nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2016‒05‒21
23 papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. A Life-Cycle Model of Trans-Atlantic Employment Experiences By Kitao, Sagiri; Ljungqvist, Lars; Sargent, Thomas J
  2. Countercyclical capital rules for small open economies By Daragh Clancy
  3. Macroprudential and Monetary Policy Interactions in a DSGE Model for Sweden By Jiaqian Chen; Francesco Columba
  4. Term Premium Variability and Monetary Policy By Fuerst, Timothy S.; Mau, Ronald
  5. Estimating point and density forecasts for the US economy with a factor-augmented vector autoregressive DSGE model By Stelios D. Bekiros; Alessia Paccagnini
  6. Population ageing and inflation with endogenous money creation By Igor Fedotenkov
  7. The implications of labor market network for business cycles By Marcelo Arbex; Sydney Caetano; Dennis O'Dea
  8. Medical Care within an OLG Economy with Realistic Demography By Ivan Frankovic; Michael Kuhn; Stefan Wrzaczek
  9. Structural Reform in Germany By Tom Krebs; Martin Scheffel
  10. Pricing Assets in an Economy with Two Types of People By Farmer, Roger E A
  11. Market Reforms in the Time of Imbalance By Cacciatore, Matteo; Duval, Romain; Fiori, Giuseppe; Ghironi, Fabio
  12. Serial Sovereign Defaults and Debt Restructurings By Tamon Asonuma
  13. Commodity prices and labour market dynamics in small open economics By Martin Bodenstein; Gunes Kamber; Christoph Thoenissen
  14. From Bismarck to Beveridge: the Other Pension Reform in Spain By José Ignacio Conde-Ruiz; Clara I. González
  15. The Intended and Unintended Consequences of Financial-Market Regulations: A General Equilibrium Analysis By Adrian Buss; Bernard Dumas; Raman Uppal; Grigory Vilkov
  16. Tractable Likelihood-Based Estimation of Non-Linear DSGE Models Using Higher-Order Approximations By Robert Kollmann
  17. On the limits of macroprudential policy By Marcin Kolasa
  18. International competition and labor market adjustment By João Paulo Pessoa
  19. VAR Information and the Empirical Validation of DSGE Models By Mario Forni; Luca Gambetti; Luca Sala
  20. Hysteresis in a New Keynesian Model By Craighead, William
  21. Optimal monetary policy in open economies revisited By Fujiwara, Ippei; Wang, Jiao
  22. Determinacy analysis in high order dynamic systems: The case of nominal rigidities and limited asset market participation By Guido Ascari; Andrea Colciago; Lorenza Rossi
  23. Great Recession, Slow Recovery and Muted Fiscal Policies in the US By Alice Albonico; Alessia Paccagnini; Patrizio Tirelli

  1. By: Kitao, Sagiri; Ljungqvist, Lars; Sargent, Thomas J
    Abstract: To understand trans-Atlantic employment experiences since World War II, we build an overlapping generations model with two types of workers (high school and college graduates) whose different skill acquisition technologies affect their career decisions. Search frictions affect short-run employment outcomes. The model focuses on labor supply responses near beginnings and ends of lives and on whether unemployment and early retirements are financed by personal savings or public benefit programs. Higher minimum wages in Europe explain why youth unemployment has risen more there than in the U.S. Turbulence, in the form of higher risks of human capital depreciation after involuntary job destructions, causes long-term unemployment in Europe, mostly among older workers, but leaves U.S. unemployment unaffected. The losses of skill interact with workers' subsequent decisions to invest in human capital in ways that generate the age-dependent increases in autocovariances of income shocks observed by Moffitt and Gottschalk (1995).
    Keywords: benefits; employment protection; Europe; minimum wage; U.S.; Unemployment
    JEL: E24 J21 J64
    Date: 2016–05
  2. By: Daragh Clancy (European Stability Mechanism)
    Abstract: The growing literature on macroprudential regulation focuses on how a combination monetary and macroprudential policies can boost financial stability. We contribute to this literature by developing a DSGE model that assesses the effectiveness of countercyclical capital regulation in small open economies, in monetary unions or with exchange rate pegs, where policymakers do not have full control over traditional stabilisation instruments such as nominal interest and exchange rates. Our model shows that, in such economies, macroprudential policy must play an outsized role in mitigating the adverse effects of macro-financial feedback loops. To validate the model’s ability to replicate the stylised facts of financial crises, we calibrate using data for the Irish economy the recent housing crash. Our results demonstrate that the pro-active use of countercyclical capital regulation can indeed help ensure financial stability. In terms of policy advice, we find that bestowing even greater flexibility on regulators to act against the credit cycle has positive benefits. We also find that more aggressive action during the release phase can bolster the economy’s ability to absorb a negative shock.
