nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2016‒08‒07
35 papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Insurance in human capital models with limited enforcement By Tom Krebs; Moritz Kuhn; Mark Wright
  2. Forecasting using a Nonlinear DSGE Model By Sergey Ivashchenko; Rangan Gupta
  3. Mortgage Design in an Equilibrium Model of the Housing Market By Timothy McQuade; Arvind Krishnamurthy; Adam Guren
  4. Substitutability and the social cost of carbon in a solvable growth model with irreversible climate change By Quaas, Martin F.; Bröcker, Johannes
  5. Finite Lifetimes, Patents' Length and Breadth, and Growth By Bharat Diwakar; Gilad Sorek
  6. Do long term interest rates drive GDP and inflation in small open economies? Evidence from Poland By Grzegorz Wesołowski
  7. Self-Fulfilling Sovereign Debt Crises By Zachary Stangebye; Satyajit Chatterjee; Harold Cole; Mark Aguiar
  8. Dynamic Principal-Agent Models By Philipp Renner; Karl Schmedders
  9. Public Sector Employment in an Equilibrium Search and Matching Model By Susan Vroman; Monica Robayo-Abril; James Albrecht
  10. The Interaction and Sequencing of Policy Reforms By Timothy Kehoe; Sewon Hur; Kim Ruhl; Jose Asturias
  11. Exchange Rate Targeting in the Presence of Foreign Debt Obligations By James Staveley-O'Carroll; Olena M. Staveley-O'Carroll
  12. The welfare effect of at income tax reform: the case of Bulgaria By Vasilev, Aleksandar
  13. Existence and uniqueness of solutions to dynamic models with occasionally binding constraints By Holden, Tom D.
  14. Private Leverage and Sovereign Default By Yan Bai; Luigi Bocola; Cristina Arellano
  15. Computation of solutions to dynamic models with occasionally binding constraints By Holden, Tom D.
  16. Business Cycles in Bulgaria and the Baltic Countries: An RBC Approach By Vasilev, Aleksandar
  17. Designing Efficient Student Loan Programs in the U.S. By Juan Sanchez; Alexander Monge-Naranjo; Lance Lochner
  18. Monetary Policy and Sovereign Debt Vulnerability By Carlos Thomas; Galo Nuño
  19. Housing Market Dynamics and Macroprudential Policy By Gabriel Bruneau; Ian Christensen; Césaire Meh
  20. Liquidity Traps and Monetary Policy: Managing a Credit Crunch By Juan Pablo Nicolini
  21. Turbulence and the Employment Experience of Older Workers By Lalé, Etienne
  22. International Trade Fluctuations and Monetary Policy By Ana Maria Santacreu; Fernando Leibovici
  23. On the Distribution of the Welfare Losses of Large Recessions By Krueger, Dirk; Mitman, Kurt; Perri, Fabrizio
  24. The Portfolio Rebalancing Channel of Quantitative Easing By Valentin Jouvanceau
  25. Higher Taxes at the Top: The Role of Entrepreneurs By Bettina Brueggemann
  26. Credit Constraints and Aggregate Economic Activity Over the Business Cycles By Giorgadze, Tamar; Vasilev, Aleksandar
  27. Trading dynamics with adverse selection and search: Market freeze, intervention and recovery By Chiu, Jonathan; Koeppl, Thorsten V
  28. Inequality and Growth: The Role of Human Capital with Heterogeneous Skills By Borissov, Kirill; Bosi, Stefano; Ha-Huy, Thai; Modesto, Leonor
  29. The Decision to Move House and Aggregate Housing-Market Dynamics By L. Rachel Ngai; Kevin Sheedy
  30. Rising inequality and trends in lesiure By Rachel Ngai; Timo Boppart
  31. Welfare gains from the adoption of proportional taxation in a general-equilibrium model with a grey economy: the case of Bulgaria's 2008 flat tax reform By Vasilev, Aleksandar
  32. Macroeconomic effects of public-sector unions By Vasilev, Aleksandar
  33. Relationships in the Interbank Market By Jonathan Chiu; Cyril Monnet
  34. Cost Channel, Interest Rate Pass-Through and Optimal Policy under Zero Lower Bound By Chattopadhyay, Siddhartha; Ghosh, Taniya
  35. A Theory of Operational Risk By Andrea M. Buffa; Suleyman Basak

  1. By: Tom Krebs; Moritz Kuhn; Mark Wright
    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: 2016–08
  2. By: Sergey Ivashchenko (Saint Petersburg Institute for Economics and Mathematics (Russian Academy of Sciences), National Research University Higher School of Economics,Russia); Rangan Gupta (Department of Economics, University of Pretoria, Pretoria)
