure from the unemployed to the old. Third, when the government finances its spending by issuing public debt, an introduction of a balanced-budget requirement increases the growth rate but may benefit the old at the expense of the unemployed.
    Keywords: Economic Growth; Fiscal Policy; Government Debt; Unemployment; Voting
    JEL: E24 E62 H60
    Date: 2014–08
  18. By: Ariel Burstein (UCLA); Andrew Atkeson (University of California)
    Abstract: We examine the quantitative impact of changes in innovation policies on growth in aggregate productivity and output in a fairly general specification of a growth model in which aggregate productivity growth is driven by investments in innovation by imperfectly competitive firms. Our model nests several commonly used models in the literature. We present simple analytical results isolating the specific features and/or parameters of the model that play the key roles in shaping its quantitative implications for the aggregate impact of policy-induced changes in innovative spending in the short-, medium- and long-term. We find that the implicit assumption made commonly in models in the literature that there is no social depreciation of innovation expenditures plays a key role not previously noted in the literature. Specifically, we find that the elasticity of aggregate productivity and output over the medium term horizon (i.e. 20 years) with respect to policy-induced changes in the innovation intensity of the economy cannot be large if the model is calibrated to match a moderate initial growth rate of aggregate productivity and builds in the assumption of no social depreciation of innovation expenditures. In this case, the medium term dynamics implied by the model are largely disconnected from the parameters of the model that determine the model's long run implications and the socially optimal innovation intensity of the economy.
    Date: 2015
  19. By: Wouter Den Haan (London School of Economics; Centre for Macroeconomics (CFM); Centre for Economic Policy Research (CEPR)); Pontus Rendahl (Univesrity of Cambridge; Centre for Macroeconomics (CFM)); Markus Riegler (Univesrity of Bonn; Centre for Macroeconomics (CFM))
    Abstract: The interaction of incomplete markets and sticky nominal wages is shown to magnify business cycles even though these two features - in isolation - dampen them. During recessions, fears of unemployment stir up precautionary sentiments which induces agents to save more. The additional savings may be used as investments which induces agents to save more. The additional savings may be used as investments in both a productive asset (equity) and an unproductive asset (money). But even a small rise in money demand has important consequences. The desire to hold money puts deflationary pressure on the economy, which, provided that nominal wages are sticky, increases wage costs and reduces firm profits. Lower profits repress the desire to save in equity, which increases (the fear of) unemployment, and so on. This is a powerful mechanism which casues the model to behave differently from both its complete markets version, and a version with incomplete markets but without aggregate uncertainty. In contrast to previous results in the literature, agents uniformly prefer non-trivial levels of unemployment insurance.
    Keywords: Keynesian unemployment, business cycles, search frictions, magnification, propogation, heterogenous agents
    JEL: E12 E24 E32 E41 J64 J65
    Date: 2015–08
  20. By: Chiu, Jonathan; Meh, Cesaire; Wright, Randall
    Abstract: The generation and implementation of ideas are crucial for economic performance. We study this in a model of endogenous growth, where productivity increases with innovation, and where the exchange of ideas (technology transfer) allows those with comparative advantage implement them. Search, bargaining, and commitment frictions impede the idea market, however, reducing efficiency and growth. We characterize optimal policies involving subsidies to innovative and entrepreneurial activity, given both knowledge and search externalities. The role of liquidity is discussed. We show intermediation helps by financing more transactions with fewer assets, and, more subtly, by ameliorating holdup problems. We also discuss some evidence.
    Keywords: Innovation, Growth, Liquidity, Intermediation, Search, Bargaining,
    Date: 2015
  21. By: Skott, Peter (Department of Economics, University of Massachusetts, Amherst, MA 01003,USA, and Aalborg University); Soon, Ryoo (Department of Finance and Economics, Adelphi University)
    Abstract: This paper examines the role of fiscal policy in the long run. We show that (i) dynamic inefficiency in a standard OLG model generates aggregate demand problems in a Keynesian setting, (ii) fiscal policy can be used to achieve full-employment growth, (iii) the required debt ratio is inversely related to both the growth rate and government consumption, and (iv) a simple and distributionally neutral tax scheme can maintain full employment in the face of variations in ‘household confidence’.
