nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2016‒12‒18
39 papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. The Inverted Leading Indicator Property and Redistribution Effect of the Interest Rate By Pintus, Patrick A.; Wen, Yi; Xing, Xiaochuan
  2. Hiring and Investment Frictions as Inflation Determinants By Leonardo Melosi; Eran Yashiv; Renato Faccini
  3. Labor Market Frictions and Monetary Policy Design By Anna Almosova;
  4. Macroeconomic Fluctuations with HANK & SAM: An Analytical Approach By Ravn, Morten O; Sterk, Vincent
  5. Equilibrium foreign currency mortgages By Marcin Kolasa
  6. Sectoral Reallocation, Employment and Earnings Over the Business Cycle By Ludo Visschers; David Wiczer; Carlos Carrillo-Tudela
  7. Can indeterminacy and self-fulfilling expectations help explain international business cycles? By Stephen McKnight; Laura Povoledo
  8. Capital Controls and Competitiveness By Fabrizio Perri; Jonathan Heathcote
  9. Testing part of a DSGE model by Indirect Inference By Minford, Patrick; Wickens, Michael; Xu, Yongdeng
  10. Capital Flows, Beliefs, and Capital Controls By Rarytska, Olena; Tsyrennikov, Viktor
  11. An Anatomy of the Business Cycle By Harris Dellas; Fabrice Collard; George-Marios Angeletos
  12. The Opportunity Cost(s) of Employment and Search Intensity By Robert Lester; Julio Garin
  13. Putting the Cycle Back into Business Cycle Analysis By Beaudry, Paul; Galizia, Dana; Portier, Franck
  14. A note on news about the future: the impact on DSGE models and their VAR representation By Le, Vo Phuong Mai; Meenagh, David; Minford, Patrick
  15. Monetary Policy, Inflation, and Inequality: The Case for Helicopters By Xavier Ragot; Florin O. Bilbiie
  16. Inflation, Debt, and Default By Illenin Kondo; Fabrizio Perri; Sewon Hur
  17. Does foreign sector help forecast domestic variables in DSGE models? By Marcin Kolasa; Michal Rubaszek
  18. When you need it or when I die? Timing of monetary transfers from parents to children By Giacomo Pasini; Rob Alessie; Adriaan Kalwij
  19. Business Cycle Accounting: Bulgaria after the Introduction of the Currency Board Arrangement (1999-2014) By Aleksandar Vasilev
  20. Monetary Policy and Durable Goods By Barsky, Robert; Boehm, Christoph E.; House, Christopher L.; Kimball, Miles
  21. Online Appendix to "Debt-Market Friction, Firm-specific Knowledge Capital Accumulation and Macroeconomic Implications" By Yicheng Wang
  22. Adaptive learning and labour market dynamics By Di Pace, Frederico; Mitra, Kaushik; Zhang, Shoujian
  23. Identifying ambiguity shocks in business cycle models using survey data By Jaroslav Borovicka
  24. Monetary Policy Rules and the Equity Premium By Anastasia Zervou
  25. Financial Fragility in Monetary Economies By Fernando Martin; Aleksander Berentsen; David Andolfatto
  26. 'Institutional Mandates for Macroeconomic and Financial Stability' By Pierre-Richard Agénor; Alessandro Flamini
  27. A Contagious Malady? Open Economy Dimensions of Secular Stagnation By Gauti Eggertsson; Neil Mehrotra; Sanjay Singh; Lawrence Summers
  28. National Income Accounting When Firms Insure Workers By Mindy X. Zhang; Hanno Lustig; Barney Hartman-Glaser
  29. Liquidity and Risk Management: Coordinating Investment and Compensation Policies By Patrick Bolton; Neng Wang; Jinqiang Yang
  30. Credit, Money, Interest, and Prices By Yuliy Sannikov; Saki Bigio
  31. A Bellman approach to periodic optimization problems By Kvamsdal, Sturla F.; Maroto, José M.; Morán, Manuel; Sandal, Leif K.
