nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2016‒06‒14
eighteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Monetary Policy and Efficiency in Over-the-Counter Financial Trade By Athanasios, Geromichalos; Kuk Mo, Jung
  2. Monetary policy transmission in China: A DSGE model with parallel shadow banking and interest rate control By Funke, Michael; Mihaylovski, Petar; Zhu, Haibin
  3. Insurance in Human Capital Models with Limited Enforcement By Krebs, Tom; Kuhn, Moritz; Wright, Mark L. J.
  4. Bernanke's No-arbitrage Argument Revisited: Can Open Market Operations in Real Assets Eliminate the Liquidity Trap? By Gauti B. Eggertsson; Kevin Proulx
  5. Solution and Estimation of Dynamic Discrete Choice Structural Models Using Euler Equations By Victor Aguirregabiria; Arvind Magesan
  6. The interaction of monetary and macroprudential policies in economic stabilisation By Silvo, Aino
  7. On the Sources of Business Cycles: Implications for DSGE Models By Michal Andrle; Jan Bruha; Serhat Solmaz
  8. Demographics and real interest rates: inspecting the mechanism By Carvalho, Carlos; Ferrero, Andrea; Nechio, Fernanda
  9. Terms of Trade Shocks and Monetary Policy in India By Ghate, Chetan; Gupta, Sargam; Mallick, Debdulal
  10. Student loans, fertility, and economic growth By Miyazaki, Koichi
  11. Multiple Equilibria in Open Economy Models with Collateral Constraints: Overborrowing Revisited By Stephanie Schmitt-Grohé; Martín Uribe
  12. Carbon Emissions and Business Cycles By Hashmat Khan; Christopher R. Knittel; Konstantinos Metaxoglou; Maya Papineau
  13. Asset bubbles and efficiency in a generalized two-sector model By Stefano Bosi; Cuong Le Van; Ngoc-Sang Pham
  14. Doves for the Rich, Hawks for the Poor? Distributional Consequences of Monetary Policy By Gornemann, Nils; Kuester, Keith; Nakajima, Makoto
  16. Band or Point Inflation Targeting? An Experimental Approach By Camille Cornand; Cheick Kader M'baye
  17. Workforce Composition, Productivity, and Labor Regulations in a Compensating Differentials Theory of Informality By Haanwinckel, Daniel; Soares, Rodrigo R.
  18. Allocative and Remitted Wages: New Facts and Challenges for Keynesian Models By Susanto Basu; Christopher L. House

  1. By: Athanasios, Geromichalos; Kuk Mo, Jung
    Abstract: We develop a monetary model that incorporates Over-the-Counter (OTC) asset trade. After agents have made their money holding decisions, they receive an idiosyncratic shock that affects their valuation for consumption and, hence, for the unique liquid asset, namely, money. Subsequently, agents can choose whether they want to enter the OTC market in order to sell assets and, thus, boost their liquidity, or to buy assets and, thus, provide liquidity to other agents. A unique feature of our model is that inflation affects welfare not only through the traditional channel, i.e., through determining equilibrium real balances, but also through influencing agents' entry decisions in the financial market. We use our framework to study the effect of inflation on welfare, asset prices, and OTC trade volume. In contrast to most monetary models, which predict a negative relationship between inflation and welfare, we find that inflation can be welfare improving within a certain range, because it mitigates a search externality that agents impose on one another when they make their OTC market entry decision.
    Keywords: monetary-search models, liquidity, asset prices, over-the-counter markets
    JEL: E31 E50 E52 G12
    Date: 2016–05
  2. By: Funke, Michael; Mihaylovski, Petar; Zhu, Haibin
    Abstract: The paper sheds light on the interplay between monetary policy, the commercial banking sector and the shadow banking sector in mainland China by means of a nonlinear stochastic general equilibrium (DSGE) model with occasionally binding constraints. In particular, we analyze the impacts of interest rate liberalization on monetary policy transmission as well as the dynamics of the parallel shadow banking sector. Comparison of various interest rate liberalization scenarios reveals that monetary policy results in increased feed-through to the lending and investment under complete liberalization. Furthermore, tighter regulation of interest rates in the commercial banking sector in China leads to an increase in loans provided by the shadow banking sector.
