nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2016‒01‒29
twenty papers chosen by

  1. Forecasting South African Macroeconomic Variables with a Markov-Switching Small Open-Economy Dynamic Stochastic General Equilibrium Model By Mehmet Balcilar; Rangan Gupta; Kevin Kotze
  2. Liquidity, Government Bonds and Sovereign Debt Crises By Francesco Molteni
  3. Entry and exit in recent US business cycles By Mikel Casares
  4. Foreign Shocks By Drago Bergholt
  5. Asymmetric Inflation Expectations, Downward Rigidity of Wages and Asymmetric Business Cycles By David Rezza Baqaee
  6. Exploring International Differences in Inflation Dynamics By Yamin Ahmad; Olena Mykhaylova
  7. Optimal time-consistent government debt maturity By Davide Debortoli; Ricardo Nunes; Pierre Yared
  8. Idiosyncratic Risk, Borrowing Constraints and Financial Integration - A Discussion of Ambiguous Results By Maik Heinemann
  9. Distributional Effects of Social Security Reforms: the Case of France By Raquel Fonseca; Thepthida Sopraseuth
  10. Elastic attention, risk sharing, and international comovements By Nie, Jun; Luo, Yulei; Li, Wei
  11. Equilibrium Price Dispersion and the Border Effect By Stevens, Luminita; Chahrour, Ryan
  12. DSGE model-based forecasting of modelled and nonmodelled inflation variables in South Africa By Rangan Gupta; Patrick T. Kanda; Mampho P. Modise; Alessia Paccagnini
  13. Disentangling goods, labor and credit market frictions in three European economies By Thomas Brzustowski; Nicolas Petrovsky-Nadeau; Etienne Wasmer
  14. Social Insurance, Private Health Insurance and Individual Welfare By Kai Zhao
  15. Technological Progress, Employment and the Lifetime of Capital By Raouf Boucekkine; Natali Hritonenko; Yuri Yatsenko
  16. Le plan Juncker peut-il nous soritr de l'ornière ? By Francesco Saraceno; Sébastien Villemot; Mathilde Lemoigne
  17. Search frictions and (in)efficient vocational training over the life-cycle By Arnaud Cheron; Anthony Terriau
  18. Suboptimality with land By Kokonas, Nikos; Polemarchakis, Herakles
  19. The Effects of Barriers to Technology Adoption on Japanese Prewar and Postwar Economic Growth By Daisuke Ikeda; Yasuko Morita
  20. Fragility of Money Markets By Ranaldo, Angelo; Rupprecht, Matthias; Wrampelmeyer, Jan

  1. By: Mehmet Balcilar (Department of Economics, Eastern Mediterranean University, Turkey; IPAG Business School, Paris, France and Department of Economics, University of Pretoria); Rangan Gupta (Department of Economics, University of Pretoria); Kevin Kotze (School of Economics, Faculty of Commerce, University of Cape Town, South Africa.)
    Abstract: The aim of this paper is to investigate structural changes in the South African economy using an estimated small open-economy dynamic stochastic general equilibrium (DSGE) model. The structure of the model follows recent work in this area and incorporates the expectations of agents and a number of shocks that are assumed to affect the economy at various points in time. In addition, the dynamic linkages between the respective variables in the model may be explained in terms of the microfoundations that characterise the behaviour of firms, households and the central bank. After estimating the model, we allow for the parameters in a number of different structural equations to change periodically over time. Different versions of the model are assessed using various statistical criteria to identify the model that is able to explain the changing dynamics in the South African economy. The results suggest that the central bank has responded in a consistent manner over the sample period; however, there are periods of time where it does not focus too greatly on output pressure. This impacts on some of the impulse response functions where we note that a monetary policy shock has a slightly larger effect on inflation, while the risk-premium shock has a larger effect on output, inflation and interest rates.
