nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2016‒05‒28
24 papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. The Great Escape? A Quantitative Evaluation of the Fed’s Liquidity Facilities By Marco Del Negro; Gauti Eggertsson; Andrea Ferrero; Nobuhiro Kiyotaki
  2. Challenges for Central Banks´ Macro Models By Lindé, Jesper; Smets, Frank; Wouters, Rafael
  3. Fertility, Longevity, and Capital Flows By Bárány, Zsófia; Coeurdacier, Nicolas; Guibaud, Stéphane
  4. Optimal Inflation Rate in a Life-Cycle Economy By Takemasa Oda
  5. Cost channel, interest rate pass-through and optimal monetary policy under zero lower bound By Siddhartha Chattopadhyay; Taniya Ghosh
  6. The Role of Money in Explaining Business Cycles for a Developing Economy: The Case of Pakistan By Shahzad Ahmad; Farooq Pasha; Muhammad Rehman
  7. Estimation and filtering of nonlinear MS-DSGE models By Sergey Ivashchenko
  8. The Imbalanced Catch-up to Rational Expectations: Capital Flows during Convergence By Cozzi, Guido; Davenport, Margaret
  9. How Credit Constraints Impact Job Finding Rates, Sorting & Aggregate Output* By Kyle Herkenhoff; Gordon Phillips; Ethan Cohen-Cole
  10. Firing Costs, Misallocation, and Aggregate Productivity By Jose-Maria Da-Rocha; Marina Mendes Tavares; Diego Restuccia
  11. Rational land and housing bubbles in infinite-horizon economies By Stefano Bosi; Cuong Le Van; Ngoc-Sang Pham
  12. Anti-poverty Income Transfers in the U.S.: A Framework for the Evaluation of Policy Reforms By Salvador Ortigueira; Nawid Siassi
  13. The Postwar Conquest of the Home Ownership Dream By Chambers, Matthew; Garriga, Carlos; Schlagenhauf, Don E.
  14. Optimal time-consistent government debt maturity By Debortoli, Davide; Nunes, Ricardo; Yared, Pierre
  15. Macroeconomic policy in DGSE and agent based models redux : new developments and challenges ahead By G. Fagiolo; A. Roventini
  16. The rise of the added worker effect By Mankart, Jochen; Oikonomou, Rigas
  17. Fracking, China and the Global Economy By Ferreira, Pedro; Trejos, Alberto
  18. New Zealand's experience with changing its inflation target and the impact on inflation expectations By Michelle Lewis; Dr John McDermott
  19. "Demographics and Tax Competition in Political Economy" By Tadashi Morita; Yasuhiro Sato; Kazuhiro Yamamoto
  20. Asset bubbles and efficiency in a generalized two-sector model By Stefano Bosi; Cuong Le Van; Ngoc-Sang Pham
  21. Mitigating the Deadly Embrace in Financial Cycles; Countercyclical Buffers and Loan-to-Value Limits By Jaromir Benes; Douglas Laxton; Joannes Mongardini
  22. How to escape a liquidity trap with interest rate rules By Duarte, Fernando M.
  23. Ignorance is bliss: Should a pension reform be announced? By Fedotenkov, Igor
  24. Demographics and tax competition in political economy By Tadashi Morita; Yasuhiro Sato; Kazuhiro Yamamoto

  1. By: Marco Del Negro; Gauti Eggertsson; Andrea Ferrero; Nobuhiro Kiyotaki
    Abstract: We introduce liquidity frictions into an otherwise standard DSGE model with nominal and real rigidities and ask: Can a shock to the liquidity of private paper lead to a collapse in short-term nominal interest rates and a recession like the one associated with the 2008 U.S. financial crisis? Once the nominal interest rate reaches the zero bound, what are the effects of interventions in which the government provides liquidity in exchange for illiquid private paper? We find that the effects of the liquidity shock can be large, and show some numerical examples in which the liquidity facilities prevented a repeat of the Great Depression in 2008-2009.
