nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2016‒11‒20
thirty-six papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Mortgage Credit: Lending and Borrowing Constraints in a DSGE Framework By Sánchez, Elmer
  2. The Slow Job Recovery in a Macro Model of Search and Recruiting Intensity By Zheng Liu; Sylvain Leduc
  3. The optimal conduct of central bank asset purchases By Darracq Pariès, Matthieu; Kühl, Michael
  4. A Quantitative Theory of Time-Consistent Unemployment Insurance By Pei, Yun; Xie, Zoe
  5. Under-Insurance in Human Capital Models with Limited Enforcement By Krebs, Tom; Kuhn, Moritz; Wright, Mark L.J.
  6. Aggregate Hiring and the Value of Jobs Along the Business Cycle By Eran Yashiv
  7. Macroeconomics and Consumption By John Muellbauer
  8. Sovereign Risk and Bank Risk-Taking By Ari, A.
  9. Elderly Care, Child Care, and Labor Supply in an Aging Japan By Ryuta Ray Kato
  10. Firm Dynamics in the Neoclassical Growth Model By Licandro, Omar
  11. Parental time investment and intergenerational mobility By Yum, Minchul
  12. Aggregate Hiring and the Value of Jobs Along the Business Cycle By Neele L. Balke; Morten O. Ravn
  13. Theory of College, Student Loans, and Education Policy By Rodolfo Manuelli; Carlos Garriga; Maria Ferreyra
  14. Structural reform in Germany By Krebs, Tom; Scheffel, Martin
  16. Business Cycles and Household Formation: The Micro vs the Macro Labor Elasticity By Jose-Victor Rios-Rull; Greg Kaplan; Sebastian Dyrda
  17. Inequality and Aggregate Demand By Matthew Rognlie; Adrien Auclert
  18. No More Excuses! A Toolbox for Solving Heterogeneous Agent Models with Aggregate Shocks By Thomas Winberry; Greg Kaplan; Benjamin Moll; SeHyoun Ahn
  19. Regulation and Rational Banking Bubbles in Infinite Horizon By Claire Océane Chevallier; Sarah El Joueidi
  20. Asset Bubbles, Endogenous Growth, and Financial Frictions By Hirano, Tomohiro; Yanagawa, Noriyuki
  21. Stress Testing in a Structural Model of Bank Behavior By Thomas Siemsen; Sigurd Mølster Galaasen; Pablo D'Erasmo; Alfonso Irarrazabal; Dean Corbae
  22. Is the output growth rate in NIPA a welfare measure? By Licandro, Omar
  23. Taxation of Temporary Jobs: Good Intentions with Bad Outcomes? By Cahuc, Pierre; Charlot, Olivier; Malherbet, Franck; Benghalem, Helène; Limon, Emeline
  24. The efficiency of surplus sharing Nicolas Petrosky-Nadeau and Etienne Wasmer By Etienne Wasmer
  25. Stimulative Effects of Temporary Corporate Tax Cuts By William GBOHOUI; Rui Castro
  26. Asset bubbles, labor market frictions, and R&D-based growth By Ken-ichi Hashimoto; Ryonghun Im
  27. On the Direction of Innovation By Francesco Squintani; Hugo A. Hopenhayn
  28. Accounting for changing returns to experience By Hendricks, Lutz
  29. Financial Intermediation Chains in an OTC Market By Shen, Ji; Wei, Bin; Yan, Hongjun
  30. Housing and the Redistributive Effects of Monetary Policy By Michael Reiter; Philipp Hergovich
  31. optimal insurance for time-inconsistent agents By Frederic Cherbonnier
  32. Fiscal consolidation in a low inflation environment: pay cuts versus lost jobs By Bandiera, Guilherme; Pappa, Evi; Sajedi, Rana; Vella, Eugenia
  33. Informality, Public Employment and Employment Protection in Developing Countries By Fran çois Langot; Shaimaa Yassin
  34. More on the Optimal Taxation of Capital By Pedro Teles; Juan Nicolini
  35. Do Individual Behavioral Biases Affect Financial Markets and the Macroeconomy? By Raman Uppal; Harjoat Bhamra
  36. Commercial Revolutions, Search, and Development By Maurizio Iacopetta

  1. By: Sánchez, Elmer (Banco Central de Reserva del Perú)
    Abstract: This paper develops a Dynamic Stochastic General Equilibrium (DSGE) framework to evaluate the relative importance of the easing of lending and borrowing constraints in mortgage credit markets for business cycle fluctuations in small open emerging economies. Credit markets are characterized by partial dollarization and are subject to demand shocks, innovations to stochastic loan-to-value ratios (borrowing constraints) imposed on borrowers, and supply shocks, innovations to stochastic bank capital-to-asset ratios (lending constraints) imposed on financial intermediaries. In addition, the model features a set of real and nominal domestic shocks to demand, productivity, and fiscal and monetary policy, as well as foreign shocks. The model is calibrated and estimated using data on the Peruvian economy. A historical decomposition conducted on household leverage ratios reveals that these variables’ cyclical dynamics were mainly driven by borrowing constraint shocks or credit demand shifts, while lending constraint shocks played a residual role. Counterfactual simulations also provide evidence in favor of this channel: turning off the borrowing constraint shocks significantly attenuates the fluctuations of leverage ratios from their steady-state levels. The importance of the demand channel in Peru is consistent with mortgage demand-boosting public programs enacted in the 2000s. While applied in the Peruvian context here, the framework is easily adaptable to the historical evolution of credit markets in a large variety of emerging market economies.