    Keywords: Public debt, Keynesian OLG model, secular stagnation, structural liquidity trap, dynamic efficiency, confidence
    JEL: E62 E22
    Date: 2015
  22. By: Yannick Kalantzis (Banque de France); Kenza Benhima (University of Lausanne (HEC)); Philippe Bacchetta (University of Lausanne)
    Abstract: In this paper we analyze the link between the ZLB and slow growth in a model with heterogeneous agents and explicit money demand. While the model is neoclassical with small shocks, a large deleveraging shock in the spirit of Eggertsson and Krugman (2012) has permanent effects even with flexible prices. It affects supply rather than demand and implies a long-term decrease in potential output and an increase in cash holding. The basic reason is that in a liquidity trap, saving is allocated to cash rather than physical capital. With short-term price stickiness, monetary policy in the form of an expansion in money supply is effective in reducing unemployment in the short-run, but not in affecting the long term output level. An increase in debt may help exiting the ZLB, but it may lower the capital stock because of higher interest rates.
    Date: 2015
  23. By: Robert Ambrisko
    Abstract: The Balassa-Samuelson (B-S) effect implies that highly productive countries have higher inflation and appreciating real exchange rates because of larger productivity growth differentials between tradable and nontradable sectors relative to advanced economies. The B-S effect might pose a threat to converging European countries, which would like to adopt the Euro because of the limits imposed on inflation and nominal exchange rate movements by the Maastricht criteria. The main goal of this paper is to judge whether the B-S effect is a relevant issue for the Czech Republic to comply with selected Maastricht criteria before adopting the Euro. For this purpose, a two-sector DSGE model of a small open economy is built and estimated using Bayesian techniques. The simulations from the model suggest that the B-S effect is not an issue for the Czech Republic when meeting the inflation and nominal exchange rate criteria. The costs of early adoption of the Euro are not large in terms of additional inflation pressures, which materialize mainly after the adoption of the single currency. Also, nominal exchange rate appreciation, driven by the B-S effect, does not breach the limit imposed by the ERM II mechanism.
    Keywords: Balassa-Samuelson effect; DSGE; European Monetary Union; exchange rate regimes; Maastricht convergence criteria;
    JEL: E31 E52 F41
    Date: 2015–08
  24. By: William (Bill) Zame (University of California, Los Angeles); Jean-Paul L'Huillier (Einaudi Institute for Economics and Finance)
    Abstract: We propose a microfoundation for sticky prices. We consider a an environment in which a monopolistic firm has better information than its consumers about the nominal aggregate state. We show that, when many consumers are uninformed (and for some ranges of parameters), it is optimal for the firm to offer contracts/prices that do not depend on the state of the world; i.e. optimal contracts/prices are sticky. We establish this result first in a general mechanism design framework that allows for non-linear pricing and screening, and then show implementation under both contract-setting and price-setting. A virtue of our microfoundation is that it is compatible with a dynamic general equilibrium model with money. We analyze whether money is neutral in this framework, and discuss the implications of this microfounded friction for welfare.
    Date: 2015
  25. By: Jaimovich, Nir; Rebelo, Sérgio; Wong, Arlene
    Abstract: We document two facts. First, during recessions consumers trade down in the quality of the goods and services they consume. Second, the production of low-quality goods is less labor intensive than that of high-quality goods. So, when households trade down, labor demand falls, increasing the severity of recessions. We find that the trading-down phenomenon accounts for a substantial fraction of the fall in U.S. employment in the recent recession. We study two business cycle models that embed quality choice and find that the presence of quality choice magnifies the response of these economies to real and monetary shocks.