    Keywords: Monetary policy, inflation targeting, Markov-switching, dynamic stochastic general equilibrium model, Bayesian estimation, small open-economy
    JEL: E32 E52 F41
    Date: 2016–01
  2. By: Francesco Molteni
    Abstract: This paper analyses the European financial crisis through the lens of sovereign bond liquidity. Using novel data we show that government securities are the prime collateral in the European repo market, which is becoming an essential source of funding for the banking system in the Euro area. We document that repo haircuts on peripheral government bonds sharply increased during the crisis, reducing their liquidity and amplifying the raise in the yields of these securities. We study the systemic impact of a liquidity shock on the business cycle and asset prices through a dynamic stochastic general equilibrium model with liquidity frictions. The model predicts a drop in economic activity, inflation and value of illiquid government bonds. We show that an unconventional policy which consists of purchasing illiquid bonds by issuing liquid bonds can alleviate the contractionary effect of liquidity shock. A Bayesian structural vector autoregressive model for the Irish economy confirms empirically the negative impact of a rise in haircuts on the value of government bonds.
    Keywords: repo;haircuts;government bonds;liquidity shock;quantitative easing
    JEL: E44 E58 G12
    Date: 2015–12
  3. By: Mikel Casares (Departamento de Economía-UPNA)
    Abstract: I show evidence indicating that the variability of the total number of business units (establishments) has significantly increased in recent US business cycles, accounting for nearly 2/3 of real GDP fluctuations during the 2003-2012 decade. Next, I examine the role of business creation and destruction in an estimated DSGE-style model extended with endogenous entry and exit. Shocks on both entry and, especially, exit have played a crucial role on explaining the latest boom-bust cycle in the US economy. I also find that the estimated innovations of total factor productivity are positive and high in 2010-2012, which might be the consequence of the dramatic increase in the exit rates observed during the recession of 2008-2009.
    Keywords: Entry and exit, DSGE models, US business cycles
    Date: 2015
  4. By: Drago Bergholt
    Abstract: How and to what extent are small open economies affected by international shocks? I develop and estimate a medium scale DSGE model that addresses both questions. The model incorporates i) international markets for firm-to-firm trade in production inputs, and ii) producer heterogeneity where technology and price setting constraints vary across industries. Using Bayesian techniques on Canadian and US data, I document several macroeconomic regularities in the small open economy, all attributed to international disturbances. First, foreign shocks are crucial for domestic fluctuations at all forecasting horizons. Second, productivity is the most important driver of business cycles. Investment efficiency shocks on the other hand have counterfactual implications for international spillover. Third, the relevance of foreign shocks accumulates over time. Fourth, business cycles display strong co-movement across countries, even though shocks are uncorrelated and the trade balance is countercyclical. Fifth, exchange rate pass-through to aggregate CPI inflation is moderate, while pass-through at the sector level is positively linked to the frequency of price changes. Few of these features have been accounted for by existing open economy DSGE literature, but all are consistent with reduced form evidence. The model presented here offers a structural interpretation of the results.
    Keywords: DSGE, Small open economy, International business cycles, Bayesian estimation
    Date: 2015–11
  5. By: David Rezza Baqaee (Department of Economics, London School of Economics (LSE); Centre for Macroeconomics (CFM))
    Abstract: Household expectations of the in ation rate are much more sensitive to inflation than to disinflation. To the extent that workers have bargaining power in wage determination, this asymmetry in their beliefs can make wages respond quickly to inflationary forces but sluggishly to deflationary ones. I microfound asymmetric household expectations using ambiguity-aversion: households, who do not know the quality of their information, overweight inflationary news since it reduces their purchasing power, and underweight deflationary news since it increases their purchasing power. I embed asymmetric beliefs into a general equilibrium model and show that, in such a model, monetary policy has asymmetric effects on employment, output, and wage inflation in ways consistent with the data. Although wages are downwardly rigid in this environment, monetary policy need not have a bias towards using inflation to grease the wheels of the labor market.
    Date: 2015–12
  6. By: Yamin Ahmad (Department of Economics, University of Wisconsin-Whitewater); Olena Mykhaylova (Department of Economics, College of the Holy Cross)
    Abstract: Standard closed-economy DSGE models have difficulty replicating the persistence of inflation. We use a multicountry dataset to establish some empirical regularities on persistence and volatility of aggregate consumer prices for 161 countries. We find persistence to be high (low) on average for developed (developing) countries, while volatility is low (high) on average for the same country groupings. We then employ a two-country DSGE framework to investigate the extent to which structural open economy features, such as incomplete exchange rate pass-through, the existence of nontraded goods, and international financial market incompleteness, can help in replicating the persistence and volatility of consumer prices. Our simulation results indicate that nominal price inertia in both wholesale and retail sectors has the potential to reconcile both the persistence and volatility of simulated inflation series with the data. When we simulate inflation series in the version of the model calibrated to a developing-developed country pair by allowing for different price contract durations and export currency choices, we are able to replicate the empirical differences reported in the first part of the paper.