    Keywords: fricciones financieras, DSGE con sector bancario.
    JEL: E37 E44 E52
    Date: 2016–09
  2. By: Zheng Liu (Federal Reserve Bank of San Francisco); Sylvain Leduc (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. A significant gap remains between the actual job filling rate and that predicted from the standard labor search model. To examine the forces behind the slow job recovery, we generalize the standard labor search 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 rates in the aftermath of the Great Recession.
    Date: 2016
  3. By: Darracq Pariès, Matthieu; Kühl, Michael
    Abstract: We analyse the effects of central bank government bond purchases in an estimated DSGE model for the euro area. In the model, central bank asset purchases are relevant in so far as agency costs distort banks asset allocation between loans and bonds, and households face transaction costs when trading government bonds. Such frictions in the banking sector induce inefficient time-variation in the term premia and open up for a credit channel of central bank government bond purchases. Considering first ad hoc asset purchase programmes like the one implemented by the ECB, we show that their macroeconomic multipliers are stronger as the lower bound on the policy rate becomes binding and when the purchasing path is fully communicated and anticipated by economic agents. From a more normative standpoint, interest rate policy and asset purchases feature strong strategic complementarities during both normal and crisis times. In a lower bound environment, optimal policy conduct features long lower bound periods and activist asset purchase policy. Our results also point to a clear sequencing of the exit strategy, stopping first the asset purchases and later on, lifting off the policy rate. In terms of macroeconomic stabilisation, optimal asset purchase strategies bring sizeable benefits and have the potential to largely offset the costs of the lower bound on the policy rate. JEL Classification: C61, E52, G11
    Keywords: banking, DSGE, portfolio optimisation, quantitative easing
    Date: 2016–11
  4. By: Pei, Yun (State University of New York at Buffalo); Xie, Zoe (Federal Reserve Bank of Atlanta)
    Abstract: During recessions, the U.S. government substantially increases the duration of unemployment insurance (UI) benefits through multiple extensions. This paper seeks to understand the incentives driving these increases. Because of the trade-off between insurance and job search incentives, the classic time-inconsistency problem arises. This paper endogenizes a time-consistent UI policy in a stochastic equilibrium search model, where a government without commitment to future policies chooses the UI benefit level and expected duration each period. A longer benefit duration increases unemployed workers’ consumption but reduces job search, leading to higher future unemployment. Quantitatively, the model rationalizes most of the variations in benefit duration during the Great Recession. We use the framework to evaluate the effects of the 2009–13 benefit extensions on unemployment and welfare.
    Keywords: time-consistent policy; unemployment insurance; labor market; business cycle
    JEL: E61 H21 J64 J65
    Date: 2016–11–01
  5. By: Krebs, Tom; Kuhn, Moritz; Wright, Mark L.J.
    Abstract: This paper uses a macroeconomic model calibrated to U.S. data to show that limited contract enforcement leads to substantial under-insurance against human capital risk. The model economy is populated by a large number of risk-averse households who can invest in risk-free physical capital and risky human capital. Expected human capital returns are age-dependent and calibrated to match the observed life-cycle profile of median labor income. 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). According to the baseline calibration, young households are severely under-insured against human capital (labor income) risk and the welfare losses due to the lack of insurance are substantial. These results are robust to realistic variations in parameter values.
