nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2016‒04‒04
seventeen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. A Closer Look at Sectoral Financial Linkages in Brazil I; Corporations’ Financial Statements By Izabela Karpowicz; Fabian Lipinsky; Jongho Park
  2. Discussion of ‘Market Reforms in the Time of Imbalance’ (M. Cacciatore, R.Duval, G. Fiori, F. Ghironi). By Kollmann, Robert; Vogel, Lukas
  3. Robust permanent income in general equilibrium By Luo, Yulei; Nie, Jun; Young, Eric R.
  4. Structural Reform in Germany By Krebs, Tom; Scheffel, Martin
  5. Capital Controls as an Alternative to Credit Policy in a Small Open Economy By Shigeto Kitano; Kenya Takaku
  6. The Welfare Multiplier of Public Infrastructure Investment By Giovanni Ganelli; Juha Tervala
  7. Education Policy and Intergenerational Transfers in Equilibrium By Brant Abbott; Giovanni Gallipoli; Costas Meghir; Giovanni L. Violante
  8. Large Firm Dynamics and the Business Cycle By Vasco M. Carvalho; Basile Grassi; ;
  9. A Note on Simple Monetary Policy Rules with Labour Market and Financial Frictions By Sarunas Girdenas
  10. The Role of Learning for Asset Prices, Business Cycles, and Monetary Policy By Winkler, Fabian
  11. From Physical to Human Capital Accumulation with Pollution By Takumi Motoyama
  12. Unemployment Insurance with Limited Commitment Wage Contracts and Savings By Rigas OIKONOMOU
  13. Business Cycle Asymmetries and the Labor Market By Kohlbrecher, Britta; Merkl, Christian
  14. International Business Cycles and Risk Sharing with Uncertainty Shocks and Recursive Preferences By Kollmann, Robert
  15. Pareto-Improving Optimal Capital and Labor Taxes By Katharina Greulich; Sarolta Laczó; Albert Marcet
  16. Demand shocks, new keynesian model and supply effects of monetary policy By Elliot Aurissergues
  17. Bargaining over Babies: Theory, Evidence, and Policy Implications By Doepke, Matthias; Kindermann, Fabian

  1. By: Izabela Karpowicz; Fabian Lipinsky; Jongho Park
    Abstract: Understanding the interplay between firms’ balance sheets and the macro-economic environment is important for understanding of the Brazilian economy. A close examination of developments in the nonfinancial corporate sector up to the early 2015 reveals weak equity growth, declining profitability, and rising leverage. The empirical work suggests that adverse shocks to financial variables lead to weaker real GDP growth in Brazil through their effect on corporate leverage, borrowing costs, and default frequencies. An estimation based on a DSGE model with financial frictions indicates that the recent economic downturn in Brazil is largely driven by a decrease in total factor productivity and by negative financial shocks.
    Keywords: Brazil;International financial markets;Western Hemisphere;balance sheet analysis, DSGE Bayesian estimation, emerging economies, equity, share, balance sheet, balance sheets, debt, International Lending and Debt Problems, International Business Cycles, General, Computable and Other Applied General Equilibrium Models, Financial Markets and the Macroeconomy,
    Date: 2016–03–02
  2. By: Kollmann, Robert; Vogel, Lukas
    Abstract: To raise employment and output growth in Europe, the leading multilateral economic institutions (EU Commission, IMF, OECD) routinely recommend ‘structural reforms’ of product and labor markets that increase competition and employment flexibility. Existing model-based analyses of those reforms generally use standard New Keynesian dynamic stochastic general equilibrium (DSGE) models in which pro-competition reforms are represented as exogenous reductions in markups (see, e.g., Everaert and Schule (2008), Roeger et al. (2008), Gomes et al. (2014) and Kollmann et al. (2015)). The Cacciatore, Duval, Fiori and Ghironi paper greatly improves the toolbox for modeling structural reforms in a DSGE framework, by allowing for richer and more realistic firm dynamics and labor market frictions than conventional policy models. This enables the paper to highlight important transmission channels of reforms that are ignored by conventional models. Cacciatore, Duval, Fiori and Ghironi provide a very valuable contribution that highlights the role of firm entry and exit and of labor market frictions for the macroeconomic effects of structural reforms. Their work also suggests promising avenues for future research.
