nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2016‒08‒14
eleven papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Estimating Dynamic Macroeconomic Models : How Informative Are the Data? By Beltran, Daniel O.; Draper, David
  2. Trends and Cycles in Small Open Economies: Making The Case For A General Equilibrium Approach By Kan Chen; Mario Crucini
  3. RBC Methodology and the Development of Aggregate Economic Theory By Edward C. Prescott
  4. Choosing the variables to estimate singular DSGE models: Comment By Iskrev, Nikolay; Ritto, Joao
  5. On the Distribution of the Welfare Losses of Large Recessions By Dirk Krueger; Kurt Mitman; Fabrizio Perri
  6. Estimation of a Roy/Search/Compensating Differential Model of the Labor Market By Christopher Taber; Rune Vejlin
  7. Expectations, Stagnation and Fiscal Policy By Evans, George W.; Honkapohja, Seppo; Mitra, Kaushik
  8. The New Keynesian Transmission Mechanism: A Heterogenous-Agent Perspective By Tobias Broer; Niels-Jakob H. Hansen; Per Krusell; Erik Öberg
  9. Finance and Synchronization By Ambrogio Cesa-Bianchi; Jean Imbs; Jumana Saleheen
  10. Monetary Policy with 100 Percent Reserve Banking: An Exploration By Edward C. Prescott; Ryan Wessel
  11. Is Optimal Capital-Control Policy Countercyclical In Open-Economy Models With Collateral Constraints? By Stephanie Schmitt-Grohé; Martín Uribe

  1. By: Beltran, Daniel O.; Draper, David
    Abstract: Central banks have long used dynamic stochastic general equilibrium (DSGE) models, which are typically estimated using Bayesian techniques, to inform key policy decisions. This paper offers an empirical strategy that quantifies the information content of the data relative to that of the prior distribution. Using an off-the-shelf DSGE model applied to quarterly Euro Area data from 1970:3 to 2009:4, we show how Monte Carlo simulations can reveal parameters for which the model's structure obscures identification. By integrating out components of the likelihood function and conducting a Bayesian sensitivity analysis, we uncover parameters that are weakly informed by the data. The weak identification of some key structural parameters in our comparatively simple model should raise a red flag to researchers trying to draw valid inferences from, and to base policy upon, complex large-scale models featuring many parameters.
    Keywords: Bayesian estimation ; Econometric modeling ; Kalman filter ; Likelihood ; Local identifcation ; Euro Area ; MCMC ; Policy-relevant parameters ; Prior-versus-posterior comparison ; Sensitivity analysis
    JEL: C11 C18 F41
    Date: 2016–08
  2. By: Kan Chen; Mario Crucini
    Abstract: Economic research into the causes of business cycles in small open economies is almost always undertaken using a partial equilibrium model. This approach is characterized by two key assumptions. The first is that the world interest rate is unaffected by economic developments in the small open economy, an exogeneity assumption. The second assumption is that this exogenous interest rate combined with domestic productivity is sufficient to describe equilibrium choices. We demonstrate the failure of the second assumption by contrasting general and partial equilibrium approaches to the study of a cross-section of small open economies. In doing so, we provide a method for modeling small open economies in general equilibrium that is no more technically demanding than the small open economy approach while preserving much of the value of the general equilibrium approach.
    JEL: C55 C68 F41 F44
    Date: 2016–07
  3. By: Edward C. Prescott
    Abstract: This essay reviews the development of neoclassical growth theory, a unified theory of aggregate economic phenomena that was first used to study business cycles and aggregate labor supply. Subsequently, the theory has been used to understand asset pricing, growth miracles and disasters, monetary economics, capital accounts, aggregate public finance, economic development, and foreign direct investment. The focus of this essay is on real business cycle (RBC) methodology. Those who employ the discipline behind the methodology to address various quantitative questions come up with essentially the same answer—evidence that the theory has a life of its own, directing researchers to essentially the same conclusions when they apply its discipline. Deviations from the theory sometimes arise and remain open for a considerable period before they are resolved by better measurement and extensions of the theory. Elements of the discipline include selecting a model economy or sometimes a set of model economies. The model used to address a specific question or issue must have a consistent set of national accounts with all the accounting identities holding. In addition, the model assumptions must be consistent across applications and be consistent with micro as well as aggregate observations. Reality is complex, and any model economy used is necessarily an abstraction and therefore false. This does not mean, however, that model economies are not useful in drawing scientific inference. The vast number of contributions made by many researchers who have used this methodology precludes reviewing them all in this essay. Instead, the contributions reviewed here are ones that illustrate methodological points or extend the applicability of neoclassical growth theory. Of particular interest will be important developments subsequent to the Cooley (1995) volume, Frontiers of Business Cycle Research. The interaction between theory and measurement is emphasized because this is the way in which hard quantitative sciences progress.
    JEL: B4 C10 E00 E13 E32 E60
    Date: 2016–07
  4. By: Iskrev, Nikolay; Ritto, Joao
    Abstract: In a recent article Canova et al. (2014) study the optimal choice of variables to use in the estimation of a simplified version of the Smets and Wouters (2007) model. In this comment we examine their conclusions by applying a different methodology to the same model. Our results call into question most of Canova et al. (2014) conclusions.
