nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2016‒07‒09
twenty-two papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. South Africa’s real business cycles: The Cycle is the trend By Hilary Patroba and Leroi Raputsoane
  2. Search and matching frictions and business cycle fluctuations in Bulgaria By Vasilev, Aleksandar
  3. Search-based endogenous asset liquidity and the macroeconomy By Cui, Wei; Radde, Sören
  4. Employment and hours over the business cycle in a model with search frictions By Noritaka Kudoh; Hiroaki Miyamoto; Masaru Sasaki
  5. The Impact of Oil Shocks in a Small Open Economy New-Keynesian Dynamic Stochastic General Equilibrium Model for South Africa By Rangan Gupta; Hylton Hollander
  6. The slow job recovery in a macro model of search and recruiting intensity By Leduc, Sylvain; Liu, Zheng
  7. Persistence and Amplification of Financial Frictions By Shirai, Daichi
  8. Means Testing of Public Pensions: The Case of Australia By George Kudrna
  9. Reserve requirements and optimal Chinese stabilization policy By Chang, Chun; Liu, Zheng; Spiegel, Mark M.; Zhang, Jingyi
  10. Inequality Causes Recessions: A Fallout from Ramsey's Conjecture By Belanger, Gilles
  11. The effects of productivity and benefits on unemployment: Breaking the link By Brown, Alessio; Kohlbrecher, Britta; Merkl, Christian; Snower, Dennis J.
  12. Euro currency risk and the geography of debt flows to peripheral European monetary union members By Ersal-Kiziler,Eylem; Nguyen,Ha Minh
  13. Policy Variation, Labor Supply Elasticities, and a Structural Model of Retirement By Mullen, Kathleen J.; Manoli, Day; Wagner, Mathis
  14. Human Capital and Labor Informality in Chile: A Life-Cycle Approach By Lopez Garcia, Italo
  15. Communication Frictions, Sentiments, and Nonlinear Business Cycles By Libo Xu; Apostolos Serletis
  16. Capital accumulation and the dynamic of secular stagnation By Gilles Le Garrec; Vincent Touzé
  17. The Dynamics of Capital Accumulation in the US: Simulations after Piketty By Philippe De Donder; John E. Roemer
  18. Financial factors and monetary policy: Determinacy and learnability of equilibrium By Paul Kitney
  19. Credit, Money and Asset Equilibria with Indivisible Goods By Han Han; Benoit Julien; Asgerdur Petursdottir; Liang Wang
  20. Occupational Choice, Retirement, and the Effects of Disability Insurance By Jacobs, Lindsay
  21. Volatility and Growth with Recursive Preferences By Barbara Annicchiarico; Alessandra Pelloni; Fabrizio Valenti
  22. The Political Economy of Underfunded Municipal Pension By Brinkman, Jeffrey; Coen-Pirani, Daniele; Sieg, Holger

  1. By: Hilary Patroba and Leroi Raputsoane
    Abstract: This paper tests the ‘cycle is the trend’ hypothesis. We investigate how far permanent and transitory productivity shocks can account for the dynamics observed in the South African business cycle over the period 1946{2014. By estimating a standard small open economy real business cycle model and its financial frictions augmented counterpart, we show that permanent productivity shocks are more important than transitory ones in explaining this country’s business cycle fluctuations. This finding supports the ‘cycle is the trend’ hypothesis in the South African business cycle. The model with financial frictions successfully mimics the downward-sloping high autocorrelation of trade balance to output ratio observed in the data, whereas the benchmark model produces a at autocorrelation function. Financial frictions such as country risk premium shocks help to explain the uctuations in investment and in the trade balance to output ratio.
    Keywords: Small open economy, real business cycle, permanent shock, transitory shock, financial frictions, Bayesian
    JEL: E13 E32 F41 F44
    Date: 2016
  2. By: Vasilev, Aleksandar
    Abstract: In this paper we investigate the quantitative importance of search and matching fric- tions in Bulgarian labor markets. This is done by augmenting an otherwise standard real business cycle model a la Long and Plosser (1983) with both a two-sided costly search and fiscal policy. This introduces a strong propagation mechanism that allows the model to capture the business cycles in Bulgaria better than earlier models. The model performs well vis-a-vis data, especially along the labor market dimension, and in addition dominates the market-clearing labor market framework featured in the stan- dard RBC model, e.g Vasilev (2009), as well as the indivisible labor extension used in Hansen (1985).