    JEL: E44 E58
    Date: 2016–05
  2. By: Lindé, Jesper (Research Department, Central Bank of Sweden); Smets, Frank (ECB, KU Leuven and CEPR); Wouters, Rafael (National Bank of Belgium and CEPR)
    Abstract: In this paper we discuss a number of challenges for structural macroeconomic models in the light of the Great Recession and its aftermath. It shows that a benchmark DSGE model that shares many features with models currently used by central banks and large international institutions has difficulty explaining both the depth and the slow recovery of the Great Recession. In order to better account for these observations, the paper analyses three extensions of the benchmark model. First, we estimate the model allowing explicitly for the zero lower bound constraint on nominal interest rates. Second, we introduce time-variation in the volatility of the exogenous disturbances to account for the non-Gaussian nature of some of the shocks. Third and finally, we extend the model with a financial accelerator and allow for time-variation in the endogenous propagation of financial shocks. All three extensions require that we go beyond the linear Gaussian assumptions that are standard in most policy models. We conclude that these extensions go some way in accounting for features of the Great Recession and its aftermath, but they do not suffice to address some of the major policy challenges associated with the use of non-standard monetary policy and macroprudential policies.
    Keywords: Monetary policy; DSGE; and VAR models; Regime-Switching; Zero Lower Bound; Financial Frictions; Great Recession; Macroprudential policy; Open economy
    JEL: E52 E58
    Date: 2016–05–01
  3. By: Bárány, Zsófia (SciencesPo Paris); Coeurdacier, Nicolas (SciencesPo Paris and CEPR); Guibaud, Stéphane (SciencesPo Paris)
    Abstract: The neoclassical growth model predicts large capital flows towards fast-growing emerging countries. We show that incorporating fertility and longevity into a lifecycle model of savings changes the standard predictions when countries differ in their ability to borrow inter-temporally and across generations through social security. In this environment, global aging triggers capital flows from emerging to developed countries, and countries’ current account positions respond to growth adjusted by current and expected demographic composition. Data on international capital flows are broadly supportive of the theory. The fact that fast-growing emerging countries are also aging faster, while having less developed credit markets and pension systems, explains why they are more likely to export capital. Our quantitative multi-country overlapping-generations model explains a significant fraction of the patterns of capital flows, across time and across developed and emerging countries.
    Date: 2016–05
  4. By: Takemasa Oda (Director and Senior Economist, Institute for Monetary and Economic Studies, Bank of Japan (E-mail:
    Abstract: This paper investigates long-run effects of inflation and deflation in a monetary life-cycle model that incorporates both capital stock and elastic labor supply as production factors. The model also introduces the zero lower bound on the nominal interest rate. The findings of this paper are twofold. First, in contrast to a result obtained from most neoclassical monetary models with an infinitely lived representative agent, the Friedman rule is not optimal and mild inflation can be desirable in this model. The Tobin effect on capital stock is encouraged by redistribution among households and therefore dominates distortionary effects of the inflation tax on labor supply and consumption. Importantly, the optimal rate of inflation depends on how inflation tax revenues are rebated to households. Second, there is a remarkable asymmetry in terms of welfare costs between inflation and deflation. For a lower rate of inflation than the rate that makes the nominal interest rate just zero, the Tobin effect works strongly in a deflationary direction because households are willing to hold more money, thus depressing aggregate output and social welfare significantly. This result reinforces the validity of pursuing mild inflation to evade the risk of hitting the zero lower bound.
    Keywords: Friedman rule, Zero lower bound, Tobin effect, Inflation tax, Redistribution
    JEL: E31 E58 O42
    Date: 2016–04
  5. By: Siddhartha Chattopadhyay (Indian Institute of Technology, Kharagpur); Taniya Ghosh (Indira Gandhi Institute of Development Research)
    Abstract: Cost channel introduces trade-off between inflation rate and output gap. Unlike the canonical New Keynesian DSGE model, optimal monetary policy cannot set both inflation rate and output gap simultaneously to zero under a demand shock. Using a perfect foresight New Keynesian model with cost channel, this paper analyzes the optimal discretionary monetary policy under Zero Lower Bound (ZLB) for varying degree of interest rate pass-through. We find (i) exit date from ZLB becomes endogenous due to the trade-off between output gap and inflation introduced by the cost channel; (ii) presence of cost channel delays the exit from ZLB compared to models without cost channel; and (iii) exit date rises monotonically with the magnitude of demand shock and degree of interest rate pass-through.
