nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2016‒04‒23
fifteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. In Search of the Transmission Mechanism of Fiscal Policy in the Euro Area. By P. Fève; J.-G. Sahuc
  2. Assessing the Fit of a Small Open-Economy DSGE Model for the Brazilian Economy By Fernando de Menezes Linardi
  3. Fertility policies and social security reforms in China By Nicolas Coeurdacier; Stéphane Guibaud; Keyu Jin
  4. Changes in nominal rigidities in Poland – a regime switching DSGE perspective By Baranowski, Paweł; Kuchta, Zbigniew
  5. Sentiment Shocks as Drivers of Business Cycles By Agustín Arias
  6. Real-Time Forecasting for Monetary Policy Analysis: The Case of Sveriges Riksbank By Iversen, Jens; Laseen, Stefan; Lundvall, Henrik; Söderström, Ulf
  7. Animal Spirits in a Monetary Model By Farmer, Roger E A; Platonov, Konstantin
  8. The Theory of Unconventional Monetary Policy By Farmer, Roger E A; Zabczyk, Pawel
  9. The Optimal Composition of Public Spending in a Deep Recession By Hafedh Bouakez; Michel Guillard; Jordan Roulleau-Pasdeloup
  10. Volatility and Growth with Recursive Preferences By Barbara Annicchiarico; Alessandra Pelloni; Fabrizio Valenti
  11. Macroeconomic Policy in DSGE and Agent-Based Models Redux: New Developments and Challenges Ahead By Giorgio Fagiolo; Andrea Roventini
  12. Quantitative Easing and the Liquidity Channel of Monetary Policy By Herrenbrueck, Lucas
  13. Can Currency Competition Work? By Jesús Fernández-Villaverde; Daniel Sanches
  14. A General and Intuitive Envelope Theorem By Andrew Clausen; Carlo Strub
  15. Bargaining over Babies: Theory, Evidence, and Policy Implications By Matthias Doepke; Fabian Kindermann

  1. By: P. Fève; J.-G. Sahuc
    Abstract: This paper applies the DSGE-VAR methodology to assess the size of fiscal multipliers in the data and the relative contributions of two transmission mechanisms of government spending shocks, namely hand-to-mouth consumers and Edgeworth complementarity. Econometric experiments show that a DSGE model with Edgeworth complementarity is a better representation of the transmission mechanism of fiscal policy as it yields dynamic responses close to those obtained with the flexible DSGE-VAR model (i.e. an impact output multiplier larger than one and a crowding-in of private consumption). The estimated share of hand-to-mouth consumers is too small to replicate the positive response of private consumption.
    Keywords: Fiscal multipliers, hand-to-mouth, Edgeworth complementarity, DSGE-VAR, Euro area, Bayesian econometrics.
    JEL: C32 E32 E62
    Date: 2016
  2. By: Fernando de Menezes Linardi
    Abstract: This paper estimates a small open-economy dynamic stochastic general equilibrium (DSGE) model using Brazil´s economy data for the inflation-targeting period. The model includes a number of shocks that are important to explain the macroeconomic fluctuations of emerging markets economies. Then the empirical fit of different specifications of the model is tested in a Bayesian framework. The potential model misspecification is also assessed by comparing it to a more general reference model using the DSGE-VAR approach. The results show that the model with no price indexation fits the data better than the fully specified one. The DSGE-VAR approach indicated some degree of misspecification in the stylized small open-economy model
    Date: 2016–04
  3. By: Nicolas Coeurdacier; Stéphane Guibaud; Keyu Jin
    Abstract: This paper analyzes the impact of relaxing fertility controls and expanding social security in China. We develop an overlapping generations model in which fertility decisions and capital accumulation are endogenously determined in the presence of social security. In our model, children are an alternative savings technology—as they transfer resources to their retired parents. Important feedback links arise between fertility and social security variables: an expansion of social security benefits reduces fertility—partially offsetting the effects of relaxing the one-child policy. The feedback loop between social security variables and fertility suggests that abandoning fertility restrictions may not be as effective in helping to finance China’s intended pension reform, especially if children are an important source of old-age support. The sustainability of the pension system is particularly at risk in the event of a growth slowdown. The objective of pension reforms may also be incongruent with other reforms, such as financial liberalization and financial integration.
    Keywords: one-child policy; social security; demographics
    JEL: E21 H55 J11 J13
    Date: 2014–08
  4. By: Baranowski, Paweł; Kuchta, Zbigniew
    Abstract: We estimate a dynamic stochastic general equilibrium model that allows for regimes Markov switching (MS-DSGE). Existing MS-DSGE papers for the United States focus on changes in monetary policy or shocks volatility, contributing the debate on the Great Moderation and/or Volcker disinflation. However, Poland which here serves as an example of a transition country, faced a wider range of structural changes, including long disinflation, EU accession or tax changes. The model identifies high and low rigidity regimes, with the timing consistent with menu cost explanation of nominal rigidities. Estimated timing of the regimes captures the European Union accession and indirect tax changes. The Bayesian model comparison results suggest that model with switching in both analyzed rigidities is strongly favored by the data in comparison with switching only in prices or in wages. Moreover, we find significant evidence in support of independent Markov chains.