    Keywords: small open economy, macroprudential policy, macro-financial linkages
    JEL: E44 E51 G10 G28
    Date: 2016–03
  3. By: Jiaqian Chen; Francesco Columba
    Abstract: We analyse the effects of macroprudential and monetary policies and their interactions using an estimated dynamic stochastic general equilibrium (DSGE) model tailored to Sweden. Households face a ceiling on their loan-to-value ratio and must amortize their mortgages. The government grants mortgage interest payment deductions. Lending rates are affected by mortgage risk weights. We find that demand-side macroprudential measures are more effective in curbing household debt ratios than monetary policy, and they are less costly in terms of foregone consumption. A tighter macroprudential stance is also found to be welfare improving, by promoting lower consumption volatility in response to shocks, especially when using a combination of macroprudential instruments.
    Keywords: Housing;Sweden;Mortgages;Housing prices;Debt;Macroprudential Policy;Monetary policy;General equilibrium models;Macroprudential Policies; Monetary Policy; Collateral Constraints
    Date: 2016–03–23
  4. By: Fuerst, Timothy S. (Federal Reserve Bank of Cleveland); Mau, Ronald (University of Notre Dame)
    Abstract: Two traditional explanations for the mean and variability of the term premium are: (i) time-varying risk premia on long bonds, and (ii) segmented markets between long- and short-term bonds. This paper integrates these two approaches into a medium-scale DSGE model. We consider two sources of business cycle variability: shocks to total factor productivity (TFP), and shocks to the marginal efficiency of investment (MEI). The ability of the risk approach to match the first moment of the term premium depends upon the relative importance of these two shocks. If MEI shocks are an important driver of the business cycle, then long bonds are a hedge against the business cycle so that the average term premium is negative. The opposite is the case for the TFP shocks. But for either source of shocks, the risk approach to the term premium predicts a trivial amount of variability in the term premium. In contrast, the segmented markets model can easily match both moments. The market segmentation reflects a real distortion, so that smoothing the term premium is typically welfare-improving. There are two difficulties with such a policy. First, the mean level of the term premium will not properly reflect the segmentation distortion because of the risk adjustment. Second, if the term premium is measured with error, the welfare gain of a term premium peg is naturally reduced. The paper demonstrates that both of these effects are quantitatively modest so that the welfare advantage to a term premium peg survives.
    Keywords: Term premium peg; time-varying risk premia; DSGE; total factor productivity; marginal efficiency of investment; monetary policy;
    JEL: E52 G12 G17
    Date: 2016–05–06
  5. By: Stelios D. Bekiros; Alessia Paccagnini
    Abstract: Although policymakers and practitioners are particularly interested in dynamic stochastic general equilibrium (DSGE) models, these are typically too stylized to be applied directly to the data and often yield weak prediction results. Very recently, hybrid DSGE models have become popular for dealing with some of the model misspecifications. Major advances in estimation methodology could allow these models to outperform well-known time series models and effectively deal with more complex real-world problems as richer sources of data become available. In this study we introduce a Bayesian approach to estimate a novel factor augmented DSGE model that extends the model of Consolo et al. [Consolo, A., Favero, C.A., and Paccagnini, A., 2009. On the Statistical Identification of DSGE Models. Journal of Econometrics, 150, 99–115]. We perform a comparative predictive evaluation of point and density forecasts for many different specifications of estimated DSGE models and various classes of VAR models, using datasets from the US economy including real-time data. Simple and hybrid DSGE models are implemented, such as DSGE-VAR and tested against standard, Bayesian and factor augmented VARs. The results can be useful for macro-forecasting and monetary policy analysis.
    Keywords: Density forecasting; Marginal data density; DSGE-FAVAR; Real-Time data
    JEL: C32 C11 C15 C53 D58
    Date: 2014–10
  6. By: Igor Fedotenkov (Bank of Lithuania)
    Abstract: This paper provides an explanation as to why population ageing is associated with deflationary processes. For this reason we create an overlapping-generations model (OLG) with money created by credits (inside money) and intergenerational trade. In other words, we combine a neoclassical OLG model with post-Keynesian monetary theory. The model links demographic factors such as fertility rates and longevity to prices. We show that lower fertility rates lead to smaller demand for credits, and lower money creation, which in turn causes a decline in prices. Changes in longevity affect prices through real savings and the capital market. Furthermore, a few links between interest rates and inflation are addressed; they arise in the general equilibrium and are not thoroughly discussed in literature. Long-run results are derived analytically; short-run dynamics are simulated numerically.