    Keywords: New-Keynesian Model, Inflation Target, Liquidity Trap
    JEL: E63 E52 E58
    Date: 2016–05
  6. By: Shahzad Ahmad (State Bank of Pakistan); Farooq Pasha (State Bank of Pakistan); Muhammad Rehman (State Bank of Pakistan)
    Abstract: This paper theoretically evaluates the role of money and monetary policy in propagating business cycle fluctuations of Pakistan’s economy. We introduce the role of money via money in utility (MIU) and cash in advance constraint (CIA) in simple closed economy DSGE models and analyze monetary policy through a money growth rule as well as Taylor type interest rate rule. We establish the theoretical and empirical linkages between nominal and real variables of Pakistan’s economy for post financial liberalization era. We find that the cash base economy models under money growth rule matches the data relatively better compared to cashless economy with Taylor rule.
    Keywords: General Equilibrium Models, Modeling and Simulations, Monetary Policy
    JEL: D58 E27 E52
    Date: 2016–04
  7. By: Sergey Ivashchenko (National Research University Higher School of Economics)
    Abstract: This article suggests and compares the properties of some nonlinear Markov-switching filters. Two of them are sigma point filters: the Markov switching central difference Kalman filter (MSCDKF) and MSCDKFA. Two of them are Gaussian assumed filters: Markov switching quadratic Kalman filter (MSQKF) and MSQKFA. A small scale financial MS-DSGE model is used for tests. MSQKF greatly outperforms other filters in terms of computational costs. It also is the first or the second best according to most tests of filtering quality (including the quality of quasi-maximum likelihood estimation with use of a filter, RMSE and LPS of unobserved variables).
    Keywords: regime switching, second-order approximation, non-linear MS-DSGE estimation, MSQKF, MSCDKF
    JEL: C13 C32 E32
    Date: 2016
  8. By: Cozzi, Guido; Davenport, Margaret
    Abstract: How long shall a country take to learn the world technological frontier? What would happen if that country found the same difficulties in learning the true model of its economy? After all, countries catching up often experience life-changing transformations during the catch-up to a balanced growth path. We show that an open economy, learning rational expectations alongside foreign technology, may be characterized by excessive saving and current account surpluses, as often observed in the data and at odds with the standard open economy theoretical predictions, and not fully explained by standard adaptations such as habit formation. Moreover, such a learning process in a large developing country can upset the savings behavior of a fully rational expectations advanced country. In a US-China calibration, we show that this effect can be so strong as to explain important current account imbalances, the savings glut hypothesis, as well as the distribution of factor income.
    Keywords: Capital flows, convergence, learning, rational expectations, productivity growth
    JEL: E03 F21 F41
    Date: 2015–08
  9. By: Kyle Herkenhoff; Gordon Phillips; Ethan Cohen-Cole
    Abstract: We empirically and theoretically examine how consumer credit access affects dis- placed workers. Empirically, we link administrative employment histories to credit reports. We show that an increase in credit limits worth 10% of prior annual earnings allows individuals to take .15 to 3 weeks longer to find a job. Conditional on finding a job, they earn more and work at more productive firms. We develop a labor sorting model with credit to provide structural estimates of the impact of credit on employ- ment outcomes, which we find are similar to our empirical estimates. We use the model to understand the impact of consumer credit on the macroeconomy. We find that if credit limits tighten during a downturn, employment recovers quicker, but output and productivity remain depressed. This is because when limits tighten, low-asset, low- productivity job losers cannot self-insure. Therefore, they search less thoroughly and take more accessible jobs at less productive firms.