    Keywords: business cycle; quality choice; recessions
    JEL: E2 E3 E4
    Date: 2015–09
  26. By: Alessandro Dovis (Pennsylvania State University); Luigi Bocola (Northwestern University and FRB of Minneapolis)
    Abstract: How important was non-fundamental risk in driving interest rate spreads during the euro-area sovereign debt crisis? To answer this question, we consider a quantitative model of sovereign borrowing with three key ingredients: multiple debt maturities, risk averse lenders and coordination failures a la Cole and Kehoe (2000). In this environment, lenders' expectations of a default can be self-fulfilling, and market sentiments contribute to variation in interest rate spreads along with economic fundamentals. We show that the joint distribution of interest rate spreads and debt duration provides information to distinguish between these two sources of default risk. We make use of this result by calibrating the model to match the empirical distribution of Italian sovereign spreads and debt duration. The process for the lenders' stochastic discount factor, a key input in our analysis, is disciplined using moments from the yield curve on safe assets and the euro-area stock price-consumption ratio. Our preliminary results indicate that the rise in Italian interest rate spreads over the 2011-2012 period was mostly the result of bad economic fundamentals and high risk premia, with a limited role played by non-fundamental uncertainty. We show how this information can be used to understand the implications of the OMT program announced by the ECB.
    Date: 2015
  27. By: Sebastian Di Tella (Stanford GSB); Pablo Kurlat (Stanford University)
    Abstract: We propose a model to explain why banks' balances sheets are exposed to interest rate risk despite the existence of markets where that risk can be hedged. A rise in nominal interest rates raises the opportunity cost of holding currency; since bank liabilities are close substitutes of currency, demand for bank liabilities rises and banks earn higher spreads. If risk aversion is higher than 1, the optimal dynamic hedging strategy is to sustain capital losses when nominal interest rates rise and, conversely, capital gains when they fall. A traditional bank balance sheet with long duration nominal assets achieves that.
    Date: 2015
  28. By: Phuong Ngo (Cleveland State University); Jianjun Miao (Boston University)
    Abstract: This paper compares the Calvo model with the Rotemberg model in a fully nonlinear dynamic new Keynesian framework with an occasionally binding zero lower bound (ZLB) on nominal interest rates. Although the two models are equivalent to a first-order approximation, they generate very different results regarding the policy functions and the government spending multiplier based on nonlinear solutions. The multiplier in the Calvo model is less than one for low persistence of the government spending shock and rises above one as the persistence increases, but eventually decreases with the persistence and falls below one for sufficiently high persistence. In addition, the multiplier increases with the duration of the ZLB. By contrast, the multiplier in the Rotemberg model is less than one and decreases with the persistence. Surprisingly, it also decreases with the duration of the ZLB.
    Date: 2015
  29. By: krolikowski, Pawell (Federal Reserve Bank of Cleveland)
    Abstract: Workers who suffer job displacement experience surprisingly large and persistent earnings losses. This paper proposes an explanation for this robust empirical puzzle in a model of search over match-quality with a significant job ladder. In addition to capturing the depth and persistence of displaced-worker-earnings losses, the model is able to match a) separation rates by tenure; b) the empirical decomposition of earnings losses into reduced wages and employment; c) observed wage dispersion; d) the pattern of employer-to-employer transitions after layoff, and e) the degree of serial correlation in separations.
    Keywords: Displacement; earnings; search; match-quality
    JEL: D83 E24 J63 J64
    Date: 2015–09–08
  30. By: Cole, Stephen
    Abstract: The unconventional monetary policy of forward guidance operates through the management of expectations about future paths of interest rates. This paper examines the link between expectations formation and the effectiveness of forward guidance. A standard New Keynesian model is extended to include forward guidance shocks in the monetary policy rule. Agents form expectations about future macroeconomic variables via either the standard rational expectations hypothesis or a more plausible theory of expectations formation called adaptive learning. The results show the efficacy of forward guidance depends on the manner in which agents form their expectations. In response to forward guidance, the paths of the output gap and inflation under adaptive learning overshoot and undershoot those implied by rational expectations. The adaptive learning impulse responses of the endogenous variables to a forward guidance shock exhibit more persistence before and after the forward guidance shock has been realized upon the economy. During an economic crisis (e.g. a recession), the assumption of rational expectations overstates the effects of forward guidance relative to adaptive learning. Specifically, the output gap is higher under rational expectations than adaptive learning. Thus, if monetary policy is based on a model with rational expectations, which is the standard assumption in the macroeconomic literature, the results of forward guidance could be potentially misleading.