    Keywords: Human Capital Risk; Insurance; Limited Enforcement
    JEL: D52 E21 E24 J24
    Date: 2016–11
  6. By: Eran Yashiv (Tel Aviv University; Centre for Macroeconomics (CFM); CEPR)
    Abstract: U.S. CPS data indicate that in recessions firms actually increase their hiring rates from the pools of the unemployed and out of the labor force. Why so? The paper provides an explanation by studying the optimal recruiting behavior of the representative firm. The model combines labor frictions, of the search and matching type, with capital frictions, of the q-model type. Optimal firm behavior is a function of the value of jobs, i.e., the expected present value of the marginal worker to the firm. These are estimated to be counter-cyclical, the underlying reason being the dynamic behavior of the labor share of GDP. The counter-cyclicality of hiring rates and job values, which may appear counter-intuitive, is shown to be consistent with well-known business cycle facts. The analysis emphasizes the difference between current labor productivity and the wider, forward-looking concept of job values. The paper explains the high volatility of firm recruiting behavior, as well as the reduction over time in labor market fluidity in the U.S., using the same estimated model. Part of the explanation has to do with job values and another part with the interaction of hiring and investment costs, both determinants having been typically overlooked.
    Keywords: Counter-cyclical job values, Business cycles, Aggregate hiring, Vacancies, Labor market frictions, Capital market functions, Volatility, Labor market fluidity
    JEL: E24 E32
    Date: 2016–11
  7. By: John Muellbauer
    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: DSGE, macroeconomic policy models, finance and the real economy, financial crisis, consumption, credit constraints, household portfolios, asset prices
    JEL: E17 E21 E44 E51 E52 E58 G01
    Date: 2016–11–02
  8. By: Ari, A.
    Abstract: In European countries recently hit by a sovereign debt crisis, banks have sharply raised their holdings of domestic sovereign debt, reduced credit to forms, and faced rising financing costs, raising concerns about economic and financial resilience. This paper develops a general equilibrium model with optimizing banks and depositors to account for these facts and provide a framework for policy assessment. Under-capitalized banks in default-risky countries have an incentive to gamble on domestic sovereign bonds. Unless there is perfect transparency of bank balance sheets, the optimal reaction by depositors to bank insolvency risk leaves the economy susceptible to self-fulfilling shifts in sentiments. In a bad equilibrium, sovereign risk shocks lead to a prolonged period of financial fragility and a persistent drop in output. The model is quantified using Portuguese data and generates similar dynamics to those observed in the Portuguese economy during the debt crisis. Policy interventions face a trade-off between alleviating funding constraints and strengthening incentives to gamble. Liquidity provision to banks may eliminate the good equilibrium when not targeted. Targeted interventions have the capacity to eliminate adverse equilibria.
    Keywords: Sovereign Debt Crises, Bank Risk-Taking, Financial Constraints
    JEL: E44 E58 F34 G21 H63
    Date: 2016–11–17
  9. By: Ryuta Ray Kato (International University of Japan)
    Abstract: This paper numerically examines the impact of the financial and time cost of child care as well as elderly care on economic growth and welfare in an aging Japan within a dynamic general equilibrium framework of multi-period overlapping generations with endogenized labor supply. Simulation results indicate that the replacement rate of the public pension scheme becomes below 50 percent from year 2039, even if the currently accumulated public pension funds are used up for paying pension benefits by year 2115. Financial burdens for the first group (age 65 and over) and for the second group (age 40 - 64) in the public long-term care insurance in year 2060 become more than double and more than five times as much as the level of year 2010 in an aging Japan, respectively. While increased child benefits stimulate savings and thus they improve welfare, the impact of elimination of the time cost of child care and elderly care is quite mixed, depending on the gender and job contract types of workers within the household. When the time cost of elderly care spent by all workers irrespective of gender and job contract types is eliminated, many generations enjoy welfare gain, but when the time cost of child care by all workers is eliminated, then almost all generations, except for relatively elder generations, reversely suffer from welfare loss. When a starting age to contribute to the long-term care insurance becomes earlier from the current age of 40 to age 35, welfare of all generations improves.
    Keywords: Child Care, Child Benefits, Elderly Care, Long-Term Care Insurance, Public Pension, Female Labor Supply, Aging, Economic Growth, Simulation, CGE Model
    JEL: C68 H51 E62 H55 J16
    Date: 2016–11
  10. By: Licandro, Omar
    Abstract: This paper integrates firm dynamics theory into the Neoclassical growth framework. It embeds selection into an otherwise standard dynamic general equilibrium model of one good, two production factors (capital and labor) and competitive markets. Selection relies on firm specific investment: i) capital is a fixed production factor --playing the role of an entry cost, ii) the productivity of capital is firm specific, but observed after investment, iii) firm specific capital is partially reversible --its opportunity cost plays the same role as fixed production costs. At equilibrium, aggregate technology is Neoclassical, but the average quality of capital is endogenous and positively related to selection; due to capital irreversibility, the marginal product of capital is larger than the user cost and capital depreciation positively depends on selection. At steady state, output per capita and welfare both raise with selection; rendering capital more reversible or increasing the variance of the idiosyncratic shock both raise selection, productivity, output per capita and welfare.