    Keywords: Population ageing, inflation, OLG model, inside money, credits
    JEL: E12 E31 E41 J10
    Date: 2016–02–23
  7. By: Marcelo Arbex (Department of Economics, University of Windsor); Sydney Caetano (Faculdade de Economia, Universidade Federal de Juiz de Fora); Dennis O'Dea (Department of Economics, University of Washington)
    Abstract: This paper modifies the standard labor market search model with social networks. Labor market networks is an important job information transmission channel and the complementarity of network and direct search by the unemployed amplify the economy's short-run response to a technological shock. We show that network search has important quantitative consequences for the business cycle, in particular, for output and unemployment.
    Keywords: Business Cycles; Labor Markets; Social networks; Job search.
    JEL: D85 E24 E32 J64
    Date: 2016–04
  8. By: Ivan Frankovic; Michael Kuhn; Stefan Wrzaczek
    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: Couple employment, European Social Survey, labour supply, preferences, economic crisis
    Date: 2016–03
  9. By: Tom Krebs; Martin Scheffel
    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 services 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 smal size of 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 surpluses is positive for any interest (discount) rate less than 9 percent.
    Keywords: Fiscal reforms;Germany;Payroll and social security taxes;Tax reforms;Primary education;Services sector;Econometric models;Structural reform, macroeconomic model, Germany, labor tax, professional services, child care, schooling
    Date: 2016–04–25
  10. By: Farmer, Roger E A
    Abstract: This paper constructs a general equilibrium model with two types of people where asset price fluctuations are caused by random shocks to the price level that reallocate consumption across generations. In this model, asset prices are volatile, and price-earnings ratios are persistent, even though there is no fundamental uncertainty and financial markets are sequentially complete. I show that the model can explain a substantial risk premium while generating smooth time series for consumption and financial assets across types. In my model, asset price fluctuations are Pareto inefficient and there is a role for treasury or central bank intervention to stabilize asset prices.
    Date: 2016–04
  11. By: Cacciatore, Matteo; Duval, Romain; Fiori, Giuseppe; Ghironi, Fabio
    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.
    Keywords: Business cycle; External borrowing constraint; Labor market; Product market; Structural reforms
    JEL: E24 E32 F41 J64 L51
    Date: 2016–04
  12. By: Tamon Asonuma
    Abstract: Emerging countries that have defaulted on their debt repayment obligations in the past are more likely to default again in the future than are non-defaulters even with the same external debt-to-GDP ratio. These countries actually have repeated defaults or restructurings in short periods. This paper explains these stylized facts within a dynamic stochastic general equilibrium framework by explicitly modeling renegotiations between a defaulting country and its creditors. The quantitative analysis of the model reveals that the equilibrium probability of default for a given debt-to-GDP level is weakly increasing with the number of past defaults. The model also accords with an additional fact: lower recovery rates (high NPV haircuts) are associated with increases in spreads at renegotiation.
    Keywords: Sovereign debt defaults;Emerging markets;Debt restructuring;Debt renegotiations;General equilibrium models;Serial Default, Sovereign Default, Debt Restructuring, Past Credit History, Haircuts, Recovery rates, Risk Premia.
    Date: 2016–03–16
  13. By: Martin Bodenstein (Federal Reserve Board,); Gunes Kamber (Reserve Bank of New Zealand); Christoph Thoenissen (Department of Economics, University of Sheffield)
    Abstract: We investigate the connection between commodity price shocks and unemployment in advanced resource-rich small open economies from an empirical and theoretical perspective. Shocks to commodity prices are shown to influence labour market conditions primarily through the real exchange rate contrasting sharply with the transmission of technology shocks which are typically argued to affect the economy by changing labour productivity. The empirical impact of commodity price shocks is obtained from estimating a panel vector autoregression; a positive price shock is found to be expansionary for the components of GDP, causes the real exchange rate to appreciate, and improves labour market conditions. For every one percent increase in commodity prices, our estimates suggest a one basis point decline in the unemployment rate and at its peak a 0.3% increase in unfilled vacancies. We then match the impulse responses to a commodity price shock from a small open economy model with net commodity exports and search and matching frictions in the labour market to these empirical responses. As in the data, an increase in commodity prices raises consumption demand in the small open economy and induces a real appreciation. Facing higher relative prices for their goods, non-commodity producing firms post additional job vacancies, causing the number of matches between firms and workers to rise. As a result, unemployment falls, even if employment in the commodity-producing sector is negligible. For commodity price shocks, there is little difference between the standard Diamond (1982), Mortensen (1982), and Pissarides (1985) approach of modelling search and matching frictions and the alternating offer bargaining model suggested by Hall and Milgrom (2008).
