nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2015‒11‒07
twenty-one papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. The Return of Fiscal Activism and Distinguishing the Effects of Fiscal Policy Tools By İbrahim Ünalmış
  2. Intertemporal equilibrium with heterogeneous agents, endogenous dividends, and borrowing constraints By Stefano Bosi; Cuong Le Van; Ngoc-Sang Pham
  3. Optimal Unemployment Insurance and Cyclical Fluctuations By Williams, Noah; Li, Rui
  4. Generically distributed investments on flexible projects and endogenous growth. By Mauro Bambi; Cristina Di Girolami; Salvatore Federico; Fausto Gozzi
  5. A Racial Inequality Trap By Badel, Alejandro
  6. Explaining Cross-Cohort Differences in Life Cycle Earnings By Kong, Yu-Chien; Ravikumar, B.; Vandenbroucke, Guillaume
  7. Learning and the Market for Housing By Eyno Rots
  8. Optimal Fiscal Policy with Labor Selection By Sanjay K. Chugh; Wolfgang Lechthalerz; Christian Merkl
  9. The macroeconomic effects of the Euro Area's fiscal consolidation By Rannenberg, Ansgar; Schoder, Christian; Strasky, Jan
  10. Income Inequality and Asset Prices under Redistributive Taxation By Lubos Pastor; Pietro Veronesi
  11. Diversity and Economic Growth in a Model with Progressive Taxation By Wang, Wei; Suen, Richard M. H.
  12. Mortgages and Monetary Policy By Garriga, Carlos; Kydland, Finn E.; Sustek, Roman
  13. The Welfare Gains from Macro-Insurance Against Natural Disasters By Borensztein, Eduardo; Cavallo, Eduardo; Jeanne, Olivier
  14. Optimal monetary policy in a currency union with labour market heterogeneity By Nikolas Kontogiannis
  15. Monetary Regime Choice and Optimal Credit Rationing at the Official Rate: The Case of Russia By Andrey G. Shulgin
  16. Credit constraints and growth in a global economy By Nicolas Coeurdacier; Stéphane Guibaud; Keyu Jin
  17. Are Low Interest Rates Deflationary? A Paradox of Perfect-Foresight Analysis By Mariana García-Schmidt; Michael Woodford
  18. The e¤ects of global bank competition and presence on local business cycles: The Goldilocks principle does not apply to global banking By Uluc Aysun
  19. Do debt and growth dance together? A DSGE model of a small open economy with sovereign debt By Zixi Liu
  20. When Ricardo Meets Chamberlin: A Simple Dynamic Model Of Monopolistic Competition By Vera Ivanova; Philip Ushchev
  21. Dynamics in an olg model with non-separable preferences By Maria Alessandra Antonelli; Valeria De Bonis

  1. By: İbrahim Ünalmış (Central Bank of Turkey)
    Abstract: The recent crisis has led to massive fiscal stimulus packages around the world to boost the economic growth. These stimulus packages include government consumption and investment spending and transfers to households. However, effects of these different fiscal policy tools on macroeconomic variables can be considerably different. In this paper, we contribute to the literature by comparing the effects of temporary increases in government consumption good spending, government investment spending and government transfers to households in a new Keynesian dynamic stochastic general equilibrium (DSGE) framework. Different from the conventional new-Keynesian literature, our model features private and public capital stock which enables us to examine the effects of productive government investment spending increases. We calibrate the model for the US economy and show that the magnitude and persistency of the responses of macroeconomic variables differ significantly across different fiscal policy choices. We also show that governments willingness for building up high debt stocks significantly affects the outcomes of fiscal stimulus efforts.
    Keywords: na
    Date: 2015
  2. By: Stefano Bosi (EPEE, University of Evry); Cuong Le Van (CNRS, Paris School of Economics, IPAG, VCREME); Ngoc-Sang Pham (EPEE, University of Evry)
    Abstract: We build dynamic general equilibrium models with heterogeneous produc- ers and financial market imperfections. First, we prove the existence of equi- librium. Second, we investigate the role of financial market imperfection in growth and land prices. Third, we introduce land dividends, then define and study land bubbles as well as individual land bubbles.