    Abstract: A medium-scale nonlinear dynamic stochastic general equilibrium (DSGE) model was estimated (54 variables, 29 state variables, 7 observed variables). The model includes an observed variable for stock market returns. The root-mean square error (RMSE) of the in-sample and out-of-sample forecasts was calculated. The nonlinear DSGE model with measurement errors outperforms AR (1), VAR (1) and the linearised DSGE in terms of the quality of the out-of-sample forecasts. The nonlinear DSGE model without measurement errors is of a quality equal to that of the linearised DSGE model
    Keywords: nonlinear DSGE; Quadratic Kalman Filter; out-of-sample
    JEL: E32 E37 E44 E47
    Date: 2016–08
  3. By: Timothy McQuade (Stanford University); Arvind Krishnamurthy (Stanford University); Adam Guren (Boston University)
    Abstract: How can mortgages be redesigned or modified in a crisis to reduce housing market volatility, consumption volatility, and default? We answer these questions using a quantitative general equilibrium life cycle model with aggregate shocks in which households have realistic long-term mortgages and a rich set of choices as to whether to prepay, refinance, move, or default, and household and lender decisions aggregate up to determine house prices. The calibrated model is used to quantitatively assess how different mortgage contracts affect housing market volatility, particularly in busts like the Great Recession. In this preliminary draft, we focus on comparing fixed-rate mortgages (FRMs) and adjustable-rate mortgages (ARMs). Although FRMs allow homeowners to increase consumption by locking in a low rate, this effect is swamped by the insurance benefits of ARMs in a crisis. ARMs reduce default and improves consumption smoothing, particularly for young and high LTV homeowners. Quantitatively, in a crisis episode defaults are 50 percent lower with ARMs, and over five years the cumulative consumption-equivalent welfare loss under ARMs is 20 percent of annual consumption. These findings suggest that welfare could be improved dramatically by introducing the insurance features of ARMs into mortgage designs.
    Date: 2016
  4. By: Quaas, Martin F.; Bröcker, Johannes
    Abstract: We develop an overlapping generations endogenous growth model with stocks of produced capital, human capital, a non-renewable resource, and irreversibly accumulated greenhouse gases in deterministic and stochastic versions. The model allows for analyzing different elasticities of substitution. We present a full analytical solution and characterization of the transition dynamics. We show that, as a rule of thumb, the social cost of carbon grow at a rate equal to the economy's growth rate divided by the elasticity of substitution. We analytically study sensitivity of the social cost of carbon with respect to key parameters: the intergenerational discount rate, the elasticity of substitution, and climate uncertainty. We show that the social cost of carbon explode at a finite level of log-normally distributed climate uncertainty. We illustrate results in a calibrated version of the model.
    Keywords: overlapping generations,substitutes vs. complements,stochastic resource dynamics,optimum growth,climate policy
    JEL: Q54 O44 Q32
    Date: 2016
  5. By: Bharat Diwakar; Gilad Sorek
    Abstract: We study the implications of patents breadth and duration (length) to growth and welfare, in an overlapping generations economy of finitely living agents. This demographic structure gives room to inter-generational trade in old patents and life-cycle saving motive, which prove to be relevant to the implications of different patent-policy dimensions. Patent breadth protection affects life-cycle saving and thereby aggregate investment, and the allocation investment between patents and physical capital. Patents duration affects also the stock of, and trade in, old patents. We show that, these unique characteristics of the OLG economy provide a case for incomplete patent breadth protection and finite patent duration, which are both growth and welfare enhancing. Furthermore, we show that the implications of patent policy to growth depend on whether the differentiated inputs are intermediate goods or investment goods. Our results contrast with the ones derived in previous studies that employed the same technologies and preferences in model economies of infinitely living agents. Hence, this work highlights the importance of the assumed demographic structure to the implications of patent policy.
