nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2016‒03‒23
thirty-two papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Aging and Health Financing in the US: A General Equilibrium Analysis By Juergen Jung; Chung Tran; Matthew Chambers
  2. Unions in a frictional labor market By Rudanko, Leena; Krusell, Per
  3. Labor force participation, wage rigidities, and inflation By Francesco Nucci; Marianna Riggi
  4. Fertility, Retirement Age, and PAYG Pensions By Chen, Hung-Ju
  5. Solution and Estimation Methods for DSGE Models By Jesús Fernández-Villaverde; Juan F. Rubio Ramírez; Frank Schorfheide
  6. Subprime Borrowers, Securitization and the Transmission of Business Cycles By Grodecka, Anna
  7. Bank Lending, Collateral, and Credit Traps in a Monetary Union By Corbisiero, Giuseppe
  8. Behavioral Macroeconomics Via Sparse Dynamic Programming By Xavier Gabaix
  9. PIIGS in the Euro Area. An Empirical DSGE Model By Alice, Albonico; Alessia, Paccagnini; Patrizio, Tirelli
  10. On the Desirability of Capital Controls By Jonathan Heathcote; Fabrizio Perri
  11. Endogenous Volatility at the Zero Lower Bound: Implications for Stabilization Policy By Susanto Basu; Brent Bundick
  12. The Interaction and Sequencing of Policy Reforms By Jose Asturias; Sewon Hur; Timothy J. Kehoe; Kim J. Ruhl
  13. Secular Labor Reallocation and Business Cycles By Gabriel Chodorow-Reich; Johannes Wieland
  14. Health-care reform or labor market reform? a quantitative analysis of the Affordable Care Act By Nakajima, Makoto; Tuzemen, Didem
  15. Credit frictions and the cleansing effect of recessions. By S. Osotimehin; F. Pappadà
  16. Inequality and Social Discounting By Emmanuel Farhi; Ivan Werning
  17. Credit constraints and differential growth in equilibrium modeling of EMU and global trade imbalances By Karl Farmer; Bogdan Mihaiescu
  18. On Indeterminacy and Growth under Progressive Taxation and Utility-Generating Government Spending By Jang-Ting Guo; Shu-Hua Chen
  19. Recursive Contracts and Endogenously Incomplete Markets By Mikhail Golosov; Aleh Tsyvinski; Nicolas Werquin
  20. Medical care within an OLG economy with realistic demography By Frankovic, Ivan; Kuhn, Michael; Wrzaczek, Stefan
  21. Political Economy of Sovereign Debt: A Theory of Cycles of Populism and Austerity By Alessandro Dovis; Mikhail Golosov; Ali Shourideh
  22. A Mathematical Model of Foreign Capital Inflow By Gopal K. Basak; Pranab Kumar Das; Allena Rohit
  23. Dynamic Panics: Theory and Application to the Eurozone By Stangebye, Zachary
  24. Accounting for Business Cycles in Canada: I. The Role of Supply-Side Factors By Accolley, Delali
  25. The Government Spending Multiplier in a (Mis-)Managed Liquidity Trap By Jordan Roulleau-Pasdeloup
  26. International Trade Finance and the Cost Channel of Monetary Policy in Open Economies By Nikhil Patel
  27. Credit-fuelled bubbles By Doblas-Madrid, Antonio; Lansing, Kevin J.
  28. On the Mechanics of New-Keynesian Models By Peter Rupert; Roman Šustek
  29. Exchange Rates and Fundamentals: A General Equilibrium Exploration By KANO, Takashi
  30. Good Booms, Bad Booms By Gary Gorton; Guillermo Ordoñez
  31. Monetary policies to counter the zero interest rate: an overview of research By Honkapohja, Seppo
  32. Wholesale Banking and Bank Runs in Macroeconomic Modelling of Financial Crises By Mark Gertler; Nobuhiro Kiyotaki; Andrea Prestipino

  1. By: Juergen Jung (Department of Economics, Towson University); Chung Tran (Research School of Economics, The Australian National University); Matthew Chambers (Department of Economics, Towson University)
    Abstract: We quantify the effects of population aging on the US healthcare system. Our analysis is based on a stochastic general equilibrium overlapping generations model of endogenous health accumulation calibrated to match pre-2010 U.S. data. We find that population aging not only leads to large increases in medical spending but also a large shift in the relative size of public vs. private insurance. Without the Affordable Care Act (ACA), aging itself leads to a 36.6 percent increase in health expenditures by 2060. The group based health insurance (GHI) market shrinks, while the individual based health insurance (IHI) market and Medicaid expand significantly. Additional funds equivalent to roughly 4 percent of GDP are required to finance Medicare in 2060 as the elderly dependency ratio increases. The introduction of the ACA increases the fraction of insured workers to 99 percent by 2060, compared to 81 percent without the ACA. This additional increase is mainly driven by the further expansion of Medicaid and the IHI market. Interestingly, the ACA reduces aggregate health care spending by enrolling uninsured workers into Medicaid which pays lower prices for medical services. Overall, the ACA adds to the fiscal cost of population aging mainly via the Medicare and Medicaid expansion.
