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on Dynamic General Equilibrium |
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Issue of 2016‒04‒16
seventeen papers chosen by Christian Zimmermann Federal Reserve Bank of St. Louis |
| By: | Kollmann, Robert |
| Abstract: | The 2007-09 global financial crisis has led to a rethinking of the role of financial intermediaries for economic fluctuations. Before the financial crisis, the workhorse macro models used by policy institutions and by academic researchers abstracted from banks (e.g., Christiano et al. (2005)). The crisis has stimulated much research that incorporates banks into quantitative dynamic stochastic general equilibrium (DSGE) models. Given the global nature of the banking industry, and of the financial crisis, that research has frequently focused on open economy models; see, e.g., Devereux and Sutherland (2011), Kollmann et al. (2011, 2013), Perri and Quadrini (2011), Ueda (2012), Dedola et al. (2013), Kamber and Thoenissen (2013) and Kollmann (2013). In this new class of DSGE models, bank capital is a key state variable for real activity; negative shocks to bank capital are predicted to increase the spread between banks’ lending and deposit rates, and to trigger a fall in bank credit, investment and output; with a globalized banking system, losses on bank assets in one country can thus lead to a worldwide recession. The paper by Victoria Nuguer makes a very interesting contribution to the new literature on open economy DSGE models with banks. Her paper highlights the role of country asymmetries for the transmission of banking shocks, and for the optimal policy response to those shocks. While most related studies assume symmetric countries, Victoria Nuguer considers a world with two countries of vastly different size. Victoria Nuguer’s paper thereby provides important insights into the role of country asymmetries for the transmission of financial shocks, and for optimal policy. Her paper also suggests fascinating avenues for future research. |
| Keywords: | Financial intermediation, globalization, transmission of banking shocks, optimal monetary policy, asymmetric economies |
| JEL: | E3 E6 F3 F4 G15 G2 |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:70191&r=dge |
| By: | Jakub Mateju; Michal Kejak |
| Abstract: | This paper suggests that the dynamics of the non-fundamental component of asset prices are one of the drivers of the credit cycle. The presented model builds on the financial accelerator literature by including a stock market where investors with limited liability trade stocks of productive firms with stochastic productivities. Investors borrow funds from the banking sector and can go bankrupt. Their limited liability induces a moral hazard problem which shifts demand for risk and drives prices of risky assets above their fundamental value. Embedding the contracting problem in a New Keynesian general equilibrium framework, the model shows that expansionary monetary policy induces loose credit conditions and leads to a rise in both the fundamental and non-fundamental components of stock prices. A positive shock to the non-fundamental component triggers a credit cycle: collateral value rises, and lending and default rates decrease. These effects reverse after several quarters, inducing a credit crunch. The credit boom lasts only while stock market growth maintains sufficient momentum. However, monetary policy does not reduce the volatility of inflation and the output gap by reacting to asset prices. |
| Keywords: | Credit cycle, limited liability, monetary policy, non-fundamental asset pricing |
| JEL: | E32 E44 E52 G10 |
| Date: | 2015–12 |
| URL: | http://d.repec.org/n?u=RePEc:cnb:wpaper:2015/16&r=dge |
| By: | Yasuo Hirose (Faculty of Economics, Keio University); Takeki Sunakawa (Graduate School of Public Policy, University of Tokyo) |
| Abstract: | How can parameter estimates be biased in a dynamic stochastic general equilibrium model that omits nonlinearity in the economy? To answer this question, we simulate data from a fully nonlinear New Keynesian model with the zero lower bound constraint and estimate a linearized version of the model. Monte Carlo experiments show that significant biases are detected in the estimates of monetary policy parameters and the steady-state inflation and real interest rates. These biases arise mainly from neglecting the zero lower bound constraint rather than linearizing equilibrium conditions. With fixed parameters, the variance-covariance matrix and impulse response functions of observed variables implied by the linearized model substantially differ from those implied by its nonlinear counterpart. However, we find that the biased estimates of parameters in the estimated linear model can make most of the differences small. |
| Keywords: | Nonlinearity, Zero lower bound, DSGE model, Parameter bias, Bayesian estimation |
| JEL: | C32 E30 E52 |
| Date: | 2016–03 |
| URL: | http://d.repec.org/n?u=RePEc:upd:utppwp:063&r=dge |
| By: | Greg Kaplan (Princeton University); Benjamin Moll (Princeton University); Giovanni L. Violante (New York University) |