    Keywords: Capital irreversibility; Entry and Exit; Firm Dynamics; Hopenhayn; Neoclassical growth model; Ramsey; selection
    JEL: O3 O4
    Date: 2016–11
  11. By: Yum, Minchul
    Abstract: This paper investigates parental time investment in children prior to formal schooling as a source of intergenerational income persistence in the U.S. I develop a dynamic general equilibrium model where lifetime income endogenously persists across generations through multiple channels. My model replicates a series of important untargeted aspects of the data including the U.S. income quintile transition matrix. I find that the parental time investment channel accounts for nearly 40 percent of the observed intergenerational income persistence. Policy experiments suggest that e¤ective ways of improving mobility should focus on narrowing discrepancies in the quantity and quality of parental time investments.
    Keywords: parental time , human capital investment , intergenerational persistence , college education
    JEL: E24 I24 J22
    Date: 2016
  12. By: Neele L. Balke (University College London (UCL); Centre for Macroeconomics (CFM)); Morten O. Ravn (University College London (UCL); Centre for Macroeconomics (CFM); Centre for Economic Policy Research (CEPR))
    Abstract: We analyze time-consistent fiscal policy in a sovereign debt model. We consider a production economy that incorporates feedback from policy to output through employment, features inequality though unemployment, and in which the government lacks a commitment technology. The government's optimal policies play off wedges due to the lack of lump-sum taxes and the distortions that taxes and transfers introduce on employment. Lack of commitment matters during a debt crises - episodes where the price of debt reacts elastically to the issuance of new debt. In normal times, the government sets procyclical taxes, transfers and public goods provision but in crisis times it is optimal to implement austerity policies which minimize the distortions deriving from default premia. Could a third party provide a commitment technology, austerity is no longer optimal.
    Keywords: Time-consistent fiscal policy, Soverign debt, Debt crisis, Austerity
    JEL: E20 E62 F34 F41
    Date: 2016–11
  13. By: Rodolfo Manuelli (Washington University and Federal Reserve Bank of St. Louis); Carlos Garriga (Federal Reserve Bank of St. Louis); Maria Ferreyra (The World Bank)
    Abstract: This paper analyzes the effectiveness of three different types of education policies: tuition subsidies (broad based, merit based, and flat tuition), grant subsidies (broad based and merit based), and loan limit restrictions. We develop a quantitative theory of college within the context of general equilibrium overlapping generations economy. College is modeled as a multi-period risky investment with endogenous enrollment, time-to-degree, and dropout behavior. Tuition costs can be financed using federal grants, student loans, and working while at college. We show that our model accounts for the main statistics regarding education (enrollment rate, dropout rate, and time to degree) while matching the observed aggregate wage premiums. Our model predicts that broad based tuition subsidies and grants increase college enrollment. However, due to the correlation between ability and financial resources most of these new students are from the lower end of the ability distribution and eventually dropout or take longer than average to complete college. Merit based education policies counteract this adverse selection problem but at the cost of a muted enrollment response. The importance of loan availability critically depends on the underlying distribution of abilities.
    Date: 2016
  14. By: Krebs, Tom; Scheffel, Martin
    Abstract: This paper provides a quantitative evaluation of the macroeconomic, distributional, and fiscal effects of three reform proposals for Germany: i) a reduction in the social security tax in the low-wage sector, ii) a publicly financed expansion of full-day child care and full-day schooling, and iii) the further deregulation of the professional service sector. The analysis is based on a macroeconomic model with physical capital, human capital, job search, and household heterogeneity. All three reforms have positive short-run and long-run effects on employment, wages, and output. The quantitative effects of the deregulation reform are relatively small due to the small size of the professional services in Germany. Policy reforms i) and ii) have substantial macroeconomic effects and positive distributional consequences. Ten years after implementation, reforms i) and ii) taken together increase employment by 1.6 percent, potential output by 1.5 percent, real hourly pre-tax wages in the low-wage sector by 3 percent, and real hourly pre-tax wages of women with children by 2.7 percent. The two reforms create fiscal deficits in the short-run, but they also generate substantial fiscal surpluses in the long-run. They are fiscally efficient in the sense that the present value of short-term fiscal deficits and long-term fiscal surpluses is positive for any interest (discount) rate less than 9 percent.
    JEL: E24 E60 J2 J3
    Date: 2016
  15. By: Fujita, Shigeru (Federal Reserve Bank of Philadelphia); Fujiwara, Ippei (Keio University and Australian National University)
    Abstract: This paper explores a causal link between aging of the labor force and declining trends in the real interest rate and inflation in Japan. We develop a New Keynesian search/matching model that features heterogeneities in age and firm-specific skills. Using the model, we examine the long-run implications of the sharp drop in labor force entry in the 1970s. We show that the changes in the demographic structure induce significant low-frequency movements in per-capita consumption growth and the real interest rate. They also lead to similar movements in the inflation rate when the monetary policy follows the standard Taylor rule, failing to recognize the timevarying nature of the natural rate of interest. The model suggests that aging of the labor force accounts for roughly 40% of the declines in the real interest rate observed between the 1980s and 2000s in Japan.