    Keywords: Population aging, health expenditures, Medicare/Mediaid, Affordable Care Act 2010, Grossman model of health capital, endogenous health spending and financing, general equilibrium.
    JEL: H51 I13 J11 E21 H62
    Date: 2016–03
  2. By: Rudanko, Leena (Federal Reserve Bank of Philadelphia); Krusell, Per (Stockholm University, CEPR, and NBER)
    Abstract: We analyze a labor market with search and matching frictions in which wage setting is controlled by a monopoly union. Frictions render existing matches a form of firm-specific capital that is subject to a hold-up problem in a unionized labor market. We study how this hold-up problem manifests itself in a dynamic infinite horizon model with fully rational agents. We find that wage solidarity, seemingly an important norm governing union operations, leaves the unionized labor market vulnerable to potentially substantial distortions because of hold-up. Introducing a tenure premium in wages may allow the union to avoid the problem entirely, however, potentially allowing efficient hiring. Under an egalitarian wage policy, the degree of commitment to future wages is important for outcomes: With full commitment to future wages, the union achieves efficient hiring in the long run but hikes up wages in the short run to appropriate rents from firms. Without commitment, and in a Markov perfect equilibrium, hiring is well below its efficient level both in the short and the long run. We demonstrate the quantitative impact of the union in an extended model with partial union coverage and multiperiod union contracting.
    Keywords: Labor unions; Frictional labor markets; Time inconsistency; Limited commitment
    JEL: E02 E24 J51 J64
    Date: 2016–02–29
  3. By: Francesco Nucci (Bank of Italy); Marianna Riggi (Bank of Italy)
    Abstract: The fall in US labor force participation during the Great Recession stands in sharp contrast with its parallel increase in the euro area. In addition to structural forces, cyclical factors are shown to account for this phenomenon, with the participation rate being procyclical in the US from the inception of the crisis and countercyclical in the euro area. We rationalize these diverging dynamics by using a general equilibrium business cycle model, which nests the endogenous participation decisions into a search and matching model. We show that the "added worker" effect might outweigh the "discouragement effect" if real wage rigidities are allowed for and/or habit in consumer preferences is sufficiently strong. We then draw the implications of variable labor force participation rates for inflation and establish the following result: if endogenous movements in labor market participation are envisaged, then the degree of real wage rigidities becomes almost irrelevant for price dynamics. Indeed, during recessions, the upward pressures on inflation stemming from the lack of a downward adjustment in real wages are offset by an opposite influence from the additional looseness in the labor market, due to the higher participation rate associated with wage rigidities.
    Keywords: labor force participation, real wage rigidities, habit, inflation, discouragement effect, added worker effect
    JEL: E31 E32 E24
    Date: 2016–02
  4. By: Chen, Hung-Ju
    Abstract: This paper develops an overlapping generations (OLG) model with exogenous and endogenous retirement age to examine the effects of fertility on long-run pay-as-you-go (PAYG) pensions. We find that in both cases, pensions may not necessarily increase with the fertility rate. In the case with exogenous retirement age, an increase in the fertility rate (retirement age) may raise pensions when the output elasticity of capital is low. When the output elasticity of capital is high, an increase in the fertility rate (retirement age) will reduce (raise) pensions if the tax rate is sufficiently high. In the case with endogenous retirement age, a higher fertility rate will reduce pensions if the fertility rate is sufficiently high, but such a change will raise pensions if the output elasticity of capital and the tax rate are sufficiently low. Our results indicate that raising the fertility rate is more likely to reduce pensions in developing countries than in developed countries, while such a change tends to raise pensions for countries with sufficiently low output elasticity of capital and tax rate.
