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on Dynamic General Equilibrium |
| By: | Lorenza Rossi (Department of Economics and Management, University of Pavia) |
| Abstract: | We consider a NK-DSGE model with endogenous firms' creation and destruction together with monopolistic competitive banks, where defaulting ?firms do not repay loans to banks. This framework implies: i) an endogenous and countercyclical number of firms destruction; ii) an endogenous and countercyclical bank markup. We study the effects of a shock to both the level and the volatility of the aggregate productivity. In response to a level shock, the interaction between i) and ii) generates a stronger propagation mechanism with respect to a model with exogenous exit and to a model with efficient banks. Remarkably, our model shows that a shock to the volatility of productivity, referred as an uncertainty shock, is recessionary. It implies a decline in firms’ creation, an increase in firms' destruction and an increase in banks’ markup. Estimating a small BVAR we find that our theoretical results are well supported by the empirical responses to uncertainty shocks. |
| Keywords: | fi?rms' ?endogenous exit, countercyclical bank markup, productivity shocks, uncertainty shock, BVAR. |
| JEL: | E32 E44 E52 E58 |
| Date: | 2016–10 |
| URL: | http://d.repec.org/n?u=RePEc:pav:demwpp:demwp0128&r=dge |
| By: | Muellbauer, John |
| Abstract: | The failure of the ubiquitous New Keynesian "Dynamic Stochastic General Equilibrium"(NK-DSGE) models to capture interactions of finance and the real economy is widely-recognized since the 2008-9 financial crisis. NK-DSGE models exclude money, debt and asset prices and, importantly, ignore changing credit markets. These problems stem from assuming unrealistic micro-foundations for household behaviour, and that aggregate behaviour mimics a fully-informed "representative agent" (both assumptions are embodied in the underlying "rational expectations permanent income" hypothesis (REPIH)). This survey critiques the NK-DSGE models and its integral REPIH model, and discusses alternative post-crisis general equilibrium models which do incorporate debt and allow crises to occur. But neither model type can be directly applied to policy-making. The survey reviews misspecifications in standard non-DSGE macro-models used by central banks (e.g. the Fed.'s FRB-US), and related co-integration literature linking consumption with household portfolios. These too omit most of the "financial accelerator", ignoring credit shifts and crucially, aggregating liquid, illiquid assets, debt and housing into a single "net worth" construct. The survey's second focus is to improve non-DSGE models for policy using the Latent Interactive Variable Equation System (LIVES) approach, in which aggregate consumption is jointly modelled with the main elements of household balance sheets, extracting credit conditions as a latent variable. Empirical work on aggregate data is surveyed revealing the important role of debt and financial assets and the time and context-dependent role of housing collateral. Rather than "one-size-fits-all" monetary and macro-prudential policy, institutional differences between countries then imply major differences for monetary policy transmission and policy. |
| Keywords: | asset prices.; Consumption; credit constraints; DSGE; finance and the real economy; financial crisis; Household portfolios; macroeconomic policy models |
| JEL: | E17 E21 E44 E51 E52 E58 G01 |
| Date: | 2016–10 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:11588&r=dge |
| By: | Duong Ngotran |
| Abstract: | Using the Smolyak grid, we solve a DSGE model where there are two types of money: reserves (e-money that banks deposit at the central bank) and zero maturity deposits (e-money that is issued by banks). Transactions between bankers are settled by reserves, while other ones are settled by zero maturity deposits. Our model, featuring only one housing demand shock, can match some key facts in the Great Recession: (i) the investment falls sharply, (ii) the excess reserves skyrocket but the money multiplier plummets, (iii) the household debt declines, (iv) the long duration of the interbank rate at the lower bound - the interest rate paid on reserves, (v) the sharp deflation then back to inflation immediately after the central bank conducts quantitative easing. Due to the maturity mismatch between deposits and loans, we find that the large scale asset purchase program is very effective in the short run but creates deflation and lower outputs in the long run. After a period of time since conducting quantitative easing, a recommended policy is to slowly raise the interest rate paid on reserves even if the central bank does not see the inflation signal. |
| JEL: | E4 E5 |
| Date: | 2016–10–29 |
| URL: | http://d.repec.org/n?u=RePEc:jmp:jm2016:png175&r=dge |
| By: | Paul De Grauwe (LONDON SCHOOL OF ECONOMICS); Eddie Gerba (Banco de España) |
| Abstract: | This paper compares two state-of-the-art but very distinct methods used in macroeconomics: rational-expectations DSGE and bounded rationality behavioural models. Both models are extended to include financial frictions on the supply side. The result in both frameworks is that production, supply of credit and the front payment to capital producers depend heavily on stock market cycles. During phases of optimism, credit is abundant, access to production capital is easy, the cash-in-advance constraint is lax, risks are undervalued, and production booms. But with a reversal in market sentiment, the contraction in all these parameters is deep and sometimes asymmetric. This is all the more evident in the behavioural model, where economic agents’ cognitive limitations exacerbate the contraction. While both models capture the empirical regularities very well, the validation exercise is even more favourable to the behavioural model |