    Keywords: aging; natural rate; deflation; Japan
    JEL: E24 E31 E52
    Date: 2016–11–07
  16. By: Jose-Victor Rios-Rull (University of Pennsylvania); Greg Kaplan (Princeton University); Sebastian Dyrda (University of Toronto)
    Abstract: We provide a new evidence on the cyclical behavior of the household size and lab or market outcomes of young people conditional on their living arrangements in the United States from 1979 to 2010. Household size is countercyclical, which is mostly driven by young people moving into or delaying departure from the parental home. We document that young people living with the old work and earn less, and their hours and wages are more volatile relative to their peers living alone. We argue that living arrangements induce larger disparities in the lab or market outcomes than age does. Motivated by these observations we provide a joint theory of household formation and labor market engagement including the business cycle. We lay down a theory where young individuals decide where to live depending on their relative wage rate, disutility of living with old and implicit transfers received from the old. We show differences in volatilities across age groups can be accounted for by incorporating household formation channel in to the real business cycle model, while restricting the labor elasticity of the old to be within the range measured by micro economists.
    Date: 2016
  17. By: Matthew Rognlie (Massachusetts Institute of Technology); Adrien Auclert (Princeton)
    Abstract: We explore the quantitative effects of transitory and persistent increases in income inequality on equilibrium interest rates and output. Our starting point is a Bewley-Huggett-Aiyagari model featuring rich heterogeneity and earnings dynamics as well as downward nominal wage rigidities. A temporary rise in inequality, if not accommodated by monetary policy, has an immediate effect on output that can be quantified using the empirical covariance between income and marginal propensities to consume. A permanent rise in inequality can lead to a permanent Keynesian recession, which is not fully offset by monetary policy due to a lower bound on interest rates. We show that the magnitude of the real interest rate fall and the severity of the steady-state slump can be approximated by simple formulas involving quantifiable elasticities and shares, together with two parameters that summarize the effect of idiosyncratic uncertainty and real interest rates on aggregate savings. For plausible parametrizations the rise in inequality can push the economy into a liquidity trap and create a deep recession. Capital investment and deficit-financed fiscal policy mitigate the fall in real interest rates and the severity of the slump.
    Date: 2016
  18. By: Thomas Winberry (University of Chicago); Greg Kaplan (Princeton University); Benjamin Moll (Princeton University); SeHyoun Ahn (Princeton University)
    Abstract: How does the joint distribution of income and wealth interact with macroeconomic aggregates? We develop a new continuous-time method that improves the theoretical characterization and computation of incomplete-market models designed to study this question, taking advantage of the fact that such models can be conveniently solved as systems of partial differential equations. We provide a complete analytic characterization of individual consumption and saving behavior as well as a closed-form solution for the wealth distribution in a special case with two income states. We show that aggregate consumption and saving are approximately independent of the distribution of wealth only in the special case of homothetic (CRRA) preferences and hence approximately constant marginal propensities to consume for rich and poor households. With non-homothetic preferences, an increase in income inequality can instead lead to a sizable increase in aggregate savings. Conversely, changes in macroeconomic aggregates may affect the distribution of wealth in unexpected ways. For instance, an increase in aggregate productivity may lead to higher wealth inequality at the bottom of the distribution. Our efficient and flexible computational algorithm easily handles non-differentiable and non-convex problems as well as transition dynamics.
    Date: 2016
  19. By: Claire Océane Chevallier (CREA, Université du Luxembourg); Sarah El Joueidi (CREA, Université du Luxembourg)
    Abstract: This chapter develops a dynamic stochastic general equilibrium model in infinite horizon with a regulated banking sector where stochastic banking bubbles may arise endogenously. We analyze the conditions under which stochastic bubbles exist and their impact on macroeconomic key variables. We show that when banks face capital requirements based on Value-at- Risk, two different equilibria emerge and can coexist: the bubbleless and the bubbly equilibria. Alternatively, under a regulatory framework where capital requirements are based on credit risk only, as in Basel I, bubbles are explosive and, as a consequence, cannot exist. The stochastic bubbly equilibrium is characterized by positive or negative bubbles depending on the tightness of capital requirements based on Value-at-Risk. We find a maximum value of capital requirements under which bubbles are positive. Below this threshold, the stochastic bubbly equilibrium provides larger wel- fare than the bubbleless equilibrium. In particular, our results suggest that a change in banking policies might lead to a crisis without external shocks.