| Abstract: | We revisit the transmission mechanism of monetary policy for household consumption in a Heterogeneous Agent New Keynesian (HANK) model. The model yields empirically realistic distributions of household wealth and marginal propensities to consume because of two key features: multiple assets with different degrees of liquidity and an idiosyncratic income process with leptokurtic income changes. In this environment, the indirect effects of an unexpected cut in interest rates, which operate through a general equilibrium increase in labor demand, far outweigh direct effects such as intertemporal substitution. This finding is in stark contrast to small- and medium-scale Representative Agent New Keynesian (RANK) economies, where intertemporal substitution drives virtually all of the transmission from interest rates to consumption. |
| Date: | 2016–03 |
| URL: | http://d.repec.org/n?u=RePEc:ceq:wpaper:1602&r=dge |
| By: | Matteo Cacciatore; Romain Duval; Giuseppe Fiori; Fabio Ghironi |
| Abstract: | We study the consequences of product and labor market reforms in a two-country model with endogenous producer entry and labor market frictions. We focus on the role of business cycle conditions and external constraints at the time of reform implementation (or of a credible commitment to it) in shaping the dynamic effects of such policies. Product market reform is modeled as a reduction in entry costs and takes place in a non-traded sector that produces services used as input in manufacturing production. Labor market reform is modeled as a reduction in firing costs and/or unemployment benefits. We find that business cycle conditions at the time of deregulation significantly affect adjustment. A reduction of firing costs entails larger and more persistent adverse short-run effects on employment and output when implemented in a recession. By contrast, a reduction in unemployment benefits boosts employment and output by more in a recession compared to normal times. The impact of product market reforms is less sensitive to business cycle conditions. Credible announcements about future reforms induce sizable short-run dynamics, regardless of whether the announcement takes place in normal times or during an economic downturn. Whether the immediate effect is expansionary or contractionary varies across reforms. Finally, lack of access to international lending in the wake of reform can amplify the costs of adjustment. |
| JEL: | E24 E32 F41 J64 L51 |
| Date: | 2016–03 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:22128&r=dge |
| By: | Ferrière, Axelle (European University Institute); Karantounias, Anastasios G. (Federal Reserve Bank of Atlanta) |
| Abstract: | How should public debt be managed when uncertainty about the business cycle is widespread and debt levels are high, as in the aftermath of the last financial crisis? This paper analyzes optimal fiscal policy with ambiguity aversion and endogenous government spending. We show that, without ambiguity, optimal surplus-to-output ratios are acyclical and that there is no rationale for either reduction or further accumulation of public debt. In contrast, ambiguity about the cycle can generate optimal policies that resemble "austerity" measures. Optimal policy prescribes front-loaded fiscal consolidations and convergence to a balanced primary budget in the long run. This is the case when interest rates are sufficiently responsive to cyclical shocks; that is, when the intertemporal elasticity of substitution is sufficiently low. |
| Keywords: | endogenous government expenditures; distortionary taxes; balanced budget; austerity; fiscal consolidation; martingale; ambiguity aversion; multiplier preferences |
| JEL: | D80 E62 H21 H63 |
| Date: | 2016–03–01 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedawp:2016-06&r=dge |
| By: | Mark Aguiar; Satyajit Chatterjee; Harold Cole; Zachary Stangebye |
| Abstract: | This chapter is on quantitative models of sovereign debt crises in emerging economies. We interpret debt crises broadly to cover all of the major problems a country can experience while trying to issue new debt, including default, sharp increases in the spread and failed auctions. We examine the spreads on sovereign debt of 20 emerging market economies since 1993 and document the extent to which fluctuations in spreads are driven by country-specific fundamentals, common latent factors and observed global factors. Our findings motivate quantitative models of debt and default with the following features: (i) trend stationary or stochastic growth, (ii) risk averse competitive lenders, (iii) a strategic repayment/borrowing decision, (iv) multi-period debt, (v) a default penalty that includes both a reputation loss and a physical output loss and (vi) rollover defaults. For the quantitative evaluation of the model, we focus on Mexico and carefully discuss the successes and weaknesses of various versions of the model. We close with some thoughts on useful directions for future research. |
| JEL: | E32 E44 E62 F34 |
| Date: | 2016–03 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:22125&r=dge |
| By: | Jose-Maria Da-Rocha; Marina Mendes Tavares; Diego Restuccia |
| Abstract: | The large differences in income per capita across countries are mostly accounted for by differences in total factor productivity (TFP). What explains the differences in TFP across countries? Empirical evidence points to factor misallocation across heterogeneous production units as an important factor. We study factor misallocation in a model where establishment-level productivity is endogenous. In this framework, policy distortions not only misallocate resources across a given set of productive units, but also worsen the productivity distribution of establishments and this effect is substantial quantitatively. Reducing the dispersion in revenue productivity by half to the level of the U.S. benchmark in the model implies an increase in aggregate output and TFP by a factor of 7.8-fold. Improved factor allocation accounts for 38 percent of the gain, whereas the change in the productivity distribution accounts for the remaining 62 percent. |
