nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2016‒07‒02
23 papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Precautionary Saving Over the Business Cycle By Edouard Challe; Xavier Ragot
  2. Default, Mortgage Standards and Housing Liquidity By Allen Head; Hongfei Sun; Chenggang Zhou
  3. Uncertainty shocks and labor market dynamics in Japan By Hiroaki Miyamoto
  4. The Effectiveness of a Fiscal Transfer Mechanism in a Monetary Union : A DSGE Model for the Euro Area By Verstegen, Loes; Meijdam, Lex
  5. The Welfare Effects of Involuntary Part-Time Work By Daniel Borowczyk-Martins; Etienne Lalé
  6. The Division of Temporary and Permanent Employment and Business Cycle Fluctuations By Chen, Kuan-Jen; Lai, Ching-Chong; Lai, Ting-Wei
  7. Matching Workers By Espen R. Moen; Eran Yashiv
  8. Public debt and aggregate risk By Desbonnet, Audrey; Kankanamge, Sumudu
  9. Impulse Response Matching Estimators for DSGE Models By GUERRON-QUINTANA, Pablo; INOUE, Atsushi; KILIAN, Lutz
  10. On-the-job search and city structure By van Vuuren, Aico
  11. Time-varying volatility, financial intermediation and monetary policy By Sandra Eickmeier; Norbert Metiu; Esteban Prieto
  12. Fiscal multipliers in Slovak economy DSGE simulation By Juraj Zeman
  13. Household Borrowing Constraints and Residential Investment Dynamics By Hashmat U. Khan; Jean-François Rouillard
  14. Effects of Income Growth on Domestic Saving Rates: The Role of Poverty and Borrowing Constraints By Markus Brueckner; Tomoo Kikuchi; George Vachadze
  15. A note on imperfect credibility By Ippei Fujiwara; Timothy Kam; Takeki Sunakawa
  16. Financing the reconstruction of public capital after a natural disaster By Bevan,David L.; Adam,Christopher
  17. Evaluating monetary policy options for managing resource revenue shocks when fiscal policy is laissez-faire : Application to Nigeria By Chuku Chuku
  18. An Amplification Mechanism in a Model of Energy By Anna Kormilitsina
  19. Raising an Inflation Target : The Japanese Experience with Abenomics By De Michelis, Andrea; Iacoviello, Matteo
  20. Is the Macroeconomy Locally Unstable and Why Should We Care? By Beaudry, Paul; Galizia, Dana; Portier, Franck
  21. Environmental Policy and Endogenous Market Structure By Barbara Annicchiarico; Luca Correani; Fabio Di Dio
  22. Sovereign risk and bank risk-taking By Ari, Anil
  23. Minimum Wage, Economic Growth and Preference for Consumption By Minoru Watanabe

  1. By: Edouard Challe (Department of Economics, Ecole Polytechnique); Xavier Ragot (OFCE)
    Abstract: We study the macroeconomic implications of time-varying precautionary savings within a general equilibrium model with borrowing constraints, aggregate shocks and uninsurable idiosyncratic unemployment risk. Our framework generates limited cross-sectional household heterogeneity as an equilibrium outcome, thereby making it possible to analyse the role of precautionary saving over the business cycle in an analytically tractable way. The time-series behaviour of aggregate consumption generated by our model is closer to the data than that implied by the hand-to-mouth and representative-agent models, and it is comparable to that produced by the Krusell and Smith (1998) model.
    Keywords: Business cycle shocks; Households; Precautionary saving
    Date: 2016–02
  2. By: Allen Head (Queen's University); Hongfei Sun (Queen's University); Chenggang Zhou (University of Waterloo)
    Abstract: The effects of households' indebtedness on their house-selling decisions are studied in a dynamic equilibrium model with search in the housing market and defaultable long-term mortgages. In equilibrium, both sellers' asking prices and time-to-sell increase with the relative size of their outstanding mortgages. In turn, the liquidity of the housing market associated with time-to-sell determines the mortgage standards of competitive lenders, measured by the maximum loan-to-value (LTV) ratio offered at origination. Calibrated to the U.S. economy, the model generates, as observed, positive correlations over time between house prices and LTV's at origination and across sellers among asking prices, time-to-sell, and LTV's outstanding.
