nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2016‒03‒17
25 papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Implementing the Zero Lower Bound in an Estimated Regime-Switching DSGE Model By Andrew Binning
  2. Monetary Policy, Residential Investment, and Search Frictions: An Empirical and Theoretical Synthesis By Lunsford, Kurt Graden
  3. Uncertainty-Induced Dynamic Inefficiency and the Optimal Inflation Rate By Jung, Kuk Mo
  4. Macrofinancial Analysis in the World Economy; A Panel Dynamic Stochastic General Equilibrium Approach By Francis Vitek
  5. Input vs. output taxation – a DSGE approach to modelling resource decoupling By Marek Antosiewicz; Jan Witajewski-Baltvilks; Piotr Lewandowski
  6. Occupational Choice, Human Capital, and Financial Constraints By Rui Castro; Pavel Sevcik
  7. Identification of Monetary Policy Shocks within a Svar Using Restrictions Consistent with a DSGE Model By Nikolay Arefiev
  8. Fiscal Policy, Sectoral Allocation, and the Skill Premium: Explaining the Decline in Latin America’s Income Inequality By Juan Guerra-Salas
  9. Fiscal Consolidation During Times of High Unemployment; The Role of Productivity Gains and Wage Restraint By Ruy Lama; Juan Pablo Medina Guzman
  10. A multi-country DSGE model with incomplete Exchange Rate Passthrough: application for the Euro area By Tovonony Razafindrabe
  11. Endogenous information revelation in a competitive credit market and credit crunch By Yuanyuan Li; Bertrand Wigniolle
  12. Informality in Paraguay; Macro-Micro Evidence and Policy Implications By Mauricio Vargas
  13. Recursive Utility and the Solution to the Bellman Equation By Masayuki Yao
  14. Sharing a Ride on the Commodities Roller Coaster; Common Factors in Business Cycles of Emerging Economies By Andres Fernandez; Andres Gonzalez; Diego Rodriguez
  15. Steady as She Goes—Estimating Potential Output During Financial “Booms and Busts†By Helge Berger; Thomas Dowling; Sergi Lanau; Mico Mrkaic; Pau Rabanal; Marzie Taheri Sanjani
  16. The Entrepreneurship Beveridge Curve By Gries, Thomas; Jungblut, Stefan; Naudé, Wim
  17. Dynamic Inefficiency in Decentralized Capital Markets By Kurmann, André; Rabinovich, Stanislav
  18. The post-crisis slump in the Euro Area and the US: evidence from an estimated three-region DSGE model By Kollmann, Robert; Pataracchia, Beatrice; Raciborski, Rafal; Ratto, Marco; Roeger, Werner; Vogel, Lukas
  19. Macroeconomic Impacts of Gender Inequality and Informality in India By Purva Khera
  20. Human Capital, Public Debt, and Economic Growth: A Political Economy Analysis By Tetsuo Ono; Yuki Uchida
  21. Monetary Commitment and the Level of Public Debt By Stefano Gnocchi; Luisa Lambertini
  22. A Possible Explanation of the Missing Deflation Puzzle By Engin Kara; Ahmed Jamal Pirzada
  23. On existence, efficiency and bubbles of Ramsey equilibrium with borrowing constraints By Robert Becker; Stefano Bosi; Cuong Le Van; Thomas Seegmuller
  24. On the Mechanics of New Keynesian Models By Peter Rupert; Roman Sustek
  25. Deadlines and Matching By Baughman, Garth

  1. By: Andrew Binning
    Abstract: The Zero Lower Bound (ZLB) on policy rates is one of the key monetary policy issues du jour. In this paper we investigate the problem of modelling and estimating the ZLB in a simple New Keynesian model with regime switches. The key features of the model include switches in the time preference shock, productivity growth rate and the steady state rate of inflation leading to two steady states: a normal steady state and a ZLB steady state. The model is fitted to US data using Bayesian methods and is found to match the US experience over the great moderation and the ZLB periods very well. The key features of the model allow us to test competing theories about the determinants of the ZLB steady state. Our results suggest that the ZLB steady state is driven by precautionary savings behavior. It is also found that expectations over different regimes crucially matter for the dynamics of the system.Length: 43 pages
    Keywords: Zero Lower Bound, Regime-switching, DSGE, Bayesian Estimation
    Date: 2016–02
  2. By: Lunsford, Kurt Graden (Federal Reserve Bank of Cleveland)