    Keywords: Banking bubbles; banking regulation; DSGE; infinitely lived agents; multiple equilibria; Value-at-Risk
    JEL: E2 E44 G01 G20
    Date: 2016
  20. By: Hirano, Tomohiro; Yanagawa, Noriyuki
    Abstract: This paper analyzes the existence and the effects of bubbles in an endogenous growth model with nancial frictions and heterogeneous investments. Bubbles are likely to emerge when the degree of pledgeability is in the middle range, implying that improving the nancial market might increase the potential for asset bubbles. Moreover, when the degree of pledgeability is relatively low, bubbles boost long-run growth; when it is relatively high, bubbles lower growth. Furthermore, we examine the effects of a bubble burst, and show that the effects depend on the degree of pledgeability, i.e., the quality of the nancial system. Finally, we conduct a full welfare analysis of asset bubbles.
    Keywords: Asset Bubbles, Endogenous Growth, Pledgeability, bubble burst, welfare effects of bubbles
    Date: 2016–10
  21. By: Thomas Siemsen (Ludwig-Maximilians-University Munich); Sigurd Mølster Galaasen (Norges Bank); Pablo D'Erasmo (FRB Philadelphia); Alfonso Irarrazabal (BI Norwegian Business School); Dean Corbae (University of Wisconsin)
    Abstract: We develop a structural banking model for microprudential stress testing. We model a single bank that optimally chooses portfolio allocation, dividend policy and exit, facing regulatory and technological constraints. In our calibrated model, the bank has an incentive to hold a buffer stock of capital even in excess of regulatory requirements to protect its charter value. We explore optimal behavior during severe macroeconomic stress. We employ bank’s endogenous exit choice as a novel metric for counterfactual stress outcomes. Finally, we discuss implications for current stress testing framework.
    Date: 2016
  22. By: Licandro, Omar
    Abstract: National Income and Product Accounts (NIPA) measure real output growth by means of a Fisher ideal chain index. Bridging modern macroeconomics and the economic theory of index numbers, this paper shows that output growth as measured by NIPA is welfare based. In a dynamic general equilibrium model with general recursive preferences and technology, welfare depends on present and future consumption. Indeed, the associated Bellman equation provides a representation of preferences in the domain of current consumption and current investment. Applying standard index number theory to this representation of preferences shows that the Fisher-Shell true quantity index is equal to the Divisia index, in turn well approximated by the Fisher ideal index used in NIPA.
    Keywords: Embodied technical change; Fisher-Shell index; Growth measurement; NIPA; Quantity indexes
    JEL: C43 D91 O41 O47
    Date: 2016–11
  23. By: Cahuc, Pierre (Ecole Polytechnique, Paris); Charlot, Olivier (University of Cergy-Pontoise); Malherbet, Franck (CREST (ENSAE)); Benghalem, Helène (CREST); Limon, Emeline (University of Cergy-Pontoise)
    Abstract: This paper analyzes the consequences of the taxation of temporary jobs recently introduced in several European countries to induce firms to create more open-ended contracts and to increase the duration of jobs. The estimation of a job search and matching model on French data shows that the taxation of temporary jobs does not reach its objectives: it reduces the mean duration of jobs and decreases job creation, employment and welfare of unemployed workers. We find that a reform introducing an open-ended contract without layout costs for separations occurring at short tenure would have opposite effects.
    Keywords: temporary jobs, employment protection legislation, taxation
    JEL: J63 J64 J68
    Date: 2016–11
  24. By: Etienne Wasmer (Sciences-Po)
    Abstract: What is the optimal sharing of value added between entrepreneurs, labor and creditors, and the optimal sharing between consumers and producers? We study the constrained efficiency properties of a model with search frictional credit, labor and goods markets. The social planner's allocation seeks to minimizes turnover costs in all three markets. The decentralized allocation with Nash bargaining is constrained efficient if Hosios conditions hold in each of the credit, labor and goods markets. Deviations from Hosios in the labor market can lead to either over or under hiring. Deviations from Hosios in the credit market always leads to under hiring. The effects of deviations from Hosios in the good market depend on the direction of the deviation from Hosios in the labor market.
    Date: 2016
  25. By: William GBOHOUI; Rui Castro (Western University)
    Abstract: Policymakers often rely on temporary corporate tax cuts in order to provide incentives for business investment in recession times. A common motivation is that such policies help relax financing frictions, which might bind more during recessions. Our aim is to assess whether this mechanism is effective at raising aggregate investment and output. We consider an industry equilibrium model where some firms are financially constrained, and therefore have high marginal propensities to invest. By increasing current cash flows, corporate tax cuts are effective at stimulating investment. We quantify by how much aggregate investment and output increase, and describe the effects in the cross-section of firms. We find that, on impact, a temporary reduction in corporate taxation increases aggregate investment by 26 cents per dollar of tax stimulus, and aggregate output by 3.5 cents. The cumulative effect multipliers yield increases of investment and output of 4.6 and 7.2 cents, respectively. A major factor preventing larger effects is that this policy tends to significantly crowd out investment among the larger, unconstrained firms.