    Keywords: Housing, Mortgages, Foreclosures, Directed Search, Liquidity, Block Recursive Equilibrium
    JEL: E30 G21 R10 R31
    Date: 2016–06
  3. By: Hiroaki Miyamoto (University of Tokyo)
    Abstract: This paper examines the effects of uncertainty shocks on Japan’s labor market. Using a measure of uncertainty from the stock market data and a structural VAR model, I find that an increase in uncertainty leads to a rise in unemployment and declines in output, vacancies, and inflation. I then develop a dynamic general equilibrium model with labor market frictions and examine the transmission mechanism of uncertainty shocks. In the model, uncertainty shocks are defined as unexpected increases in the volatility of technology shock. My model can replicate the observed pattern of labor market responses to uncertainty shocks. I also discuss how the job separation channel influences the macroeconomic effect of uncertainty shocks.
    Keywords: Uncertainty, Unemployment, Search and matching, Japanese economy
    JEL: E24 E32 J64
    Date: 2016–06
  4. By: Verstegen, Loes (Tilburg University, Center For Economic Research); Meijdam, Lex (Tilburg University, Center For Economic Research)
    Abstract: In this paper, we incorporate a transfer mechanism into a DSGE model with a rich fiscal sector to assess the effectiveness of fiscal transfers for a monetary union, in particular for the Economic and Monetary Union. Using a heterogeneous setup, the model is estimated for the North and the South of Europe using Bayesian methods. The results show that the transfer mechanism is effective in stabilizing the economy of the southern block of countries during the financial crisis, although the total welfare effect for the EMU is negative, though small. Ex ante, a transfer mechanism would be beneficial for both the North and the South in terms of welfare and stabilization purposes.
    Keywords: Two-country DSGE; Fiscal Federalism; Monetary union; fiscal policy
    JEL: E62 E63 F42
    Date: 2016
  5. By: Daniel Borowczyk-Martins (Département d'économie); Etienne Lalé (Department of Economics (University of Bristol))
    Abstract: Employed individuals in the U.S. are increasingly more likely to work part-time involuntarily than to be unemployed. Spells of involuntary part-time work are different from unemployment spells: a full-time worker who takes on a part-time job suffers an earnings loss while remaining employed, and is unlikely to receive income compensation from publicly-provided insurance programs.We analyze these differences through the lens of an incomplete-market, job-search model featuring unemployment risk alongside an additional risk of involuntary part-time employment.A calibration of the model consistent with U.S. institutions and labor-market dynamics shows that involuntary part-time work generates lower welfare losses relative to unemployment. This finding relies critically on the much higher probability to return to full-time employment from part-time work. We interpret it as a premium in access to full-time work faced by involuntary part-time workers, and use our model to tabulate its value in consumption-equivalent units.
    Keywords: Involuntary part-time work; Unemployment; Welfare
    Date: 2016–06
  6. By: Chen, Kuan-Jen; Lai, Ching-Chong; Lai, Ting-Wei
    Abstract: This paper investigates the fluctuations in temporary relative to aggregate employment over the business cycle, as well as the underlying driving forces. We develop a dynamic general equilibrium model to investigate the following stylized facts: (i) temporary employment is more volatile than permanent employment, (ii) the share of temporary employment (the ratio of temporary to aggregate employment) exhibits strong pro-cyclicality, (iii) permanent employment lags by two quarters on average, and (iv) the correlation between temporary employment and output is stronger than that involving the permanent counterpart. The quantitative analysis suggests that the proposed channels explain the main facts very well and the model provides a possible prediction based on the counter-factual exercises.