    Abstract: Using a factor-augmented vector autoregression (FAVAR), this paper shows that residential investment contributes substantially to GDP following monetary policy shocks. Further, it shows that the number of new housing units built, not changes in the sizes of existing or new housing units, drives residential investment fluctuations. Motivated by these results, this paper develops a dynamic stochastic general equilibrium (DSGE) model where houses are built in discrete units and traded through searching and matching. The search frictions transmit shocks to housing construction, making them central to producing fluctuations in residential investment. The interest rate spread between mortgages and risk-free bonds also transmits monetary policy to the housing market. Following monetary shocks, the DSGE model matches the FAVAR’s positive co-movement between nondurable consumption and residential construction spending. In addition, the FAVAR shows that the mortgage spread falls following an expansionary monetary shock, providing empirical support for the DSGE model’s monetary transmission mechanism.
    Keywords: Factor-augmented vector autoregression; interest rate spread; monetary policy; residential investment; search theory;
    JEL: C32 E30 E40 E50 R31
    Date: 2016–02–12
  3. By: Jung, Kuk Mo
    Abstract: I construct an overlapping-generations model of money with Epstein and Zin (1989) preferences and study how aggregate output uncertainty affects the optimal rate of inflation. When money only serves as savings instruments, I find that the optimality of Friedman Rule breaks up only if agents prefer late resolution of uncertainty. However, if an additional role of money as a medium of exchange is introduced, then the Friedman Rule becomes generally suboptimal regardless of agents' preferences for the timing of uncertainty resolution. The aggregate output uncertainty, nevertheless, crucially determines the level of optimal inflation rate in this case.
    Keywords: money; overlapping generations; recursive preferences; optimal inflation
    JEL: E31 E52 E58
    Date: 2016–02
  4. By: Francis Vitek
    Abstract: This paper develops a structural macroeconometric model of the world economy, disaggregated into forty national economies. This panel dynamic stochastic general equilibrium model features a range of nominal and real rigidities, extensive macrofinancial linkages, and diverse spillover transmission channels. A variety of monetary policy analysis, fiscal policy analysis, macroprudential policy analysis, spillover analysis, and forecasting applications of the estimated model are demonstrated. These include quantifying the monetary, fiscal and macroprudential transmission mechanisms, accounting for business cycle fluctuations, and generating relatively accurate forecasts of inflation and output growth.
    Date: 2015–10–28
  5. By: Marek Antosiewicz; Jan Witajewski-Baltvilks; Piotr Lewandowski
    Abstract: Environmental taxes constitute a crucial instrument aimed at reducing resource use through lower production losses, resource-leaner products and more resource-efficient production processes. In this paper we focus on material use and apply a multisector DSGE model to study two types of taxation: tax on material inputs used by industry, energy, construction and transport sectors, and tax on output of these sectors. We allow for endogenous adaption of resource saving technologies. We calibrate the model for the EU27 area using IO matrix. We consider taxation introduced from 2021 and simulate its impact until 2050. We compare the taxes along their ability to induce reduction in material use and raise revenue. We also consider the effect of spending this revenue on reduction of labour taxation. We find that input and output taxation create contrasting incentives and have opposite effects on resource efficiency. The material input tax induces investment in efficiency improving technology which in the long term results in GDP and employment by 15-20% higher in comparison to comparable output tax. We also find that using revenues to reduce taxes on labour has stronger beneficial effects for the input tax.