    Keywords: Inflation dynamics, persistence, volatility, DSGE modeling, simulations
    JEL: E31 F41 C22
    Date: 2015–09
  7. By: Davide Debortoli; Ricardo Nunes; Pierre Yared
    Abstract: This paper develops a model of optimal government debt maturity in which the government cannot issue state-contingent bonds and cannot commit to fiscal policy. If the government can perfectly commit, it fully insulates the economy against government spending shocks by purchasing short-term assets and issuing long-term debt. These positions are quantitatively very large relative to GDP and do not need to be actively managed by the government. Our main result is that these conclusions are not robust to the introduction of lack of commitment. Under lack of commitment, large and tilted positions are very expensive to finance ex-ante since they exacerbate the problem of lack of commitment ex-post. In contrast, a flat maturity structure minimizes the cost of lack of commitment, though it also limits insurance and increases the volatility of fiscal policy distortions. We show that the optimal time-consistent maturity structure is nearly flat because reducing average borrowing costs is quantitatively more important for welfare than reducing fiscal policy volatility. Thus, under lack of commitment, the government actively manages its debt positions and can approximate optimal policy by confining its debt instruments to consols.
    Keywords: Public debt, optimal taxation, fiscal policy
    JEL: H63 H21 E62
    Date: 2016–01
  8. By: Maik Heinemann (University of Potsdam)
    Abstract: This paper examines the effects of financial frictions in the context of financial integration. We employ a general equilibrium model with heterogeneous entrepreneurs and address the question of capital flows from poor to rich countries and focus on the consequences for domestic capital accumulation, output and welfare. Motivated by the mixed results from the literature, entrepreneurs in our model face capital risk, earn risky profits and receive riskless wage income. Moreover, borrowing constraints impede consumption smoothing and limit the access to external funds for scaling up production. In the first of three scenarios we focus on uninsurable risk only. We show that for plausible parametrizations, capital does flow from poor to rich and that an increase in the interest rate necessarily leads to larger levels of the domestic capital stock and output in the steady state under financial integration. We derive two rules of thumb which explain the described outcome with high accuracy. In the second scenario we consider tight borrowing constraints and in the third scenario we increase the persistence of shocks. Both changes strongly affect the results derived in the first scenario and mainly lead to tighter parameter restrictions.
    Keywords: Incomplete markets; Borrowing constraints; Financial integration
    JEL: D52 E22 F41 G11
    Date: 2015–11–01
  9. By: Raquel Fonseca; Thepthida Sopraseuth
    Abstract: This paper uses a calibrated dynamic life-cycle model to quantify the long-run distributional impact of two opposite Social Security reforms: modifying the parameters of a defined benefit (DB) plan (such as in France with Ayrault’s reform) or switching to a notional defined contribution (NDC) plan (such as in Italy). Both reforms yield an inequal distribution of welfare losses. Low-skilled workers are the main losers of the reforms. This is so for different reasons in each reform. In the case of Ayrault’s reform, low-skilled individuals delay retirement by 2 years, up to age 62. In switching to a NDC scheme, low-skilled workers’pensions fall substantially. In NDC schemes, inequalities along the working-life are directly translated into inequalities in pension levels. The switch from a DB plan to the Italian reform yields substantial welfare losses, pensions drastically fall, and individuals save more. Since low-skilled workers do not save as much as middle or high-skilled workers, the switch to NDC schemes leads to a more unequal society in terms of asset distribution.
    Keywords: Pension reforms, life-cycle heterogeneous-agent model, distributional effects
    JEL: E24 H31 H55 J26
    Date: 2015
  10. By: Nie, Jun (Federal Reserve Bank of Kansas City); Luo, Yulei; Li, Wei
    Abstract: In this paper we examine the effects of elastic information-processing capacity (or optimal inattention) proposed in Sims (2010) on international consumption and income correlations in a tractable small open economy (SOE) model with exogenous income processes. We find that in the presence of capital mobility in financial markets, optimal inattention due to fixed information-processing cost lowers the international consumption correlations by generating heterogeneous consumption adjustments to income shocks across countries facing different macroeconomic uncertainty. In addition, we show that RI can also improve the model's predictions for the other key moments of the joint dynamics of consumption and income. Finally, we show that the main conclusions of our benchmark model do not change in an extension with capital accumulation.