    Keywords: Forward Guidance; Monetary Policy; Adaptive Learning; Expectations
    JEL: D84 E30 E50 E52 E58 E60
    Date: 2015–09–07
  31. By: Moritz Kuhn (University of Bonn); Philip Jung (Bonn University)
    Abstract: The Hartz reforms in the early 2000s have reshaped the German labor market and have led to what many observers call the "German labor market miracle". This paper closes a gap in the evaluation of the reforms by providing a macroeconomic analysis of the effects of the reform on worker flows. We use SIAB micro data to construct worker flow series between employment and unemployment for the period from 1980 to 2010. To disentangle cyclical from long-run effects, we construct a new data series using unemployment benefit claims to extend worker flow series until 2014. Using this new data, we show that 40 % of the decrease in unemployment is accounted for by cyclical movements in the separation rate. The remaining 60 % are accounted for by the reversed secular decline in Germany's job finding rate. We complete our analysis by a structural analysis based on a search and matching model of the German labor market. We estimate the effects of each of the four reform steps (Hartz I - IV) to provide an answer to the question which part of the reform has been most important in generating Germany's labor market miracle.
    Date: 2015
  32. By: Claudio Campanale
    Abstract: Most macroeconomic models are based on the assumption of a single homogeneous consumption good. In the present paper we consider a model with two goods: A basic good and a luxury good. We then apply this assumption to a standard general equi- librium heterogeneous agent model. We ¯nd a substantial reduction in precautionary savings compared to a standard model. The e®ect on wealth inequality turns out to be ambiguous and to depend on the size of the assumed earnings risk.
    Keywords: precautionary savings, wealth inequality, luxury consumption, non-homothetic utility
    JEL: E21
    Date: 2015
  33. By: Shigeru Makioka (Faculty of Economics, Keio University)
    Abstract: In a basic model of search and match, thanks to the assumption that producer-sellers and consumer-buyers pay constant search costs per one unit of a single type of goods, it suffices to consider the retail transactions between producer-sellers and consumer-buyers. We extend this model to allow for the possibilities of economies and diseconomies of scopes in search activities over two types goods. We show that producer-sellers make wholesale transactions with one another when the benefit of economies of scope is strong enough. But when the benefit of economies of scope in search activities for buyers compensates the loss of diseconomies of scope in search activities for sellers, there are multiple equilibria: Matched pairs of producer-sellers always make wholesale transactions in one equilibrium. But they never make those in another, so that there only are retail transactions.
    Keywords: search and match, economies of scope, wholesale transaction
    JEL: D83
    Date: 2015–03
  34. By: Masaya Sakuragawa (Faculty of Economics, Keio University)
    Abstract: A great concern is whether there is any means of monetary policy that works for the "leaning against the wind" policy in the bubbly economy. This paper explores the scope for monetary policy that can control bubbles within the framework of the stochastic version of overlapping-generations model with rational bubbles. The policy that raises the cost of external finance, could be identified as monetary tightening, represses the boom, but appreciate bubbles. In contrast, an open market operation using public bonds is conductive as the "leaning against the wild" policy. Selling public bonds in the open market by the central bank raises the interest rate, represses the boom, and depreciates bubbles. In conducting monetary tightening, the central bank faces the tradeoff between the loss from killing the boom and the gain from lessening the loss of the bursting of bubbles.
    Keywords: rational bubbles, monetary policy, open market operation
    JEL: E52
    Date: 2015–02
  35. By: Williamson, Stephen D. (Federal Reserve Bank of St. Louis)
    Abstract: A two-sector general equilibrium banking model is constructed to study the functioning of a floor system of central bank intervention. Only retail banks can hold reserves, and these banks are also subject to a capital requirement, which creates “balance sheet costs” of holding reserves. An increase in the interest rate on reserves has very different qualitative effects from a reduction in the central bank’s balance sheet. Increases in the central bank’s balance sheet can have redistributive effects, and can reduce welfare. A reverse repo facility at the central bank puts a floor un- der the interbank interest rate, and is always welfare improving. However, an increase in reverse repos outstanding can increase the margin between the interbank interest rate and the interest rate on government debt.