    Keywords: Structural reforms, firm dynamics, labor market frictions, current account, household heterogeneity, nominal rigidities
    JEL: E24 E3 F2 F3 F4 J2 J3 J6 L1 L4
    Date: 2015
  3. By: Luo, Yulei; Nie, Jun (Federal Reserve Bank of Kansas City); Young, Eric R.
    Abstract: This paper provides a tractable continuous-time constant-absolute-risk averse (CARA)-Gaussian framework to quantitatively explore how the preference for robustness (RB) affects the interest rate, the dynamics of consumption and income, and the welfare costs of model uncertainty in general equilibrium. We show that RB significantly reduces the equilibrium interest rate, and reduces the relative volatility of consumption growth to income growth when the income process is stationary. Furthermore, we find that the welfare costs of model uncertainty are nontrivial for plausibly estimated income processes and calibrated RB parameter values. Finally, we extend the benchmark model to consider the separation of risk aversion and intertemporal substitution and regime-switching in income growth.
    Keywords: Interest rates; Savings; Income; Consumption; General equilibrium
    JEL: C61 D81 E21
    Date: 2015–10–29
  4. By: Krebs, Tom (University of Mannheim); Scheffel, Martin (University of Cologne)
    Abstract: This paper provides a quantitative evaluation of the macroeconomic, distributional, and fiscal effects of three reform proposals for Germany: i) a reduction in the social security tax in the low-wage sector, ii) a publicly financed expansion of full-day child care and full-day schooling, and iii) the further deregulation of the professional service sector. The analysis is based on a macroeconomic model with physical capital, human capital, job search, and household heterogeneity. All three reforms have positive short-run and long-run effects on employment, wages, and output. The quantitative effects of the deregulation reform are relatively small due to the small size of the professional services in Germany. Policy reforms i) and ii) have substantial macroeconomic effects and positive distributional consequences. Ten years after implementation, reforms i) and ii) taken together increase employment by 1.6 percent, potential output by 1.5 percent, real hourly pre-tax wages in the low-wage sector by 3 percent, and real hourly pre-tax wages of women with children by 2.7 percent. The two reforms create fiscal deficits in the short-run, but they also generate substantial fiscal surpluses in the long-run. They are fiscally efficient in the sense that the present value of short-term fiscal deficits and long-term fiscal surpluses is positive for any interest (discount) rate less than 9 percent.
    Keywords: structural reform, Germany
    JEL: E24 E60 J2 J3
    Date: 2016–03
  5. By: Shigeto Kitano (Research Institute for Economics & Business Administration (RIEB), Kobe University, Japan); Kenya Takaku (Faculty of Business, Aichi Shukutoku University)
    Abstract: We develop a sticky price, small open economy model with financial frictions a la Gertler and Karadi (2011), in combination with liability dollarization. An agency problem between domestic financial intermediaries and foreign investors of emerging economies introduces financial frictions in the form of time-varying endogenous balance sheet constraints on the domestic financial intermediaries. We consider a shock that tightens the balance sheet constraint and show that capital controls, the possibility of which is rigorously examined as a policy tool for the emerging economies, can be an alternative to credit policy employed by advanced economy central banks in mitigating the negative shock.
    Keywords: Capital control, Credit policy, Balance sheets, Small open economy, Nominal rigidities, New Keynesian, DSGE, Financial intermediaries, Financial frictions, Crisis
    JEL: E44 E58 F32 F41
    Date: 2015–03
  6. By: Giovanni Ganelli; Juha Tervala
    Abstract: We analyze the welfare multipliers of public spending (the consumption equivalent change in welfare for one dollar change in public spending) in a DSGE model. The welfare multipliers of public infrastructure investment are positive if infrastructure is sufficiently effective. When the medium-term output multipliers are consistent with the empirical estimates (1-1.4), the welfare multiplier is 0.8. That is, a dollar spent by the government for investment raises domestic welfare by equivalent of 0.8 dollars of private consumption. This suggests that the welfare gains of public infrastructure investment, if chosen wisely, may be substantial.