    Keywords: Infinite horizon, general equilibrium, financial market imperfection, land bubbles
    JEL: C62 D53 D9 E44 G10
    Date: 2015
  3. By: Williams, Noah (University of Wisconsin–Madison); Li, Rui (University of Massachusetts–Boston)
    Abstract: The authors study the design of optimal unemployment insurance in an environment with moral hazard and cyclical fluctuations. The optimal unemployment insurance contract balances the insurance motive to provide consumption for the unemployed with the provision of incentives to search for a job. This balance is affected by aggregate conditions, as recessions are characterized by reductions in job finding rates. We show how benefits should vary with aggregate conditions in an optimal contract. In a special case of the model, the optimal contract can be solved in closed form. We show how this contract can be implemented in a rather simple way by allowing unemployed workers to borrow and save in a bond (whose return depends on the state of the economy), providing flow payments that are constant over an unemployment spell but vary with the aggregate state, and giving additional lump-sum payments (or charges) upon finding a job or when the aggregate state switches. We then consider a calibrated version of the model and study the quantitative impact of changing from the current unemployment system to the optimal one. In a recession, the optimal system reduces unemployment rates by roughly 2.5 percentage points and shortens the duration of unemployment by about 50 percent.
    Keywords: optimal contract; unemployment benefits; lump-sum payments; welfare; unemployment durations
    JEL: E32
    Date: 2015–08–01
  4. By: Mauro Bambi (University of York, Department of Economics and Related Studies, York, UK); Cristina Di Girolami (Università di Pescara, Dipartimento di Economia Aziendale, Pescara, Italy; Département de Mathèmatiques, Avenue Olivier Messiaen 72085 Le Mans Cedex 9, France); Salvatore Federico (Dipartimento di Scienze per l'Economia e l'Impresa, Universita' degli Studi di Firenze, Italy); Fausto Gozzi (Dipartimento di Scienze Economiche ed Aziendali, Università LUISS - Guido Carli, Rome, Italy)
    Abstract: In this paper we study an endogenous growth model where investments are (generically) distributed over multi-period flexible projects leading to new capital once completed. Recently developed techniques in dynamic programming are adapted and used to unveil the global dynamics of this model. Based on this analytical ground, several numerical exercises are performed to show the quantitative relevance of the analytical findings with an emphasis on the relation between project features and economic growth and speed of convergence toward the balanced growth path.
    Keywords: Endogenous growth, investment projects, distributed delays, optimal control, dynamic programming, infinite dimensional problems.
    JEL: E22 E32 O40
    Date: 2015–10
  5. By: Badel, Alejandro (Federal Reserve Bank of St. Louis)
    Abstract: Why has the U.S. black/white earnings gap remained around 40 percent for nearly 40 years? This paper''s answer consists of a model of skill accumulation and neighborhood formation featuring a trap: Initial racial inequality and racial preferences induce racial segregation and asymmetric skill accumulation choices that perpetuate racial inequality. Calibrated to match the U.S. distribution of race, house prices and earnings across neighborhoods, the model produces one-half of the observed racial earnings gap. Moving the economy from the trap to a racially integrated steady state implies a 15.6 percent welfare gain for black households and a 2.7 percent loss for white households.
    Keywords: Racial Inequality; Neighborhood Externalities; Human Capital; Segregation; Incomplete Markets; Earnings Inequality
    JEL: E24 J15 J24 O18
    Date: 2015–09–11
  6. By: Kong, Yu-Chien (La Trobe University, Australia); Ravikumar, B. (Federal Reserve Bank of St. Louis); Vandenbroucke, Guillaume (Federal Reserve Bank of St. Louis)
    Abstract: Earnings growth has been systematically decreasing from one cohort to the next, starting with the cohort that was 25-year-old in 1940. This cohort's labor earnings grew by a factor of 4 between the ages of 25 and 55. For the 1980 cohort the same calculation yields a factor of only 2.2. Why are the earnings profiles flatter for the recent cohorts? We build and calibrate a parsimonious model of schooling and human capital accumulation on the job. Our model accounts for more than 70 percent of the flattening in the earnings profiles between the 1940 and the 1980 cohorts. The flattening in our model is the result of a single exogenous factor: increasing aggregate productivity. Higher productivity faced by the recent cohorts implies a higher marginal return to human capital which in turn increases the college enrollment and affects the educational composition of workers.
    Date: 2015–10–01
  7. By: Eyno Rots (Magyar Nemzeti Bank (the Central Bank of Hungary))
    Abstract: House prices have inertia, which may be because housing-market participants need time to recognize long booms and recessions. Within a dynamic stochastic general-equilibrium model with markets for housing and defaultable mortgages, I consider the case of imperfect knowledge and learning about the persistence of exogenous shocks. I evaluate the performance of the model against the last 40 years of key U.S. macroeconomic data. Bayesian comparison strongly favors the model with learning over the baseline case with perfect knowledge, although additional assumptions about the learning process may be necessary for an adequate account of house-price dynamics.