    Keywords: Pro-cyclicality of Temporary Employment; Lagged Behavior of Permanent Employment; Labor Productivity; Business Cycles
    JEL: E24 E32
    Date: 2016–04–26
  7. By: Espen R. Moen (Økonomisk institutt Universitetet i Oslo); Eran Yashiv (Tel Aviv University; Centre for Macroeconomics (CFM))
    Abstract: This paper studies the matching of workers within the firm when the productivity of workers depends on how well they match with their co-workers. The firm acts as a coordinating device and derives value from this role. It is shown that a worker's contribution to firm value changes over time in a non-trivial way as co-workers are replaced by new workers. The paper derives optimal hiring and replacement policies, including an optimal stopping rule, and characterizes the resulting equilibrium in terms of worker flows, firm output and the distribution of firm values. Simulations of the model reveal a rich pattern of worker turnover dynamics and their connections to the resulting firm values distribution. The paper stresses the role of horizontal differences in worker productivity, which are different from vertical, assortative matching issues. It derives the rent from organizational capital, with worker complementarities playing a key role. We compare the model to match-specific productivity models and explore the essential differences, with the emphasis laid on worker interactions and complementarities.
    Keywords: Worker interactions, Firm value, Complementarity, Worker value, Organizational capital, Salop circle, Hiring, Firing, Match Quality, Optimal Stopping.
    JEL: E23 E24 D23 J24
    Date: 2016–06
  8. By: Desbonnet, Audrey; Kankanamge, Sumudu
    Abstract: In this paper, we investigate the importance of aggregate fluctuations for the assessment of the optimal level of public debt in an incomplete markets economy. We start by building a steady state model in which households are only subject to uninsurable idiosyncratic risk and evaluate the optimal level of public debt. We then augment the model to allow for aggregate risk and measure the impact on the optimal level. We show that the cyclical behavior of the economy has a quantitative impact on this level that can be decomposed into the effects of the aggregate productivity shock and the cyclicality of unemployment. Moreover, we find that matching wealth distribution statistics substantially changes the optimal level of public debt.
    Keywords: public debt, aggregate risk, precautionary saving, credit constraints.
    JEL: E32 E60 H30 H60
    Date: 2016–05
  9. By: GUERRON-QUINTANA, Pablo; INOUE, Atsushi; KILIAN, Lutz
    Abstract: One of the leading methods of estimating the structural parameters of DSGE models is the VAR-based impulse response matching estimator. The existing asymptotic theory for this estimator does not cover situations in which the number of impulse response parameters exceeds the number of VAR model parameters. Situations in which this order condition is violated arise routinely in applied work. We establish the consistency of the impulse response matching estimator in this situation, we derive its asymptotic distribution, and we show how this distribution can be approximated by bootstrap methods. Our analysis sheds new light on the choice of the weighting matrix and covers both weakly and strongly identified DSGE model parameters. We also show that under our assumptions special care is needed to ensure the asymptotic validity of Bayesian methods of inference. A simulation study suggests that the interval estimators we propose are reasonably accurate in practice. We also show that using these methods may affect the substantive conclusions in empirical work.
    Keywords: Structural estimation, DSGE, VAR, impulse response, nonstandard asymptotics, bootstrap, weak identification, robust inference.
    JEL: C32 C52 E30 E50
    Date: 2016–05–30
  10. By: van Vuuren, Aico (Department of Economics, School of Business, Economics and Law, Göteborg University)
    Abstract: This paper investigates an equilibrium search model in which search frictions are increas- ing with the distance to a city’s central business district, allowing for on-the-job search and endogenous wage formation and land allocation. The findings suggest that the decentralized market results in a more segregated outcome than may be socially desirable. The externality comes from the misguided incentives for the low-paid workers, who have a high preference for central locations in order to climb up the job ladder. Policies reducing the rental costs of unemployed workers for locations close to the central business district may potentially increase welfare.