    Keywords: DSGE model, monetary policy, financial market reform, shadow banking, China
    JEL: E32 E42 E52 E58
    Date: 2015–03–09
  3. By: Krebs, Tom (University of Mannheim); Kuhn, Moritz (University of Bonn); Wright, Mark L. J. (Federal Reserve Bank of Chicago)
    Abstract: This paper develops a tractable human capital model with limited enforceability of contracts. The model economy is populated by a large number of long-lived, risk-averse households with homothetic preferences who can invest in risk-free physical capital and risky human capital. Households have access to a complete set of credit and insurance contracts, but their ability to use the available financial instruments is limited by the possibility of default (limited contract enforcement). We provide a convenient equilibrium characterization that facilitates the computation of recursive equilibria substantially. We use a calibrated version of the model with stochastically aging households divided into 9 age groups. Younger households have higher expected human capital returns than older households. According to the baseline calibration, for young households less than half of human capital risk is insured and the welfare losses due to the lack of insurance range from 3 percent of lifetime consumption (age 40) to 7 percent of lifetime consumption (age 23). Realistic variations in the model parameters have non-negligible effects on equilibrium insurance and welfare, but the result that young households are severely underinsured is robust to such variations.
    Keywords: human capital risk, limited enforcement, insurance
    JEL: E21 E24 D52 J24
    Date: 2016–05
  4. By: Gauti B. Eggertsson; Kevin Proulx
    Abstract: We first show that, at least in theory, open market operations in real assets can be a useful tool for overcoming a liquidity trap because they change the inflation incentives of the government, and thus change private sector expectations from deflationary to inflationary. We argue that this formalizes Ben Bernanke's arbitrage argument for why a central bank can always increase nominal demand, despite the zero lower bound. We illustrate this logic in a calibrated New Keynesian model assuming the government acts under discretion. Numerical experiments suggest, however, that the needed intervention is incredibly high, creating a serious limitation of this solution to the liquidity trap. Our experiments suggest that while asset purchases can be a helpful commitment device in theory, they may need to be combined in practice with fiscal policy coordination to achieve the desired outcome.
    JEL: E31 E4 E42 E43 E50 E51 E52 E58 E61 E62
    Date: 2016–05
  5. By: Victor Aguirregabiria; Arvind Magesan
    Abstract: This paper extends the Euler Equation (EE) representation of dynamic decision problems to a general class of discrete choice models and shows that the advantages of this approach apply not only to the estimation of structural parameters but also to the computation of a solution and to the evaluation of counterfactual experiments. We use a choice probabilities representation of the discrete decision problem to derive marginal conditions of optimality with the same features as the standard EEs in continuous decision problems. These EEs imply a fixed point mapping in the space of conditional choice values, that we denote the Euler equation-value (EE-value) operator. We show that, in contrast to Euler equation operators in continuous decision models, this operator is a contraction. We present numerical examples that illustrate how solving the model by iterating in the EE-value mapping implies substantial computational savings relative to iterating in the Bellman equation (that requires a much larger number of iterations) or in the policy function (that involves a costly valuation step). We define a sample version of the EE-value operator and use it to construct a sequence of consistent estimators of the structural parameters, and to evaluate counterfactual experiments. The computational cost of evaluating this sample-based EE-value operator increases linearly with sample size, and provides an unbiased (in finite samples) and consistent estimator the counterfactual. As such there is no curse of dimensionality in the consistent estimation of the model and in the evaluation of counterfactual experiments. We illustrate the computational gains of our methods using several Monte Carlo experiments.