    Keywords: housing market, DSGE, signal extraction, Bayesian estimation.
    JEL: E32 E37 R31
    Date: 2015
  8. By: Sanjay K. Chugh (Boston College); Wolfgang Lechthalerz (Kiel Institute for the World Economy); Christian Merkl (Friedrich-Alexander-University Erlangen-Nuremberg)
    Abstract: This paper characterizes long-run and short-run optimal fiscal policy in the labor selection framework. Quantitatively, the time-series volatility of the labor income tax rate is orders of magnitude larger than the "tax-smoothing" results based on Walrasian labor markets, but is a few times smaller than the results based on search and matching labor markets. To understand these results in terms of model primitives, we develop a welfare-relevant analytic concept of externalities for the selection model, which we label "tightness." This concept of tightness is the source of the decentralized economy's inefficient cross-sectional wage premia between the average newly-hired worker and the marginal newly-hired worker. Compared to the traditional concept of labor-market tightness in the search and matching literature, this new concept of tightness plays a highly similar role, and, like in the matching model, is crucial for understanding efficiency and optimal policy.
    Keywords: labor market frictions, hiring costs, efficiency, optimal taxation, labor wedge, zero intertemporal distortions
    JEL: E24 E32 E50 E62 E63 J20
    Date: 2015–10–25
  9. By: Rannenberg, Ansgar (Central Bank of Ireland); Schoder, Christian (Vienna University of Economics and Business); Strasky, Jan (Organisation for Economic Co-operation and Development)
    Abstract: This economic letter summarizes research by Rannenberg et al. (2015), who simulate the Euro Area's fiscal consolidation between 2011 and 2013 by employing two DSGE models used by the ECB and the European Commission. The cumulative multiplier over the 2011-2013 period amounts to 0.7 and 1.0 in the baseline, but increases to 1.3 with a reasonably calibrated nancial accelerator and a crisis-related increase of the share of credit constrained households. In the latter scenario, fiscal consolidation would be largely responsible for the further decline in GDP relative to its pre-crisis trend during 2011-2013. Postponing the fiscal consolidation to a period of unconstrained monetary policy (until after the economic recovery) would have avoided most of these losses.
    Date: 2015–10
  10. By: Lubos Pastor; Pietro Veronesi
    Abstract: We develop a simple general equilibrium model with heterogeneous agents, incomplete financial markets, and redistributive taxation. Agents differ in both skill and risk aversion. In equilibrium, agents become entrepreneurs if their skill is sufficiently high or risk aversion sufficiently low. Under heavier taxation, entrepreneurs are more skilled and less risk-averse, on average. Through these selection effects, the tax rate is positively related to aggregate productivity and negatively related to the expected stock market return. Both income inequality and the level of stock prices initially increase but eventually decrease with the tax rate. Investment risk, stock market participation, and skill heterogeneity all contribute to inequality. Cross-country empirical evidence largely supports the model's predictions.
    JEL: E24 G1 H2 J24 J31 J38
    Date: 2015–10
  11. By: Wang, Wei; Suen, Richard M. H.
    Abstract: Is a more heterogeneous population conducive or detrimental to capital accumulation and economic growth? This paper addresses this question using a dynamic general equilibrium model with ex ante heterogeneous consumers and progressive taxation. We show that the answer depends crucially on the shape of the marginal tax function. If this function is concave, then a more heterogeneous population will have a lower average marginal tax rate and a higher level of capital accumulation. The opposite is true when the marginal tax function is convex. These results are robust in a variety of models with either exogenous or endogenous economic growth.
    Keywords: Consumer Heterogeneity, Progressive Taxation, Economic Growth
    JEL: D31 E62
    Date: 2015–10–30
  12. By: Garriga, Carlos (Federal Reserve Bank of St. Louis); Kydland, Finn E. (University of California–Santa Barbara and NBER); Sustek, Roman (University of London and Centre for Macroeconomics)
    Abstract: Mortgages are long-term nominal loans. Under incomplete asset markets, monetary policy is shown to affect housing investment and the economy through the cost of new mortgage borrowing and the value of payments on outstanding debt. These channels, distinct from traditional transmission of monetary policy, are evaluated within a general equilibrium model. Persistent monetary policy shocks, resembling the level factor in the nominal yield curve, have larger effects than transitory shocks, manifesting themselves as long-short spread. The transmission is stronger under adjustable- than fixed-rate mortgages. Higher, persistent, inflation benefits homeowners under FRMs, but hurts them under ARMs.