    Keywords: general equilibrium,unemployment and wages,business cycles,fiscal policy
    JEL: D51 E24 E32 J40
    Date: 2016
  3. By: Cui, Wei; Radde, Sören
    Abstract: We endogenize asset liquidity in a dynamic general equilibrium model with search frictions on asset markets. In the model, asset liquidity is tantamount to the ease of issuance and resaleability of private financial claims, which is driven by investors' participation on the search market. Limited market liquidity of private claims creates a role for liquid assets, such as government bonds or at money, to ease financing constraints. We show that endogenising liquidity is essential to generate positive comovement between asset (re)saleability and asset prices. When the capacity of the asset market to channel funds to entrepreneurs deteriorates, investment falls while the hedging value of liquid assets increases, driving up liquidity premia. Our model, thus, demonstrates that shocks to the cost of financial intermediation can be an important source of flight-to-liquidity dynamics and macroeconomic fluctuations, matching key business cycle characteristics of the U.S. economy. JEL Classification: E22, E44, G11
    Keywords: asset search markets, endogenous asset liquidity, financial shocks, financing constraints, liquidity premium
    Date: 2016–06
  4. By: Noritaka Kudoh (Nagoya University); Hiroaki Miyamoto (University of Tokyo); Masaru Sasaki (Osaka University)
    Abstract: This paper studies a labor market search-matching model with multi-worker firms to investigate how firms utilize employment and hours of work over the business cycle. The earnings function derived from intra-firm bargaining determines the costs of utilizing the two margins of labor adjustment. We calibrate the model for the Japanese labor market, in which fluctuations in hours of work account for 79 percent of the variations in total labor input. The model replicates much of the fluctuations in total labor input, employment, and hours per employee without wage rigidity even though the source of fluctuations is total factor productivity (TFP) alone. If hours of work are determined by bargaining, then the intensive margin makes the unemployment volatility puzzle much harder to resolve.
    Keywords: search, hours of work, employment, business cycles, multi-worker firms
    JEL: E32 J20 J64
    Date: 2016–06
  5. By: Rangan Gupta (Department of Economics, University of Pretoria); Hylton Hollander (Department of Economics, Stellenbosch University, Stellenbosch)
    Abstract: This paper studies the effects of foreign (real) oil price shocks on key macroeconomic variables for South Africa: a net-importer of oil. We develop and estimate a small open economy new-Keynesian dynamic stochastic general equilibrium model with a role for oil in consumption and production. The substitutability of oil for capital and consumption goods is low, import price pass-through is incomplete, domestic and foreign prices and wages are sticky, and the uncovered interest rate parity condition holds imperfectly. Foreign real oil price shocks have a strong and persistent effect on domestic production and consumption activities and, hence, are a fundamental driver of output, inflation and interest rates in both the short- and long-run. Oil price shocks also generate a trade-off between output and inflation stabilisation. As a result, episodes of endogenous tightening of monetary policy slow the recovery of South Africa's real economy. Our findings go further to suggest an important role for oil prices in predicting the South African output during and after the recession that followed the 2008 global financial crisis.
    Keywords: Oil shocks, small open economy, DSGE model, South Africa
    JEL: E31 E32 E37 E52 Q41 Q43
    Date: 2016–06
  6. By: Leduc, Sylvain (Bank of Canada); Liu, Zheng (Federal Reserve Bank of San Francisco)
    Abstract: Despite steady declines in the unemployment rate and increases in the job openings rate after the Great Recession, the hiring rate in the United States has lagged behind. Significant gaps remain between the actual job filling and finding rates and those predicted from the standard labor search model. To examine the forces behind the slow job recovery, we generalize the standard model to incorporate endogenous variations in search intensity and recruiting intensity. Our model features a vacancy creation cost, which implies that firms rely on variations in both the number of vacancies and recruiting intensity to respond to aggregate shocks, in contrast to the textbook model with costless vacancy creation and thus constant recruiting intensity. Cyclical variations in search and recruiting intensity drive a wedge into the matching function even absent exogenous changes in match efficiency. Our estimated model suggests that fluctuations in search and recruiting intensity help substantially bridge the gap between the actual and model-predicted job filling and finding rates in the aftermath of the Great Recession.