    Keywords: Search; city structure; urban economics
    JEL: J00 J64 R14
    Date: 2016–06
  11. By: Sandra Eickmeier; Norbert Metiu; Esteban Prieto
    Abstract: We document that expansionary monetary policy shocks are less effective at stimulating output and investment in periods of high volatility compared to periods of low volatility, using a regime-switching vector autoregression. Exogenous policy changes are identified by adapting an external instruments approach to the non-linear model. The lower effectiveness of monetary policy can be linked to weaker responses of credit costs, suggesting a financial accelerator mechanism that is weaker in high volatility periods. To rationalize our robust empirical results, we use a macroeconomic model in which financial intermediaries endogenously choose their capital structure. In the model, the leverage choice of banks depends on the volatility of aggregate shocks. In low volatility periods, financial intermediaries lever up, which makes their balance sheets more sensitive to aggregate shocks and the financial accelerator more effective. On the contrary, in high volatility periods banks decrease leverage, which renders the financial accelerator less effective; this in turn decreases the ability of monetary policy to improve funding conditions and credit supply, and thereby to stimulate the economy. Hence, we provide a novel explanation for the non-linear effects of monetary stimuli observed in the data, linking the effectiveness of monetary policy to the procyclicality of leverage.
    Keywords: Monetary policy, credit spread, non-linearity, intermediary leverage, financial accelerator
    JEL: C32 E44 E52
    Date: 2016–05
  12. By: Juraj Zeman (National Bank of Slovakia, Research Department)
    Abstract: In order to calculate fiscal multipliers for Slovakia, I used a small open DSGE model of Slovakia constructed by Zeman and Senaj (2009), augmented by more sophisticated fiscal sector that comprises of government expenditure components – consumption, investment and social transfers to liquidity constrained households as well as government revenue components – personal income tax, employer social contributions, VAT tax and lump-sum tax. The Slovak government has laid out a plan of public finance consolidation for the period from 2013 to 2017 in order to meet the Fiscal Compact criteria. According to fiscal multipliers calculated in this paper the consolidation will cause an aggregate loss of 2.5 % of GDP during this period.
    Keywords: Fiscal multipliers, expenditure and revenue components, DSGE simulations
    JEL: E32 E62 H20 H50
    Date: 2016–05
  13. By: Hashmat U. Khan (Department of Economics, Carleton University); Jean-François Rouillard (Universite de Sherbrooke)
    Abstract: Why does residential investment lead output in the US and Canada but it is coincident in other industrialized countries? In this paper we explore the role of home-equity loans used to boost consumption as a channel that affects residential investment. Towards this end, we consider a multi-agent real business cycle model augmented with household borrowing constraints that re flect home-equity loans or refinancing constraints. The main contribution of our paper is to highlight that the severity of these borrowing constraints in the economy can generate both stylized facts of residential investment dynamics. In US and Canada, a greater proportion of households rely on home-equity loans relative to other industrialized countries. This difference matters for the distinct residential investment dynamics observed across countries.
    Keywords: Home-Equity Loans, Borrowing Constraints, Residential Investment, Business Cycles
    JEL: E22 E32 R21 R31
    Date: 2016–05–30
  14. By: Markus Brueckner; Tomoo Kikuchi; George Vachadze
    Abstract: We study an overlapping generations model where ex-ante identical agents make an occupational choice under a borrowing constraint. Indivisible investment gives rise to entrepreneurial rents and does not allow everyone to become an entrepreneur. Competition forces entrepreneurs to save more than workers. The model predicts that growth in national income has a positive effect on domestic saving rates in poor countries but a negative effect in rich countries. Borrowing constraints increase domestic saving rates as well as the response of domestic saving to growth in income. These predictions are supported by empirical evidence based on panel data that covers 130 countries during 1960-2007.
    Keywords: overlapping generations, entrepreneurship, occupational choice, saving, borrowing constraints
    JEL: E2 O1
    Date: 2016–06
  15. By: Ippei Fujiwara; Timothy Kam; Takeki Sunakawa
    Abstract: We explore how outcomes of optimal monetary policy with loose commitment (Schaumburg and Tambalotti, 2007; Debortoli and Nunes, 2010) can be observationally equivalent, or interpretable as outcomes of deeper optimal policy under sustainable plans (Chari and Kehoe, 1990). Both interpretations of "imperfect credibility" in optimal monetary policy design are attempts to rationalize outcomes that lie in between the conventional extremes of optimal policy under commitment and under discretion. In a standard monetary-policy framework, when we match impulse responses of inflation and the output gap to large enough markup shocks, we find that a small probability (1 - a = 0.05) of replanning in the quasi/loose commitment world corresponds to N = 18 in the N-period punishment optimal sustainable monetary policy, in terms of observable outcomes. For plausible cases of loose-commitment model economies (with a between 0.77 and 1) we can find an observationally equivalent sustainable-plan economy indexed by some N.