    Keywords: DSGE models, Observables, Identification, Information matrix, Cramér-Rao lower bounds
    JEL: C1 C9 E32
    Date: 2016–08
  5. By: Dirk Krueger; Kurt Mitman; Fabrizio Perri
    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.
    JEL: E21 E32 J65
    Date: 2016–07
  6. By: Christopher Taber; Rune Vejlin
    Abstract: In this paper we develop a model capturing key features of the Roy model, a search model, compensating differentials, and human capital accumulation on-the-job. We establish which features of the model can be non-parametrically identified and which can not. We estimate the model and use it to asses the relative contribution of the different factors for overall wage inequality. We find that Roy model inequality is the most important component accounting for the majority of wage variation. We also demonstrate that there is substantial interaction between the other features - most notably the importance of the job match obtained by search frictions varies from around 9% to around 29% depending on how we account for other features. Compensating differentials and search are both very important for explaining other features of the data such as the variation in utility. Search is important for turnover, but so is compensating differentials: 1/3 of all choices between two jobs would have resulted in a different outcome if the worker only cared about wages.
    JEL: J3
    Date: 2016–07
  7. By: Evans, George W.; Honkapohja, Seppo; Mitra, Kaushik
    Abstract: Stagnation as the new norm and fiscal policy are examined in a New Keynesian model with adaptive learning determining expectations. We impose inflation and consumption lower bounds, which can be relevant when agents are pessimistic. The inflation target is locally stable under learning. Pessimistic initial expectations may sink the economy into steady-state stagnation with deflation. The deflation rate can be near zero for discount factors near one or if credit frictions are present. Following a severe pessimistic expectations shock a large temporary fiscal stimulus is needed to avoid or emerge from stagnation. A modest stimulus is sufficient if implemented early.
    Keywords: Adaptive Learning; Deflation; Expectations; Fiscal policy; New Keynesian Model; Output Multiplier; Stagnation
    JEL: D84 E21 E43 E62
    Date: 2016–08
  8. By: Tobias Broer; Niels-Jakob H. Hansen; Per Krusell; Erik Öberg
    Abstract: We argue that a 2-agent version of the standard New Keynesian model—where a “worker” receives only labor income and a “capitalist” only profit income— offers insights about how income inequality affects the monetary transmission mechanism. Under rigid prices, monetary policy affects the distribution of consumption, but it has no effect on output as workers choose not to change their hours worked in response to wage movements. In the corresponding representative-agent model, in contrast, hours do rise after a monetary policy loosening due to a wealth effect on labor supply: profits fall, thus reducing the representative worker’s income. If wages are rigid too, however, the monetary transmission mechanism is active and resembles that in the corresponding representative-agent model. Here, workers are not on their labor supply curve and hence respond passively to demand, and profits are procyclical.
    JEL: E00 E32
    Date: 2016–07
  9. By: Ambrogio Cesa-Bianchi (Bank of England; Centre for Macroeconomics (CFM)); Jean Imbs (Paris School of Economics; Centre for Economic Policy Research (CEPR)); Jumana Saleheen (Bank of England)
    Abstract: In the workhorse model of international real business cycles, financial integration exacerbates the cycle asymmetry created by country-specific supply shocks. The prediction is identical in response to purely common shocks in the same model augmented with simple country heterogeneity (e.g., where depreciation rates or factor shares are different across countries). This happens because common shocks have heterogeneous consequences on the marginal products of capital across countries, which triggers international investment. In the data, filtering out common shocks requires therefore allowing for country-specific loadings. We show that finance and synchronization correlate negatively in response to such common shocks, consistent with previous findings. But finance and synchronization correlate non-negatively, almost always positively, in response to purely country-specific shocks.
    Keywords: Financial linkages, Business cycles synchronization, Contagion, Common shocks, Idiosynchratic shocks
    JEL: E32 F15 F36 G21 G28
    Date: 2016–08
  10. By: Edward C. Prescott; Ryan Wessel
    Abstract: We explore monetary policy in a world without fractional reserve banking. In our world, banks are purely transaction institutions. Money is a form of government debt that bears interest, which can be negative as well as positive. Services of money are a factor of production. We show that the national accounts must be revised in this world. Using our baseline economy, we determine a balanced growth path for a set of money interest rate policy regimes. Besides this interest rate, the only policy variable that differs across regimes is the labor income tax rate. Within this set of policy regimes, there is a balanced growth welfare-maximizing regime. We show that Friedman monetary satiation without deflation is possible in this world. We also examine a set of inflation rate targeting regimes. Here, the only other policy variable that differs across regimes is the inflation rate.
    JEL: E4 E5 E6
    Date: 2016–07
  11. By: Stephanie Schmitt-Grohé; Martín Uribe
    Abstract: This paper contributes to a literature that studies optimal capital control policy in open economy models with pecuniary externalities due to flow collateral constraints. It shows that the optimal policy calls for capital controls to be lowered during booms and to be increased during recessions. Moreover, in the run-up to a financial crisis optimal capital controls rise as the contraction sets in and reach their highest level at the peak of the crisis. These findings are at odds with the conventional view that capital controls should be tightened during expansions to curb capital inflows and relaxed during contractions to discourage capital flight.
    JEL: E44 F41
    Date: 2016–08

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