    JEL: E32 J63 J64
    Date: 2016–05–13
  7. By: Shirai, Daichi
    Abstract: We quantitatively evaluate the various types of working capital loans affected by borrowing constraints using a simple real business cycle model. We explore which borrowing constraints generate persistence and/or amplified output responses to productivity and financial shocks. We find that limiting investment on account of borrowing constraints generates a persistent response to a one-time transitory shock. This finding implies that investment wedge plays an important role in generating persistence. There is a trade-off relationship between persistence and amplification among models and the working capital loan channel does not always generate amplification.
    Keywords: Financing frictions, Business cycle propagation, Persistence, Business cycle accounting
    JEL: E32 E37 E44 G01
    Date: 2016–06–08
  8. By: George Kudrna (University of New South Wales)
    Abstract: The Australian age pension is noncontributory, funded through general tax revenues and means tested against pensioners?private resources, including labour earnings. This paper constructs an overlapping generations (OLG) model of the Australian economy to examine the economy wide implications of several counterfactual experiments in the means testing of the age pension. These experiments include policy changes that both relax and tighten the existing mean test. We also consider a policy change that only exempts labour earnings from the means testing. Our simulation results indicate that tightening the existing means test combined with lower income tax rates leads to higher labour supply, domestic assets and consumption per capita, as well as to welfare gains in the long run, while labour earnings exemptions from the means testing have largely positive e¤ects on labour supply at older ages. Population ageing is shown to further strengthen the case for the pension means testing.
    Date: 2015–10
  9. By: Chang, Chun (Shanghai Advanced Institute of Finance, Shanghai Jiao Tong University); Liu, Zheng (Federal Reserve Bank of San Francisco); Spiegel, Mark M. (Federal Reserve Bank of San Francisco); Zhang, Jingyi (Shanghai Advanced Institute, Shanghai Jiao Tong University)
    Abstract: We build a two-sector DSGE model of the Chinese economy to study the role of reserve requirement policy for capital reallocation and business cycle stabilization. In the model, state-owned enterprises (SOEs) have lower average productivity than private firms, but they have superior access to bank loans because of government guarantees. Private firms rely on “shadow” bank financing. Commercial banks are subject to reserve requirement regulations but shadow banks are not. Our framework implies a tradeoff for reserve requirement policy: Increasing the required reserve ratio acts as a tax on SOE activity and reallocates resources to private firms, raising aggregate productivity. This reallocation is supported by empirical evidence. However, raising reserve requirements also increases the incidence of costly SOE failures. Under our calibration, reserve requirement policy can be complementary to interest rate policy for stabilizing macro fluctuations and improving welfare.
    JEL: D81 E21 P31
    Date: 2016–06–09
  10. By: Belanger, Gilles
    Abstract: Ramsey's conjecture implies that a market economy tends toward a politically impossible form of extreme inequality (with "the thrifty enjoying bliss and the improvident at the subsistence level"). Because political actions are not systematic, but arbitrary or random, the combination of market and political forces leads to instability, sometimes full-fledged crisis. I show how the mechanisms of debt relief, redistribution and the uncertainty related to them could boil down to a discount rate shock for an aggregate representative agent. Furthermore, to make this shock possible into a simple Real Business Cycle (RBC) model, I propose a two-capital setup, which provides an improved solution to the interest-rate-inelasticity issue than the usual investment adjustment costs. Finally, I show the model's generality by adding wage rigidity and inflation. Considering the simplicity of the general equilibrium model, results provide rich narratives for recessions.
    Keywords: Inequality, Credit crises, business cycles, discount factor heterogeneity.