    Keywords: Mortgage finance; monetary policy; general equilibrium; housing investment; redistribution
    JEL: E32 E52 G21 R21
    Date: 2015–10–25
  13. By: Borensztein, Eduardo; Cavallo, Eduardo; Jeanne, Olivier
    Abstract: This paper uses a dynamic optimization model to estimate the welfare gains that a small open economy can derive from insuring against natural disasters with catastrophe (CAT) bonds. We calibrate the model by reference to the risk of earthquakes, floods and storms in developing countries. We find that the countries most vulnerable to these risks would find it optimal to use CAT bonds for insurance only if the cost of issuing these bonds were significantly smaller than it is in the data. The welfare gains from CAT bonds range from small to substantial depending on how insurance affects the country's external borrowing constraint. The option of using CAT bonds may bring a welfare gain of several percentage points of annual consumption by improving external debt sustainability. These large gains disappear if the country can opportunistically default on its external debt.
    Keywords: CAT bonds; insurance; natural disaster
    JEL: F3 G22
    Date: 2015–11
  14. By: Nikolas Kontogiannis (University of Leicester)
    Abstract: I construct a New Keynesian, two-country model with labour market frictions in the search and matching process and real wage rigidity. Following a linear-quadratic approach, I analyse quantitatively the welfare-based optimal monetary policy in a currency union. I allow for labour market heterogeneity among the member states captured by an index based on the real wage rigidity differential. I show that when the optimal monetary policy is conducted, in the presence of productivity shocks, thewelfare loss in the currency union increasesmonotonically with the value of the labour market heterogeneity index. That is based on the key role of the terms of trade which intensify the effects of the shocks. I also draw the implications of labour market heterogeneity for the optimal regime choice by the central bank.
    Keywords: Currency union; Optimal monetary policy; Labour market heterogeneity.
    JEL: E24 E31 E52 F41
    Date: 2015
  15. By: Andrey G. Shulgin (National Research University Higher School of Economics)
    Abstract: Stabilizing monetary policy in a small open economy is constrained by the open economy trilemma. In a crisis this constraint may not allow the Central Bank to cut interest rates because this may cause significant capital flight and the ensuing problems. In this paper we investigate whether the Central Bank’s credit rationing at the official rate (CROR) may soften the open economy trilemma constraint and improve the results of monetary policy for different monetary regimes. We construct a DSGE model appropriate for analysing the forward-looking behaviour of households facing a non-zero probability of credit rationing at the official rate. A simulation of estimated on a Russian data model and welfare optimization exercises allow us to contribute to the question of optimal monetary regime choice and to analyse the role of credit rationing for different monetary regimes. We have found significant credit rationing in the quarterly Russian data of 2001–2014. The share of liquidity constrained (non-Ricardian) households and the probability of CROR are estimated as 22% and 66% respectively. Welfare maximization exercises reveal a trade off between low-inflation and high-welfare solutions and favour of a floating exchange rate regime. Researching CROR gives mixed results. On the one hand we found the optimal value of the probability of CROR in both exchange rate-based and Taylor rule-based models. On the other hand the resulting improvement in welfare is very small.
    Keywords: DSGE; Bayesian estimation; intermediate exchange rate regime; rationing of credit; exchange rate rule; Russia
    JEL: E52 E58 F41
    Date: 2015
  16. By: Nicolas Coeurdacier; Stéphane Guibaud; Keyu Jin
    Abstract: We show that in an open-economy OLG model, the interaction between growth differentials and household credit constraints—more severe in fast-growing countries— can explain three prominent global trends: a divergence in private saving rates between advanced and emerging economies, large net capital outflows from the latter, and a sustained decline in the world interest rate. Micro-level evidence on the evolution of age-saving profiles in the U.S. and China corroborates our mechanism. Quantitatively, our model explains about a third of the divergence in aggregate saving rates, and a significant portion of the variations in age-saving profiles across countries and over time.
    Keywords: household credit constraints; age-saving profiles; international capital flows; allocation puzzle.
    JEL: F21 F32 F41
    Date: 2015
  17. By: Mariana García-Schmidt; Michael Woodford
    Abstract: We illustrate a pitfall that can result from the common practice of assessing alternative monetary policies purely by considering the perfect foresight equilibria (PFE) consistent with the proposed rule. In a standard New Keynesian model, such analysis may seem to support the “Neo-Fisherian” proposition according to which low nominal interest rates can cause inflation to be lower. We propose instead an explicit cognitive process by which agents may form their expectations of future endogenous variables. Under some circumstances, a PFE can arise as a limiting case of our more general concept of reflective equilibrium, when the process of reflection is pursued sufficiently far. But we show that an announced intention to fix the nominal interest rate for a long enough period of time creates a situation in which reflective equilibrium need not resemble any PFE. In our view, this makes PFE predictions not plausible outcomes in the case of such policies. Our alternative approach implies that a commitment to keep interest rates low should raise inflation and output, though by less than some PFE analyses apply.
