nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2015‒12‒01
35 papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. External shocks, banks and optimal monetary policy in an open economy By Yasin Mimir; Enes Sunel
  2. Short- and long-run tradeoff monetary easing By Koki Oikawa; Kozo Ueda
  3. 'Cyclically Adjusted Provisions and Financial Stability' By Kyriakos C. Neanidis; L. Pereira da Silva
  4. Optimal pay-as-you-go social security with endogenous retirement By Miyazaki, Koichi
  5. Frictions or deadlocks? Job polarization with search and matching frictions By Julien Albertini; Jean Olivier Hairault; François Langot; Thepthida Sopraseuth
  6. The historical evolution of the wealth distribution: A quantitative-theoretic investigation By Per Krusell; Anthony Smith; Joachim Hubmer
  7. Unemployment and Vacancy Dynamics with Imperfect Financial Markets By Carrillo-Tudela, Carlos; Graber, Michael; Wälde, Klaus
  8. A new approach to multi-step forecasting using dynamic stochastic general equilibrium models By Kapetanious, George; Price, Simon; Theodoridis, Konstantinos
  9. The structure of labor market flows By Papp, Tamás K.
  10. Estimating Discrete-Continuous Choice Models: The Endogenous Grid Method with Taste Shocks By Fedor Iskhakov; Thomas Høgholm Jørgensen; John Rust; Bertel Schjerning
  11. Explaining Cross-Cohort Differences in Life Cycle Earnings By Guillaume Vandenbroucke; B Ravikumar; Yu-Chien Kong
  12. Loss of Skill and Labor Market Fluctuations By Etienne Lalé
  13. Trading down and the business cycle By Jaimovich, Nir; Rebelo, Sergio; Wong, Arlene
  14. The Great Recession and the UK labour market By Millard, Stephen
  15. Inflation dynamics during the financial crisis By Gilchrist, Simon; Schoenle, Raphael; Sim, Jae W.; Zakrajsek, Egon
  16. The Interaction and Sequencing of Policy Reforms By Kehoe, Timothy J.; Asturias, Jose; Hur, Sewon; Ruhl, Kim J.
  17. Oil Prices and the Dynamics of Output and Real Exchange Rate By Meenagh, David; Minford, Patrick; Oyekola, Olayinka
  18. Monetary Policy and Welfare in a Currency Union By D’Aguanno, Lucio
  19. Discounting and Welfare Evaluation of Policies By Mertens, Jean-Francois; Rubinchik, Anna
  20. Housing and Monetary Policy in the Business Cycle: What do Housing Rents have to Say? By Joao Bernardo Duarte; Daniel A. Dias
  21. Equilibria Under Monetary and Fiscal Policy Interactions in a Portfolio Choice Model By Gliksberg, Baruch
  22. Sharing a Ride on the Commodities Roller Coaster: Common Factors in Business Cycles of Emerging Economies By Andrés Fernández; Andrés González; Diego Rodríguez
  23. Risk sharing in a world economy with uncertainty shocks By Robert Kollmann
  24. Information Provision and Consumer Search By Jay Lu; Simon Board
  25. Online Appendix to "Capital Values and Job Values" By Eran Yashiv
  26. Debt Covenants and Macroeconomic Dynamics By Francois Gourio; Pedro Gete
  27. Controlling a distribution of heterogeneous agents By Galo Nuño; Benjamin Moll
  28. Wage Dispersion and Search Behavior By Hall, Robert; Mueller, Andreas I.
  29. Future-biased government By Francisco M. Gonzalez; Itziar Lazkano; Sjak A. Smulders
  30. A search-based model of the interbank money market and monetary policy implementation By Morten Linneman Bech; Cyril Monnet
  31. Price Setting Under Uncertainty About Inflation By Diego Perez; Andres Drenik
  32. Envelope Theorem, Euler, and Bellman Equations without Differentiability By Jan Werner; Ramon Marimon
  33. Innovation, Technological Interdependence, and Economic Growth By Douglas Hanley
  34. The Role of the IT Revolution in Knowledge Diffusion, Innovation and Reallocation By Salome Baslandze
  35. Is Neo-Walrasian Macroeconomics a Dead End? By Marchionatti, Roberto; Sella, Lisa

  1. By: Yasin Mimir; Enes Sunel
    Abstract: We document empirically that the 2007-09 Global Financial Crisis exposed emerging market economies (EMEs) to an adverse feedback loop of capital outflows, depreciating exchange rates, deteriorating balance sheets, rising credit spreads and falling real economic activity. In order to account for these empirical findings, we build a New-Keynesian DSGE model of a small open economy with a banking sector that has access to both domestic and foreign funding. Using the calibrated model, we investigate optimal, simple and operational monetary policy rules that respond to domestic/external financial variables alongside inflation and output. The Ramsey-optimal policy rule is used as a benchmark. The results suggest that such an optimal policy rule features direct and non-negligible responses to lending spreads over the cost of foreign debt, the real exchange rate and the US policy rate, together with a mild anti-inflationary policy stance in response to domestic and external shocks. Optimal policy faces trade-offs in smoothing inefficient fluctuations in the intratemporal and intertemporal wedges driven by inflation, credit spreads and the real exchange rate. In response to productivity and external shocks, a countercyclical reserve requirement (RR) rule used in coordination with a conventional interest rate rule attains welfare levels comparable to those implied by spread- and real exchange rate-augmented rules.