    Keywords: Fertility; Retirement; OLG, PAYG pensions.
    JEL: H55 J13 J26
    Date: 2016–03–02
  5. By: Jesús Fernández-Villaverde; Juan F. Rubio Ramírez; Frank Schorfheide
    Abstract: This paper provides an overview of solution and estimation techniques for dynamic stochastic general equilibrium (DSGE) models. We cover the foundations of numerical approximation techniques as well as statistical inference and survey the latest developments in the field.
    JEL: C11 C13 C32 C52 C61 C63 E32 E52
    Date: 2016–01
  6. By: Grodecka, Anna (Financial Stability Department, Central Bank of Sweden)
    Abstract: A growing literature (i.e. Jaffee, Lynch, Richardson, and Van Nieuwerburgh, 2009, Acharya and Schnabl, 2009) argues that securitization improves financial stability if the securitized assets are held by capital market participants, rather than financial intermediaries. I construct a quantitative macroeconomic model with a novel specification for mortgage-backed securities (MBS) to evaluate this claim for subprime securitization during the Great Recession. I find that output in the U.S. would have dropped by only about a third and house prices by only a half of what we actually observed, if subprime MBS had been purchased by non-financial agents, rather than held by banks. This is because banks are subject to capital requirements and if MBS remain within the banking system, the fall in their value puts a strain on banks’ balance sheets. The subsequent deleveraging amplifies business cycles. My findings suggest that the existence of the securitization market stabilizes the economy under the condition that financial intermediaries do not engage in the acquisition of securitized assets.
    Keywords: Subprime Borrowers; Securitization; Financial Intermediation; Great Recession
    JEL: E32 E44 G01 G13 G21 R21
    Date: 2016–03–01
  7. By: Corbisiero, Giuseppe (Central Bank of Ireland)
    Abstract: This paper provides a theory to investigate the transmission of non-standard monetary policy to corporate lending in a monetary union where financial frictions limit firms’ access to external finance. The model incorporates a banking-sovereign nexus by assuming that sovereign default would generate a liquidity shock severely hitting domestic banks’ balance sheet. I find that this feature crucially impairs the transmission of monetary policy, generating asymmetric lending responses and the risk of contagion across economies. In particular I show that, in some circumstances, the liquidity injected into the risky country’s banks results in financing the sovereign rather than boosting lending, and sovereign risk in one country generates negative spillover effects on lending throughout the monetary union via the collateral channel. The model sheds light on the troubled transmission of the ECB’s policy measures to the economy of stressed countries during the euro sovereign debt crisis.
    Keywords: Bank Lending, Sovereign Risk, Monetary Policy, Crisis, Euro Area
    JEL: E44 E52 F36 G01 G33
    Date: 2016–03
  8. By: Xavier Gabaix
    Abstract: This paper proposes a tractable way to model boundedly rational dynamic programming. The agent uses an endogenously simplified, or "sparse," model of the world and the consequences of his actions and acts according to a behavioral Bellman equation. The framework yields a behavioral version of some of the canonical models in macroeconomics and finance. In the life-cycle model, the agent initially does not pay much attention to retirement and undersaves; late in life, he progressively saves more, generating realistic dynamics. In the consumption-savings model, the consumer decides to pay little or no attention to the interest rate and more attention to his income. Ricardian equivalence and the Lucas critique partially fail because the consumer may not pay full attention to taxes and policy changes. In a Merton-style dynamic portfolio choice problem, the agent endogenously pays limited or no attention to the varying equity premium and hedging demand terms. Finally, in the neoclassical growth model, agents act on a simplified model of the macroeconomy; in equilibrium, fluctuations are larger and more persistent.
    JEL: D03 E21 E6 G02 G11
    Date: 2016–01
  9. By: Alice, Albonico; Alessia, Paccagnini; Patrizio, Tirelli
    Abstract: We build up and estimate a two-region DSGE model of the Euro area, investigating the interactions between the peripheral countries (PIIGS) and the rest of EMU. Our main focus is on the 2008-2009 financial crisis and on the subsequent 2010-sovereign bond crisis. One striking result is that the two crises are characterized by demand shocks in the core Euro area countries, whereas region-specific permanent technology shocks explain most of output growth slowdown in the PIIGS countries. Our results suggest that the capital flows reversals caused important supply-side e¤ects in the Eurozone periphery.