| Keywords: | supply side, beliefs, financial frictions, model validations |
| JEL: | B41 C63 C68 E22 E23 E37 |
| Date: | 2016–10 |
| URL: | http://d.repec.org/n?u=RePEc:bde:wpaper:1626&r=dge |
| By: | Cociuba, Simona (University of Western Ontario); Shukayev, Malik (University of Alberta, Department of Economics); Ueberfeldt, Alexander (Bank of Canada) |
| Abstract: | We develop a model in which a financial intermediarys investment in risky assets risk taking is excessive due to limited liability and deposit insurance, and characterize the policy tools that implement efficient risk taking. In the calibrated model, coordinating interest rate policy with state-contingent macroprudential regulations either capital or leverage regulation, and a tax on pro ts achieves efficiency. Interest rate policy mitigates excessive risk taking, by altering the return and the supply of collateralizable safe assets. In contrast to commonly-used capital regulation, leverage regulation has stronger effects on risk taking and calls for higher interest rates. |
| Keywords: | Financial intermediation; risk taking; interest rate policy; macroprudential regulations; capital requirements; leverage ratio |
| JEL: | E44 E52 G11 G18 |
| Date: | 2016–11–01 |
| URL: | http://d.repec.org/n?u=RePEc:ris:albaec:2016_017&r=dge |
| By: | Simona Cociuba; Malik Shukayev; Alexander Ueberfeldt |
| Abstract: | We develop a model in which a financial intermediary’s investment in risky assets—risk taking—is excessive due to limited liability and deposit insurance and characterize the policy tools that implement efficient risk taking. In the calibrated model, coordinating interest rate policy with state-contingent macroprudential regulations, either capital or leverage regulation, and a tax on profits achieves efficiency. Interest rate policy mitigates excessive risk taking by altering both the return and the supply of collateralizable safe assets. In contrast to commonly used capital regulation, leverage regulation has stronger effects on risk taking and calls for higher interest rates. |
| Keywords: | Financial system regulation and policies, Monetary policy framework |
| JEL: | E44 E52 G11 G18 |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocawp:16-47&r=dge |
| By: | Pedro Bento; Diego Restuccia |
| Abstract: | We consider a tractable model of heterogeneous production units that features endogenous entry and productivity investment to assess the quantitative impact of policy distortions on aggregate output and establishment size. Relative to the standard factor misallocation framework, policy distortions featuring a positive productivity elasticity of distortions imply larger reductions in output through smaller investments in establishment productivity. A calibrated version of the model implies that when the productivity elasticity of distortions increases from 0.09 in the U.S. to 0.5 in India, aggregate output and average establishment size fall by 53 and 86 percent, compared to 37 and 0 percent in the standard factor misallocation model. Entry productivity investment and factor misallocation contribute equally to the reduction in output, whereas the effect of lower life-cycle productivity growth is fully offset by increased entry and reduced productivity dispersion. Establishment size differences in the model are consistent with evidence from a comprehensive dataset we construct on average establishment size in manufacturing using census data for 134 countries. |
| Keywords: | misallocation, establishment size, productivity, investment, idiosyncratic distortions, life-cycle growth. |
| JEL: | O1 O4 |
| Date: | 2016–10–27 |
| URL: | http://d.repec.org/n?u=RePEc:tor:tecipa:tecipa-567&r=dge |
| By: | Daniel Sanches (Federal Reserve Bank of Philadelphia); Todd Keister (Rutgers University) |
| Abstract: | We study a model in which both money and private credit instruments can potentially be used as media of exchange to overcome trading frictions in decentralized markets. Entrepreneurs in our model have access to productive projects, but face credit constraints due to limited pledgeability of their returns. If credit claims cannot circulate, the optimal monetary policy is the Friedman rule, which leads to efficient patterns of exchange, but the equilibrium level of investment is inefficiently low. When credit claims do circulate, monetary policy affects the liquidity premium on private credit and thereby influences the cost of borrowing and the level of investment. The Friedman rule is no longer optimal; we show that the optimal policy instead strikes a balance between easing borrowing constraints for entrepreneurs and promoting efficient exchange. We relate our result to the traditional bank lending channel of monetary policy and derive implications for optimal banking regulation. |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed016:1267&r=dge |
| By: | Gaston Navarro (Federal Reserve Board); Axelle Ferriere (European University Institute) |
| Abstract: | Empirical work suggests that government spending generates large expansions of output and consumption. Most representative-agent models predict a moderate expansion of output, and a crowding-out of consumption. We reconcile these findings by taking into account the distribution of taxes. Using US data from 1913 to 2012, we provide evidence that government spending induces larger expansions in output and consumption when financed with more progressive taxes. We then develop a model with heterogeneous households and idiosyncratic risk, to show that a rise in government spending can be expansionary, both for output and consumption, only if financed with more progressive labor taxes. Key to our results is the model endogenous heterogeneity in households’ marginal propensities to consume and labor supply elasticities. In this respect, the distributional impact of fiscal policy is central to its aggregate effects. |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed016:1286&r=dge |