    Keywords: Optimal monetary policy, banks, credit frictions, external shocks, foreign debt
    Date: 2015–11
  2. By: Koki Oikawa; Kozo Ueda
    Abstract: In this study, we illustrate a tradeoff between the short-run positive and long-run negative effects of monetary easing by using a dynamic stochastic general equilibrium model embedding endogenous growth with creative destruction and sticky prices due to menu costs. While a monetary easing shock increases the level of consumption because of price stickiness, it lowers the frequency of creative destruction (i.e., product substitution) because inflation reduces the reward for innovation via menu cost payments. The model calibrated to the U.S. economy suggests that the adverse effect dominates in the long run.
    Keywords: Schumpeterian, new Keynesian, non-neutrality of money
    JEL: E31 E58 O33 O41
    Date: 2015–11
  3. By: Kyriakos C. Neanidis; L. Pereira da Silva
    Abstract: This paper studies the extent to which alternative loan loss provisioning regimes affect the procyclicality of the financial system and financial stability. It uses a DSGE model with financial frictions (namely, balance sheet and collateral effects, as well as economies of scope in banking) and a generic formulation of provisioning regimes. Numerical experiments with a parameterized version of the model show that cyclically adjusted (or, more commonly called, dynamic) provisioning can be highly effective in terms of mitigating procyclicality and financial instability, measured in terms of the volatility of the credit-output ratio and real house prices, in response to financial shocks. The optimal combination of simple cyclically adjusted provisioning and countercyclical reserve requirements rules is also studied. The simultaneous use of these instruments does not improve the ability of either one of them to mitigate financial instability, making them partial substitutes rather than complements.
    Date: 2015
  4. By: Miyazaki, Koichi
    Abstract: This paper considers an overlapping-generations model with pay-as-you-go social security and retirement decision making by an old agent. In addition, the paper assumes that labor productivity depreciates. Under this setting, socially optimal allocations are examined. The first-best allocation is an allocation that maximizes welfare when a social planner distributes resources and forces an old agent to work and retire as she wants. The second-best allocation is an allocation that maximizes welfare when she can use only pay-as-you-go social security in a decentralized economy. The paper finds a range of an old agent’s labor productivity such that the first-best allocation is achieved in the decentralized economy. This differs from the finding in Micheland Pestieau [“Social security and early retirement in an overlapping-generations growth model”, Annals of Economics & Finance, 2013] that the first-best allocation cannot be achieved in the decentralized economy.
    Keywords: Overlapping-generations model, pay-as-you-go social security, endogenous retirement, depreciation of labor productivity, first-best allocation, second-best allocation
    JEL: D91 H21 H55 J26
    Date: 2015–07–02
  5. By: Julien Albertini; Jean Olivier Hairault; François Langot; Thepthida Sopraseuth
    Abstract: This paper extends Pissarides (1990)’s matching model by considering two sectors (routine and manual) and workers’ occupational choices, in the context of skill-biased demand shifts, to the detriment of routine jobs and in favour of manual jobs because of technological changes. The theoretical challenge is to investigate the reallocation process from the middle towards the bottom of the wage distribution. By using this framework, we shed light on the way in which labour market institutions affect the job polarization observed in the United States and Europe. The results of our quantitative experiments suggest that search frictions have non-trivial effects on the reallocation process and transitional dynamics of aggregate employment.