    Keywords: PIIGS, Euro crisis, two-country DSGE, Bayesian estimation
    JEL: C11 C13 C32 E21 E32 E37
    Date: 2016–03–11
  10. By: Jonathan Heathcote; Fabrizio Perri
    Abstract: In a standard two country international macro model we ask whether imposing restrictions on international non-contingent borrowing and lending is ever desirable. The answer is yes. If one country imposes capital controls unilaterally, it can generate favorable changes in the dynamics of equilibrium interest rates and the terms of trade, and thereby benefit at the expense of its trading partner. If both countries simultaneously impose capital controls, the welfare effects are ambiguous. We identify calibrations in which symmetric capital controls improve terms of trade insurance against country specific shocks, and thereby increase welfare for both countries.
    JEL: F32 F41 F42
    Date: 2016–01
  11. By: Susanto Basu; Brent Bundick
    Abstract: At the zero lower bound, the central bank's inability to offset shocks endogenously generates volatility. In this setting, an increase in uncertainty about future shocks causes significant contractions in the economy and may lead to non-existence of an equilibrium. The form of the monetary policy rule is crucial for avoiding catastrophic outcomes. State-contingent optimal monetary and fiscal policies can attenuate this endogenous volatility by stabilizing the distribution of future outcomes. Fluctuations in uncertainty and the zero lower bound help our model match the unconditional and stochastic volatility in the recent macroeconomic data.
    JEL: E32 E52
    Date: 2015–12
  12. By: Jose Asturias; Sewon Hur; Timothy J. Kehoe; Kim J. Ruhl
    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. The model includes barriers to entry of new firms, barriers to international trade, and barriers to contract enforcement. We find that the same reform can have very different effects on other economic outcomes, depending on the types of distortions present. In our model, we find that 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, we find that reforms to contract enforcement and the barriers to entry are complementary. Finally, the optimal sequence of reforms requires reforming trade barriers before contract enforcement.
    JEL: F13 F4 O11 O19 O24
    Date: 2016–01
  13. By: Gabriel Chodorow-Reich; Johannes Wieland
    Abstract: We study the effect of mean-preserving labor reallocation on business cycle outcomes. We develop an empirical methodology using a local area's exposure to industry reallocation based on the area's initial industry composition and employment trends in the rest of the country over a full employment cycle. Using confidential employment data by local area and industry over the period 1980-2014, we find sharp evidence of reallocation contributing to worse employment outcomes during national recessions but not during national expansions. We repeat our empirical exercise in a multi-area, multi-sector search and matching model of the labor market. The model reproduces the empirical results subject to inclusion of two key, empirically plausible frictions: imperfect mobility across industries, and downward nominal wage rigidity. Combining the empirical and model results, we conclude that reallocation can generate substantial amplification and persistence of business cycles at both the local and the aggregate level.
    JEL: E24 E32 J6
    Date: 2016–01
  14. By: Nakajima, Makoto; Tuzemen, Didem (Federal Reserve Bank of Kansas City)
    Abstract: An equilibrium model with firm and worker heterogeneity is constructed to analyze labor market and welfare implications of the Patient Protection and Affordable Care Act (ACA). Our model implies a significant reduction in the uninsured rate from 22.6 percent to 5.6 percent. {{p}} The model predicts a moderate positive welfare gain from the ACA, due to redistribution of income through Health Insurance Subsidies at the Exchange as well as Medicaid expansion. About 2.1 million more part-time jobs are created under the ACA, in expense of 1.6 million full-time jobs, mainly because the link between full-time employment and health insurance is weakened. The model predicts a small negative effect on total hours worked (0.36%), partly because of the general equilibrium effect.
    Keywords: Health insurance; Affordable Care Act; Labor market;
    JEL: D91 E24 E65 I10
    Date: 2015–09–01
  15. By: S. Osotimehin; F. Pappadà
    Abstract: Recessions are conventionally considered as times when the least productive firms are driven out of the market. How do credit frictions affect this cleansing effect of recessions? We build and calibrate a model of firm dynamics with credit frictions and endogenous entry and exit to investigate this question. We find that there is a cleansing effect of recessions in the presence of credit frictions, despite their effect on the selection of exiting and entering firms. This result holds true regardless of the nature of the recession: average firm-level productivity rises following a negative aggregate productivity shock, as well as following a negative financial shock. The intensity of the cleansing effect of recessions is however lower in the presence of credit frictions, especially when the recession is driven by a financial shock.