| By: | Agnese, Pablo (UIC Barcelona); Hromcová, Jana (Universitat Autònoma de Barcelona) |
| Abstract: | We discuss the effects of low-skill offshoring on the endogenous schooling decision of workers along with the potential changes in the labor market. The analysis is performed in the context of a matching model with different possible equilibria. Our exercise suggests that the endogenous adjustment of low-skill workers can only partially offset the welfare-deteriorating effects of offshoring. As a result, we aim at restoring welfare by increasing the opportunity cost of staying low-skill. In addition to this, we also consider labor flexibility as an effective policy to deal with the adverse welfare effects of offshoring that befall those in the lowest end of the skill ladder. |
| Keywords: | offshoring, welfare, skills, education, flexibility |
| JEL: | F66 I25 J64 |
| Date: | 2016–10 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp10299&r=dge |
| By: | Thomas Sargent (New York University); Mikhail Golosov (Princeton University); David Evans (University of Oregon); anmol bhandari (university of minnesota) |
| Abstract: | A Ramsey planner chooses a distorting tax on labor and manages a portfolio of securities in an environment with incomplete markets. We develop a method that uses second order approximations of the policy functions to the planner’s Bellman equation to obtain expressions for the unconditional and conditional moments of debt and taxes in closed form such as the mean and variance of the invariant distribution as well as the speed of mean reversion. Using this, we establish that asymptotically the planner’s portfolio minimizes an appropriately defined measure of fiscal risk. Our analytic expressions that approximate moments of the invariant distribution can be readily applied to data recording the primary government deficit, aggregate consumption, and returns on traded securities. Applying our theory to U.S. data, we find that an optimal target debt level is negative but close to zero, that the invariant distribution of debt is very dispersed, and that mean reversion is slow. |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed016:1284&r=dge |
| By: | Vincenzo Quadrini (USC) |
| Abstract: | We study a firm dynamics model where access to credit improves the bargaining position of firms with workers and increases the incentive to hire. To evaluate the importance of the bargaining channel for the hiring decisions of firms, we estimate the model structurally using data from Compustat and Capital IQ. We find that the bargaining channel contributes to about 5.7% of variation in firm-level employment. We also evaluate the contribution of different types of firm-level shocks to employment volatility and find that credit shocks contribute to about 8%, revenue shocks to 48% and job separation shocks to 44%. |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed016:1254&r=dge |
| By: | Ignacio Presno (Universidad de Montevideo); Anna Orlik (Federal Reserve Board of Governors) |
| Abstract: | This paper studies the design of optimal time-consistent monetary policy in an economy where the planner trusts his own model, while a representative household uses a set of alternative probability distributions governing the evolution of the exogenous state of the economy. In such environments, unlike in the original studies of time-consistent monetary policy, management of households’ expectations becomes an active channel of optimal policymaking per se; a feature that our paternalistic government seeks to exploit. We adapt recursive methods in the spirit of Abreu, Pearce, and Stacchetti (1990) as well as computational algorithms based on Judd, Yeltekin, and Conklin (2003) to fully characterize the equilibrium outcomes for a class of policy games between the government and a representative household that distrusts the model used by the government. |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed016:1280&r=dge |
| By: | Lahcen, BOUNADER |
| Abstract: | This paper conducts the first assessment of the optimal monetary policy in the case of behavioral New Keynesian model proposed by Gabaix (2016). Consistent with the previous studies, I find that monetary policy under commitment continues to be important for optimal policy, but the optimal policy is found to be more history-dependent than in the traditional New Keynesian model. Importantly, I find that monetary policy under discretion may be optimal under some constraints on the parameters of the model which seems to correspond better to the reality of the conduct of monetary policy in central banks of developing, emerging and transitional economies. This finding is considered as filling the gap that always has been between the practice and the theory of the optimal monetary policy. |
| Keywords: | Optimal Monetary Policy, Behavioral New Keynesian Model |
| JEL: | D84 E52 |
| Date: | 2016–08–26 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:74743&r=dge |
| By: | Martin, Fernando M. (Federal Reserve Bank of St. Louis) |