    Keywords: Search and matching, job polarization, reallocation, labor market institutions
    JEL: E24 J62 J64 O33
  6. By: Per Krusell (Stockholm University); Anthony Smith (Yale University); Joachim Hubmer (Yale University)
    Abstract: We derive qualitative and quantitative predictions of a microfounded model of wealth inequality and look at how the model's predictions compare with actual outcomes in the United States over the postwar period. The model's microeconomic core emphasizes that a household faces important earnings risks (deriving from the risk of unemployment and from uncertain wages) and cannot fully insure against these risks. To capture these features, we base our work on the broadly used Bewley-Huggett-Aiyagari (BHA) setup. Our model also features stochastic movements in saving rates that go beyond the mere precautionary-savings motive inherent in the BHA setup: we posit some randomness in discount factors, as in Krusell and Smith (1998). We demonstrate that such randomness gives rise to a Pareto-shaped right tail of the wealth distribution, a feature that appears to approximate the data well and that has been discussed much recently and derived in a variety of highly stylized models. Piketty and Zucman (2014) develop one such model and we argue that it can be viewed as a reduced form for the model we present here, and indeed also for the one in Krusell and Smith (1998).
    Date: 2015
  7. By: Carrillo-Tudela, Carlos (University of Essex); Graber, Michael (University College London); Wälde, Klaus (University of Mainz)
    Abstract: This paper proposes a simple general equilibrium model with labour market frictions and an imperfect financial market. The aim of the paper is to analyse the transitional dynamics of unemployment and vacancies when financial constraints are in place. We model the financial sector as a monopolistically competitive banking sector that intermediates financial capital between firms. This structure implies a per period financial resource constraint which has a closed form solution and describes the transition path of unemployment and vacancies to their steady state values. We show that the transition path crucially depends on the degree of wage flexibility. When wages are bargained sequentially the transition path is always downward sloping. This implies unemployment and vacancies adjust in opposite directions as observed in the data. When calibrating the model to the Great Recession and its aftermath we find that the lack of an improvement in the financial sector's effectiveness to intermediate resources played a crucial role in the slow recovery of the labour market.
    Keywords: job search, unemployment, financial markets
    JEL: J63 J64 G10
    Date: 2015–11
  8. By: Kapetanious, George (Bank of England); Price, Simon (Bank of England); Theodoridis, Konstantinos (Bank of England)
    Abstract: DSGE models are of interest because they offer structural interpretations, but are also increasingly used for forecasting. Estimation often proceeds by methods which involve building the likelihood by one-step ahead (h=1) prediction errors. However in principle this can be done using different horizons where h>1. Using the well-known model of Smets and Wouters (2007), for h=1 classical ML parameter estimates are similar to those originally reported. As h extends some estimated parameters change, but not to an economically significant degree. Forecast performance is often improved, in several cases significantly.
    Keywords: DSGE models; multi-step prediction errors; forecasting.
    Date: 2015–11–20
  9. By: Papp, Tamás K. (Institute for Advanced Studies, Vienna)
    Abstract: We show that a general class of frictional labor market models with a participation margin and an individual-specific state can only match labor market transition rates within a certain range, which we characterize analytically. Transition rates in the data are outside the range the model can match, which explains the failure of previous papers to calibrate to these flows. We also examine whether extending the model can bring it closer to the data, and find that endogenous search intensity and state-dependent separation rates do not help, but misclassification, persistently inactive workers, and modifications of the productivity process such as learning on the job can match the gross flows.
    Date: 2015–11
  10. By: Fedor Iskhakov (ARC Centre of Excellence in Population Ageing Research, University New South Wales); Thomas Høgholm Jørgensen (Department of Economics, University of Copenhagen); John Rust (Department of Economics, Georgetown University); Bertel Schjerning (Department of Economics, University of Copenhagen)
    Abstract: We present a fast and accurate computational method for solving and estimating a class of dynamic programming models with discrete and continuous choice variables. The solution method we develop for structural estimation extends the endogenous gridpoint method (EGM) to discrete-continuous (DC) problems. Discrete choices can lead to kinks in the value functions and discontinuities in the optimal policy rules, greatly complicating the solution of the model. We show how these problems are ameliorated in the presence of additive choice-specic IID extreme value taste shocks. We present Monte Carlo experiments that demonstrate the reliability and eciency of the DC-EGM and the associated Maximum Likelihood estimator for structural estimation of a life cycle model of consumption with discrete retirement decisions.
    Keywords: Structural estimation, lifecycle model, discrete and continuous choice, retirement choice, endogenous gridpoint method, nested xed point algorithm, extreme value taste shocks, smoothed max function.