    Keywords: DSGE model; resource decoupling; technological change; environmental taxes; environmental policy; double dividend
    JEL: C68 Q32 Q43
    Date: 2016–02
  6. By: Rui Castro (University of Western Ontario); Pavel Sevcik (ESG UQAM)
    Abstract: We study the aggregate productivity effects of firm-level financial frictions. Credit constraints affect not only production decisions but also household-level schooling decisions. In turn, entrepreneurial schooling decisions impact firm-level productivities, whose cross-sectional distribution becomes endogenous. In anticipation of future constraints, entrepreneurs under-invest in schooling. Frictions lower aggregate productivity because talent is misallocated across occupations, and capital misallocated across firms. In addition, firm-level productivities are also lower due to distortions induced by the schooling responses. We find that these effects combined account for about 1/5 of the U.S.-India aggregate productivity difference. Requiring the model to match schooling differences significantly amplifies the impact of frictions, and the model accounts for 58% of the aggregate productivity difference.
    Keywords: Aggregate Productivity; Financial Frictions; Entrepreneurship; Human Capital
    JEL: E24 I25 J24 O11 O15 O16
    Date: 2016
  7. By: Nikolay Arefiev (National Research University Higher School of Economics)
    Abstract: I identify and estimate the monetary policy rule and the monetary policy shocks within a structural vector autoregression model for the US economy. I make two contributions to the literature. First, for identi cation I propose to use restrictions consistent with the literature on dynamic stochastic general equilibrium (DSGE) models. Typical DSGE model produces more restrictions than is required for the identi cation, so overidentifying restrictions can be tested against the data. The second contribution is a new method of testing the overidentifying restrictions. This method divides the set of identifying restrictions into subsets, and tests each subset independently of the others. This method does not reject most restrictions produced by the DSGE model. The only rejections provide evidence that the Federal Reserve uses delayed information about the in ation in policy making. The proposed approach to identi cation helps explain and solve the price puzzle problem reported in the previous literature.
    Keywords: graphical identi cation; sparse SVAR; price puzzle.
    JEL: C30 E52
    Date: 2016
  8. By: Juan Guerra-Salas
    Abstract: This paper offers an explanation for the substantial decline in income inequality in Latin America during the 2000s, which is known to have been mainly driven by a decline in the skill premium. The 2000s were characterized by an economic expansion concentrated on low-skill-intensive service sectors. The expansion induced an increase in the demand for low-skilled labor relative to highskilled labor, which compressed the skill premium. Procyclical fiscal policy exacerbated the distributional effects of the boom by contributing to the growth of the service sector. I first document the expansion was concentrated on services while manufacturing lagged behind, and show declining inequality is associated with procyclical fiscal policy. I then rationalize the evidence using a small open economy DSGE model that features a low-skill-intensive nontradable sector relative to the tradable sector, and procyclical government purchases. This framework implies that at least part of the decline in inequality is transitory, a prediction supported by recent data
    Date: 2016–02
  9. By: Ruy Lama; Juan Pablo Medina Guzman
    Abstract: This paper studies the Swedish fiscal consolidation episode of the 1990s through the lens of a small open economy model with distortionary taxation and unemployment. We argue that the simultaneous reduction in the fiscal deficit and unemployment rate in this episode stems from two factors: (i) high growth rates of total factor productivity (TFP), experienced after the implementation of structural reforms; and (ii) a sustained wage restraint that occurred during the 1990s. The model simulations show that economic growth, accounted for mostly by TFP gains, improved the fiscal balance by 8 percentage points of GDP through an expansion of the tax base and fiscal revenues. Moreover, the combination of stable wages and higher TFP boosted net exports and led to a reduction in the unemployment rate. A counterfactual simulation assuming stagnant TFP shows that fiscal consolidation measures alone would have generated a double-digit unemployment rate without eliminating the fiscal deficit.