    Keywords: Dynamic programming discrete choice models; Euler equations; Policy iteration; Estimation; Approximation bias
    JEL: C13 C35 C51 C61
    Date: 2016–05–24
  6. By: Silvo, Aino
    Abstract: I analyse the dynamics of a New Keynesian DSGE model where the financing of investments is affected by a moral hazard problem. I solve for jointly Ramsey-optimal monetary and macroprudential policies. I find that when a financial friction is present in addition to the standard nominal friction, the optimal policy can replicate the first-best if the social planner can conduct both monetary and macroprudential policy to control both inflation and the level of investments. Using monetary policy alone is not enough to fully stabilise the economy: it leads to a policy trade-off between stabilising inflation and the output gap. When policy follows simple rules instead, the source of fluctuations is highly relevant for the choice of the appropriate policy mix.
    Keywords: monetary policy, macroprudential policy, financial frictions
    JEL: E32 E44 E52 G28
    Date: 2016–02–10
  7. By: Michal Andrle; Jan Bruha; Serhat Solmaz
    Abstract: What are the drivers of business cycle fluctuations? And how many are there? By documenting strong and predictable co-movement of real variables during the business cycle in a sample of advanced economies, we argue that most business cycle fluctuations are driven by one major factor. The positive co-movement of real output and inflation convincingly argues for a demand story. This feature-robust across time and space-provides a simple smell test for structural macroeconomic models. We propose a simple statistic that can compare data and models. Based on this statistic, we show that the recent vintage of structural economic models has difficulties replicating the stylized facts we document.
    Keywords: Business cycle, demand shocks, DSGE models, dynamic principal component analysis
    JEL: C10 E32 E50
    Date: 2016–03
  8. By: Carvalho, Carlos (PUC-Rio); Ferrero, Andrea (University of Oxford); Nechio, Fernanda (Federal Reserve Bank of San Francisco)
    Abstract: The demographic transition can affect the equilibrium real interest rate through three channels. An increase in longevity—or expectations thereof—puts downward pressure on the real interest rate, as agents build up their savings in anticipation of a longer retirement period. A reduction in the population growth rate has two counteracting effects. On the one hand, capital per-worker rises, thus inducing lower real interest rates through a reduction in the marginal product of capital. On the other hand, the decline in population growth eventually leads to a higher dependency ratio (the fraction of retirees to workers). Because retirees save less than workers, this compositional effect lowers the aggregate savings rate and pushes real rates up. We calibrate a tractable life-cycle model to capture salient features of the demographic transition in developed economies, and find that its overall effect is a reduction of the equilibrium interest rate by at least one and a half percentage points between 1990 and 2014. Demographic trends have important implications for the conduct of monetary policy, especially in light of the zero lower bound on nominal interest rates. Other policies can offset the negative effects of the demographic transition on real rates with different degrees of success.
    JEL: E52 E58 J11
    Date: 2016–03–01
  9. By: Ghate, Chetan; Gupta, Sargam; Mallick, Debdulal
    Abstract: Central banks in emerging markets often grapple with understanding the monetary policy response to an inter-sectoral terms of trade shock. To address this, we develop a three sector closed economy NK-DSGE model calibrated to India. Our framework can be generalized to other emerging markets and developing countries. The model is characterized by a manufacturing sector and an agricultural sector. The agricultural sector is disaggregated into a food grain and vegetable sector. The government procures grain from the grain market and stores it. We show that the procurement of grain leads to higher inflation, a change in the sectoral terms of trade, and a positive output gap because of a change in the sectoral allocation of labor. We compare the transmission of a single period positive procurement shock with a single period negative productivity shock and discuss what implications such shocks have for monetary policy setting. Our paper contributes to a growing literature on monetary policy in India and other emerging market economies.