    Keywords: Public investment;Welfare;Public Infrastructure, investment, consumption, multipliers, elasticity, Open Economy Macroeconomics, Publicly Provided Private Goods, Infrastructures, All Countries,
    Date: 2016–02–29
  7. By: Brant Abbott (University of British Columbia); Giovanni Gallipoli (University of British Columbia); Costas Meghir (Cowles Foundation, Yale University); Giovanni L. Violante (New York University)
    Abstract: This paper examines the equilibrium effects of alternative financial aid policies intended to promote college participation. We build an overlapping generations life-cycle, heterogeneous-agent, incomplete-markets model with education, labor supply, and consumption/saving decisions. Driven by both altruism and paternalism, parents make inter vivos transfers to their children. Both cognitive and non-cognitive skills determine the non-pecuniary cost of schooling. Labor supply during college, government grants and loans, as well as private loans, complement parental resources as means of funding college education. We find that the current financial aid system in the U.S. improves welfare, and removing it would reduce GDP by 4-5 percentage points in the long-run. Further expansions of government- sponsored loan limits or grants would have no salient aggregate effects because of substantial crowding-out: every additional dollar of government grants crowds out 30 cents of parental transfers plus an equivalent amount through a reduction in student’s labor supply. However, a small group of high-ability children from poor families, especially girls, would greatly benefit from more generous federal aid.
    Keywords: Education, Education policy, Public finance, Financial aid, Inter vivos transfers, Altruism, Overlapping generations, Credit constraints, Labor supply, Equilibrium
    JEL: E24 I22 J23 J24
    Date: 2013–02
  8. By: Vasco M. Carvalho; Basile Grassi; ;
    Abstract: Do large firm dynamics drive the business cycle? We answer this question by developing a quantitative theory of aggregate fluctuations caused by firm-level disturbances alone. We show that a standard heterogeneous firm dynamics setup already contains in it a theory of the business cycle, without appealing to aggregate shocks. We offer a complete analytical characterization of the law of motion of the aggregate state in this class of models – the firm size distribution – and show that the resulting closed form solutions for aggregate output and productivity dynamics display: (i) persistence, (ii) volatility and (iii) time-varying second moments. We explore the key role of moments of the firm size distribution – and, in particular, the role of large firm dynamics – in shaping aggregate fluctuations, theoretically, quantitatively and in the data.
    Keywords: Large Firm Dynamics; Firm Size Distribution; Random Growth; Aggregate Fluctuations
    Date: 2016–04–30
  9. By: Sarunas Girdenas (Department of Economics, University of Exeter)
    Abstract: We consider a New-Keynesian model with ?financial and labour market frictions where ?firms borrowing is limited by the enforcement constraint. The wage is set in a bargaining process where the fi?rm?s shareholder and worker share the production surplus. As debt service is considered to be a part of production costs, ?firms borrow to reduce the surplus which allows to lower the wage. We study the model?s response to ?nancial shock under two Taylor-type interest rate rules: ?first one responds to in?ation and borrowing, second - to in?ation and unemployment. We have found that the second rule delivers better policy in terms of the welfare measure. Additionally, we show that the feedback on unemployment in this rule depends on the extent of workers? bargaining power.
    Keywords: Labour Market Frictions, Financial Frictions, Optimal Monetary Policy, Monetary Policy Rules.