    Keywords: IPR; Patent length; Patent Breadth; Growth; OLG
    JEL: L16 O30
    Date: 2016–07
  6. By: Grzegorz Wesołowski
    Abstract: I show that the long term interest rate that includes a time-varying term premium stabilizes GDP and it does not affect significantly inflation volatility in Poland. I derive this result from an estimated DSGE model of a small open economy. GDP volatility would have been much higher if the endogenous part of the term premium had been switched off in the model, while the inflation volatility has not been affected by the presence of the term premium. At the same time, the term premium shock had only a minor impact on GDP and inflation volatilities which suggests that the QE programs conducted by the major central banks did not have a substantial impact on the Polish economy.
    Keywords: long term interest rates, time-varying term premium, business cycle, small open economy
    JEL: E32 E43 E44
    Date: 2016
  7. By: Zachary Stangebye (University of Notre Dame); Satyajit Chatterjee (Federal Reserve Bank of Philadelphia); Harold Cole (University of Pennsylvania); Mark Aguiar (Princeton University)
    Abstract: Sovereign debt spreads occasionally exhibit sharp, large spikes in spreads over risk-free bonds. We document that these movements are only weakly correlated with movements in domestic output and are frequently followed by reductions in the face value of debt outstanding. Motivated by this evidence, we propose a quantitative model with long-term bonds and three sources of risk: fluctuations in the growth of domestic income; movements in the risk premia associated with default risk; and shifts in creditor ``beliefs'' regarding the actions of other creditors. We show that the shifts in creditor beliefs directly play an important role in generating default risk, but also amplify the impact of shocks to fundamentals. Interestingly, persistent changes to risk premia have a negligible impact on spreads, and an increase in risk premium may even lead to a decline in spreads. The latter reflects that a higher risk premium provides discipline regarding future debt issuances. More generally, the sovereign borrowing decisions are quantitatively sensitive to equilibrium bond prices. Even large, relatively unexpected shocks to creditor beliefs have only a modest effect on spreads as the government responds by aggressively deleveraging.
    Date: 2016
  8. By: Philipp Renner (Stanford University - The Hoover Institution on War, Revolution and Peace); Karl Schmedders (University of Zurich)
    Abstract: This paper contributes to the theoretical and numerical analysis of discrete time dynamic principal-agent problems with continuous choice sets. We first provide a new and simplified proof for the recursive reformulation of the sequential dynamic principal-agent relationship. Next we prove the existence of a unique solution for the principal's value function, which solves the dynamic programming problem in the recursive formulation, by showing that the Bellman operator is a contraction mapping. Therefore, the theorem also provides a convergence result for the value function iteration. To compute a solution for the problem we have to solve a collection of static principal-agent problems at each iteration. Under the assumption that the agent's expected utility is a rational function of his action, we can transform the bi-level optimization problem into a standard nonlinear program (NLP). We can then solve these nonlinear problems with a standard NLP solver. The final results of our solution method are numerical approximations of the policy and value functions for the dynamic principal-agent model. We illustrate our solution method by solving variations of two prominent social planning models from the economics literature.
    Keywords: Optimal unemployment tax, principal-agent model, repeated moral hazard
    JEL: C63 D80 D82
  9. By: Susan Vroman (Georgetown University); Monica Robayo-Abril (Georgetown University); James Albrecht (Georgetown University)
    Abstract: In this paper, we extend the Diamond-Mortensen-Pissarides model of equilibrium unemployment to incorporate public-sector employment. We calibrate the model to Colombian data and analyze the effects of public-sector wage and employment policy on the unemployment rate, on the division of employment between the private and public sectors, and on the distributions of waes, productivities and education in the two sectors.
    Date: 2016
  10. By: Timothy Kehoe (University of Minnesota); Sewon Hur (University of Pittsburgh); Kim Ruhl (New York University Stern School of Busi); Jose Asturias (Georgetown University)
    Abstract: In what order should a developing country adopt policy reforms? Do some policies complement each other? Do others substitute for each other? To address these questions, we develop a two-country dynamic general equilibrium model with entry and exit of firms that are monopolistic competitors. Distortions in the model include barriers to entry of firms, barriers to international trade, and barriers to contract enforcement. We find that a reform that reduces one of these distortions has different effects depending on the other distortions present. In particular, reforms to trade barriers and barriers to the entry of new firms are substitutable, as are reforms to contract enforcement and trade barriers. In contrast, reforms to contract enforcement and the barriers to entry are complementary. Finally, the optimal sequencing of reforms requires reforming trade barriers before contract enforcement.