    Keywords: nominal rigidities, Markov-switching DSGE models, Bayesian model comparison, regime switching
    JEL: C11 E31 E32 J30 P22
    Date: 2015–12
  5. By: Agustín Arias
    Abstract: This paper studies the role of sentiment shocks as a source of business cycle fluctuations. Considering a standard New Keynesian model of the business cycle, it introduces agents that update beliefs about the parameters of their forecasting models using newly observed data and exogenous sentiment shocks. The resulting learning model fits U.S. data better than its non-sentiment version and than its rational expectations counterpart. Sentiment is found to be an important driver of economic fluctuations, accounting for up to half of the forecast error variance of aggregate variables at business cycle frequencies. Furthermore, sentiment displays a common pattern for real GDP, investment and consumption growth, where a significant part of the sluggish recovery following a recession can be attributed to the persistent pessimistic views of agents. Sentiment also explains a substantial fraction of the high inflation experienced during the 70’s and early 80’s.
    Date: 2016–03
  6. By: Iversen, Jens; Laseen, Stefan; Lundvall, Henrik; Söderström, Ulf
    Abstract: We evaluate forecasts made in real time to support monetary policy decisions at Sveriges Riksbank (the central bank of Sweden) from 2007 to 2013. We compare forecasts made with a DSGE model and a BVAR model with judgemental forecasts published by the Riksbank, and we evaluate the usefulness of conditioning information for the model-based forecasts. We also study the perceived usefulness of model forecasts for central bank policymakers when producing the judgemental forecasts.
    Keywords: Forecast evaluation; Inflation targeting; Monetary policy; Real-time forecasting
    JEL: E37 E52
    Date: 2016–03
  7. By: Farmer, Roger E A; Platonov, Konstantin
    Abstract: We integrate Keynesian economics with general equilibrium theory in a new way. Our approach differs from the prevailing New Keynesian paradigm in two ways. First, our model displays steady state indeterminacy. This feature allows us to explain persistent unemployment which we model as movements among the steady state equilibria of our model. Second, our model displays dynamic indeterminacy. This feature allows us to explain the real effects of nominal shocks by selecting a dynamic equilibrium where prices are slow to respond to unanticipated money supply disturbances. Price rigidity arises as part of a rational expectations equilibrium in which the equilibrium is selected by beliefs. To close our model, we introduce a new fundamental that we refer to as the belief function.
    Keywords: animal spirits; belief function; Keynesian economics; Unemployment
    JEL: E12 E3 E4
    Date: 2016–03
  8. By: Farmer, Roger E A; Zabczyk, Pawel
    Abstract: This paper is about the effectiveness of qualitative easing, a form of unconventional monetary policy that changes the risk composition of the central bank balance sheet with the goal of stabilizing economic activity. We construct a general equilibrium model where agents have rational expectations and there is a complete set of financial securities, but where some agents are unable to participate in financial markets. We show that a change in the risk composition of the central bank's balance sheet will change equilibrium asset prices and we prove that, in our model, a policy in which the central bank stabilizes non-fundamental fluctuations in the stock market is Pareto improving and self-financing.
    Keywords: Qualitative Easing; Sunspots; Unconventional Monetary Policy
    JEL: E02 E6 G11 G21
    Date: 2016–03
  9. By: Hafedh Bouakez; Michel Guillard; Jordan Roulleau-Pasdeloup
    Abstract: We study optimal monetary and fiscal policy under commitment in an economy where monetary policy is constrained by the zero lower bound on the nominal interest rate, and where the government can allocate spending to public consumption and public investment. We show that the optimal response to an adverse shock that precipitates the economy into a liquidity trap entails a small and short-lived increase in public consumption but a large and persistent increase in public investment, which lasts well after the natural rate of interest has ceased to be negative. During this period, the optimal composition of public spending is therefore heavily skewed towards public investment. Contrary to the literature that abstracts from public investment, we find that the optimal increase in total public spending in a deep recession is sizable. However, we show that this fiscal expansion has little to do with a stabilization motive and is instead warranted by the intertemporal allocation of resources that efficiency dictates even in the absence of an output gap.