| Abstract: | This paper investigates how institutional constraints discipline the behavior of discretionary governments and evaluates the welfare properties of such restrictions. The focus is on constraints implemented in actual economies: inflation and interest rate targets, and deficit and debt ceilings. I find that most welfare gains from these restrictions arise when constraining government behavior during normal times, which to a large extent is sufficient to discipline policy in adverse times. It is not optimal to ever suspend constraints when facing expenditure shocks, whereas for other types of shocks, the costs of suspending constraints during abnormal times is minimal. For a variety of aggregate shocks considered, the best policy is to impose a minimum primary surplus of about half a percent of output. The optimal design of policy constraints carries some risk, as choosing the wrong target or an inappropriate implementation time can lead to large welfare losses. |
| Keywords: | time-consistency; discretion; government debt; inflation; deficit; fiscal constraints; inflation targeting; institutional design; political frictions. |
| JEL: | E52 E58 E61 E62 |
| Date: | 2016–02–27 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2016-019&r=dge |
| By: | Jean Imbs (Paris School of Economics); Basile Grassi (University of Oxford) |
| Abstract: | Because they are populated with large firms. We construct a model of idea flows in which growth and volatility both depend on the prevalence of large firms in a sector. There is a finite number of firms that choose whether to imitate or to experiment. Experimenting means producing using a random technology, given by a discrete Markov deviation from its earlier value. In the limit, experimenting firms define an expanding technology frontier. Imitating means drawing tech- nology from the pool of existing producers. In equilibrium, only large enough firms experiment, and growth increases in their share. Since experimenting has stochastic consequences, so does volatility. The model’s key predictions are born out in US firm-level data: growth and volatility both increase in the share of large firms. The dispersion in tails can explain about 40% of the positive link between growth and volatility at the 4-digit level. As the data are aggregated, growth and volatility cease to correlate significantly: We argue this is consistent with our model, as structural change reallocates factors across sectors from high to low technology growth. In the aggregate, the link between large, experimenting firms, growth, and volatility is broken. |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed016:1209&r=dge |
| By: | Monica Costa-Dias (Institute for Fiscal Studies) |
| Abstract: | We develop an equilibrium life-cycle model of education, marriage and labor supply and consumption in a transferable utility context. Individuals start by choosing their investments in education anticipating returns in the marriage market and the labor market. They then match based on the economic value of marriage and on preferences. Equilibrium in the marriage market determines intra-household allocation of resources. Following marriage households (married or single) save, supply labor and consume private and public under uncertainty. Marriage thus has the dual role of providing public goods and offering risk sharing. The model is estimated using the British Household Panel Survey. |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed016:1285&r=dge |
| By: | Diego Comin (Dartmouth College); Daniel Lashkari (Harvard U.); Marti Mestieri (Northwestern University) |
| Abstract: | We develop a multi-sectoral endogenous growth model in which the direction of innovation across sectors is endogenous. Thus, our model provides a theoretical framework to think about the classical demand-pull versus technology-push drivers of innovation in a general equilibrium framework. A robust prediction that emerges from our analysis is that innovation growth should be higher in more income-elastic sectors. We test this prediction using the universe of U.S. patents for the period 1976-2007. We find empirical support for this prediction. Preliminary analysis of firm R&D expenditures from the U.S. census also confirm this prediction. |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed016:1287&r=dge |
| By: | Richard Lowery (University of Texas, Austin); Tim Landvoigt (The University of Texas at Austin) |
| Abstract: | To explain the sources of heterogeneity and fragility in the financial sector, we develop a dynamic model of entry, exit, and firm quality in the market for issuance and trading of complex financial securities. Firm quality has two dimensions; security production expertise, which creates a positive externality for other firms, and trading expertise, which allows firms to obtain more favorable prices when trading with other firms. We find that increasing the quality of securities, which in the model increases the scope for investment in trading expertise, leads to markets that exhibit greater concentration, firm heterogeneity, fragility, and price dispersion. |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed016:1248&r=dge |
| By: | Damiano Sandri (International Monetary Fund); Paolo Cavallino (International Monetary Fund) |
| Abstract: | We develop a tractable model of monetary policy in emerging markets featuring currency mismatches and occasionally binding collateral constraints. We show that, if currency mismatches are severe, monetary policy is constrained in its ability to support output, even under flexible exchange rates. We characterize the existence of a strictly positive \expansionary lower bound" (ELB) on interest rates below which further monetary easing has contractionary effects. The ELB is affected by foreign monetary conditions that can in turn constrain domestic monetary policy. In particular, a US monetary tightening raises the ELB and can have recessionary consequences for emerging markets. As a result, a need for policy coordination arises. When the ELB is binding, social efficiency requires accepting some overheating in the US to reduce the contractionary effects on emerging markets. |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed016:1250&r=dge |