    Date: 2016
  11. By: James Staveley-O'Carroll (Economics Division, Babson College); Olena M. Staveley-O'Carroll (Department of Economics, College of the Holy Cross)
    Abstract: We study the impact of foreign debt on the trade-off between the three open economy objectives of a central bank - international risk sharing, the need to facilitate expenditure-switching, and the incentive to tilt international prices to lower the labor effort of domestic households - in a two-country DSGE model with incomplete asset markets and deviations from the purchasing power parity. We fi?nd that at low debt levels, a Taylor rule outperforms simple targeting rules. However, the central bank can improve welfare by up to 0.25 percent of consumption via an exchange rate peg when debt-to-GDP ratio reaches 100 percent.
    Keywords: international risk sharing, foreign debt, exchange rate policy
    JEL: E52 F32 F41
    Date: 2016–07
  12. By: Vasilev, Aleksandar
    Abstract: This paper is a first attempt to provide a quantitative evaluation of the welfare gains resulting from the introduction of flat income taxation in Bulgaria in 2008. Using a calibrated micro-founded endogenous growth model with physical and human capital accumulation to Bulgarian data, a computational experiment is performed to quantify the dynamic welfare effect of progressive income taxation vis-a-vis flat income taxation. The model demonstrates that significant welfare gains, measured in terms of per-period consumption, can be realized with the introduction of flat income taxation. In addition, these welfare gains increase proportionally with the length of the time horizon considered. Finally, sensitivity analysis was performed to demonstrate that the results obtained are robust.
    Keywords: taxation,endogenous growth,human capital,welfare gains
    JEL: D91 O41
    Date: 2015
  13. By: Holden, Tom D.
    Abstract: We present the first necessary and sufficient conditions for there to be a unique perfect-foresight solution to an otherwise linear dynamic model with occasionally binding constraints, given a fixed terminal condition. We derive further conditions on the existence of a solution in such models. These results give determinacy conditions for models with occasionally binding constraints, much as Blanchard and Kahn (1980) did for linear models. In an application, we show that widely used New Keynesian models with endogenous states possess multiple perfect foresight equilibrium paths when there is a zero lower bound on nominal interest rates, even when agents believe that the central bank will eventually attain its long-run, positive inflation target. This illustrates that a credible long-run inflation target does not render the Taylor principle sufficient for determinacy in the presence of the zero lower bound. However, we show that price level targeting does restore determinacy in these situations.
    Keywords: occasionally binding constraints,zero lower bound,existence,uniqueness,price targeting,Taylor principle,linear complementarity problem
    JEL: C62 E3 E4 E5
    Date: 2016
  14. By: Yan Bai (University of Rochester); Luigi Bocola (Northwestern University); Cristina Arellano (Federal Reserve Bank of Minneapolis)
    Abstract: During the recent European debt crisis, sovereign spreads rose substantially and economic activity collapsed. In this paper, we develop an integrated framework of government debt crises and aggregate fluctuations in an environment of firms default risk. Firms face interest rates that depend on their default risk and also on government default risk. We consider two sources of aggregate fluctuations; one arising from the public sector that directly affects government spreads and another one arising in the private sector which affects the productivity of all firms. Public shocks affect firms differentially based on their credit needs. Aggregate productivity shocks, in contrast, affect all firms equally. We use firm level data and our model to identify the source of the crisis. We find that public shocks account for about 50% of the decline in output for Italy.
    Date: 2016
  15. By: Holden, Tom D.
    Abstract: We construct the first algorithm for the perfect foresight solution of otherwise linear models with occasionally binding constraints, with fixed terminal conditions, that is guaranteed to return a solution in finite time, if one exists. We also provide a proof of the inescapability of the “curse of dimensionality” for this problem when nothing is known a priori about the model. We go on to extend our algorithm to deal with stochastic simulation, other non-linearities, and future uncertainty. We show that the resulting algorithm produces fast and accurate simulations of a range of models with occasionally binding constraints.