    JEL: E21 E22 E24 E32 E37
    Date: 2016–07–02
  11. By: Brown, Alessio (UNU‐MERIT, Maastricht University); Kohlbrecher, Britta (Friedrich-Alexander-Universität Erlangen-Nürnberg); Merkl, Christian (Friedrich-Alexander-Universität Erlangen-Nürnberg, and IZA); Snower, Dennis J. (Kiel Institute for the World Economy, IZA, CEPR, and Christian -Albrechts-Universität Kiel)
    Abstract: In the standard macroeconomic search and matching model of the labour market, there is a tight link between the effects of (i) productivity on unemployment and (ii) unemployment benefits on unemployment. This tight link is at odds with the empirical literature. We present a two-sided model of labour market search where the household and firm decisions are decomposed into job offers, job acceptances, firing, and quits. In such a model, unemploy-ment benefits affect households’ behaviour directly, without having to run via the bargained wage. In line with the evidence, productivity shocks may have quantitatively large effects on unemployment, while benefits only have moderate effects. Our analysis shows the importance of investigating the effects of policies on the households’ work incentives and the firms’ employment incentives within the search process.
    Keywords: Unemployment benefits, search and matching, aggregate shocks, macro model, labour market
    JEL: E24 E32 J63 J64
    Date: 2016–05–24
  12. By: Ersal-Kiziler,Eylem; Nguyen,Ha Minh
    Abstract: The pattern of debt flows to peripheral European Monetary Union members seems puzzling: they are mostly indirect and channeled through the large countries of the European Monetary Union. This paper examines to what extent the introduction of the euro and the elimination of the intra-area currency risk can explain this puzzle. A three-country dynamic stochastic general equilibrium framework with endogenous portfolio choice and two currencies is developed. In the equilibrium, the core members of the European Monetary Union emerge as the main group of lenders to the peripheral European Monetary Union members. Outside lenders are pushed from the periphery debt markets because of currency risk. The model generates a pattern of debt flows consistent with the data despite the absence of any exogenous frictions or market segmentations.
    Keywords: Currencies and Exchange Rates,Debt Markets,Financial Intermediation,Economic Theory&Research,Emerging Markets
    Date: 2016–06–30
  13. By: Mullen, Kathleen J.; Manoli, Day; Wagner, Mathis
    Abstract: This paper exploits a combination of policy variation from multiple pension reforms in Austria and administrative data from the Austrian Social Security Database. Using the policy changes for identiï¬ cation, we estimate social security wealth and accrual elasticities in individuals’ retirement decisions. Next, we use these elasticities to es-timate a dynamic programming model of retirement decisions. Finally, we use the estimated model to examine the labor supply and welfare consequences of potential social security reforms.
    Keywords: policy variation, retirement, labor supply elasticities
    JEL: J26 H55
    Date: 2014–11
  14. By: Lopez Garcia, Italo
    Abstract: Labor informality accounts for nearly 40% of the labor force in Latin America. While a more traditional view sees this phenomenon as a consequence of barriers to mobility resulting from poorly designed labor regulations, recent work provides evidence that individuals choose informal jobs based on their comparative advantage. In this paper, I develop a dynamic life-cycle model estimated with rich Chilean longitudinal data, in which individuals jointly decide on their schooling and labor participation, to investigate the extent to which comparative advantage drives participation in informal labor markets. I find that human capital accumulation and preferences for job amenities explain up to 72% of transitions between the informal and the formal sector while labor market segmentation accounts for 28%. These barriers to mobility are decreasing in education. These results are largely driven by heterogeneous preferences and returns to skills across sectors. For example, more educated individuals assign a higher relative importance to non-wage benefits, particularly in formal jobs, while less educated individuals value more monetary rewards; high ability workers are more productive in the formal sector, while low ability workers are more productive in the informal sector; and unlike labor market experience acquired in informal activities, experience acquired in formal jobs is transferable across sectors. Finally, using the model to simulate the effects of a 20% wage subsidy in formal jobs for young workers, I find that individuals react to labor market expectations and their decisions are persistent. The subsidy would decrease the incentives to informality for both targeted groups and younger workers, while the reduction in informality rates as a consequence of the policy would remain persistent for all the life-cycle.
    Date: 2015–02
  15. By: Libo Xu (University of Calgary); Apostolos Serletis (University of Calgary)
    Abstract: In the context of a rational expectations macroeconomic model with communication fric- tions, we show that the level of economic activity is a nonlinear and time-varying function of aggregate economic fundamentals and sentiment shocks. In particular, because of communication frictions, it is possible for small sentiment shocks to cause large changes in aggregate output, and, similarly, for large changes in sentiment shocks to cause small changes in aggregate output. We also find that communication frictions have nonlinear effects on the variance of aggregate output, meaning that improving the communication does not always reduce the variance of aggregate output.