    JEL: C13 C63 D91
    Date: 2015–11–27
  11. By: Guillaume Vandenbroucke (Federal Reserve Bank of St Louis); B Ravikumar (Federal Reserve Bank of St Louis); Yu-Chien Kong (University of Iowa)
    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 were multiplied by a factor of 4 between the ages of 25 and 55. For the 1980 cohort the same calculation yields a factor of 2.2. Why are recent cohorts facing flatter earnings profiles? Our theory combines two elements: (1) the incentives to accumulate human capital over one's work life are decreasing in the initial stock of human capital; (2) recent cohorts are more educated and do start their work lives with more human capital. We build and calibrate a parsimonious model of schooling and human capital accumulation on the job to fit the earnings of the 1940 cohort at different ages. Our model accounts for more than 60% of the decline in the growth rate of earnings between the 1940 and the 1980 cohorts as the result of a single exogenous factor: increasing aggregate productivity.
    Date: 2015
  12. By: Etienne Lalé
    Abstract: This paper studies the effects of skill loss on compositional changes in the pool of unemployed, and their impact on aggregate labor market fluctuations. We develop a computationally tractable stochastic version of the Diamond-Mortensen-Pissarides model, wherein workers accumulate skills on the job and lose them during unemployment. Skill loss provides a mechanism for amplifying fluctuations: the loss of skills shifts the average composition of the unemployment pool towards low-surplus workers, which magnifies the response of vacancies to aggregate productivity shocks. The model, however, cannot generate large compositional changes at business cycle frequency: the dynamics of unemployment remains too fast for the pool of searching workers to deteriorate markedly during downturns. Finally, we find that loss of skill plays a quantitatively important role if skills are destroyed immediately upon job loss, and more so during recessions.
    Keywords: Diamond-Mortensen-Pissarides model, Labor market volatility, Skill loss
    JEL: E24 E32 J24 J63 J64
    Date: 2015–11–17
  13. By: Jaimovich, Nir (University of Southern California and NBER); Rebelo, Sergio (Northwestern University); Wong, Arlene (Northwestern University)
    Abstract: The authors 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. Therefore, when households trade down, labor demand falls, increasing the severity of recessions. The authors find that the trading-down phenomenon accounts for a substantial fraction of the fall in U.S. employment in the recent recession. They 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: recessions; quality choice; business cycles
    JEL: E2 E3 E4
    Date: 2015–11–01
  14. By: Millard, Stephen (Bank of England)
    Abstract: In line with most of the developed world, the United Kingdom experienced in 2008–09 its worst recession since the Great Depression of the 1920s and 30s: the Great Recession. But despite the 6% peak-to-trough fall in output (as measured by real gross value added at basic prices) the unemployment rate only rose from 5.2% in 2007 Q4 to 8.4 in 2011 Q3. This muted response is often attributed to the flexibility of the UK labour market and, in particular, the willingness of UK workers to see their real wages fall. This paper uses an estimated DSGE model of the UK economy to investigate this hypothesis, assessing which shocks were largely responsible for the Great Recession and the extent to which the effect of these shocks on unemployment would have been worse had the UK labour market responded less flexibly.
    Keywords: Labour market flexibility; Great Recession.
    JEL: E24 E32
    Date: 2015–11–13
  15. By: Gilchrist, Simon (Boston University and NBER); Schoenle, Raphael (Brandeis University); Sim, Jae W. (Federal Reserve Board of Governors); Zakrajsek, Egon (Federal Reserve Board of Governors)
    Abstract: Firms with limited internal liquidity significantly increased prices in 2008, while their liquidity unconstrained counterparts slashed prices. Differences in the firms' price-setting behavior were concentrated in sectors likely characterized by customer markets. The authors develop a model in which firms face financial frictions while setting prices in a customer-markets setting. Financial distortions create an incentive for firms to raise prices in response to adverse demand or financial shocks. These results reflect the firms' reaction to preserve internal liquidity and avoid accessing external finance, factors that strengthen the countercyclical behavior of markups and attenuate the response of inflation to fluctuations in output.
    Keywords: missing deflation; sticky customer base; costly external finance; financial shocks; cost channel; inflation-output tradeoff
    JEL: E31 E32 E44 E51
    Date: 2015–11–01
  16. By: Kehoe, Timothy J. (University of Minnesota); Asturias, Jose (School of Foreign Service in Qatar, Georgetown University); Hur, Sewon (University of Pittsburgh); Ruhl, Kim J. (Stern School of Business, New York University)
    Abstract: In what order should a developing country adopt policy reforms? Do some policies complement each other? Do others substitute for each other? To address these questions, we develop a two-country dynamic general equilibrium model with entry and exit of firms that are monopolistic competitors. Distortions in the model include barriers to entry of firms, barriers to international trade, and barriers to contract enforcement. We find that a reform that reduces one of these distortions has different effects depending on the other distortions present. In particular, reforms to trade barriers and barriers to the entry of new firms are substitutable, as are reforms to contract enforcement and trade barriers. In contrast, reforms to contract enforcement and the barriers to entry are complementary. Finally, the optimal sequencing of reforms requires reforming trade barriers before contract enforcement.