    Keywords: occasionally binding constraints,zero lower bound,computation,DSGE,linear complementarity problem
    JEL: C61 C63 E3 E4 E5
    Date: 2016
  16. By: Vasilev, Aleksandar
    Abstract: This paper explores the business cycle in Bulgaria and the Baltic countries: Estonia, Latvia and Lithuania during the 1993-2005 period. The paper aims at deepening the understanding of the nature of output fluctuations. The neoclassical approach will be employed, much in the spirit of the Real Business Cycle (RBC) literature, which gives a general equilibrium picture of the transition process. The model used in this paper follows the methodology of King, Plosser and Rebelo (1988). Both the model and data series show that the major drop in output was due to productivity. In addition, the timing of the banking reforms coincides with the improvement of economic performance. This is a strong indication that banking regulations in place were crucial for the output performance throughout the period in Bulgaria and the Baltic countries, a finding that has important implications for economic policy.
    Keywords: Business cycles,productivity
    JEL: C68
    Date: 2016
  17. By: Juan Sanchez (Federal Reserve Bank of St. Louis); Alexander Monge-Naranjo (Federal Reserve Bank of St. Louis); Lance Lochner (University of Western Ontario)
    Abstract: This study develops a quantitative lifecycle framework to study dynamic student loan contracts that account for problems associated with moral hazard, limited commitment, and costly income verification. Within this environment, we study how optimal student loan limits should be set as functions of observable borrower characteristics and how loan repayments should be structured as functions of current income, past payments, and student debt. We calibrate our quantitative model using previous estimates of earnings and employment dynamics in the U.S. and to match various moments derived from longitudinal data on American borrowing and repayment behavior. Our calibrated model is used to characterize constrained efficient credit contracts and to compare the nature of those contracts with current GSL programs in the U.S. as well as frequently discussed income-based alternatives. We not only compare the contracts themselves, but we also study their implications in terms of borrowing, schooling, and repayment behavior. Our analysis considers both the efficiency of various lending regimes as well as their distributional consequences across ability and wealth groups. Importantly, we discuss general lessons that can be used in the practical development of GSL programs.
    Date: 2016
  18. By: Carlos Thomas (Banco de España); Galo Nuño (Banco de España)
    Abstract: We investigate the trade-o¤s between price stability and sovereign debt sustainability, in a small-open-economy model where the government issues nominal debt without committing not to default or inflate. Inflation allows to absorb the e¤ect of aggregate shocks on the debt ratio, which improves sovereign debt sustainability. But the government incurs an ‘inflationary bias’: it creates (costly) inflation even when default is distant. For plausible calibrations, we find that abandoning the ability to inflate debt away raises welfare, even when the economy is close to default: the benefits from eliminating the inflationary bias dominate the costs from losing inflation’s debt-stabilizing role.
    Date: 2016
  19. By: Gabriel Bruneau; Ian Christensen; Césaire Meh
    Abstract: We perform an analysis to determine how well the introduction of a countercyclical loanto- value (LTV) ratio can reduce household indebtedness and housing price fluctuations compared with a monetary policy rule augmented with house price inflation. To this end, we construct a New Keynesian model in which a fraction of households borrow against the value of their houses and we introduce news shocks on housing demand. We estimate the model with Canadian data using Bayesian methods. We find that the introduction of news shocks can generate a housing market boom-bust cycle, the bust following unrealized expectations on housing demand. Our study also suggests that a countercyclical LTV ratio is a useful policy to reduce the spillover from the housing market to consumption, and to lean against news-driven boom-bust cycles in housing price and credit generated by expectations of future macroeconomic developments.
    Keywords: Business fluctuations and cycles, Financial stability, Housing, Monetary policy framework, Transmission of monetary policy
    JEL: E31 E42 H23
    Date: 2016
  20. By: Juan Pablo Nicolini (Minneapolis Fed)
    Abstract: We study a model with heterogeneous producers that face collateral and cash in advance constraints. A tightening of the collateral constraint results in a credit-crunch generated recession that reproduces several features of the financial crisis that unraveled in 2007. The model can suitable be used to study the effects on the main macroeconomic variables and of alternative policies following the credit crunch. The policy implications are in sharp contrast with the prevalent view in most Central Banks, based on the New Keynesian explanation of the liquidity trap.