| Keywords: | distortions, misallocation, investment, endogenous productivity, establishments. |
| JEL: | O1 O4 |
| Date: | 2016–04–07 |
| URL: | http://d.repec.org/n?u=RePEc:tor:tecipa:tecipa-558&r=dge |
| By: | Tomoyuki Nakajima (Institute of Economic Research, Kyoto University and Canon Institute for Global Studies.); Shuhei Takahashi (Institute of Economic Research, Kyoto University) |
| Abstract: | We analyze lump-sum transfers financed through consumption taxes in a heterogeneous- agent model with uninsured idiosyncratic wage risk and endogenous labor supply. The model is calibrated to the U.S. economy. We find that consumption inequality and uncertainty decrease with transfers much more substantially under divisible than indi- visible labor. Increasing transfers by raising the consumption tax rate from 5% to 35% decreases the consumption Gini by 0.04 under divisible labor, whereas it has almost no effect on the consumption Gini under indivisible labor. The divisibility of labor also affects the relationship among consumption-tax financed transfers, aggregate saving, and the wealth distribution. |
| Keywords: | Transfers; Consumption taxes; Inequality; Uncertainty; Divisibility of labor; Incomplete markets |
| JEL: | E62 D31 J22 C68 |
| Date: | 2016–03 |
| URL: | http://d.repec.org/n?u=RePEc:upd:utppwp:065&r=dge |
| By: | Kim, Minseong |
| Abstract: | This paper explores how accounting consistency affects DSGE models. As many DSGE models descended from real business cycle models, I explore a simple labor-only RBC model with an exogenous external sector introduced. The conclusion reached in this paper is that once an external sector is introduced, DSGE models may suffer from accounting inconsistency, unless disequilibrium or some non-orthodox theory of price level, real monetary supply or bonds is accepted. |
| Keywords: | accounting consistency, DSGE, external sector, fiscal deficit |
| JEL: | B41 E13 E62 F41 |
| Date: | 2016–03–29 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:70404&r=dge |
| By: | Sergio A. Lago Alves |
| Abstract: | I expand the standard model with labor frictions and matching function, to account to the endogenous decision to either leave the labor market or migrate to a different sector, after a stochastic training period. Sectors (manufacturing and services) are asymmetric, firms are subject to price stickiness, have specific labor force, post vacancies advertisement and explore both the intensive as the extensive margin of labor. After estimating the model with 13 quarterly data from the goods and labor market, from 2003:Q1 to 2014:Q4, I show that the estimated version of this model is able to account for the heterogeneous dynamics of the labor and goods market in Brazil |
| Date: | 2016–03 |
| URL: | http://d.repec.org/n?u=RePEc:bcb:wpaper:421&r=dge |
| By: | Frederic Ganon (University of Le Havre - EDEHN); Gilles Le Garrec (OFCE Sciences PO); Vincent Touzé (OFCE, Sciences Po) |
| Abstract: | This paper analyses how the economic, demographic and institutional differences between two regions -one developed and called the North, the other emerging and called the South- drive the international capital flows and explain the world economic equilibrium. To this end, we develop a simple two-period OLG model. We compare closed-economy and open-economy equilibria. We consider that openness facilitates convergence of South’s characteristics towards North’s. We examine successively the consequences of a technological catching-up, a demographic transition and an institutional convergence of pension schemes. We determine the analytical solution of the dynamics of the world interest rate and deduce the evolution of the current accounts. These analytical results are completed by numerical simulations. They show that the technological catching-up alone leads to a welfare loss for the North in reason of capital flows towards the South. If we add to this first change a demographic transition, the capital demand is reduced in the South whereas its saving increases in reason of a higher life expectancy. These two effects contribute to reduce the capital flows from the North to the South. Finally, an institutional convergence of the two pension schemes reduces the South’s saving rate which increases the capital flow from the North to the South. |
| Keywords: | International Capital flows, OLG, Economic convergence, demographic transition |
| JEL: | D91 F40 J10 O33 |
| Date: | 2016–03 |
| URL: | http://d.repec.org/n?u=RePEc:fce:doctra:1609&r=dge |
| By: | Caterina Mendicino (European Central Bank - Directorate General Research - Monetary Policy Research); Yahong Zhang (Department of Economics, University of Windsor) |
| Abstract: | Recent literature suggests that risk shocks –idiosyncratic uncertainty on asset returns – plays an important role in explaining business cycle ?uctuations. In this paper, we study the effect of risk shocks in a small open economy with tradable and non-tradable sectors of production. Following Christiano, Motto and Rostagno (2014), we assume that ?rms are subject to uncertainty when converting raw capital into effective capital. Due to the ?nancial frictions, when risk is high ?rms pay higher borrowing costs. This leads to a decline in investment and output. We conduct Bayesian estimation and draw implications on the sources of the Canadian business cycle. Our ?ndings suggest that a signi?cant fraction of the ?uctuations in output, investment, risk premium and ?rms’ net worth can be accounted for by risk shocks. |