    Date: 2016–06–20
  16. By: Gilles Le Garrec (OFCE-Sciences Po); Vincent Touzé (OFCE-Sciences PO)
    Abstract: We characterize the dynamics of secular stagnation as a permanent regime switching from a full employment equilibrium to an underemployment equilibrium. In the latter, the natural interest rate is negative, and the economy is in deáation. Due to the non negativity condition imposed on policy rate, the zero lower bond (ZLB) applies which prevents targeting ináation. The secular stagnation equilibrium is achieved in a standard overlapping generations model with capital accumulation where two market imperfections are introduced: credit rationing and downward nominal wage rigidity. To Ögure out how to escape the secular stagnation trap, we study the impact of various macroeconomic policies. Raising the ináation target is only e§ective if the central bank has enough credibility. By supporting aggregate demand, Öscal policy can help the economy get out of the secular stagnation trap. However, this policy reduces the incentive to accumulate capital: there is a trade-o§ between exiting secular stagnation and depressing potential GDP. Dynamic multi- pliers are upper than one unless the Öscal stimilus is too strong. We also shed light on an asymmetry in the dynamics: recovery takes longer than falling into recession.
    Keywords: Secular stagnation, Capital accumulation, Zero lower bound
    JEL: D91 E31 E52
    Date: 2016–06
  17. By: Philippe De Donder (Toulouse School of Economics); John E. Roemer (Dept. of Political Science & Cowles Foundation, Yale University)
    Abstract: We develop a dynamic model where a competitive ?rm produces a single good from labor and capital, with market clearing rates of return. Individuals are heterogeneous in skills, with an endowment in capital/wealth increasing in skill. Individuals aspire to a standard consumption level, with a constant marginal propensity to consume out of income above this level. We de?ne a steady state of this model as an equilibrium where factor returns and wealth shares remain constant. We calibrate the model to the US economy and obtain that a steady state exists. We then study three variants of the model: one with a higher rate of return for large capitals than for smaller ones, one with social mobility, and one with a capital levy ?nancing a lump sum transfer. In all variants, a steady state exists. We also run the model starting from the 2012 US wealth distribution and obtain convergence to the steady state in the basic model as well as in all variants. Convergence takes a long time and is non monotone, with factor returns and wealth shares moving away from their steady state values for long periods.
    Keywords: Piketty, dynamics of wealth accumulation, convergence to steady state, spirit of capitalism, differential rates of return to capital, intergenerational mobility, capital levy, US calibration
    JEL: D31 D58 E37
    Date: 2016–06
  18. By: Paul Kitney
    Abstract: This paper contributes to the debate whether central banks should respond to asset prices, credit spreads and other financial factors in setting monetary policy, by evaluating determinacy and expectational stability of equilibria under various monetary policy rules. With adaptive learning, beliefs constitute an additional set of state variables, which may require more than a response to inflation, that has traditionally been argued in the literature as sufficient to achieve central bank objectives under rational expectations. Furthermore, financial frictions are introduced by extending the determinacy and adaptive learning methodology embodied in Bullard and Mitra (2002) and Bullard and Mitra (2007), beyond the New Keynesian modelling framework by incorporating a Financial Accelerator (Bernanke, Gertler and Gilchrist 1999). A key result is that monetary policy rules responding to lagged asset prices and credit volume have less desirable determinacy and learnability characteristics than responding to current asset prices and credit spreads. This conclusion dovetails with recent research such as Gilchrist and Zakrajsek (2011) and Gilchrist and Zakrajsek (2012), who show that signals derived from credit spreads contain information which help explain business cycle fluctuations and demonstrate that a credit spread augmented monetary policy rule dampens cycle variability. Another result is that the conclusions in both Bullard and Mitra (2002) and Bullard and Mitra (2007) are robust to a New Keynesian model with financial frictions.