    Keywords: Sweden;Europe;Fiscal Consolidation, Search Models of Unemployment, Small Open Economy, productivity, economy, unemployment, competition, unemployment rate, Unemployment: Models, Duration, Incidence, and Job Search, Incidence,
    Date: 2015–12–10
  10. By: Tovonony Razafindrabe
    Date: 2016–02–18
  11. By: Yuanyuan Li (University of Bielefeld - University of Bielefeld, CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique); Bertrand Wigniolle (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics)
    Abstract: In this paper, we propose a new mechanism able to explain the occurrence of credit crunches. Considering a credit market with an asymmetry of information between borrowers and lenders, we assume that borrowers have to pay a cost to reveal information on the quality of their project. They decide to be transparent if it is necessary for getting a loan or for paying a lower interest rate. Two types of competitive equilibria may exist: an opaque equilibrium in which all projects receive funding without revealing information; a transparent one in which only the best projects reval information and receive funding. It is also possible to get multiple equilibria. Incorporating this microeconomic mechanism in an OLG model, the economy may experience fluctuations due to the change of regime, and indeterminacy may occur.
    Keywords: endogenous information revelation,credit crunch
    Date: 2016–01
  12. By: Mauricio Vargas
    Abstract: Paraguay’s economy features a high degree of informality. Based on different estimation approaches, informal activity represents more than half of total employment in Paraguay, a higher rate than those observed in its Latin American and the Caribbean peers. Theoretical and empirical considerations support the notion that regulations, enforcement policies, and government effectiveness are the ultimate determinants of informality. In all of these areas Paraguay performs weakly compared to regional peers. Using household and enterprise surveys, we find that Paraguay’s informal sector absorbs the most vulnerable workers but affects negatively medium and large firms in the formal sector. DSGE model simulations suggest that the optimal combination of policies to reduce informality is not straightforward, and needs to reflect the specific circumstances and objectives of the country.
    Keywords: Western Hemisphere;Paraguay;Informal Economy, Labor Regulations, Tax System, economy, income, taxes, gdp, production, Tax System.,
    Date: 2015–11–24
  13. By: Masayuki Yao (Research Associate (Non-tenured), Department of Economics, Keio University)
    Abstract: This study infinite-horizon deterministic dynamic programming problems based on recursive utility in discrete time. Under a small number of conditions, we show that the Bellman operator has a fixed point using Knaster-Tarski's fixed point theorem. We also show the fixed point of the Bellman operator can be computed by iteration from the initial function between the lower boundary and the fixed point. To show the convergence theorem, we use Tarski-Kantorovitch's fixed point theorem.
    Keywords: Recursive utility, Fixed point theorem, Dynamic programming, Bellman equation
    JEL: C61 O41
    Date: 2016–02
  14. By: Andres Fernandez; Andres Gonzalez; Diego Rodriguez
    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: Business cycles;Commodity prices;Emerging economies, common factors, Bayesian estimation, dynamic stochastic equilibrium models, commodity, prices, price, commodity price, Open Economy Macroeconomics, International Business Cycles, All Countries, dynamic stochastic equilibrium models.,
    Date: 2015–12–29
  15. By: Helge Berger; Thomas Dowling; Sergi Lanau; Mico Mrkaic; Pau Rabanal; Marzie Taheri Sanjani
    Abstract: Potential output—in the sense of the GDP level or path an economy can sustain over the medium term—is a crucial benchmark for policymakers. However, it is difficult to estimate when financial “booms and busts†are driving the real economy. This paper uses a simple multivariate filtering approach to illustrate the role financial variables play in driving potential or sustainable output. The results suggest that it moves more steadily during financial “boom and bust†periods than implied by conventional HP filter estimates, which tend to more closely follow actual GDP. A two-region, multisector New Keynesian DSGE model with financial frictions sheds light on the economic forces that could be behind the results obtained from the filter. This has important implications for policymakers.
    Keywords: Potential output;Credit;Output gap, variables, gdp, demand, Financial Markets and the Macroeconomy, Model Construction and Estimation, Estimation, All Countries,
    Date: 2015–11–09
  16. By: Gries, Thomas (University of Paderborn); Jungblut, Stefan (University of Paderborn); Naudé, Wim (Maastricht University)
    Abstract: We propose that the rate of creation and failure of start-up firms can be modelled as a search and matching process, following labor market matching models. Setting out an endogenous growth model with entrepreneurship we derive a Entrepreneurship Beveridge Curve, through which we illustrate that entrepreneurial start-ups are the outcome of the efficiency with which entrepreneurial abilities are matched with business opportunities. The Entrepreneurship Beveridge Curve is a potentially useful analytical tool to add to the formalization of the economics of entrepreneurship, and we mention a number of extentions and applications.