    Keywords: Public spending; Public investment; Time to build; Ramsey policies; Zero lower bound
    JEL: E4 E52 E62 H54
    Date: 2016–04
  10. By: Barbara Annicchiarico (Department of Economics and Finance, University of Rome Tor Vergata, Italy); Alessandra Pelloni (Department of Economics and Finance, University of Rome Tor Vergata, Italy; The Rimini Centre for Economic Analysis, Italy); Fabrizio Valenti (Save the Children International, Freetown, Sierra Leone)
    Abstract: This paper studies the relationship between volatility and long-run growth in a complete market economy with human capital accumulation and Epstein-Zin preferences. There is both cross-country and time-series evidence that volatility is associated with lower growth. Matching this evidence has proved a challenge for growth models with no market failures as they tend to predict the opposite for values of risk aversion higher than unity. However in our model, risk aversion and intertemporal elasticity of substitution are allowed to move independently of each other, and when both are relatively high or relatively low, the relationship between volatility and growth is negative. Indeed this is the case for parametrizations of preferences in line with the literature.
    Date: 2016–04
  11. By: Giorgio Fagiolo; Andrea Roventini
    Abstract: The Great Recession seems to be a natural experiment for economic analysis, in that it has shown the inadequacy of the predominant theoretical framework -- the New Neoclassical Synthesis (NNS) -- grounded on the DSGE model. In this paper, we present a critical discussion of the theoretical, empirical and political-economy pitfalls of the DSGE-based approach to policy analysis. We suggest that a more fruitful research avenue should escape the strong theoretical requirements of NNS models (e.g., equilibrium, rationality, representative agent, etc.) and consider the economy as a complex evolving system, i.e. as an ecology populated by heterogenous agents, whose far-from-equilibrium interactions continuously change the structure of the system. This is indeed the methodological core of agent-based computational economics (ACE), which is presented in this paper. We also discuss how ACE has been applied to policy analysis issues, and we provide a survey of macroeconomic policy applications (fiscal and monetary policy, bank regulation, labor market structural reforms and climate change interventions). Finally, we conclude by discussing the methodological status of ACE, as well as the problems it raises.
    Keywords: Economic Policy, New Neoclassical Synthesis, New Keynesian Models, DSGE Models, Agent-Based Computational Economics, Agent-Based Models, Complexity Theory, Great Recession, Crisis
    Date: 2016–04–13
  12. By: Herrenbrueck, Lucas
    Abstract: How do central bank purchases of illiquid assets affect interest rates and the real economy? In order to answer this question, I construct a parsimonious and very flexible general equilibrium model of asset liquidity. In the model, households are heterogeneous in their asset portfolios and demand for liquidity, and asset trade is subject to frictions. I find that open market purchases of illiquid assets are fundamentally different from helicopter drops: asset purchases stimulate private demand for consumption goods at the expense of demand for assets and investment goods, while helicopter drops do the reverse. A temporary program of quantitative easing can therefore cause a 'hangover' of elevated yields and depressed investment after it has ended. When assets are already scarce, further purchases can crowd out the private flow of funds and cause high real yields and disinflation, resembling a liquidity trap. In the long term, lowering the stock of government debt reduces the supply of liquidity but increases the capital-output ratio. The consequences for output are ambiguous in theory but a calibration to US data suggests that the liquidity effect dominates; in other words, the supply of Treasuries is 'too small'.
    Keywords: Monetary theory, asset liquidity, search frictions, quantitative easing, liquidity trap
    JEL: E31 E40 E50 G1 G12
    Date: 2014–12–06
  13. By: Jesús Fernández-Villaverde; Daniel Sanches
    Abstract: Can competition among privately issued fiat currencies such as Bitcoin or Ethereum work? Only sometimes. To show this, we build a model of competition among privately issued fiat currencies. We modify the current workhorse of monetary economics, the Lagos-Wright environment, by including entrepreneurs who can issue their own fiat currencies in order to maximize their utility. Otherwise, the model is standard. We show that there exists an equilibrium in which price stability is consistent with competing private monies, but also that there exists a continuum of equilibrium trajectories with the property that the value of private currencies monotonically converges to zero. These latter equilibria disappear, however, when we introduce productive capital. We also investigate the properties of hybrid monetary arrangements with private and government monies, of automata issuing money, and the role of network effects.
    JEL: E40 E42 E52
    Date: 2016–04
  14. By: Andrew Clausen; Carlo Strub
    Abstract: Previous envelope theorems establish differentiability of value functions in convex settings. Our envelope theorem applies to all functions whose derivatives appear in first-order conditions, and in non-convex settings. For example, in Stackelberg games, the leader’s first-order condition involves the derivative of the follower’s policy. Similarly, we differentiate (i) the borrower’s value function and default cut-off policy function in an unsecured credit economy, (ii) the firm’s value function in a capital adjustment problem with fixed costs, and (iii) the households’ value functions in insurance arrangements with indivisible goods. Our theorem accommodates optimization problems involving discrete choices, infinite horizon stochastic dynamic programming, and Inada conditions.
    Keywords: First-order conditions, policy functions, discrete choice, Inada conditions, dynamic programming, reverse calculus dynamic programming, reverse calculus.
    Date: 2016–04–19
  15. By: Matthias Doepke (Northwestern University); Fabian Kindermann (Universitat 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: 2016–04

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