  32. Welfare Gains from Reducing the Implementation Delays in Public Investment By Huseyin Murat Ozbilgin
  33. The Effects of Monetary Policy and Other Announcements By Chao Gu; Han Han; Randall Wright
  34. Fiscal Discipline and Defaults By Gonzalo F. de-Córdoba; Pau S. Pujolas; José L. Torres
  35. Population growth, saving, interest rates and stagnation By Peter Spahn
  36. Trend Inflation and Exchange Rate Dynamics : A New Keynesian Approach By KANO, Takashi
  37. Inter-generational transfers and precautionary saving By Mi Luo; Matthew Shapiro; Joseph Briggs; Chris Tonetti; Andrew Caplin; John Ameriks
  38. Speculative Trade under Ambiguity By Jan Werner
  39. The Twilight of the American Dream? How Inequality and Segregation Are Shaping Social Mobility in the U.S. By Alessandra Fogli

  1. By: Pintus, Patrick A. (Banque de France); Wen, Yi (Federal Reserve Bank of St. Louis); Xing, Xiaochuan (Yale University)
    Abstract: The interest rate at which US firms borrow funds has two features: (i) it moves in a countercyclical fashion and (ii) it is an inverted leading indicator of real economic activity: low interest rates today forecast future booms in GDP, consumption, investment, and employment. We show that a Kiyotaki-Moore model accounts for both properties when interest-rate movements are driven, in a significant way, by self-fulfilling shocks that redistribute income away from lenders and to borrowers during booms. The credit-based nature of such self-fulfilling equilibria is shown to be essential: the dynamic correlation between current loanable funds rate and future aggregate economic activity depends critically on the property that the interest rate is state-contingent. Bayesian estimation of our benchmark DSGE model on US data shows that the model driven by redistribution shocks results in a better fit to the data than both standard RBC models and Kiyotaki-Moore type models with unique equilibrium.
    Keywords: Endogenous Collateral Constraints; State-Contingent Loan Repayment; Redistribution Shocks; Multiple Equilibria.
    JEL: E21 E22 E32 E44 E63
    Date: 2016–11–30
  2. By: Leonardo Melosi (Federal Reserve Bank of Chicago); Eran Yashiv (Tel Aviv University); Renato Faccini (Queen Mary, University of London)
    Abstract: We embed convex hiring and investment frictions in a New Keynesian DSGE model with intra-firm wage bargaining. We show that these frictions have crucial implications for the response of marginal costs, and consequently inflation; and for the co-movement of inflation with real variables. We elucidate how the presence of hiring and investment frictions affects the transmission mechanism of monetary and technological shocks by means of impulse responses. We find that hiring frictions are a key determinant of current period marginal costs; investment frictions also matter, by affecting expectations of future marginal costs. Estimating the model with private-sector US data shows that both hiring frictions and investment frictions help explain inflation dynamics. Smoothed estimates of marginal costs are radically different in models with and without hiring frictions. Our results indicate that hiring frictions explain around 50% of the variation in marginal costs, the real wage component explains around 35% while the remain 15% is accounted for by an intrafirm bargaining component. These estimates rely only on moderate levels of the relevant frictions.
    Date: 2016
  3. By: Anna Almosova;
    Abstract: This paper estimates a New Keynesian DSGE model with search frictions and monetary rules augmented with di erent labor market indicators. In accordance with a theoretical literature I nd that a central bank reacts to a labor market tightness, employment or unemployment. Posterior odds tests speak in favor of models with augmented Taylor rules versus a model with a model with a standard rule. The augmented rules were also shown to be more ecient in terms of welfare.
    JEL: E52 E24 C11
    Date: 2016–12
  4. By: Ravn, Morten O; Sterk, Vincent
    Abstract: New Keynesian models with unemployment and incomplete markets are rapidly becoming a new workhorse model in macroeconomics. Such models typically require heavy computational methods which may obscure intuition and overlook equilibria. We present a tractable version which can be characterized analytically. Our results highlight that - due to the interaction between incomplete markets, sticky prices and endogenous unemployment risk - productivity shocks may have radically different effects than in traditional NK models, that the Taylor principle may fail, and that pessimistic beliefs may be self-fulfilling and move the economy into temporary episodes of low demand and high unemployment, as well as into a long-lasting "unemployment trap". At the Zero Lower Bound, the presence of endogenous unemployment risk can create inflation and overturn paradoxical properties of the model. We further study financial asset prices and show that non-negligible risk premia emerge.