    Date: 2016–01
  10. By: Jose-Maria Da-Rocha; Marina Mendes Tavares; Diego Restuccia
    Abstract: We assess the quantitative impact of firing costs on aggregate total factor productivity (TFP) in a dynamic general-equilibrium framework where the distribution of establishment-level productivity is not invariant to the policy. We show that firing costs not only generate static misallocation, but also a worsening of the productivity distribution substantially contributing to large aggregate TFP losses. In a calibrated version of the model, firing costs equivalent to 5 years' wages imply a drop in TFP of more than 20 percent. Consistent with the existing literature on firing costs, static misallocation only generates a small drop in TFP, accounting for around 20 percent of the total loss, whereas the remaining 80 percent arises from the endogenous change in the productivity distribution.
    Keywords: firing costs, inaction, misallocation, establishments, productivity.
    JEL: O1 O4 E1 E6
    Date: 2016–05–19
  11. By: Stefano Bosi (EPEE - Centre d'Etudes des Politiques Economiques - Université d'Evry-Val d'Essonne); Cuong Le Van (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique, IPAG BUSINESS SCHOOL - IPAG BUSINESS SCHOOL PARIS, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics); Ngoc-Sang Pham (EPEE - Centre d'Etudes des Politiques Economiques - Université d'Evry-Val d'Essonne, LEM - Lille - Economie et Management - Université de Lille, Sciences et Technologies - Fédération Universitaire et Polytechnique de Lille - Université de Lille, Sciences Humaines et Sociales - CNRS - Centre National de la Recherche Scientifique)
    Abstract: This paper considers rational land and housing bubbles in an infinite-horizon general equilibrium model. Their demands rest on two different grounds: the land is an input to produce while the house may be consumed. Our work differs from the existing literature in two respects. First, dividends on both these long-lived assets are endogenous and their sequences are computed. Second, we introduce and study different concepts of bubbles, including individual and strong bubbles.
    Keywords: housing bubble,infinite horizon,general equilibrium,land bubble
    Date: 2016–02
  12. By: Salvador Ortigueira (Department of Economics, University of Miami); Nawid Siassi (Department of Economics, University of Konstanz, Universit¨atsstrasse)
    Abstract: We develop a dynamic model of labor supply, consumption, savings and marriage decisions to study the behavioral responses of low-income workers to anti-poverty income transfers in the U.S. The model is calibrated to match moments from a sample of non-college-educated workers with children drawn from the 2014 Annual Social and Economic Supplement. The categorical, asset and income eligibility criteria of the transfer programs, along with the income and payroll taxes, yield complex budget constraints and introduce a web of interactions whose effects we identify and measure. We examine the workers' behavioral responses across the model's equilibrium distribution over living arrangements, labor productivities, wealth and number of children. Then we use the model to assess the effects of three recent proposals to reform the U.S. tax-transfer system, including the "21st Century Worker Tax Cut Act" and the "Tax Reform Act of 2014". A core objective of these proposals is the mitigation of the disincentives introduced by the Earned Income Tax Credit to married mothers' labor market participation.
    Keywords: Anti-poverty income transfers, household decisions, cohabitation and marriage Publication Status: Under Review
    JEL: E21 H24 H31 J12
    Date: 2016–04–29
  13. By: Chambers, Matthew (Towson University); Garriga, Carlos (Federal Reserve Bank of St. Louis); Schlagenhauf, Don E. (Federal Reserve Bank of St. Louis)
    Abstract: Post-World War II witnessed the largest housing boom in recent history. This paper develops a quantitative equilibrium model of tenure choice to analyze the key determinants in the co-movement between home-ownership and house prices over the period 1940-1960. The parameterized model matches key features and is capable of accounting for the observed housing boom. The key driver in understanding this boom is an asymmetric productivity change that favors the goods sector relative to the construction sector. Other factors such as demographics, income risk, and government policy are important determinants of the homeownership rate but have small effect on house prices.