    Keywords: commodity prices; search and matching unemployment
    JEL: E44 E61 F42
    Date: 2016
  14. By: José Ignacio Conde-Ruiz; Clara I. González
    Abstract: Ageing is the major challenge for the PAYG pension systems in developed countries. Most of them are undergoing reforms in order to adapt to the new demographic reality. The package of reforms implemented includes increasing the retirement age, reducing the replacement rate, or introducing a sustainability factor linking pension to life expectancy. The aim of this paper is to analyse the potential consequences of a different type of reform that is at a very incipient stage in Spain but that could have a significant impact if it were fully implemented. This reform, called ‘silent reform’ because it is imperceptible to citizens in its early stages, basically consists in increasing maximum pensions in line with inflation instead of wage or productivity growth. This policy is reducing the replacement rate only for high earning workers and increasing the redistributive component of the system. This paper is the first to quantify and evaluate the potential consequences of this type of reform in Spain. We have used an accounting model with heterogeneous agents and overlapping generations in order to project pension expenditure for the next five decades. The results show that this type of reform could potentially contain future expenditure but at the cost of changing the nature of the pension system from a contributory or Bismarckian-type system into a pure redistributive pension system or Beveridgean-type one. The paper also shows that the institutional characteristics (i.e. the existence of maximum limits to pensions and contributions) that make this kind of reform possible are also present in the majority of developed countries with Bismarckian pension systems. Therefore, the lessons learned in this paper could be useful to other countries.
    Date: 2016–04
  15. By: Adrian Buss; Bernard Dumas; Raman Uppal; Grigory Vilkov
    Abstract: In a production economy with trade in financial markets motivated by the desire to share labor-income risk and to speculate, we show that speculation increases volatility of asset returns and investment growth, increases the equity risk premium, and reduces welfare. Regulatory measures, such as constraints on stock positions, borrowing constraints, and the Tobin tax have similar e ects on financial and macroeconomic variables. However, borrowing constraints and the Tobin tax are more successful than constraints on stock positions at improving welfare because they substantially reduce speculative trading without impairing excessively risk-sharing trades.
    Keywords: Tobin tax, borrowing constraints, short-sale constraints, stock market volatility, di erences of opinion.
    JEL: G01 G12 G18 E44
    Date: 2016
  16. By: Robert Kollmann
    Abstract: This paper discusses a tractable approach for computing the likelihood function of non-linear Dynamic Stochastic General Equilibrium (DSGE) models that are solved using second- and third order accurate approximations. By contrast to particle filters, no stochastic simulations are needed for the method here. The method here is, hence, much faster and it is thus suitable for the estimation of medium-scale models. The method assumes that the number of exogenous innovations equals the number of observables. Given an assumed vector of initial states, the exogenous innovations can thus recursively be inferred from the observables. This easily allows to compute the likelihood function. Initial states and model parameters are estimated by maximizing the likelihood function. Numerical examples suggest that the method provides reliable estimates of model parameters and of latent state variables, even for highly non-linear economies with big shocks.
    Keywords: likelihood-based estimation of non-linear DSGE models; higher-order approximations; pruning; latent state variables
    JEL: C63 C68 E37
    Date: 2016–03
  17. By: Marcin Kolasa
    Abstract: This paper studies how macroprudential policy tools can complement the interest ratebased monetary policy in achieving a selection of dual stabilization objectives. We show analytically in a canonical New Keynesian model with collateral constraints that using the loan-to-value ratio as an additional policy instrument does not resolve the inflation-output volatility tradeoff. Perfect targeting of inflation and either credit or house prices with monetary and macroprudential policy is possible only if the role of credit in the economy is sufficiently small. Any of these three dual stabilization objectives can be achieved with the monetary-fiscal policy mix. The identified limits to the LTV ratio-based policy are related to its predominantly intertemporal effect on decisions made by financially constrained agents.