    Keywords: imperfect credibility, monetary policy, sustainable policy
    JEL: E52 E58 E61
    Date: 2016–06
  16. By: Bevan,David L.; Adam,Christopher
    Abstract: When a natural disaster destroys public capital, these direct losses are exacerbated by indirect losses arising from reduced output while reconstruction takes place. These indirect losses may be much larger, relative to the direct ones, in low-income countries, because they lack the finance for rapid reconstruction. This paper uses a dynamic general equilibrium model to examine sovereign disaster risk insurance, increased taxation, and budget reallocation as alternative financing mechanisms for countries where increased borrowing is impractical. The analysis suggests that insurance may or may not be helpful, depending on detailed circumstances, and that budget reallocation is potentially very damaging. Raised taxation, if feasible, may be an attractive option.
    Keywords: Debt Markets,Public Sector Development,Economic Theory&Research,Access to Finance,Investment and Investment Climate
    Date: 2016–06–21
  17. By: Chuku Chuku
    Abstract: This study considers the implications of alternative monetary policy regimes to deal with a laissez-faire fiscal policy rule, where the government completely spends resource revenue windfall contemporaneously. A three sector dynamic stochastic general equilibrium model, which features key structural characteristics of resource-rich developing economies, such as; the Dutch disease, limited international capital mobility, credit constrained consumers, and limited labour mobility are core ingredients of the model. The model is calibrated to match the Nigerian economy.Three alternative mainstream monetary policy regimes are considered:i) a flexible exchange rate regime;ii) a crawling peg; andiii) a money growth target.The results show that the macroeconomic responses to these monetary policy regimes, depends on other auxiliary polices of the central bank, such as; sterilization policy, foreign reserve accumulation policy and openmarket operations. In particular, we find that a flexible exchange rate regime with full domestic absorption delivers the highest level of aggregate employment, though with higher volatility for other macroeconomic variables.The other policy rules deliver lower macroeconomic volatility but at the cost of crowding-out the private sector, depending on the mix of open-market operations. In welfare terms, policy regime (i) delivers the best outcome to economic agents.
    Keywords: Monetary policy
    Date: 2016
  18. By: Anna Kormilitsina (Southern Methodist University)
    Abstract: This paper investigates a propagation mechanism of the energy price shock in a model where capital utilization is associated with costly energy consumption. Endogenous depreciation is an important element of the model, as it has been shown to produce a significant negative effect of energy prices on output. I show that the amplifying effect of endogenous depreciation is determined by the choice of the functional form and calibration strategy for the energy cost function. My estimates of the energy cost function allow to conclude that the energy price shock has only a moderate effect on output in this model, while endogenous depreciation mitigates rather than amplifies the effect of the energy price shock.
    Keywords: energy price, oil price shock, RBC model, endogenous depreciation
    JEL: E32 Q43
    Date: 2015–11
  19. By: De Michelis, Andrea; Iacoviello, Matteo
    Abstract: This paper draws from Japan’s recent monetary experiment to examine the effects of an increase in the inflation target during a liquidity trap. We review Japanese data and examine through a VAR model how macroeconomic variables respond to an identified inflation target shock. We apply these findings to calibrate the effect of a shock to the inflation target in a new-Keynesian DSGE model of the Japanese economy. We argue that imperfect observability of the inflation target and a separate exchange rate shock are needed to successfully account for the behavior of nominal and real variables in Japan since late 2012. Our analysis indicates that Japan has made some progress towards overcoming deflation, but further measures are needed to raise inflation to 2 percent in a stable manner.