    Keywords: cleansing, business cycles, firm dynamics, credit frictions.
    JEL: E32 E44 D21
    Date: 2016
  16. By: Emmanuel Farhi; Ivan Werning
    Abstract: We explore steady-state inequality in an intergenerational model with altruistically linked individuals who experience privately observed taste shocks. When the welfare function depends only on the initial generation, efficiency requires immiseration: inequality grows without bound and everyone?s consumption converges to zero.We study other efficient allocations in which the welfare function values future generations directly, placing a positive but vanishing weight on their welfare. The social discount factor is then higher than the private one, and for any such difference we find that consumption exhibits mean reversion and that a steady-state, cross-sectional distribution for consumption and welfare exists, with no one trapped at misery.
  17. By: Karl Farmer (University of Graz); Bogdan Mihaiescu (University of Graz)
    Abstract: Increases in the private saving rate in emerging economies and its steady decline in advanced economies, huge external surpluses in the former and similar deficits in the latter and a persistent decline in the world long-term interest rate characterize the evolution of the world economy since Euro-related intra-EMU and global financial integration in the beginning 2000s. While the intra-EMU and global trade imbalances and the interest decline can be explained by means of Farmer and Ban's (2015) three-country OLG model, the saving rate divergence cannot. Coeurdacier et al. (2015) attribute this divergence to the interaction of household credit constraints and international growth differentials in a two-country OLG model. This paper introduces these novel modeling elements into Farmer and Ban's (2015) three-country OLG model, and finds that country-specific credit constraints and Asian's rapid growth enlarge the model-generated trade imbalances and let saving rates decline – to some extent in line with empirical evidence.
    Keywords: Trade Imbalances; European Economic and Monetary Union; Overlapping Generations; Three-Country Model; Global imbalances
    JEL: F36
    Date: 2016–03
  18. By: Jang-Ting Guo (Department of Economics, University of California Riverside); Shu-Hua Chen (National Taipei University)
    Abstract: We examine the theoretical interrelations between progressive income taxation and macroeconomic (in)stability in an otherwise standard one-sector AK model of endogenous growth with utility-generating government purchases of goods and services. In sharp contrast to traditional Keynesian-type stabilization policies, progressive taxation operates like an automatic destabilizer that generates equilibrium indeterminacy and belief-driven fluctuations in our endogenously growing macroeconomy. This instability result is obtained regardless of (i) the degree of the public-spending preference externality, and (ii) whether private and public consumption expenditures are substitutes, complements, or additively separable in the household's utility function.
    Keywords: Progressive Income Taxation, Equilibrium (In)determinacy, Utility-Generating Government Spending, Endogenous Growth.
    JEL: E32 E62
    Date: 2016–03
  19. By: Mikhail Golosov; Aleh Tsyvinski; Nicolas Werquin
    Abstract: In this chapter we study dynamic incentive models in which risk sharing is endogenously limited by the presence of informational or enforcement frictions. We comprehensively overview one of the most important tools for the analysis such problems — the theory of recursive contracts. Recursive formulations allow to reduce often complex models to a sequence of essentially static problems that are easier to analyze both analytically and computationally. We first provide a self-contained treatment of the basic theory: the Revelation Principle, formulating and simplifying the incentive constraints, using promised utilities as state variables, and analyzing models with persistent shocks using the first-order approach. We then discuss more advanced topics: duality theory and Lagrange multiplier techniques, models with lack of commitment, and martingale methods in continuous time. Finally, we show how a variety of applications in public economics, corporate finance, development and international economics featuring incomplete risk-sharing can be analyzed using the tools of the theory of recursive contracts.
    JEL: C61 E2 E61
    Date: 2016–02
  20. By: Frankovic, Ivan; Kuhn, Michael; Wrzaczek, Stefan
    Abstract: We study the role of health care within a continuous time economy of overlapping generations subject to endogenous mortality. The economy consists of two sectors: final goods production and a health care sector, selling medical services to individuals. Individuals demand health care with a view to lowering mortality over their life-cycle. We derive the age-specific individual demand for health care based on the value of life as well as the resulting aggregate demand for health care across the population. We then characterize the general equilibrium allocation of this economy, providing both an analytical and a numerical representation. We study the allocational impact of a medical innovation both in the presence and absence of anticipation; and a temporary baby boom. We place particular emphasis on disentangling general equilibrium from partial equilibrium impacts and identifying the relevant transmission channels.