    Keywords: Sequencing reforms; Trade barriers; Entry barriers; Contract enforcement
    JEL: F13 F4 O11 O19 O24
    Date: 2015–11–23
  17. By: Meenagh, David (Cardiff Business School); Minford, Patrick (Cardiff Business School); Oyekola, Olayinka
    Abstract: We examine the role of oil price shocks in effecting changes both at the aggregate and sectoral levels using an estimated dynamic stochastic equilibrium open economy model. Our main finding is that energy price shocks are not able directly to generate the magnitude of the economic downturn observed in the data. These shocks, however, do possess a strong indirect transmission link that endogenously spreads their effect through the system such that they account for a considerable portion of the U.S. business cycle movements. This leads us to conclude that previous results that attribute a minimal importance to oil price shocks must be focusing more on the energy cost share of gross domestic product and less on how they affect the intertemporal decisions of economic agents. We also find that external shocks have been responsible for explaining volatility in U.S. economic activities for a long time. This leads us to conclude that modelling the U.S. as a closed economy discounts a sizeable set of very relevant factors.
    Keywords: Two sector; non-stationary DSGE model; Oil price; Relative prices; Domestic shocks; Imported shocks
    JEL: E32 D58 F41 C52 Q43
    Date: 2015–11
  18. By: D’Aguanno, Lucio (Department of Economics University of Warwick)
    Abstract: What are the welfare gains from being in a currency union? I explore this question in the context of a dynamic stochastic general equilibrium model with monetary barriers to trade, local currency pricing and incomplete markets. The model generates a trade off between monetary independence and monetary union. On one hand, distinct national monetary authorities with separate currencies can address business cycles in a countryspecific way, which is not possible for a single central bank. On the other hand, short-run violations of the law of one price and long-run losses of international trade occur if different currencies are adopted, due to the inertia of prices in local currencies and to the presence of trade frictions. I quantify the welfare gap between these two international monetary arrangements in consumption equivalents over the lifetime of households, and decompose it into the contributions of di.erent frictions. I show that the welfare ordering of alternative currency systems depends crucially on the international correlation of macroeconomic shocks and on the strength of the monetary barriers affecting trade with separate currencies. I estimate the model on data from Italy, France, Germany and Spain using standard Bayesian tools, and I find that the trade off is resolved in favour of a currency union among these countries.
    Keywords: Currency union ; Incomplete markets ; Nominal rigidities ; Local currency pricing ; Trade frictions ; Welfare
    JEL: D52 E31 E32 E42 E52 F41 F44
    Date: 2015
  19. By: Mertens, Jean-Francois (CORE, Universite Catholique de Louvain); Rubinchik, Anna (Department of Economics, University of Haifa)
    Abstract: If policy discounting is to have any welfare relevance, it must be a derivative of a social welfare function. If that derivative is to have a net present value form, the baseline allocation must be stationary. Given a stationary baseline in an overlapping generations growth economy the inter-generationally fair discount rate under the relative utilitarian welfare function equals the growth rate of per-capita consumption, roughly, 2% for the U.S. This differs from the interest rate, even in the golden rule equilibrium unless population growth is null.
    Keywords: policy evaluation, discounting, social welfare function, social discount rate, overlapping generations
    JEL: D50 H43 H50
    Date: 2015–08–12
  20. By: Joao Bernardo Duarte; Daniel A. Dias
    Abstract: In this paper we unveil a feedback loop between monetary policy, housing tenure choice (own vs rent) and measured inflation and quantify its consequences. This feedback loop is explained in three parts: i) Housing rents respond positively to contractionary monetary policy shocks; ii) This effect of interest rates on housing rents gives rise to an important and systematic inflation mismeasurement problem because, directly and indirectly, housing rents weigh approximately 30\% in the CPI and 13\% in the PCE; iii) When interest rates are set according to a Taylor rule, the systematic mismeasurement of inflation gives rise to a feedback loop by which the monetary authority keeps setting interest rates too high (low) because inflation is apparently too high (low). To rationalize i) and quantify the importance of iii) we propose a standard New Keynesian model augmented with an endogenous housing tenure choice mechanism. Using a calibrated version of the model, we do a counterfactual exercise and estimate that, when the monetary authority targets the implied consumer price index net of housing rents instead of the implied consumer price index, the loss function of monetary policy is 14.5\% lower and the welfare in terms of consumption equivalent variation is 0.9\% higher. Finally, analyzing the same alternative scenario for the 1983-2006 US experience, we find that the standard deviation of housing prices and nominal inflation would have been 24.8\% and 19.9\% lower, respectively.