    Keywords: Abenomics ; Credibility ; Deflation ; Inflation target ; Japan ; Monetary policy
    JEL: E31 E32 E47 E52 E58 F31 F41
    Date: 2016–05
  20. By: Beaudry, Paul; Galizia, Dana; Portier, Franck
    Abstract: In most modern macroeconomic models, the steady state (or balanced growth path) of the system is a local attractor, in the sense that, in the absence of shocks, the economy would converge to the steady state. In this paper, we examine whether the time series behavior of macroeconomic aggregates (especially labor market aggregates) is in fact supportive of this local-stability view of macroeconomic dynamics, or if it instead favors an alternative interpretation in which the macroeconomy may be better characterized as being locally unstable, with nonlinear deterministic forces capable of producing endogenous cyclical behavior. To do this, we extend a standard AR representation of the data to allow for smooth nonlinearities. Our main finding is that, even using a procedure that may have low power to detect local instability, the data provide intriguing support for the view that the macroeconomy may be locally unstable and involve limit-cycle forces. An interesting finding is that the degree of nonlinearity we detect in the data is small, but nevertheless enough to alter the description of macroeconomic behavior. We complete the paper with a discussion of the extent to which these two different views about the inherent dynamics of the macroeconomy may matter for policy.
    Keywords: Business Cycles; Limit Cycles; Time Series
    JEL: E24 E3 E32
    Date: 2016–05
  21. By: Barbara Annicchiarico (DEF and CEIS, Università di Roma "Tor Vergata"); Luca Correani (Dipartimento di Economia e Impresa, Università degli Studi della Tuscia); Fabio Di Dio (Sogei S.p.a. - IT Economia)
    Abstract: This paper presents a simple dynamic general equilibrium model with supply-side strategic interactions to study the economic effects of mitigating greenhouse gas emissions in an economy with an emission cap and oligopolistic firms competing on prices. With such endogenous market structure a gradual decarbonization policy is likely to induce higher markups, while the number of active firms displays a U-shaped behavior, first decreasing and then increasing. In the long run more firms are active, but they transfer a part of the compliance cost to households by charging a higher markup. The negative effects on the level of economic activity of this anti-competitive outcome are strongly mitigated by recycling policies.
    Keywords: Environmental Policy, Dynamic General Equilibrium Model, Endogenous Market Structure.
    JEL: E32 Q54 Q58
    Date: 2016–06–22
  22. By: Ari, Anil
    Abstract: In European countries recently hit by a sovereign debt crisis, the share of domestic sovereign debt held by the national banking system has sharply increased, raising issues in their economic and financial resilience, as well as in policy design. This paper examines these issues by analyzing the banking equilibrium in a model with optimizing banks and depositors. To the extent that sovereign default causes bank losses also independently of their holding of domestic government bonds, under-capitalized banks have an incentive to gamble on these bonds. The optimal reaction by depositors to insolvency risk imposes discipline, but also leaves the economy susceptible to self-fulfilling shifts in sentiments, where sovereign default also causes a banking crisis. Policy interventions face a trade-off between alleviating funding constraints and strengthening incentives to gamble. Liquidity provision to banks may eliminate the good equilibrium when not targeted. Targeted interventions have the capacity to eliminate adverse equilibria. JEL Classification: E44, E58, F34, G21, H63
    Keywords: bank risk-taking, Eurozone, financial constraints, sovereign debt crises
    Date: 2016–04
  23. By: Minoru Watanabe (Faculty of Economics and Business Administration, Kyoto Gakuin University)
    Abstract: We build a simple overlapping generations model with minimum wage. Many eariler papers do not enough consider household fs preference in the context of minimum wage and ecoomic growth under a dynamic framework Therefore our study focus on the household fs preference for consumption. Results show whether an increase in minimum wage promotes economic growth or not depends on the preference for consumption.
    Keywords: Minimum wage: Unemployment: Economic growth
    JEL: E24 J31 O40
    Date: 2016–06

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