    Keywords: Rational inattention; Elastic capacity; Risk sharing; International consumption correlations
    JEL: D83 E21 F41 G15
    Date: 2015–12–01
  11. By: Stevens, Luminita (Federal Reserve Bank of Minneapolis); Chahrour, Ryan (Boston College)
    Abstract: We develop a model of equilibrium price dispersion via retailer search and show that the degree of market segmentation within and across countries cannot be separately identified by good-level price data alone. We augment a set of well-known empirical facts about the failure of the law of one price with data on aggregate intranational and international trade quantities, and calibrate the model to match price and quantity facts simultaneously. The calibrated model matches the data very well and implies that within-country markets are strongly segmented, while international borders contribute virtually no additional market segmentation.
    Keywords: Law of one price; Border effect; Real exchange rate
    JEL: E30 F30 F41
    Date: 2015–12–18
  12. By: Rangan Gupta; Patrick T. Kanda; Mampho P. Modise; Alessia Paccagnini
    Abstract: Inflation forecasts are a key ingredient for monetary policy-making – especially in an inflation targeting country such as South Africa. Generally, a typical Dynamic Stochastic General Equilibrium (DSGE) only includes a core set of variables. As such, other variables, for example alternative measures of inflation that might be of interest to policy-makers, do not feature in the model. Given this, we implement a closed-economy New Keynesian DSGE model-based procedure which includes variables that do not explicitly appear in the model. We estimate such a model using an in-sample covering 1971Q2 to 1999Q4 and generate recursive forecasts over 2000Q1 to 2011Q4. The hybrid DSGE performs extremely well in forecasting inflation variables (both core and nonmodelled) in comparison with forecasts reported by other models such as AR(1). In addition, based on ex-ante forecasts over the period 2012Q1–2013Q4, we find that the DSGE model performs better than the AR(1) counterpart in forecasting actual GDP deflator inflation.
    Keywords: DSGE model; Inflation; Core variables; Noncore variables
    JEL: C11 C32 C53 E27 E47
    Date: 2015
  13. By: Thomas Brzustowski (London School of Economics and Political Science (LSE)); Nicolas Petrovsky-Nadeau (Tepper School of Business); Etienne Wasmer (Département d'économie)
    Abstract: We build a flexible model with search frictions in three markets: credit, labor, and goods markets. We then apply this model (called CLG) to three different economies: a flexible, finance-driven economy (the UK), an economy with wage moderation (Germany), and an economy with structural rigidities (Spain). In the three countries, goods and credit market frictions play a dominant role in entry costs and account for 75% to 85% of total entry costs. In the goods market, adverse supply shocks are amplified through their propagation to the demand side, as they also imply income losses for consumers. This adds up to, at most, an additional 15% to 25% to the impact of the shocks. Finally, the speed of matching in the goods market and the credit market accounts for a small fraction of unemployment: Most of the variation in unemployment comes from the speed of matching in the labor market.
    Keywords: Goods market; Credit market; Unemployment
    Date: 2015–12
  14. By: Kai Zhao (University of Connecticut)
    Abstract: This paper studies the impact of social insurance on private insurance and individualwelfare in a dynamic general equilibrium model with uncertain medical expenses and individual health insurance choices. I find that social insurance (modeled as a combination of the minimum consumption floor and the Medicaid program) crowds out private health insurance coverage, and this crowd-out is important for understanding the welfare consequences of social insurance. When the crowding out effect on private insurance is taken into account, the welfare gain from social insurance becomes substantially smaller and under some certain conditions it becomes a welfare loss. The intuition for these results is that the crowding out effect partially offsets the insurance benefits provided by social insurance. The findings of the paper suggest that it is important to consider the endogenous responses on private insurance choices when examining any social insurance policy reform. They also imply that the existence of social insurance programs may be one reason why some Americans do not buy any health insurance.