    Keywords: entrepreneurship, start-ups, labor market matching
    JEL: L26 M13 O10 O14
    Date: 2016–02
  17. By: Kurmann, André (School of Economics); Rabinovich, Stanislav (Department of Economics Amherst College)
    Abstract: We study the efficiency implications of bargaining in frictional capital markets in which firms match bilaterally with dealers in order to buy or sell capital. We show how two of the distinguishing characteristics of capital – ownership and the intertemporal nature of investment – give rise to a dynamic inefficiency. Firms that anticipate buying capital in the future overinvest because this increases their outside option of no trade in negotiations with dealers in the future, thereby lowering the bargained purchase price. Vice versa, firms that anticipate selling capital in the future strategically underinvest because this increases the bargained sale price. If the only motive for trade is capital depreciation, there is overinvestment in capital. With stochastic productivity, there is insufficient dispersion of capital across firms and investment is insufficiently responsive to shocks. A regressive tax on capital can restore the efficient capital allocation.
    Keywords: Dynamic inefficiency; trading frictions; bargaining; over-the-counter markets.
    JEL: D83 G11 G12
    Date: 2016–02–17
  18. By: Kollmann, Robert (ECARES, Université Libre de Bruxelles and CEPR); Pataracchia, Beatrice (European Commission, Joint Research Centre); Raciborski, Rafal (European Commission, DG ECFIN); Ratto, Marco (European Commission, Joint Research Centre); Roeger, Werner (European Commission, DG ECFIN); Vogel, Lukas (European Commission, DG ECFIN)
    Abstract: The global financial crisis (2008-09) led to a sharp contraction in both Euro Area (EA) and US real activity, and was followed by a long-lasting slump. However, the post-crisis adjustment in the EA and the US shows striking differences—in particular, the EA slump has been markedly more protracted. We estimate a three-region (EA, US and Rest of World) New Keynesian DSGE model (using quarterly data for 1999-2014) to quantify the drivers of the divergent EA and US adjustment paths. Our results suggest that financial shocks were key drivers of the 2008-09 Great Recession, for both the EA and the US. The post-2009 slump in the EA mainly reflects a combination of adverse aggregate demand and supply shocks, in particular lower productivity growth, and persistent adverse shocks to capital investment, linked to the continuing poor health of the EA financial system. Adverse financial shocks were less persistent for the US. The financial shocks identified by the model are consistent with observed performance indicators of the EA and US banking systems.
    JEL: C5 E2 E3 E5 E6 F3 F4
    Date: 2016–02–29
  19. By: Purva Khera
    Abstract: This paper examines the macroeconomic interaction between informality and gender inequality in the labor market. A dynamic stochastic general equilibrium model is built to study the impact of gender-targeted policies on female labor force participation, female formal employment, gender wage gap, as well as on aggregate economic outcomes. The model is estimated using Bayesian techniques and Indian data. Although these policies are found to increase female labor force participation and output, lack of sufficient formal job creation due to labor market rigidities leads to an increase in unemployment and informality, and further widens gender gaps in formal employment and wages. Simultaneously implementing such policies with formal job creating policies helps remove these adverse impacts while also leading to significantly larger gains in output.
    Keywords: Poverty and inequality;India;Gender;Labor markets;Labor force participation;Informal sector;General equilibrium models;gender inequality, informality, DSGE model, Indian economy, Bayesian estimation
    Date: 2016–02–09
  20. By: Tetsuo Ono (Graduate School of Economics, Osaka University); Yuki Uchida (Graduate School of Economics, Osaka University)
    Abstract: This study considers public education policy and its impact on growth and wel- fare across generations. In particular, the study compares two fiscal perspectives| tax finance and debt finance|and shows that in a competitive equilibrium context, the growth and utility in the debt-finance case could be higher than those in the tax-finance case in the long run. However, the result is reversed when the policy is shaped by politics. Voters choose debt finance, despite its worse performance, in each period because a current generation can pass the cost of debt repayment to future generations.