    JEL: E31 E43 R21
    Date: 2015–11–26
  21. By: Gliksberg, Baruch (Department of Economics, University of Haifa)
    Abstract: This paper analyzes the aftermath of monetary and fiscal policy interactions from the perspective of portfolio choice. In particular, it studies how the presence of income- taxes change the properties of general equilibrium models. It finds that relative to the previous literature [following Leeper (1991)] a new regime exists where a passive fiscal rule combined with a passive monetary rule can still deliver determinacy where the same area of the parameter space would lead to multiple solutions if taxes were lump sum. It characterizes analytically the extent to which tax cuts are self-financing and how the distortionary tax Laffer curve looks near the steady state in order to obtain the size of the new regime. In the new regime, the inflation target can temporarily increase in order to increase seigniorage revenues. With this flexibility, the monetary policy is consistent with the real debt remaining bounded, and the arithmetic that follows is monetarist and unpleasant in the sense of Sargent and Wallace (1981).
    Keywords: Distorting Taxes; Dynamic Laffer Curve; Fiscal Policy; Liquidity-in- advance; Monetary Policy; Portfolio Choice; Unpleasant Monetarist Arithmetic.
    JEL: C62 E60 G11 H60
    Date: 2015–10–14
  22. By: Andrés Fernández; Andrés González; Diego Rodríguez
    Abstract: Fluctuations in commodity prices are an important driver of business cycles in small emerging market economies (EMEs). We document how these fluctuations correlate strongly with the business cycle in EMEs. We then embed a commodity sector into a multi-country EMEs business cycle model where exogenous fluctuations in commodity prices follow a common dynamic factor structure and coexist with other driving forces. The estimated model assigns to commodity shocks 42 percent of the variance in income, of which a considerable part is linked to the common factor. A further amplification mechanism is a spillover effect from commodity prices to risk premia.
    Keywords: Emerging economies, business cycles, commodity prices, common factors, Bayesian estimation, dynamic stochastic equilibrium models.
    JEL: E32 F41 F44
    Date: 2015–11–18
  23. By: Robert Kollmann
    Abstract: This paper analyzes the effects of output volatility shocks and of risk appetite shocks on the dynamics of consumption, trade flows and the real exchange rate, in a two-country world with recursive preferences and complete financial markets. When the risk aversion coefficient exceeds the inverse of the intertemporal substitution elasticity, then an exogenous rise in a country’s output volatility triggers a wealth transfer to that country, in equilibrium; this raises its consumption, lowers its trade balance and appreciates its real exchange rate. The effects of risk appetite shocks resemble those of volatility shocks. In a recursive preferences-complete markets framework, volatility and risk appetite shocks account for a noticeable share of the fluctuations of net exports, net foreign assets and the real exchange rate. These shocks help to explain the high empirical volatility of the real exchange rate and the disconnect between relative consumption growth and the real exchange rate.
    Keywords: External balance, exchange rate, volatility, risk appetite, consumption-real exchange rate anomaly.
    JEL: F31 F32 F36 F41 F43
    Date: 2015–11
  24. By: Jay Lu (Cornell University); Simon Board (University of California - Los Angeles)
    Abstract: Buyers often search across multiple retailers or websites to learn which product best fits their needs. We study how sellers manage these search incentives through their disclosure policies (e.g. advertisements, product trials and reviews), and ask whether competition leads sellers to provide more information. We first show that if sellers can track buyers (e.g. they can observe buyers' search history via their cookies), then in a broad range of environments, there is a unique equilibrium in which all sellers provide the 'monopoly level' of information. However, if buyers are anonymous and the search cost is small, then all sellers provide full information about their products. Tracking software thus enables sellers to implicitly collude, providing a motivation for regulation.