    Date: 2016
  26. By: Ken-ichi Hashimoto (Graduate School of Economics, Kobe University); Ryonghun Im (Japan Society for the Promotion of Science, Research Fellowship for Young Scientists, Graduate School of Economics, Kobe University)
    Abstract: Employing an overlapping generations model of research and development (R&D)-based growth with labor market frictions, this paper examines how employment changes induced by labor market frictions influence asset bubbles and long-run economic growth. Asset bubbles can (cannot) exist when the employment rate is high (low), which leads to higher (lower) economic growth through labor market efficiency. We also explore the steady state and transitional dynamics of bubbles, economic growth, and employment. Furthermore, we show that policy or parameter changes that have a negative influence on the labor market can lead to a bubble burst.
    Keywords: overlapping generations, asset bubbles, labor market friction, employment rate, R&D
    JEL: J64 O41 O42
    Date: 2016–11
  27. By: Francesco Squintani (University of Warwick); Hugo A. Hopenhayn (University of California Los Angeles)
    Abstract: Research on the efficiency of innovation markets is usually concerned on whether the level of R&D firm investment is socially optimal. Instead, this paper studies whether R&D resources are employed optimally across research areas. Under weak assumptions, we find that competitive equilibrium innovative efforts are biased excessively into high returns areas. This form of market inefficiency is a novel result, and would take place even if innovators' profits coincided with the social value of innovations. We first demonstrate it in a simple, fundamental model. Then we embed our analysis in a canonical dynamic framework directly comparable with extant R&D models, and precisely identify the features of R&D competition that lead to the market failure we identify.
    Date: 2016
  28. By: Hendricks, Lutz
    Abstract: Returns to experience for U.S. workers have changed over the post-war period. This paper argues that a simple model goes a long way towards replicating these changes. The model features three well-known ingredients: (i) an aggregate production function with constant skill-biased technical change; (ii) cohort qualities that vary with average years of schooling; and crucially (iii) time-invariant ageefficiency profiles. The model quantitatively accounts for changes in longitudinal and cross-sectional returns to experience, as well as the differential evolution of the college wage premium for young and old workers.
    Keywords: Returns to experience,College wage premium
    JEL: E24 I26 J31
    Date: 2016
  29. By: Shen, Ji; Wei, Bin; Yan, Hongjun
    Abstract: This paper analyzes financial intermediation chains in a search model with an endogenous intermediary sector. We show that the chain length and price dispersion among inter-dealer trades are decreasing in search cost, search speed, and market size, but increasing in investors’ trading needs. Using data from the U.S. corporate bond market, we find evidence broadly consistent with these predictions. Moreover, as search speed approaches infinity, the search equilibrium does not always converge to the centralized-market equilibrium: prices and allocation converge, but the trading volume may not. Finally, the multiplicity and stability of the equilibrium is analyzed.
    Keywords: Search, Chain, Financial Intermediation, Multiplicity, Stability
    JEL: G10
    Date: 2016–10
  30. By: Michael Reiter (Institute for Advanced Studies); Philipp Hergovich (University of Vienna)
    Abstract: We study the redistributive effects of monetary policy in the framework of a large OLG model, with endogenous housing choice, downpayment constraints, and different types of shocks. We pay special attention to the structure of debt, whether it is short-term or long-term, nominal or real. We find that monetary policy shocks have long-lasting effects on the inter-generational wealth distribution. While the debt structure only has a mild effect on aggregate statistics, it matters a lot for how different types of shocks under different monetary policy regimes affect the distribution.
    Date: 2016
  31. By: Frederic Cherbonnier (Toulouse School of Economics)
    Abstract: We examine the provision of insurance against non-observable liquidity shocks for a time-inconsistent agent who can privately store resources. When the lack of self control is strong enough, hidden storage does not constrain the allocation of resources. The optimal contract is strictly concave and similar to a credit contract : It allows the agent to borrow at an increasing cost, and save at a decreasing rate of return. Extending the model to an infinite horizon, we then show that, in the presence of repeated shocks, the optimal contract leads consumers to impoverishment almost surely. By contrast, the optimal contract for a time-consistent agent only allows him to borrow at the economy’s interest rate, and induces him to almost surely accumulate wealth indefinitely. Those results bring out how lack of self-control changes the nature of optimal savings and borrowing instruments, and may lead individuals and states to impoverishment. We discuss applications to consumer over-indebtedness, social security design, sovereign debt crises and Pigovian regulation.