    Date: 2016
  21. By: Lalé, Etienne (University of Bristol)
    Abstract: This paper provides a unified account of the trends in unemployment and labor force participation pertaining to the employment experience of older male workers during the past half-century. We build an equilibrium life-cycle model with labor-market frictions and an operative labor supply margin, wherein economic turbulence à la Ljungqvist and Sargent (1998) interact with institutions in ways that deteriorate employment. The model explains simultaneously: (i) the fall in labor force participation in the United States, (ii) the similar but more pronounced decline in Europe alongside rising unemployment rates and (iii) differences across European countries in the role played respectively by unemployment and labor force participation. The model also shows that policies that fostered early retirement may have exacerbated the deterioration of European labor markets: raising early retirement incentives to reduce unemployment among older workers tends to increase unemployment at younger ages, especially in turbulent economic times and under stringent employment protection legislation.
    Keywords: job search, job loss, turbulence, European unemployment, labor force participation
    JEL: E24 J21 J64
    Date: 2016–07
  22. By: Ana Maria Santacreu (Federal Reserve Bank of Saint Louis and); Fernando Leibovici (York University)
    Abstract: This paper studies the role of trade openness for the design of monetary policy. We extend a standard small open economy model of monetary policy to capture cyclical fluctuations of international trade flows, and parameterize it to match key features of the data. We find that accounting for trade fluctuations matters for monetary policy: when the monetary authority follows a Taylor rule, inflation and the output gap are more volatile. Moreover, we find that the volatility of these variables is significantly higher when the central bank follows the optimal policy based on a model that cannot account for international trade fluctuations.
    Date: 2016
  23. By: Krueger, Dirk; Mitman, Kurt; Perri, Fabrizio
    Abstract: How big are the welfare losses from severe economic downturns, such as the U.S. Great Recession? How are those losses distributed across the population? In this paper we answer these questions using a canonical business cycle model featuring household income and wealth heterogeneity that matches micro data from the Panel Study of Income Dynamics (PSID). We document how these losses are distributed across households and how they are affected by social insurance policies. We find that the welfare cost of losing one's job in a severe recession ranges from 2% of lifetime consumption for the wealthiest households to 5% for low-wealth households. The cost increases to approximately 8% for low-wealth households if unemployment insurance benefits are cut from 50% to 10%. The fact that welfare losses fall with wealth, and that in our model (as in the data) a large fraction of households has very low wealth, implies that the impact of a severe recession, once aggregated across all households, is very significant (2.2% of lifetime consumption). We finally show that a more generous unemployment insurance system unequivocally helps low-wealth job losers, but hurts households that keep their job, even in a version of the model in which output is partly demand determined, and therefore unemployment insurance stabilizes aggregate demand and output.
    Keywords: great recession; Social Insurance; Wealth Inequality
    JEL: E21 E32 J65
    Date: 2016–07
  24. By: Valentin Jouvanceau (Univ Lyon, CNRS, GATE UMR 5824, F-69130 Ecully, France)
    Abstract: This paper analyzes the portfolio rebalancing channel of Quantitative Easing (QE hereafter) interventions. First, we identify the effects of a QE shock using a Bayesian VAR on US data using a sign and zero restrictions identification scheme. We find that QE shocks have substantial effects on corporate spreads with different ratings, supportive of a portfolio rebalancing channel. Second, we build a DSGE model with a securitzation mechanism. We confront the resulting impulse response functions to those uncovered by our VAR analysis, and find a fairly good match. Finally, we show that the portfolio rebalancing channel crucially affects the transmission of QE shocks to real economy.
    Keywords: E44, E52, G2
    JEL: H71 H72 R50 R51
    Date: 2016
  25. By: Bettina Brueggemann (Goethe University Frankfurt)
    Abstract: This paper contributes to the recent and growing literature on optimal top marginal income tax rates. It computes optimal marginal tax rates for top earners in a Bewley-Aiyagari type economy explicitly accounting for entrepreneurs. Entrepreneurs make up more than one third of the highest-earning one percent in the income distribution despite representing less than ten percent of the population. They are thus disproportionately affected by an increase in the top marginal income tax rate. Since entrepreneurs overall also employ half of the private-sector workforce, such policy changes can have important repercussions for aggregate labor demand and productivity. Nonetheless, the welfare maximizing top marginal tax rate amounts to 82.5 percent, and the revenue maximizing one to 90 percent. A steady state comparison between the benchmark economy featuring the current US tax system and the economy with the welfare maximizing top marginal tax rate illustrates the underlying mechanisms. The substantial increase in taxes leads to a large degree of redistribution, yielding sizable welfare gains for low-income households. Lower equilibrium wages benefit medium-sized entrepreneurs and enable them to grow, such that all entrepreneurs except those directly affected by the higher tax experience considerable welfare gains.