    JEL: E4 E5
    Date: 2015–09–13
  36. By: Tetsuo Ono (Graduate School of Economics, Osaka University)
    Abstract: This study presents an overlapping-generation model featuring probabilistic vot- ing over two policy issues: pensions and public goods. The results show that as the population ages, the pension-to-GDP ratio and the growth rate of capital increase, but the public goods-to-GDP ratio decreases. Moreover, per retiree pension-to- GDP shows a hump-shaped pattern in response to population aging, but only a rising phase is valid under empirically plausible parameter values.
    Keywords: Economic Growth; Population Aging; Probabilistic Voting; Public Pension; Public Goods Provision
    JEL: D70 E24 H55
    Date: 2014–04
  37. By: Pierre-Richard Agénor; Jan Mares; Piritta Sorsa
    Abstract: This paper studies how public policies, including pro-women interventions, can raise female labour force participation and promote economic growth in India. The first part provides a brief review of gender issues in the country. The second part presents a gender-based OLG model, based on Agénor (2015) and Agénor and Canuto (2015), that accounts for women’s time allocation between market work, child rearing, human capital accumulation, and home production. Bargaining between spouses depends on relative human capital stocks. The model is calibrated and various experiments are conducted, including investment in infrastructure, conditional cash transfers, and a reduction in gender bias in the market place. The analysis shows raising female labour force participation with a package of pro-growth and pro-women policies could boost the growth rate by about 2 percentage points over time.
    Keywords: gender equality, female labour force participation, gender, India
    JEL: I15 I25 J16 O41
    Date: 2015–09–07
  38. By: Ryoji Hiraguchi; Keiichiro Kobayashi
    Abstract: We investigate a monetary model `a la Lagos and Wright (2005), in which there are two kinds of decentralized markets, and each agent stochastically chooses which one to participate in by expending effort. In one market, the pricing mechanism is competitive, whereas in the other market, the terms of trade are determined by Nash bargaining. It is shown that the optimal monetary policy may deviate from the Friedman rule. As the nominal interest rate deviates from zero, buyers expend more effort because a higher interest rate increases the gain for buyers from entering the competitive market, while the marginal increase in social welfare by entering the competitive market is also positive.
    Date: 2015–08
  39. By: Viktor Tsyrennikov (IMF)
    Abstract: We study a production economy in which agents have heterogeneous beliefs. When wealth is distributed evenly belief diversity depresses investment because the negative impact of pessimists outweighs the positive impact of optimists. Wealth volatility, driven by speculation, depresses investment further. Through a series of numerical simulations we show that imposing 'leverage-like' financial constraints on agents limits wealth movements, boosts investment, and significantly improves welfare.
    Date: 2015
  40. By: Franck Portier (Toulouse School of Economics); Dana Galizia (University of British Columbia); Paul Beaudry (University of British Columbia)
    Abstract: Recessions often happen after periods of rapid accumulation of houses, consumer durables and business capital. This observation has led some economists, most notably Friedrich Hayek, to conclude that recessions mainly reflect periods of needed liquidation resulting from past over-investment. According to the main proponents of this view, government spending should not be used to mitigate such a liquidation process, as doing so would simply result in a needed adjustment being postponed. In contrast, ever since the work of Keynes, many economists have viewed recessions as periods of deficient demand that should be countered by activist fiscal policy. In this paper we reexamine the liquidation perspective of recessions in a setup where prices are flexible but where not all trades are coordinated by centralized markets. We show why and how liquidations can produce periods where the economy functions particularly inefficiently, with many socially desirable trades between individuals remaining unexploited when the economy inherits too many capital goods. In this sense, our model illustrates how liquidations can cause recessions characterized by deficient aggregate demand and accordingly suggests that Keynes' and Hayek's views of recessions may be much more closely linked than previously recognized. In our framework, interventions aimed at stimulating aggregate demand face the trade-off emphasized by Hayek whereby current stimulus mainly postpones the adjustment process and therefore prolongs the recessions. However, when examining this trade-off, we find that some stimulative policies may nevertheless remain desirable even if they postpone a recovery.
    Date: 2015

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