    Keywords: Housing finance; first-time buyers; life-cycle
    JEL: E2 E6
    Date: 2016–04–12
  14. By: Debortoli, Davide (Universitat Pompeu Fabra); Nunes, Ricardo (Federal Reserve Bank of Boston); Yared, Pierre (Columbia University)
    Abstract: The current literature on a government's optimal debt maturity structure contends that by purchasing short-term assets and selling long-term debt, it is possible to fully insulate the economy against fiscal shocks. The required short and long positions are large relative to GDP and constant. The market value of debt adjusts automatically and the constant debt positions and fluctuating bond prices insulate against potential shocks. However, achieving the goal of averting future shocks depends on the government perfectly committing to the future fiscal policy, for without this sustained commitment, the large debt positions required to insure against future spending shocks are extremely expensive to service; moreover, the government faces a tradeoff between using the debt maturity structure to service its debt obligations and using it to protect against economic shocks. As the authors point out, in practice a government chooses tax, spending, and debt levels sequentially in each period, taking into account its outstanding debt portfolio and anticipating the behavior of future governments. The paper develops an alternative model of optimal debt maturity that solves the problem of a government's lack of commitment.
    Keywords: public debt; optimal taxation; fiscal policy
    JEL: E62 H21 H63
    Date: 2016–05–17
  15. By: G. Fagiolo (Scuola Superiore Sant'Anna); A. Roventini (Scuola Superiore Sant'Anna & OFCE Sciences Po)
    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 heterogeneous 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.
    JEL: B41 B50 E32 E52
    Date: 2016–04
  16. By: Mankart, Jochen; Oikonomou, Rigas
    Abstract: We document that the added worker effect (AWE) has increased over the last three decades. We develop a search model with two earner households and we illustrate that the increase in the AWE from the 1980s to the 2000s can be explained through i) the narrowing of the gender pay gap, ii) changes in the frictions in the labor market and iii) changes in the labor force participation costs of married women.
    Keywords: Heterogeneous Agents,Family Self Insurance,Dual Earner,Unemployment,Labor Market Search
    JEL: E24 J12 J64
    Date: 2016
  17. By: Ferreira, Pedro; Trejos, Alberto
    Abstract: We develop an intertemporal model of the international economy, where tradeable intermediate goods are produced with capital, labor and hydrocarbons, and used in the production of non-tradeable consumption and investment goods. The model is calibrated to 176 countries, grouped according to their characteristics. We conduct simulations about key events that are currently reshaping the world e.g., fracking and China's new model of development. The model reproduces closely the recent fall in oil prices and delivers results about the impact on global output and con- sumption, but also about the propagation to di¤erent countries through terms of trade and capital accumulation.
    Date: 2016–05–04
  18. By: Michelle Lewis; Dr John McDermott (Reserve Bank of New Zealand)
    Abstract: We document the experience of the Reserve Bank of New Zealand in changing its inflation target, particularly the effects on inflation expectations. Firstly, the Reserve Bank of New Zealand's DSGE model is used to highlight expectation-formation in the transmission following a change in the inflation target. Secondly, a Nelson-Siegel model is used to combine a number of inflation expectation surveys into a continuous curve where expectations can be plotted as a function of the forecast horizon. Using estimates of long-run inflation expectations derived from the Nelson-Siegel model, we find that numerical changes in the inflation target result in an immediate change in inflation expectations.
    Date: 2016–07
  19. By: Tadashi Morita (Faculty of Economics, Kindai University); Yasuhiro Sato (Faculty of Economics, The University of Tokyo); Kazuhiro Yamamoto (Graduate School of Economics, Osaka University)
    Abstract: We examine possible impacts of demographics on outcomes of capital tax competition in political economy. For this purpose, we develop an overlapping generations model wherein public good provision financed by capital tax is determined by majority voting. When a population is growing, younger people represent the majority, whereas when a population is decreasing, older people represent the majority. We show that the race to the bottom is likely to emerge in the population growing economy whereas the race to the top might emerge in the population decreasing economy.