    Date: 2016
  26. By: Giorgadze, Tamar; Vasilev, Aleksandar
    Abstract: The paper examines that imperfections in financial markets are themselves a source of macroeconomic fluctuations. Small, temporary shocks to technology or income distribution can generate large fluctuations in output and asset prices and spill over to other sectors. The work is based on the original model by Kiyotaki and Moore (1997). This paper will simulate a one-unit technology shock and study the propagation through the credit channel, evaluating its quantitative impact. While in the Kiyotaki-Moore model there is a linear production function used, we will try to do the derivation using the non-linear function and analyze how it changes the previously obtained result.
    Keywords: Credit cycles,aggregate fluctuations
    JEL: E32
    Date: 2016
  27. By: Chiu, Jonathan; Koeppl, Thorsten V
    Abstract: We study trading dynamics in an asset market where the quality of assets is private information and finding a counterparty takes time. When trading ceases in equilibrium as a response to an adverse shock to asset quality, a government can resurrect trading by buying up lemons which involves a financial loss. The optimal policy is centred around an announcement effect where trading starts already before the intervention for two reasons. First, delaying the intervention allows selling pressure to build up thereby improving the average quality of assets for sale. Second, intervening at a higher price increases the return from buying an asset of unknown quality. It is optimal to intervene immediately at the lowest price when the market is sufficiently important. For less important markets, when the shock to quality and search frictions are small, it is optimal to rely on the announcement effect. Here delaying the intervention and fostering the effect by intervening at the highest price tend to be complements.
    Keywords: Adverse selection, Search, Trading dynamics, Government asset purchases, Announcement effect,
    Date: 2016
  28. By: Borissov, Kirill (European University of St. Petersburg); Bosi, Stefano (University of Evry); Ha-Huy, Thai (University of Evry); Modesto, Leonor (Universidade Catolica Portuguesa, Lisbon)
    Abstract: We extend the Lucas' 1988 model introducing two classes of agents with heterogeneous skills, discount factors and initial human capital endowments. We consider two regimes according to the planner's political constraints. In the first regime, that we call meritocracy, the planner faces individual constraints. In the second regime the planner faces an aggregate constraint, redistributing. We find that heterogeneity matters, particularly with redistribution. In the meritocracy regime, the optimal solution coincides with the BGP found by Lucas (1988) for the representative agent's case. In contrast, in the redistribution case, the solution for time devoted to capital accumulation is never interior for both agents. Either the less talented agents do not accumulate human capital or the more skilled agents do not work. Moreover, social welfare under the redistribution regime is always higher than under meritocracy and it is optimal to exploit existing differences. Finally, we find that inequality in human capital distribution increases in time and that, in the long run, inequality always promotes growth.
    Keywords: human capital, heterogeneous skills
    JEL: J24 O15 O40
    Date: 2016–07
  29. By: L. Rachel Ngai (Centre for Economic Policy Research (CEP); Economics Department London School of Economics (LSE); Centre for Macroeconomics (CFM)); Kevin Sheedy (Centre for Economic Policy Research (CEP); Economics Department London School of Economics (LSE); Centre for Macroeconomics (CFM))
    Abstract: Using data on house sales and inventories, this paper shows that housing-market dynamics are driven mainly by listings and less so by transaction speed, thus the decision to move house is key to understanding the housing market. The paper builds a model where moving house is essentially an investment in match quality, implying that moving depends on macroeconomic developments and housing-market conditions. The endogeneity of moving means there is a cleansing effect - those at the bottom of the match quality distribution move first - which generates overshooting in aggregate variables. The model is applied to the 1995{2004 housing-market boom.
    Keywords: Housing market, Search and Matching, Endogenous moving, Match quality investment
    JEL: D83 E22 R31
    Date: 2016–06
  30. By: Rachel Ngai (london school of economics); Timo Boppart (IIES, Stockholm University)
    Abstract: This paper develops a growth model that explains the U.S. facts of rising aggregate leisure and increasing leisure inequality. Households derive utility from three sources: market produced goods, home produced goods and leisure. A key assumption is that leisure is a production activity requiring time and capital. Households allocate time and capital into each production activity. The dynamics are driven by activity-specific TFP growth and a spread in the distribution of household-specific market efficiencies. They combine to explain the time series and cross-sectional evolutions whilst the economy remains on its aggregate balance growth path.