    Keywords: demographic change,life-cycle model,health care,health policy,medical change,overlapping generations,value of life
    JEL: D91 I11 I12 I18 J11 J17 O31 O41
    Date: 2016
  21. By: Alessandro Dovis; Mikhail Golosov; Ali Shourideh
    Abstract: We study optimal fiscal and redistributive policies in an open economy without commitment. Due to its redistributive motives, the government’s incentive to default on its external debt is affected by inequality. We show that in equilibrium the economy endogenously fluctuates between two regimes. In the first regime, the government borrows from abroad, spends generously on transfers and keeps the inequality low. In the second regime, it implements austerity-like policies by cutting transfers, reducing foreign debt and increasing the inequality. The equilibrium dynamics resembles the populist cycles documented in many developing countries.
    JEL: E60 F30 F34
    Date: 2016–01
  22. By: Gopal K. Basak; Pranab Kumar Das; Allena Rohit
    Abstract: The paper models foreign capital inflow from the developed to the developing countries in a stochastic dynamic programming framework. The model is solved by numerical technique because of the non-linearity of the functions. A number of comparative dynamic analyses explore the impact of parameters of the model on dynamic paths of capital inflow, interest rate in the international loan market and the exchange rate. The model also explores the possibility of financial crisis originating either in the developed country or in the developing country. The explanation of crisis in this structure is based on trade theoretic terms in a dynamic terms of trade framework rather than due to informational imperfections.
    Date: 2016–03
  23. By: Stangebye, Zachary
    Abstract: It is shown in a standard quantitative model of sovereign debt and default that sentiment shocks can alter the distribution of fundamental defaults. The channel through which this occurs is a new type of dynamic lender coordination problem in sovereign debt markets that I call a dynamic panic. During a dynamic panic of this kind, expectations of future negative investor sentiments dilute the price of long-term debt; the sovereign's optimal response to such a panic can be to borrow aggressively, which justifies investors' fears of dilution. Such panics generate naturally many of the unique features the recent Eurozone crisis, and so I explore policy implications in this environment. I find that rate ceilings are an ineffective policy tool but that liquidity provision, appropriately implemented, can eliminate such panics.
    Keywords: Sovereign Debt Crises, Confidence-Driven Crises, Long-Term Debt
    JEL: E44 F34 G01 H63
    Date: 2015–04–14
  24. By: Accolley, Delali
    Abstract: After documenting business cycle facts in Canada, I have used a bunch of popular models to explain them. The common features of these models are: the use of the neoclassical growth framework, the assumption that prices are flexible enough to ensure a general equilibrium, and the reliance on supply-side factors, mainly technological change, to explain business cycles. I have also assessed the ability of these models to replicate these business cycle facts.
    Keywords: Macroeconomics, Business Cycle
    JEL: E32
    Date: 2016–03–03
  25. By: Jordan Roulleau-Pasdeloup
    Abstract: I study the impact of a government spending shock in a New Keynesian model when monetary policy is set optimally. In this framework, the economy is at the Zero Lower Bound but expectations are well managed by the Central Bank. As such, the multiplier effect of government spending increases on expected inflation is small while the one on output can be larger than one. This is consistent with recent empirical evidence on the effects of the 2009 ARRA.
    Keywords: Zero lower bound; New Keynesian; Government spending multiplier
    JEL: E31 E32 E52 E62
    Date: 2016–03
  26. By: Nikhil Patel
    Abstract: This paper models the interaction between international trade finance and monetary policy in open economies and shows that trade finance affects the propagation mechanism of all macroeconomic shocks that are identified to be drivers of business cycles in advanced economies. The model is estimated with Bayesian techniques using output, price and bilateral trade data from the US and the Eurozone. The estimation exercise shows that trade finance conditions, which in turn are driven by US interest rates, are critical in explaining economic fluctuations. Quantitatively, trade finance has a larger impact on spillover effects of shocks to foreign countries, implying that incorporation of trade finance is particularly important when modeling small open economies.