    JEL: E52 E43 E24
    Date: 2016
  10. By: Winkler, Fabian
    Abstract: The importance of financial frictions for the business cycle is widely recognized, but it is less recognized that their effects depend heavily on the underlying asset pricing theory. This paper examines the implications of learning-based asset pricing. I construct a model in which firms’ ability to access credit depends on their market value, and investors rely on past observation to predict future stock prices. Agents' expectations remain model-consistent conditional on their beliefs about stock prices, which disciplines the expectation formation process. The model matches several asset price properties such as return volatility and predictability and also leads to a powerful feedback loop between asset prices and real activity, substantially amplifying business cycle shocks. Agents' expectational errors on asset prices spill over to forecasts of economic activity, resulting in forecast error predictability that closely matches survey data. A reaction of monetary po li cy to asset prices is welfare-improving under learning but not under rational expectations.
    Keywords: Asset Pricing ; Credit Constraints ; Learning ; Monetary policy ; Survey Data
    JEL: D83 E32 E44 E52 G12
    Date: 2016–01–20
  11. By: Takumi Motoyama (Graduate School of Economics, Osaka University)
    Abstract: This study examines the process of economic development in an overlapping generations model where higher physical capital involves pollution and deteriorates the productivity of education. In this setting, households may not invest into education and multiple steady states of the physical/human capital ratio can arise, leading long-run production with low initial endowment (physical capital) to be higher than that with high initial endowment. This occurs because, owing to the low productivity of education caused by pollution, only physical capital accumulation occurs with high initial endowment, while physical and human capital accumulation occur with low initial endowment. This result is consistent with the resource curse. We also show that higher abatement technology can solve the resource curse problem since it helps households redirect physical capital accumulation toward human capital accumulation.
    Keywords: Semiconductor Human capital, Pollution, Resource curse
    JEL: I15 O13 Q52
    Date: 2016–03
  12. By: Rigas OIKONOMOU (UNIVERSITE CATHOLIQUE DE LOUVAIN, Institut de Recherches Economiques et Sociales (IRES) and Center for Operations Research and Econometrics (CORE))
    Abstract: I present a model of optimal contracts between firms and workers, under limited commitment and with worker savings. In the model, firms provide insurance against unemployment through targeting a frontloaded path of wages which encourages wealth accumulation. I provide analytical results characterising the wage and savings schedules and the path of consumption during employment and unemployment. I then consider how unemployment benefits affect risk sharing through private markets. I find that benefits should be frontloaded; the government has the incentive to drive the allocation to the point where the firm's participation constraint binds. At this point wages are equal to productivity in every period, wealth exceeds the buffer stock level, and consumption and savings drop over time. The drop in the level of consumption during unemployment is mitigated. Finally, I compare the optimal contract model to the standard heterogeneous agent model whereby wealth is utilized for self-insurance purposes. I show that the two models are equivalent under the optimal UI policy.
    Keywords: Unemployment Insurance, Incomplete Markets, Optimal Contracts, Limited Commitment, Household Self-Insurance
    JEL: D52 E21 H31 H53 J41
    Date: 2016–02–29
  13. By: Kohlbrecher, Britta (University of Erlangen-Nuremberg); Merkl, Christian (University of Erlangen-Nuremberg)
    Abstract: This paper shows that the matching function and the Beveridge curve in the United States exhibit strong nonlinearities over the business cycle. These patterns can be replicated by enhancing a search and matching model with idiosyncratic productivity shocks for new contacts. Large negative aggregate shocks move the hiring cutoff point into a part of the idiosyncratic density function with higher density and thereby generate large, asymmetric job-finding rate and unemployment reactions. Our proposed mechanism is of high relevance as it leads to time varying effects of certain policy interventions.
    Keywords: business cycle asymmetries, matching function, Beverdige curve, job-finding rate, unemployment, effectiveness of policy
    JEL: E24 E32 J63 J64
    Date: 2016–03
  14. By: Kollmann, Robert
    Abstract: This paper analyzes the effects of output volatility shocks on the dynamics of consumption, trade flows and the real exchange rate, in a two-country, two-good world with consumption home bias, 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, to compensate for the greater riskiness of the country’s output stream. This risk sharing transfer raises the country’s consumption, lowers its trade balance and appreciates its real exchange rate. In the recursive preferences framework here, volatility shocks account for a non-negligible 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 and the real exchange rate.