    Date: 2016
  31. By: Vasilev, Aleksandar
    Abstract: This paper provides a quantitative evaluation of the welfare effect of the introduction of proportional taxation in Bulgaria in 2008, an effect that operates through the grey economy channel. Using a general-equilibrium model, augmented with informal sector, a computational experiment is performed to evaluate the welfare gain from the adoption of proportional taxation. The lower effective tax burden in the new tax regime produces a relocation of people into the official sector, stimulates investment, and increases output and consumption. Finally, under the flat tax regime, the size of the informal sector is smaller, and quantitatively consistent with OECD (2009) and European Commission (2012) figures.
    Keywords: taxation,informal sector
    JEL: D91 J46
    Date: 2015
  32. By: Vasilev, Aleksandar
    Abstract: Motivated by the highly-unionized public sectors, the high public shares in total employment, and the public-sector wage premia observed in Europe, this paper examines the importance of public-sector unions for macroeconomic theory. The model generates cyclical behavior in hours and wages that is consistent with data behavior in an economy with highly-unionized public sector, namely Germany during the period 1970-2007. The union model is an improvement over a model with exogenous public employment. In addition, endogenously-determined public wage and hours add to the distortionary effect of contractionary tax reforms by generating greater tax rate changes, thus producing higher welfare losses.
    Keywords: public sector labor unions,fiscal policy,public wages,public employment
    JEL: E62 J51
    Date: 2015
  33. By: Jonathan Chiu; Cyril Monnet
    Abstract: The market for central bank reserves is mainly over-the-counter and exhibits a core-periphery network structure. This paper develops a model of relationship lending in the unsecured interbank market. In equilibrium, a tiered lending network arises endogenously as banks choose to build relationships to insure against liquidity shocks and to economize on the cost to trade in the interbank market. Relationships matter for banks’ bidding strategies at the central bank auction and introduce a relationship premium that can significantly distort the observed overnight rate. For example, it can explain some anomalies in the level of interest rates—namely, that banks sometimes trade above (below) the central bank’s lending (deposit) rate. The model also helps to explain how monetary policy affects the network structure of the interbank market and its functioning, and how the market responds dynamically to an exit from the floor system. We also use the model to discuss the potential effects of bilateral exposure limits on relationship lending.
    Keywords: Interest rates, Monetary policy implementation, Transmission of monetary policy
    JEL: E4 E5
    Date: 2016
  34. By: Chattopadhyay, Siddhartha; Ghosh, Taniya
    Abstract: This paper analyzes optimal monetary policy under zero lower bound in the presence of cost channel. Cost channel introduces trade-off between output and inflation when economy is out of ZLB. As a result, exit time both under discretion and commitment is endogenous in the presence of cost channel. We also find that commitment outperforms discretion by promising future boom and inflation and a T-only policy closely replicates commitment both under presence and absence of cost channel. Moreover, the exit date (from ZLB) under discretion, commitment and T-only policy rises with the magnitude of demand shock given the degree of interest rate pass-through irrespective if the cost channel is present. We also show that, while exit date both under discretion and T-only policy rises with the degree of interest rate pass-through/credit market imperfection, it falls under commitment given demand shock.
    Keywords: New-Keynesian Model, Cost Channel, Liquidity Trap
    JEL: E52 E58 E63
    Date: 2016–07–20
  35. By: Andrea M. Buffa (Boston University); Suleyman Basak (London Business School)
    Abstract: We study the dynamic decision making of a financial institution in the presence of a novel implementation friction that gives rise to operational risk. We distinguish between internal and external operational risks depending on whether the institution has control over them. Internal operational risk naturally arises in the context of model risk, as the institution exposes itself to operational errors whenever it updates and improves its investment model. In this case, it is no longer optimal to implement the best model available, thus leaving scope for endogenous deviation from it, and hence model sophistication. We show that the optimal exposure to operational risk may well become decreasing in the level of internal operational risk, which in turn makes the exposure to market risk less volatile. We uncover that financial constraints interact with operational risk, whether internal or external, and prompt the institution to always adopt a more sophisticated model. While such constraints are always detrimental when operational risk is internal, they may be beneficial, despite inducing an excessive level of sophistication, when it is external.
    Date: 2016

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