    Keywords: trade finance, monetary policy, DSGE
    Date: 2016–01
  27. By: Doblas-Madrid, Antonio (Michigan State University); Lansing, Kevin J. (Federal Reserve Bank of San Francisco)
    Abstract: In the context of recent housing busts in the United States and other countries, many observers have highlighted the role of credit and speculation in fueling unsustainable booms that lead to crises. Motivated by these observations, we develop a model of credit-fuelled bubbles in which lenders accept risky assets as collateral. Booming prices allow lenders to extend more credit, in turn allowing investors to bid prices even higher. Eager to profit from the boom for as long as possible, asymmetrically informed investors fuel and ride bubbles, buying overvalued assets in hopes of reselling at a profit to a greater fool. Lucky investors sell the bubbly asset at peak prices to unlucky ones, who buy in hopes that the bubble will grow at least a bit longer. In the end, unlucky investors suffer losses, default on their loans, and lose their collateral to lenders. In our model, tighter monetary and credit policies can reduce or even eliminate bubbles. These findings are in line with conventional wisdom on macro prudential regulation, and stand in contrast with those obtained by Galí (2014) in an overlapping generations context.
    JEL: G01 G12
    Date: 2016–03–01
  28. By: Peter Rupert (University of California-Santa Barbara); Roman Šustek (Queen Mary University of London and Centre for Macroeconomics)
    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
  29. By: KANO, Takashi
    Abstract: Engel and West (2005) claim that the observed near random-walk behavior of nominal exchange rates is an equilibrium outcome of a present-value model of a partial equilibrium asset approach when economic fundamentals follow exogenous first-order integrated processes and the discount factor approaches one. Subsequent empirical studies further confirm this proposition by estimating discount factors close to one under distinct identification schemes. In this paper, I argue that the unit market discount factor creates a theoretical trade-off within a neoclassical, two-country, incomplete-market monetary model; on the one hand, the unit discount factor generates near random-walk nominal exchange rates, while, on the other hand, it counterfactually implies perfect consumption risk sharing as well as flat money demand. Bayesian posterior simulation exercises based on post-Bretton Woods data from Canada and the United States reveal difficulties in reconciling the equilibrium random-walk proposition within the canonical model; in particular, the market discount factor is identified as being much smaller than one.
    Keywords: Exchange rate, Present-value model, Economic fundamental, Random walk, Two-country model, Incomplete market, Cointegrated TFPs, Perfect risk sharing
    JEL: E31 E37 F41
    Date: 2016–03–07
  30. By: Gary Gorton; Guillermo Ordoñez
    Abstract: Credit booms are not rare and usually precede financial crises. However, some end in a crisis (bad booms) while others do not (good booms). We document that credit booms start with an increase in productivity, which subsequently falls much faster during bad booms. We develop a model in which crises happen when credit markets change to an information regime with careful examination of collateral. As this examination is more valuable when collateral backs projects with low productivity, crises become more likely during booms that display large productivity declines. As productivity decays over a boom as an endogenous result of more economic activity, a crisis may be the result of an exhausted boom and not necessarily of a negative productivity shock. We test the main predictions of the model and identify the component of productivity behind crises.
    JEL: E32 E44 G01 G1
    Date: 2016–02
  31. By: Honkapohja, Seppo
    Abstract: ​Many central banks have lowered their interest rates close to zero in response to the crisis since 2008. In standard monetary models the zero lower bound (ZLB) constraint implies the existence of a second steady state in addition to the inflation-targeting steady state. Large scale asset purchases (APP) have been used as a tool for easing of monetary policy in the ZLB regime. I provide a theoretical discussion of these issues using a stylized general equilibrium model in a global nonlinear setting. I also review briefly the empirical literature about effects of APP’s.
    Keywords: adaptive learning, monetary policy, inflation targeting, zero interest rate lower bound
    JEL: E63 E52 E58
    Date: 2015–08–20
  32. By: Mark Gertler; Nobuhiro Kiyotaki; Andrea Prestipino
    Abstract: There has been considerable progress in developing macroeconomic models of banking crises. However, most of this literature focuses on the retail sector where banks obtain deposits from households. In fact, the recent financial crisis that triggered the Great Recession featured a disruption of wholesale funding markets, where banks lend to one another. Accordingly, to understand the financial crisis as well as to draw policy implications, it is essential to capture the role of wholesale banking. The objective of this paper is to characterize a model that can be seen as a natural extension of the existing literature that provides a step toward accomplishing this objective. The model accounts for both the buildup and collapse of wholesale banking, and also sketches out the transmission of the crises to the real sector. We also draw out the implications of possible instaibility in the wholesale banking sector for lender-of-last resort policy as well as for macroprudential policy.
    JEL: E44
    Date: 2016–01

This nep-dge issue is ©2016 by Christian Zimmermann. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.