    Keywords: Multi-sector New Keynesian DSGE Models, Terms of Trade Shocks, Reserve Bank of India, Indian Economy, Agricultural Procurement
    JEL: E31 E52 E58 Q18
    Date: 2016–05–09
  10. By: Miyazaki, Koichi
    Abstract: The cost of attaining higher education is growing in some developed countries. More young people borrow larger amounts than before to finance their higher education. Several media reports indicate that student loans might affect young people's decision making regarding important life events such as marriage, childbirth, purchasing a house, and so on. Specifically, this paper focuses on how the burden of student loans affects young people's decision making with regard to the number of children to have, and studies the fertility rate, gross domestic product (GDP) growth rate, and growth rate of GDP per capita using a three-period overlapping generations model. A young agent needs to borrow to accumulate his/her human capital, although for some reason, s/he faces the borrowing constraint. In the next period, the agent repays his/her debt as well as determines the number of children to have. Under this setting, this paper analyzes how the tightness of the borrowing constraints affects the growth rates of the population, GDP, and GDP per capita. The paper finds that when rearing children is time-consuming, the population growth rate decreases as the borrowing constraints are relaxed. Moreover, the paper shows a case in which the GDP growth rate decreases as the borrowing constraints are relaxed, whereas the growth rate of GDP per capita still increases. In addition, I show that if the cost of rearing children is mainly monetary, then the population growth rate is not necessarily decreasing as the borrowing constraints are relaxed. The paper also calibrates the model using U.S. data.
    Keywords: Student loans, human capital accumulation, fertility, growth rate of GDP, growth rate of GDP per capita, overlapping generations model
    JEL: E44 I25 J13 J24
    Date: 2016–05–24
  11. By: Stephanie Schmitt-Grohé; Martín Uribe
    Abstract: This paper establishes the existence of multiple equilibria in infinite-horizon open- economy models in which the value of tradable and nontradable endowments serves as collateral. In this environment, the economy displays self-fulfilling financial crises in which pessimistic views about the value of collateral induces agents to deleverage. The paper shows that under plausible calibrations, there exist equilibria with underborrowing. This result stands in contrast to the overborrowing result stressed in the related literature. Underborrowing emerges in the present context because in economies that are prone to self-fulfilling financial crises, individual agents engage in excessive precautionary savings as a way to self-insure.
    JEL: E44 F41 G01 H23
    Date: 2016–05
  12. By: Hashmat Khan; Christopher R. Knittel; Konstantinos Metaxoglou; Maya Papineau
    Abstract: U.S. carbon dioxide emissions are highly procyclical—they increase during expansions and fall during recessions. Given this empirical fact, we estimate the response of emissions to four prominent technology shocks from the business-cycle literature using structural vector autoregressive methodologies and data for 1973–2012. By studying the response of emissions to these shocks, we provide a novel approach to assess the shocks’ relevance as sources of aggregate output fluctuations. We find that emissions rise on impact only after an anticipated investment-specific technology shock; the response is statistically significant after the first quarter. The same shock explains most— roughly a third—of the total variation in emissions at a horizon of 5 years. Notably, emissions decrease on impact after an unanticipated neutral technology shock in a statistically significant way. This negative empirical response has the opposite sign from its theoretical counterpart in recent environmental DSGE (E-DSGE) models. Since the positive response of emissions drives the E-DSGE models’ recommendation for an optimal procyclical policy, our findings suggest that such a policy recommendation should be treated cautiously.
    JEL: E32 Q43 Q48 Q54
    Date: 2016–05
  13. By: Stefano Bosi (EPEE - Centre d'Etudes des Politiques Economiques - Université d'Evry-Val d'Essonne); Cuong Le Van (IPAG BUSINESS SCHOOL - IPAG BUSINESS SCHOOL PARIS, CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique); Ngoc-Sang Pham (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, EPEE - Centre d'Etudes des Politiques Economiques - Université d'Evry-Val d'Essonne)
    Abstract: We consider a multi-sector infinite-horizon general equilibrium model. Asset supply is endogenous. The issues of equilibrium existence, 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
    Date: 2016–03
  14. By: Gornemann, Nils; Kuester, Keith; Nakajima, Makoto
    Abstract: We build a New Keynesian business-cycle model with rich household heterogeneity. A central feature is that matching frictions render labor-market risk countercyclical and endogenous to monetary policy. Our main result is that a majority of households prefer substantial stabilization of unemployment even if this means deviations from price stability. A monetary policy focused on unemployment stabilization helps "Main Street" by providing consumption insurance. It hurts "Wall Street" by reducing precautionary saving and, thus, asset prices. On the aggregate level, household heterogeneity changes the trans mission of monetary policy to consumption, but hardly to GDP. Central to this result is allowing for self-insurance and aggregate investment.