    JEL: E31 E43 E52
    Date: 2015–10
  18. By: Uluc Aysun (University of Central Florida, Orlando, FL)
    Abstract: I solve a two-country real business cycle model that includes Cournot competitive global and local banks to investigate the impact of banking competition and global bank presence on local business cycles. Simulations reveal an inverted U-shaped relationship between the two factors and the volatility of output when global banks face portfolio adjustment costs. This relationship is determined by the asymmetric degree of diminishing returns to lending that global banks face in each economy. SpeciÂ…cally, when global banks have a larger presence or are less competitive in one of the economies than the other, the cross-country mobility of loanable funds and the local responses to domestic shocks are smaller compared those obtained when the two economies are more symmetric.
    Keywords: Global banks, Cournot competition, real business cycles, bank size
    JEL: E32 E44 F33 F44
    Date: 2015–10
  19. By: Zixi Liu (Goethe University Frankfurt)
    Abstract: Regarding the financial crisis since 2008, one heated debate lies in the relationships between public debt and economic growth. The present paper develops a theoretical model in a small open economy with sovereign risk based on Galí  and Monacelli (2005, 2008). A country- specific sovereign risk parameter is inserted into the sovereign interest rate equation to analyze its influence to the links between debt and growth. This paper shows that there is no single threshold and additionally, the relationship between debt and growth is country-specific and it varies depending on the degree of sovereign risk. Three scenarios are considered conditional on one set of randomly drawn simulated exogenous shocks. In a country with a high sovereign risk, there is a negative relationship between debt and growth whereby debt- GDP ratio is above 90%. With an extremely high sovereign risk, the relationship turns out to be rather negative and the turning point is quite low. In some countries that sovereign risk is not that high, fiscal stimulus could be effective to improve the economic growth. Moreover, the relationships between debt and growth under the three scenarios are all hump-shaped.
    Keywords: Growth, Sovereign Debt, DSGE, Fiscal Policy.
    JEL: E62 F41 H30 H60
    Date: 2015
  20. By: Vera Ivanova (National Research University Higher School of Economics); Philip Ushchev (National Research University Higher School of Economics)
    Abstract: We develop a dynamic model of monopolistic competition which sheds light on how the interplay between the degree of product dierentiation and intertemporal elasticity of substitution aects the steady-state equilibrium. Consumers love variety and split their labor endowment between wage labor, which brings immediate income, and producing capital, which yields a rent in the future. The impact of the elasticity of substitution across varieties on the market outcome depends crucially on whether consumption today and consumption tomorrow are gross substitutes or gross complements. The case of Cobb-Douglas intertemporal utility is a borderline situation, when the market outcome is invariant to the degree of product dierentiation. We also fully characterize the unique steady-state equilibrium path and show that the key dynamic properties of the model, such as local stability and determinacy of equilibrium, also hinge mainly on the interplay between the intra- and intertemporal elasticities of substitution.
    Keywords: intertemporal choice, intertemporal elasticity of substitution, love for variety, product dierentiation, toughness of competition, overlapping generations, capital, structural instability.
    JEL: D43 D90 D91 L13
    Date: 2015
  21. By: Maria Alessandra Antonelli; Valeria De Bonis (Università Sapienza di Roma - Dipartimento di Studi Giuridici, Filosofici ed Economici)
    Abstract: In questo lavoro esaminiamo le caratteristiche dei sistemi di welfare europei con riferimento alla tradizionale quadripartizione in regimi (nordico, anglosassone, continentale, meridionale), considerando misure della spesa sociale che tengono conto sia della differenza tra spesa lorda e spesa netta, sia di quella tra spesa pubblica e spesa privata. Inoltre, all’analisi della struttura della spesa pubblica, uniamo quella del finanziamento della stessa. Attraverso il metodo dell’analisi dei gruppi, troviamo che non esiste una distinzione tra paesi continentali e meridionali, e che l’Irlanda appartiene al gruppo anglo-sassone se si considerano esclusivamente gli indicatori dal lato del finanziamento. Length: 68 pages
    Keywords: Non-separable preferences, OLG, cycles
    JEL: D50 D91 E13 E32 O41
    Date: 2015–10

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