  20. By: Stefano Bosi (EPEE - Université d'Evry); Cuong Le Van (Centre d'Economie de la Sorbonne - Paris School of Economics, IPAG Business School); Ngoc-Sang Pham (EPEE - Université d'Evry and LEM - Université de Lille 3)
    Abstract: We consider a multi-sector infinite-horizon general equilibrium model. Asset supply is endogenous. The issues of equilibrium exisence, efficiency, and bubble emergence are addressed. We show how different assets give rise to very different rational bubbles. We also point out that efficient bubbly equilibria may exist
    Keywords: infinite horizon; general equilibrium; aggregate good bubble; capital good bubble; efficiency
    JEL: D31 D91 E22 G10
    Date: 2016–03
  21. By: Jaromir Benes; Douglas Laxton; Joannes Mongardini
    Abstract: This paper presents a new version of MAPMOD (Mark II) to study the effectiveness of macroprudential regulations. We extend the original model by explicitly modeling the housing market. We show how household demand for housing, house prices, and bank mortgages are intertwined in what we call a deadly embrace. Without macroprudential policies, this deadly embrace naturally leads to housing boom and bust cycles, which can be very costly for the economy, as shown by the Global Financial Crisis of 2008-09.
    Keywords: Business cycles;Credit demand;Credit booms;Household credit;Housing prices;Mortgages;Systemic risk;Macroprudential Policy;Risk management;lending booms, credit crunch, financial crisis, financial cycle, housing market, countercyclical buffers, loan-to-value limits, macroprudential policies
    Date: 2016–04–08
  22. By: Duarte, Fernando M. (Federal Reserve Bank of New York)
    Abstract: I give necessary and sufficient conditions under which interest-rate feedback rules eliminate aggregate instability by inducing a globally unique optimal equilibrium in a canonical New Keynesian economy with a binding zero lower bound. I consider a central bank that initially keeps interest rates pegged at zero for a length of time that depends on the state of the economy and then switches to a standard Taylor rule. There are two crucial principles to achieving global uniqueness. In response to deepening deflationary expectations, the central bank must, first, sufficiently extend the initial period of zero interest rates and, afterward, follow a Taylor rule that does not obey the Taylor principle. I obtain all results assuming a passive or Ricardian fiscal policy stance, so that it is monetary policy alone that eliminates undesired equilibria. The interest rate rules that I consider do not require central banks to undergo any significant institutional change and do not rely on the Neo-Fisherian mechanism of inducing an increase in inflation by first increasing interest rates.
    Keywords: zero lower bound (ZLB); liquidity trap; New Keynesian model; indeterminacy; monetary policy; Taylor rule; Taylor principle; interest rate rule; forward guidance
    JEL: E43 E52 E58
    Date: 2016–05–01
  23. By: Fedotenkov, Igor
    Abstract: This paper studies whether a pension reform, namely a switch from a pay-as-you-go (PAYG) to a more-funded scheme should be announced. We show that such an announcement increases savings, leading to a decline in interest rates. Smaller returns to savings lead to higher losses for the first transitional generation, which suffers from the reform the most. On the other hand, higher savings by the first transitional generation lead to faster capital accumulation, which benefits younger generations. We argue that if a government cares about the agents with the most to lose, it may more beneficial not to announce such a reform.
    Keywords: Pension reform, announcement, savings, interest rate
    JEL: E13 E21 H55
    Date: 2016–05–01
  24. By: Tadashi Morita (Faculty of Economics, Kindai University,); Yasuhiro Sato (Faculty of Economics, University of Tokyo); Kazuhiro Yamamoto (Graduate School of Economics, Osaka University)
    Abstract: We examine possible impacts of demographics on outcomes of capital tax compe- tition in political economy. For this purpose, we develop an overlapping generations model wherein public good provision financed by capital tax is determined by majority voting. When a population is growing, younger people represent the majority, whereas when a population is decreasing, older people represent the majority. We show that the race to the bottom is likely to emerge in the population growing economy whereas the race to the top might emerge in the population decreasing economy.
    Keywords: tax competition, majority voter, fiscal externality, political externality
    JEL: H20 J11
    Date: 2016–05

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