    Keywords: General Equilibrium; Heterogeneous Agents; Monetary policy; Search and Matching; Unemployment
    JEL: E12 E21 E24 E32 E52 J64
    Date: 2016–04
    Date: 2016
  16. By: Camille Cornand (Université de Lyon, Lyon, F-69007, France ; CNRS, GATE Lyon St Etienne,F-69130 Ecully, France); Cheick Kader M'baye (University of Bamako, Bamako, Mali)
    Abstract: We conduct laboratory experiments with human subjects to test the rationale of adopting a band versus point inflation targeting regime. Within the standard New Keynesian model, we evaluate the macroeconomic performances of both regimes according to the strength of shocks affecting the economy. We find that when the economy faces small shocks, the average level of inflation as well as its volatility are significantly lower in a band targeting regime, while the output gap and interest rate levels and volatility are significantly lower in a point targeting regime with tolerance bands. However, when the economy faces large shocks, choosing the suitable inflation targeting regime is irrelevant because both regimes lead to comparable performances. These findings stand in contrast to those of the literature and question the relevance of clarifying a mid-point target within the bands, especially in emerging market economies more inclined to large and frequent shocks.
    Keywords: band inflation target, point inflation target, inflation expectations, monetary policy, New Keynesian model, macroeconomic shocks, laboratory experiments
    JEL: E58 E52 C91 C92
    Date: 2016
  17. By: Haanwinckel, Daniel (University of California, Berkeley); Soares, Rodrigo R. (Sao Paulo School of Economics)
    Abstract: We develop a search model of informal labor markets with worker and firm heterogeneity, intra-firm bargaining with imperfect substitutability across types of workers, and a comprehensive set of labor regulations, including minimum wage. Stylized facts associated with the informal sector, such as smaller firms and lower wages, emerge endogenously as firms and workers decide whether to comply with regulations. Imperfect substitutability across types of workers and decreasing returns to scale enable the model to reproduce empirical patterns incompatible with existing frameworks in the literature: the presence of skilled and unskilled workers in the formal and informal sectors, the rising share of skilled workers by firm size, and the declining formal wage premium by skill level. These features also allow us to analyze the equilibrium responses to changes in the demand and supply of different types of labor. We estimate the model using Brazilian data and show that it closely reproduces the decline in informality observed between 2003 and 2012. The change in the composition of the labor force appears as the main driving force behind this phenomenon. We illustrate the use of the model for policy analysis by assessing the effectiveness of a progressive payroll tax in reducing informality.
    Keywords: informality, labor market, search, minimum wage, compensating differentials, Brazil
    JEL: J24 J31 J46 J64 O17
    Date: 2016–05
  18. By: Susanto Basu; Christopher L. House
    Abstract: Modern monetary business-cycle models rely heavily on price and wage rigidity. While there is substantial evidence that prices do not adjust frequently, there is much less evidence on whether wage rigidity is an important feature of real world labor markets. While real average hourly earnings are not particularly cyclical, and do not react significantly to monetary policy shocks, systematic changes in the composition of employed workers and implicit contracts within employment arrangements make it difficult to draw strong conclusions about the importance of wage rigidity. We augment a workhorse monetary DSGE model by allowing for endogenous changes in the composition of workers and also by explicitly allowing for a difference between allocative wages and remitted wages. Using both individual-level and aggregate data, we study and extend the available evidence on the cyclicality of wages and we pay particular attention to the response of wages to identified monetary policy shocks. Our analysis suggests several broad conclusions: (i) in the data, composition bias plays a modest but noticeable role in cyclical compensation patterns; (ii) empirically, both the wages for newly hired workers and the "user cost of labor" respond strongly to identified monetary policy innovations; (iii) a model with implicit contracts between workers and firms and a flexible allocative wage replicates these patterns well. We conclude that price rigidity likely plays a substantially more important role than wage rigidity in governing economic fluctuations.
    JEL: E24 E3 E31 E32
    Date: 2016–05

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