    Keywords: macroprudential policy, monetary policy, stabilization tradeoffs
    JEL: E32 E58 E63 G21 G28
    Date: 2016
  18. By: João Paulo Pessoa
    Abstract: How does welfare change in the short- and long-run in high wage countries when integrating with low wage economies like China? Even if consumers benefit from lower prices, there can be significant welfare losses from increases in unemployment and lower wages. I construct a dynamic multi-sector country Ricardian trade model that incorporates both search frictions and labor mobility frictions. I then structurally estimate this model using cross-country sector-level data and quantify both the potential losses to workers and benefits to consumers arising from China’s integration into the global economy. I find that overall welfare increases in northern economies, both in the transition period and in the new steady state equilibrium. In import competing sectors, however, workers bear a costly transition, experiencing lower wages and a rise in unemployment. I validate the micro implications of the model using employer-employee panel data.
    Keywords: trade; unemployment; earnings; China
    JEL: R14 J01
    Date: 2016–03
  19. By: Mario Forni; Luca Gambetti; Luca Sala
    Abstract: A shock of interest can be recovered, either exactly or with a good approximation, by means of standard VAR techniques even when the structural MA representation is non- invertible or non-fundamental. We propose a measure of how informative a VAR model is for a specific shock of interest. We show how to use such a measure for the validation of shocks' transmission mechanism of DSGE models through VARs. In an application, we validate a theory of news shocks. The theory does remarkably well for all variables, but understates the long-run effects of technology news on TFP.
    Keywords: invertibility, non-fundamentalness, news shocks, DSGE model validation, structural VAR
    JEL: C32 E32
    Date: 2016–04
  20. By: Craighead, William
    Abstract: This paper examines “hysteresis” in which persistent unemployment takes on structural characteristics over time. Hysteresis is modeled as deterioration in labor market matching efficiency as the average duration of unemployment increases. This is embedded in a simple New Keynesian macro model. A decline in labor market matching efficiency would be consistent with the observed rightward shift of the Beveridge curve since the 2007-09 recession. Hysteresis is shown to lead to larger and more persistent responses of the unemployment rate and unemployment duration to productivity, intertemporal preference and monetary shocks. Hysteresis also generates an increase in the natural rate of unemployment.
    Keywords: Hysteresis, Unemployment, Labor Market Search
    JEL: E24 E32 J64
    Date: 2016–04–02
  21. By: Fujiwara, Ippei (Keio University); Wang, Jiao (Australian National University)
    Abstract: This paper revisits optimal monetary policy in open economies, in particular, focusing on the noncooperative policy game under local currency pricing in a two-country dynamic stochastic general equilibrium model. We first derive the quadratic loss functions which noncooperative policy makers aim to minimize. Then, we show that noncooperative policy makers face extra trade-offs regarding stabilizing the real marginal costs induced by deviations from the law of one price under local currency pricing. As a result of the increased number of stabilizing objectives, welfare gains from cooperation emerge even when two countries face only technology shocks, which usually leads to equivalence between cooperation and noncooperation. Still, gains from cooperation are not large, implying that frictions other than nominal rigidities are necessary to strongly recommend cooperation as an important policy framework to increase global welfare.
    JEL: E52 F41 F42
    Date: 2016–05–01
  22. By: Guido Ascari; Andrea Colciago; Lorenza Rossi
    Abstract: We show how to use Hurwitz polynomials to study the stability and uniqueness of Rational Expectation equilibria in Dynamic General Equilibrium models. We apply this method to a model characterized by staggered wage and price contracts and by limited asset market participation (LAMP). We prove analytically in a fourth-order dynamics system that, once nominal wage stickiness is taken into account, LAMP does not invalidate the Taylor Principle: for any plausible degree of asset market participation an active interest rate rule ensures the uniqueness of the rational expectation equilibrium.
    Keywords: determinacy; high-order dynamics; sticky wages; non-Ricardian household
    JEL: C62 E50
    Date: 2016–04
  23. By: Alice Albonico; Alessia Paccagnini; Patrizio Tirelli
    Abstract: This paper reconsiders the role of macroeconomic shocks and policies in determining the Great Recession and the subsequent recovery in the US. The Great Recession was mainly caused by a large demand shock and by the ZLB on the interest rate policy. In contrast with previous findings, the subsequent jobless recovery is explained by the ZLB effect. We estimate a fraction of non-Ricardian households which is close to 50%, and obtain comparatively large fiscal multipliers. However we cannot detect a significant contribution of fiscal policies in stabilizing the US economy. For instance, the 2007-2009 large increase in expenditure-to-GDP ratios was apparently determined by the adverse non-policy shocks that caused the recession.
    Keywords: DSGE; Limited asset market participation; Bayesian estimation; US economy; Business cycle; Monetary policy; Fiscal policy
    JEL: C11 C13 C32 E21 E32 E37
    Date: 2016–03

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