    Keywords: uncertainty shocks, international business cycles, international risk sharing, external balance, exchange rate, consumption-real exchange rate anomaly
    JEL: E3 F3 F4
    Date: 2016
  15. By: Katharina Greulich; Sarolta Laczó; Albert Marcet
    Abstract: We study Pareto-optimal fiscal policy in a model with agents who are heterogeneous in their labor productivity and wealth. We show a natural modification of the standard Ramsey problem to guarantee that long-run capital taxes are zero. We focus on Pareto-improving policies and we find that a gradual reform is crucial in achieving a Pareto improvement: labor taxes should be cut and capital taxes should remain high for a very long time before reaching zero. Therefore, the long-run optimal tax mix is the opposite of the short- and medium-run one. This policy redistributes wealth in favor of workers so that all agents benefit, and it favors quick capital growth after the reform. The labor tax cut is financed by deficits which lead to a positive level of government debt in the long run, reversing the standard prediction that the government accumulates savings in models with optimal capital taxes. The welfare benefits from the tax reform are relatively large and they can be shifted entirely to capitalists or workers by varying the length of the transition. We address a number of technical issues such as sufficiency of Lagrangian solutions in a Ramsey problem, relation of Pareto-improving allocations with welfare functions, asymptotic behavior, and solution algorithms.
    Keywords: fiscal policy, Pareto-improving tax reform, redistribution
    JEL: E62 H21
    Date: 2016–03
  16. By: Elliot Aurissergues (EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics)
    Abstract: Demand shocks likely play a key role in driving business cycles. However, in the standard new keynesian model, the monetary policy reaction to these shocks have a supply side effect. The change in real rate affects the marginal utility of consumption generating an income effect on labor supply. Wages, inflation and through monetary policy, aggregate demand will increase. This supply side effect have a surprising importance for the model, especially when the sensi- tivity of aggregate demand to interest rate is low. A demand shock will have a large impact (close to one) on output, but a very small one on the output gap. The limited monetary policy movement induced by the taylor rule remains very close to the natural rate of interest. There are nearly no differences between the sticky price and the flexible price model. It represents a very disappointing result, the entire purpose of sticky prices being to generate inefficiencies when the aggregate demand is hit. Coupled with very tiny empirical support for this supply side effect of monetary policy, it suggests to explore the theoretical possibilities to kill this ef- fect. First, we review the two ways the literature have proposed, nonseparable preferences and sticky wages. The main drawback is a strong reliance on very specific assumption for the labor market. We explore an alternative approach. We attempt a radical departure from traditionnal assumption about the optimizing behavior of the representative agent. Instead of optimizing simulatneously with respect to hours, consumption and saving, the household decomposes the problem in two steps. First, the agent chooses between labor income and hours. Second, he optimizes between consumption and saving. The interest is to disentangle the income effect which affects the labor equation and those affecting the intertemporal choice. Thus it is possible to reduce the wealth effect on labor supply whereas keeping a low sensitivity of consumption to interest rate. This flexible approach also allows to challenge the effect of interest rate on wealth offering a potential explanation for small effects of interest rate on both labor supply and consumption whereas keeping large income effects.
    Keywords: Demand shock, comovement, labor supply, elasticity of intertemporal substitution, wealth effect
    Date: 2016–02
  17. By: Doepke, Matthias (Northwestern University); Kindermann, Fabian (University of Bonn)
    Abstract: It takes a woman and a man to make a baby. This fact suggests that for a birth to take place, the parents should first agree on wanting a child. Using newly available data on fertility preferences and outcomes, we show that indeed, babies are likely to arrive only if both parents desire one, and there are many couples who disagree on having babies. We then build a bargaining model of fertility choice and match the model to data from a set of European countries with very low fertility rates. The distribution of the burden of child care between mothers and fathers turns out to be a key determinant of fertility. A policy that lowers the child care burden specifically on mothers can be more than twice as effective at increasing the fertility rate compared to a general child subsidy.
    Keywords: fertility, bargaining, child care
    JEL: J13
    Date: 2016–03

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