    Date: 2016
  32. By: Bandiera, Guilherme (European University Institute); Pappa, Evi (European University Institute); Sajedi, Rana (Bank of England); Vella, Eugenia (University of Sheffield)
    Abstract: We construct a model of a monetary union to study fiscal consolidation in the Periphery of the euro area, through cuts in public sector wages or hiring when the nominal interest rate is constrained at its lower bound. Consolidation induces a positive wealth effect that increases demand, as well as a reallocation of workers towards the private sector, which together boost private activity. However, in a low inflation environment, demand is suppressed and the private sector is not able to absorb the additional workers. Comparing the two instruments, cuts in public hiring increase unemployment persistently in this environment, while wage cuts reduce it. Regions with higher mobility of labour between the two sectors are able to consolidate more effectively. Price flexibility is also key at the zero lower bound: for a higher degree of price rigidity in the Periphery, consolidation becomes harder to achieve. Consolidations can be self-defeating when the public good is productive, or a complement to private consumption.
    Keywords: Fiscal consolidation; public wage bill; zero lower bound
    JEL: E32 E62
    Date: 2016–11–11
  33. By: Fran çois Langot (University of Le Mans (GAINS-TEPP & IRA), Paris School of Economics, CEPREMAP and IZA.); Shaimaa Yassin (University of Neuchâtel (IRENE), University of Paris 1 Panthéon-Sorbonne (CES and Paris School of Economics) and University of Le Mans (GAINS-TEPP).)
    Abstract: This paper proposes an equilibrium matching labor market model for developing countries where the interaction between public, formal and informal sectors is considered. Theoretical analysis shows that labor markets' liberalization reforms can be evicted by shifts in public employment. Since the public sector accounts for a substantial share of employment in developing countries, this approach is crucial to understand their labor market outcomes. Wage offers to public sector employees increase the outside option value of workers during their bargaining processes in the formal and informal sectors. It becomes more profitable for workers to search on-the-job to access more attractive and stable jobs. The public sector therefore acts as an additional tax imposed on private firms. Using workers flows data from Egypt, we show that labor markets' liberalization plays against informal employment by increasing formal jobs' profitability, but is evicted by the increase of public sector wages observed at the same time.
    Keywords: Job search, Informality, Public Sector, Egypt, Unemployment, Wages, Policy Interventions.
    JEL: E24 E26 J60 J64 O17
    Date: 2016–11
  34. By: Pedro Teles (Banco de Portugal, Universidade Catolica); Juan Nicolini (Federal Reserve Bank of Minneapolis)
    Abstract: Should capital income taxes be zero in the long run, as argued by Chamley (1986) and Judd (1985)? Or should instead capital be heavily taxed as suggested by Straub and Werning (2015)? We revisit the Ramsey literature on the optimal taxation of capital and make again the case for a low, possibly zero, tax on capital income.
    Date: 2016
  35. By: Raman Uppal (Edhec Business School); Harjoat Bhamra (Imperial College Business School)
    Abstract: A common criticism of behavioral economics is that it has not shown that individual investors' biases lead to aggregate long-run effects on both asset prices and macroeconomic quantities. Our objective is to address this criticism in a production economy where individual portfolio biases cancel when summed across investors, but still have an effect on aggregate quantities in the long-run. We solve in closed form a model of a stochastic general-equilibrium production economy with a large number of heterogeneous firms and investors. Investors are ambiguity averse, so they hold portfolios biased toward familiar assets. We specify this bias to be unsystematic - it cancels out when aggregated across investors. However, each investor bears more risk than necessary, which distorts the consumption of all investors in the same direction. Hence, distortions in consumption do not cancel out in aggregate and increasing the price of risk and distorting aggregate investment and growth. The increased risk from holding biased portfolios, which increases the demand for the risk-free asset, leading to a higher equity risk premium and lower risk-free rate that match empirical values. Our analysis illustrates that idiosyncratic behavioral biases can have long-run distortionary effects on both financial markets and the macroeconomy
    Date: 2016
  36. By: Maurizio Iacopetta (OFCE/Sciences Po and SKEMA Business School)
    Abstract: A society can reap more benefits generated by an improvement in communication and transportation when the gap between privileged and less-privileged individuals is small. This hypothesis is investigated in a Kiyotaki-Wright search environment where people enjoy different rental positions. Historical evidence about the rise of Italian seaport cities during the Middle Ages, of the Netherlands in the 17th century, and about the French nobility's resistance to trade during the pre-revolutionary period is used to support the hypothesis.
    Date: 2016

This nep-dge issue is ©2016 by Christian Zimmermann. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.