    Keywords: DSGE, financial frictions, learning, determinacy, e-stability, expectations, asset prices, credit spreads, financial factors, monetary policy, Taylor rule
    JEL: E43 E44 E50 E52 E58
    Date: 2016–07
  19. By: Han Han (School of Economics Peking University); Benoit Julien (UNSW Australia); Asgerdur Petursdottir (University of Bath); Liang Wang (University of Hawaii Manoa)
    Abstract: We study the trade of indivisible goods using credit, divisible money and divisible assets in a frictional market. We show how indivisibility matters for equilibria. Bargaining generates a price that is not linked to nominal interest rates, dividend value of the asset, or the number of active buyers. To reestablish this connection, we consider price posting with competitive search. We provide conditions under which stationary equilibrium exists. With bargaining, we find that for negative dividend value on the asset, multiple equilibria occur. Otherwise, in all possible combinations of liquidity and price mechanisms the equilibrium is unique or generically unique.
    Keywords: Nash Bargaining; Competitive Search; Indivisibility; Multiplicity; Uniqueness
    JEL: D51 E40
  20. By: Jacobs, Lindsay
    Abstract: There is much variation in the physical requirements across occupations, giving rise to great differences in later-life productivity, disability risk, and the value of Social Security Disability Insurance (SSDI). In this paper, I look at how such differences across occupations affect initial career choice as well as the extent to which SSDI, which insures shocks to productivity due to disability, prompts more people to choose physically intense occupations. Using data from the Health and Retirement Study (HRS) and the Current Population Survey (CPS), I estimate a dynamic model of occupational choice and retirement with heterogeneous agents and equilibrium effects on earnings across occupations. I document the differences between blue-collar and white-collar occupations in the effects of declining health and disability on productivity, which affects labor supply in later life and, in the context of a life-cycle model, influences the occupation decision. Through counterfactual exercises, I show that the additional disability risk in blue-collar jobs relative to white-collar jobs is equivalent to an additional six percentage point reduction in lifetime consumption and that the absence of SSDI, which insures some of this risk, would be equivalent to, respectively, a twelve and seven percent reduction in consumption for those in blue- and white- collar jobs. Furthermore, I find that the presence of SSDI results in three percent more individuals choosing blue-collar occupations, which is comparable to the effect on occupation selection resulting from an eight-percent increase in blue-collar earnings. This overall effect, however, masks the importance of the selection of less risk-averse individuals into blue-collar jobs and the equilibrium effects on wages; earnings for the most risk-averse type would have to be nearly fifteen percent greater to choose blue-collar occupations in the absence of SSDI.
    Keywords: Occupational choice ; Disability ; Life-cycle modeling ; Retirement
    JEL: H31 J14 J24 J26 C63
    Date: 2015–09–20
  21. By: Barbara Annicchiarico (DEF and CEIS, Università di Roma "Tor Vergata"); Alessandra Pelloni (DEF and CEIS, Università di Roma "Tor Vergata"); Fabrizio Valenti (DEF, Università di Roma "Tor Vergata")
    Abstract: This paper studies the relationship between volatility and long-run growth in a complete market economy with human capital accumulation and Epstein-Zin preferences. There is both crosscountry and time-series evidence that volatility is associated with lower growth. Matching this evidence has proved a challenge for growth models with no market failures as they tend to predict the opposite for values of risk aversion higher than unity. However in our model, risk aversion and intertemporal elasticity of substitution are allowed to move independently of each other, and when both are relatively high or relatively low, the relationship between volatility and growth is negative. Indeed this is the case for parametrizations of preferences in line with the literature.
    Keywords: Growth and Uncertainty; Epstein-Zin Preferences; Intertemporal Elasticity of Substitution; Risk Aversion
    JEL: D92 E22 E32 O49
    Date: 2016–06–24
  22. By: Brinkman, Jeffrey (Federal Reserve Bank of Philadelphia); Coen-Pirani, Daniele (University of Pittsburgh); Sieg, Holger (University of Pennsylvania and NBER)
    Abstract: This paper analyzes the determinants of underfunding of local government’s pension funds using a politico-economic overlapping generations model. We show that a binding down payment constraint in the housing market dampens capitalization of future taxes into current land prices. Thus, a local government’s pension funding policy matters for land prices and the utility of young households. Underfunding arises in equilibrium if the pension funding policy is set by the old generation. Young households instead favor a policy of full funding. Empirical results based on cross-city comparisons in the magnitude of unfunded liabilities are consistent with the predictions of the model.
    Keywords: Unfunded Liabilities; Political Economy; Land Prices; Capitalization
    JEL: E6 H3 H7 R5
    Date: 2016–05–27

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