    Date: 2015
  25. By: Eran Yashiv (Tel Aviv University)
    Abstract: Online appendix for the Review of Economic Dynamics article
    Date: 2015
  26. By: Francois Gourio (FRB Chicago); Pedro Gete (Georgetown University)
    Abstract: Debt covenants are an important non-price mechanism through which credit is allocated to nonfinancial firms, and are strongly countercyclical. Macroeconomic models however abstract from this margin and focus on price measures such as credit spreads. We propose a simple extension of the canonical Bernanke-Gertler-Gilchrist (1999; BGG) model that gives a role for covenants and that allows to study both their determination, and their macroeconomic impact. In the model, covenants allocate control rights of investment across states of natures, and are determined by a trade-off between the risk of letting the entrepreneur invest excessively, and the cost of letting the lender reduce investment excessively. We demonstrate that covenants alter impulse response functions, relative to BGG, and that the pre-determined convenant tightness is an important state variable for the economy. Finally, we show that the demand for savings and expectations of future productivity are important determinants of covenant tightness.
    Date: 2015
  27. By: Galo Nuño (Banco de España); Benjamin Moll (Princeton university)
    Abstract: This paper analyzes the problem of a benevolent planner wishing to control a population of heterogeneous agents subject to idiosyncratic shocks. This is equivalent to a deterministic control problem in which the state variable is the cross-sectional distribution. We show how, in continuous time, this problem can be broken down into a dynamic programming equation plus the law of motion of the distribution, and we introduce a new numerical algorithm to solve it. As an application, we analyze the constrained-efficient allocation of an Aiyagari economy with a fat-tailed wealth distribution. We fi nd that the constrained-efficient allocation features more wealth inequality than the competitive equilibrium.
    Keywords: Kolmogorov forward equation, wealth distribution, social welfare function, mean field control
    JEL: C6 D3 D5 E2
    Date: 2015–11
  28. By: Hall, Robert (Stanford University); Mueller, Andreas I. (Columbia University)
    Abstract: We use a rich new body of data on the experiences of unemployed job-seekers to determine the sources of wage dispersion and to create a search model consistent with the acceptance decisions the job-seekers made. From the data and the model, we identify the distributions of four key variables: offered wages, offered non-wage job values, the value of the job-seeker's non-work alternative, and the job-seeker's personal productivity. We find that, conditional on personal productivity, the dispersion of offered wages is moderate, accounting for 21 percent of the total variation in observed offered wages, whereas the dispersion of the non-wage component of offered job values is substantially larger. We relate our findings to an influential recent paper by Hornstein, Krusell, and Violante who called attention to the tension between the fairly high dispersion of the values job-seekers assign to their job offers – which suggest a high value to sampling from multiple offers – and the fact that the job-seekers often accept the first offer they receive.
    Keywords: wage dispersion, reservation wages, search frictions, unemployment
    JEL: J31 J32 J64
    Date: 2015–11
  29. By: Francisco M. Gonzalez (Department of Economics, University of Waterloo); Itziar Lazkano (University of Wisconsin-Milwaukee); Sjak A. Smulders (Tilburg University)
    Abstract: We argue that governments are future biased when they aggregate the preferences of overlapping generations. Future bias, which involves preference reversals favoring future over current consumption, explains why governments legislate old-age transfers at the expense of capital accumulation and growth, even if generations are altruistic.
    JEL: D71 D72 H55
    Date: 2015–10
  30. By: Morten Linneman Bech; Cyril Monnet
    Abstract: We present a search-based model of the interbank money market and monetary policy implementation. Banks are subject to reserve requirements and the central bank tenders reserves. Interbank payments redistribute holdings and banks trade with each other in a decentralized (over-the-counter) market. The central bank provides standing facilities where banks can either deposit surpluses or borrow to cover shortfalls of reserves overnight. The model provides insights on liquidity, trading volume, and rate dispersion in the interbank market - features largely absent from the canonical models in the tradition of Poole (1968) - and fits a number of stylized facts for the Eurosystem observed during the recent period of unconventional monetary policies. Moreover, it provides insights on the implications of different market structures.
    Keywords: Interbank market, monetary policy implementation, unconventional monetary policy
    Date: 2015–11
  31. By: Diego Perez (Stanford); Andres Drenik (Stanford)
    Abstract: When setting prices firms use idiosyncratic information about the demand for their products as well as public information about the aggregate macroeconomic state. This paper provides an empirical assessment of the effects of the availability of public information about inflation on price setting. We exploit an event in which economic agents lost access to information about the inflation rate: starting in 2007 the Argentinean government began to misreport the national inflation rate. Our difference-in-difference analysis reveals that this policy led to an increase in the coefficient of variation of prices of 18% with respect to its mean. This effect is analyzed in the context of a general equilibrium model in which agents make use of publicly available information about the inflation rate to set prices. We quantify the model and use it to further explore the effects of higher uncertainty about inflation on the effectiveness of monetary policy and aggregate welfare. We find that monetary policy becomes more effective in a context of higher uncertainty about inflation and that not reporting accurate measures of the CPI entails significant welfare losses.