    Keywords: Economic growth, Human capital, Public debt, Political equilib- rium
    JEL: D70 E24 H63
    Date: 2016–01
  21. By: Stefano Gnocchi; Luisa Lambertini
    Abstract: We analyze the interaction between committed monetary policy and discretionary fiscal policy in a model with public debt, endogenous government expenditures, distortive taxation and nominal rigidities. Fiscal decisions lack commitment but are Markov-perfect. Monetary commitment to an interest rate path leads to a unique level of debt. This level of debt is positive if the central bank adopts closed-loop strategies that raise the real interest rate when inflation is above target owing to fiscal deviations. More aggressive defence of the inflation target implies lower debt and higher welfare. Simple Taylor-type interest rate rules achieve welfare levels similar to those generated by sophisticated closed-loop strategies.
    Keywords: Credibility; Fiscal policy; Inflation targets; Monetary policy framework
    JEL: E24 E32 E52
    Date: 2016
  22. By: Engin Kara; Ahmed Jamal Pirzada
    Abstract: During the Great Recession, despite the large fall in output, the fall in inflation was modest. This is known as the missing deflation puzzle. In this paper, we develop and estimate a New Keynesian model to provide an explanation for the puzzle. The new model allows for time-varying volatility in cross-sectional idiosyncratic uncertainty and accounts for changes in intermediate goods prices. Our model can forecast the large fall in output and stable inflation during the Great Recession. We show that ination did not fall much because intermediate goods prices were increasing during the Great Recession.
    Keywords: Price Mark-up Shocks; Great Recession; Ination; DSGE; Intermediate Inputs.
    Date: 2016–03–01
  23. By: Robert Becker; Stefano Bosi; Cuong Le Van; Thomas Seegmuller
    Date: 2016–02–18
  24. By: Peter Rupert (Department of Economics University of California-Santa Barbara (UCSB)); Roman Sustek (School of Economics and Finance Queen Mary; Centre for Macroeconomics (CFM))
    Abstract: We scrutinize the monetary transmission mechanism in New-Keynesian models, focusing on the role of capital, the key ingredient in the transition from the basic framework to DSGE models. The widely held view that monetary policy affects output and inflation in these models through a real interest rate channel is shown to be misguided. A decline in output and inflation is consistent with a decline, increase, or no change in the real interest rate. The expected path of Taylor rule shocks and the New-Keynesian Phillips Curve are key for inflation and output; the real rate largely reflects consumption smoothing.
    Keywords: New-Keynesian models, monetary transmission mechanism, real interest rate channel, capital
    JEL: E30 E40 E50
    Date: 2016–02
  25. By: Baughman, Garth (Board of Governors of the Federal Reserve System (U.S.))
    Abstract: Deadlines and fixed end dates are pervasive in matching markets including school choice, the market for new graduates, and even financial markets such as the market for federal funds. Deadlines drive fundamental non-stationarity and complexity in behavior, generating significant departures from the steady-state equilibria usually studied in the search and matching literature. I consider a two-sided matching market with search frictions where vertically differentiated agents attempt to form bilateral matches before a deadline. I give conditions for existence and uniqueness of equilibria, and show that all equilibria exhibit an "anticipation effect" where less attractive agents become increasingly choosy over time, preferring to wait for the opportunity to match with attractive agents who, in turn, become less selective as the deadline approaches. When payoffs accrue after the deadline, or agents do not discount, a sharp characterization is available: at any point in time, the market is segmented into a first class of matching agents and a second class of waiting agents. This points to a different interpretation of unraveling observed in some markets and provides a benchmark for other studies of non-stationary matching. A simple intervention -- a small participation cost -- can dramatically improve efficiency.
    Keywords: Deadlines; matching; nonstationary dynamics; search
    Date: 2016–02–24

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