    Keywords: Saving, Uncertain Medical Expenses, Health Insurance, Means Testing
    JEL: E20 E60 H30 I13
    Date: 2016–01
  15. By: Raouf Boucekkine (AMSE - Aix-Marseille School of Economics - EHESS - École des hautes études en sciences sociales - Centre national de la recherche scientifique (CNRS) - Ecole Centrale Marseille (ECM) - AMU - Aix-Marseille Université, IUF - Institut Universitaire de France - M.E.N.E.S.R. - Ministère de l'Éducation nationale, de l’Enseignement supérieur et de la Recherche); Natali Hritonenko (Prairie View - A&M University); Yuri Yatsenko (School of business, Houston Baptist University - Houston Baptist University)
    Abstract: We study the impact of technological progress on the level of employment in a vintage capital model where: i) capital and labor are gross complementary; ii) labor supply is endogenous and indivisible; iii) there is full employment, and iv) the rate of labor-saving technological progress is endogenous. We characterize the stationary distributions of vintage capital goods and the corresponding equilibrium values for employment and capital lifetime. It is shown that both variables are non-monotonic functions of technological progress indicators. Technological accelerations are found to increase employment provided innovations are not too radical.
    Keywords: vintage capital,technological progress,employment,compensation theory
    Date: 2015–12
  16. By: Francesco Saraceno (OFCE); Sébastien Villemot (OFCE); Mathilde Lemoigne (OFCE (OFCE))
    Abstract: Dans cet article nous effectuons un exercice quantitatif simple permettant d’évaluer l’impact du plan Juncker au sein de la zone euro et sa capacité à faire sortir les économies européennes de la situation de trappe à liquidités dans laquelle elles sont à présent. Nous estimons un modèle d’équilibre général inter- temporel et stochastique (DSGE) de l’économie à partir de données agrégées sur la zone euro, dans lequel nous introduisons l’existence de capital public, dans l’esprit de ce qui a été proposé par Leeper et al. (2010). Nous simulons alors un plan d’investissement avec une composante publique et une composante privée, reproduisant l’effet de levier privé attendu dans le plan Juncker.
    Keywords: Investissement; Investissement public; Trappe à liquidités; Plan Juncker
    Date: 2015–12
  17. By: Arnaud Cheron; Anthony Terriau
    Date: 2015
  18. By: Kokonas, Nikos (Department of Economics, University of Bath); Polemarchakis, Herakles (Department of Economics, University of Warwick)
    Abstract: In a stochastic economy of overlapping generations subject to uninsurable risks, competitive allocations need not be constrained optimal. This is the case even in the presence of long-lived assets and no short sales.
    Keywords: long-lived assets ; optimality
    JEL: D52 D61
    Date: 2015
  19. By: Daisuke Ikeda (Director and Senior Economist, Institute for Monetary and Economic Studies, Bank of Japan (currently Financial System and Bank Examination Department, E-mail:; Yasuko Morita (Director and Senior Economist, Institute for Monetary and Economic Studies, Bank of Japan@(E-mail:
    Abstract: Following the start of modern economic growth around the mid- 1880s, Japanfs economy continued to substantially lag behind leading economies before World War II, but achieved rapid catch-up after the war. To explain the patterns, we build a dynamic model and examine the role of barriers to technology adoption. We find such barriers hampered catch-up in the prewar period and explain about 40 percent of the postwar miracle. Taking a historical perspective, we argue that factors that acted as barriers include low capacity to absorb technology, economic and political frictions with the outside world, and a lack of competition.
    Keywords: Japan, Barriers to technology adoption, Investment specific technology, Catch-up, Postwar miracle
    JEL: N15 N75 O11 O41
    Date: 2016–01
  20. By: Ranaldo, Angelo; Rupprecht, Matthias; Wrampelmeyer, Jan
    Abstract: We provide the first comprehensive theoretical model for money markets encompassing unsecured and secured funding, asset markets, and central bank policy. Capital-constrained, leveraged banks invest in assets and raise short-term funds by borrowing in the unsecured and secured money markets. Our model derives how funding liquidity across money markets is related, explains how a shock to asset values can lead to mutually reinforcing liquidity spirals in both money markets, and shows how borrowers' flight-to-safety and risk-seeking behavior impacts their liability structure. We derive the social optimum and show which combination of conventional and unconventional monetary policies and regulatory measures can reduce money market fragility.
    Date: 2016–01

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