    Date: 2015
  32. By: Jan Werner (University of Minnesota); Ramon Marimon (European University Inst. & UPF - Barcelona GSE)
    Abstract: We extend the envelope theorem, the Euler equation, and the Bellman equation to dynamic constrained optimization problems where binding constraints can give rise to non-differentiable value functions. The envelope theorem -- an extension of Milgrom and Segal (2002) theorem for concave functions -- provides a generalization of the Euler equation and establishes a relation between the Euler and the Bellman equation. For example, we show how solutions to the standard Belllman equation may fail to satisfy the respective Euler equations, in contrast with solutions to the infinite-horizon problem. In standard maximisation problems the failure of Euler equations may result in inconsistent multipliers, but not in non-optimal outcomes. However, in problems with forward looking constraints this failure can result in inconsistent promises and non-optimal outcomes. We also show how the inconsistency problem can be resolved by a minimal extension of the co-state. As an application we extend the theory of recursive contracts of Marcet and Marimon (1998, 2015) to the case where solutions are not unique, resolving a problem pointed out by Messner and Pavoni (2004).
    Date: 2015
  33. By: Douglas Hanley (University of Pittsburgh)
    Abstract: There is substantial heterogeneity across industries in the level of interdependence between new and old technologies. I propose a measure of this interdependence--an index of sequentiality in innovation--which is the transfer rate of patents in a particular industry. I find that highly sequential industries have higher profitability, higher variance of firm growth, lower exit rates, and lower rates of patent expiry. To better understand these trends, I construct a model of firm dynamics where the productivity of firms evolves endogenously through innovations. New innovators either replace existing technologies or must purchase the rights to existing technologies from incumbents in order to produce, depending on the level of sequentiality in the industry. Estimating the model using data on US firms and recent data on US patent transfers, I can account for a large fraction of the cross-industry trends described above. Because innovation results in larger monopoly distortions in more sequential industries, there is an overinvestment of research inputs into these industries. This misallocation, which amounts to 2.5% in consumption equivalent terms, can be partially remedied using a patent policy featuring weaker protection in more sequential industries, yielding welfare gains of 1.7%.
    Date: 2015
  34. By: Salome Baslandze (UPenn)
    Abstract: What is the impact of information and communications technologies (ICT) on aggregate productivity growth and industrial reallocation? In this paper, I analyze the impact of ICT through facilitating knowledge diffusion in the economy. There are two opposing effects. The increased flow of ideas between firms and industries improves learning opportunities and spurs innovation. However, knowledge diffusion through ICT also results in broader accessibility of knowledge by competitors, reducing expected returns from research efforts and hence harming innovation incentives. The nature of the tradeoff between these opposing forces depends on an industry's technological characteristics, which I call external knowledge dependence. Industries whose innovations rely more on external knowledge benefit greatly from knowledge externalities and expand, while more self-contained industries are more affected by intensified competition and shrink. This results in the reallocation of innovation and production activities toward more externally-focused, ``knowledge-hungry'' industries. I develop a general equilibrium endogenous growth model featuring this mechanism. In the model, firms belonging to technologically heterogeneous industries learn from external knowledge and innovate. These firms' abilities to access external information is governed by ICT. Using NBER patent and citations data together with BEA industry-level data on ICT, I empirically validate the mechanism of the paper. Quantitative analysis from the calibrated model illustrates that it is important to account for both technological heterogeneity and the knowledge-diffusion role of ICT to explain U.S. trends in productivity growth and sectoral reallocation in recent decades. Counterfactual experiments are conducted to quantitatively assess separate channels and illustrate various growth decompositions.
    Date: 2015
  35. By: Marchionatti, Roberto; Sella, Lisa (University of Turin)
    Abstract: After the ‘new Great Crisis’ exploded in 2008 it is widely recognized that mainstream macroeconomics - the last result of Lucas’s anti-Keynesian revolution of the 1980s which tried to give macroeconomics sound neo-Walrasian microeconomic bases - has failed to anticipate and then appraise the crisis. Has this crisis revealed a failure of this macroeconomics as a scientific theory? Mainstream macroeconomists defend their models on the basis of their alleged superiority in terms of clarity and coherence. The thesis of this paper is that this claim about superiority is false. The paper argues that the reasons for the failure of mainstream macroeconomics – in particular its poor predictive performance and interpretative weakness - reside in the implications of the neo-Walrasian legacy and the problems connected with the implementation of that programme.
    Date: 2015–06

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