| Keywords: | Risk; Financial frictions; Business Cycles. |
| JEL: | E31 E32 |
| Date: | 2016–04 |
| URL: | http://d.repec.org/n?u=RePEc:wis:wpaper:1602&r=dge |
| By: | Susanto Basu (Boston College; NBER); Pierre De Leo (Boston College) |
| Abstract: | Yes, they should. Central banks nearly always state explicit or implicit inflation targets in terms of consumer price inflation. If there are nominal rigidities in the pricing of both consumption and investment goods and if the shocks to the two sectors are not identical, then monetary policy cannot stabilize inflation and output gaps in both sectors. Thus, the central bank faces a tradeoff between targeting consumption price inflation and investment price inflation. In this setting, ignoring investment prices typically leads to substantial welfare losses because the intertemporal elasticity of substitution in investment is much higher than in consumption. In our calibrated model, consumer price targeting leads to welfare losses that are at least three times the loss under optimal policy. A simple rule that puts equal weight on stabilizing consumption and investment price comes close to replicating the optimal policy. Thus, GDP deflator targeting is not a good approximation to optimal policy. We conclude that significant welfare gains can be achieved if central banks shift to targeting a weighted average of consumer and investment price inflation, although this would require a major change in current central banking practice. |
| Keywords: | Inflation Targeting; Investment-Specific Technical Change; Investment Price Rigidity; Optimal Monetary Policy |
| JEL: | E52 E58 E32 E31 |
| Date: | 2016–03–25 |
| URL: | http://d.repec.org/n?u=RePEc:boc:bocoec:910&r=dge |
| By: | Frédéric Gannon (EconomiX); Gilles Le Garrec (OFCE); Vincent Touze (OFCE) |
| Abstract: | This paper analyses how the economic, demographic and institutional differences between two regions -one developed and called the North, the other emerging and called the South- drive the international capital flows and explain the world economic equilibrium. To this end, we develop a simple two-period OLG model. We compare closed-economy and open-economy equilibria. We consider that openness facilitates convergence of South’s characteristics towards North’s. We examine successively the consequences of a technological catching-up, a demographic transitionand an institutional convergence of pension schemes. We determine the analytical solution of the dynamics of the world interest rate and deduce the evolution of the current accounts. These analytical results are completed by numerical simulations. They show that the technological catching-up alone leads to a welfare loss for the North in reason of capital flows towards the South. If we add to this Örst change a demographic transition, the capital demand is reduced in the South whereas its saving increases in reason of a higher life expectancy. These two effects contribute to reduce the capital flows from the North to the South. Finally, an institutional convergence of the two pension schemes reduces the South’s saving rate which increases the capital flow from the North to the South. |
| Keywords: | International capital flows; Economic Convergence; Demographic transition |
| JEL: | D91 F40 J10 O33 |
| Date: | 2016–03 |
| URL: | http://d.repec.org/n?u=RePEc:spo:wpmain:info:hdl:2441/6dhper3pho8nspmsluhrt4lcd8&r=dge |
| By: | Holden, Tom |
| Abstract: | We construct the first algorithm for the perfect foresight solution of otherwise linear models with occasionally binding constraints, with fixed terminal conditions, that is guaranteed to return a solution in finite time, if one exists. We also provide a proof of the inescapability of the “curse of dimensionality” for this problem when nothing is known a priori about the model. We go on to extend our algorithm to deal with stochastic simulation, other non-linearities, and future uncertainty. We show that the resulting algorithm produces fast and accurate simulations of a range of models with occasionally binding constraints. |
| Keywords: | occasionally binding constraints,zero lower bound,computation,DSGE,linear complementarity problem |
| JEL: | C61 C63 E3 E4 E5 |
| Date: | 2016–04–04 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:esprep:130143&r=dge |
| By: | Airaudo, Marco (School of Economics) |
| Abstract: | This paper studies the global equilibrium dynamics implied by a Lucas’ tree asset pricing model where the representative agent has dynamic self-control preferences, as defined by Gul and Pesendorfer (Econometrica, 2004). It shows that endogenous cycles of period 2 and higher, as well as chaotic dynamics exist provided temptation utility is sufficiently important (with respect to standard commitment utility) and sufficiently convex. For parameterizations leading to complex deterministic dynamics, the model also admits stationary and non-stationary sunspot equilibria. |
| Keywords: | Asset Pricing; Temptation; Self-Control; Endogenous Cycles; Chaotic Dynamics; Sunspot Equilibrium |
| JEL: | C62 E32 G12 |
| Date: | 2016–01–21 |
| URL: | http://d.repec.org/n?u=RePEc:ris:drxlwp:2016_002&r=dge |