    Keywords: incomplete asset markets; matching frictions; multiple equilibria; sticky prices
    JEL: E10 E21 E24 E30 E52
    Date: 2016–12
  5. By: Marcin Kolasa
    Abstract: This paper proposes a novel explanation for why foreign currency denominated loans to households have become so popular in some emerging economies. Our argument is based on what we call the debt limit channel, which arises when multi-period contracts are offered to financially constrained borrowers against collateral that is established on newly acquired assets. Whenever the difference between domestic and foreign interest rates is positive, this channel biases borrowers' choices towards foreign currency, even if the exchange rate is known to depreciate as implied by the interest parity condition. We next use a small open economy DSGE model to analyze how the debt limit channel affects agents' choices under uncertainty. The model implies that, if first-order effects related to the debt limit channel are neutralized by appropriate adjustment in debt contracts, the equilibrium share of foreign currency loans is small.
    Keywords: foreign currency loans, mortgages, portfolio choice, general equilibrium models
    JEL: D58 E32 E44 F41 G11 G21
    Date: 2016–12
  6. By: Ludo Visschers (The University of Edinburgh/Universidad); David Wiczer (FRB St. Louis); Carlos Carrillo-Tudela (Essex)
    Abstract: Recessions change job flows, increasing unemployment risk, reducing job-finding rates, and occupational switching rates among those still changing jobs. This article connects these cyclical differences in job flows to differences in the earnings change distribution across the cycle. The connection is natural because earnings change much larger when a worker experiences a job change and even larger when switching occupation. First, we present a statistical analysis of the contribution from (a) the change in the incidence of occupation and job change and (b) the change in the ``return'' to these changes. Then, because job and occupation switching is endogenous we look through the lens of a business cycle model with on-the-job search and occupational mobility.
    Date: 2016
  7. By: Stephen McKnight (El Colegio de Mexico); Laura Povoledo (El Colegio de Mexico)
    Abstract: We introduce equilibrium indeterminacy into a two-country incomplete asset model with imperfect competition and analyze whether self-fulfilling, belief-driven fluctuations (i.e., sunspot shocks) can help resolve the major puzzles of international business cycles. In contrast to the one-good models of the existing literature, we show that sunspot shocks alone cannot replicate the data. Next, we consider a combination of sunspot shocks and technology shocks, and find that the indeterminacy model can now account for the counter-cyclical behavior observed for the terms of trade and real net exports, while simultaneously increasing their volatilities relative to output. The empirical success of the model is due to an unconventional transmission mechanism, whereby the terms of trade appreciates, rather than depreciates, in response to a positive technology shock. This unconventional feature, when combined with sunspot shocks, helps to reconcile the model with the data. However, the major failure of the model is its inability to resolve the Backus-Smith puzzle without a strongly negative cross-country correlation for productivity shocks.
    Keywords: indeterminacy, sunspots, international business cycles, net exports, terms of trade, Backus-Smith puzzle.
    JEL: E32 F41 F44
    Date: 2016–09
  8. By: Fabrizio Perri (Federal Reserve Bank of Minneapolis); Jonathan Heathcote (Federal Reserve Bank of Minneapolis)
    Abstract: When capital flows were liberalized within the European Union in the 1980s capital flowed into Southern Europe. But rather than stimulating investment and labor productivity, these capital flows were associated with rapid growth of the non-tradable sector, rising prices of non-tradable goods, a perceived loss of competitiveness in the tradable sector, and rising unemployment. We develop a model to interpret these trends, and to investigate their welfare consequences. A key departure from standard theory is that output is produced in two sectors: a tradable sector, and a non-tradable sector. Both sectors use two non-reproducible factors, one whose price is fully flexible (land) and another (unionized labor) whose price is downwardly rigid. The tradable sector is relatively intensive in the fixed-price factor. A relaxation of constraints on international borrowing leads to an increase in consumption of tradable goods. As a result, demand for non-traded goods also rises, and factors of production migrate to the non-traded sector. This bids up the price of the flex price factor – there is a real estate boom. Domestic firms cannot raise the price of traded output, and their workers will not accept lower wages. They are therefore forced to shrink in scale, and aggregate unemployment rises.
    Date: 2016
  9. By: Minford, Patrick (Cardiff Business School); Wickens, Michael (Cardiff Business School); Xu, Yongdeng (Cardiff Business School)
    Abstract: We propose a new type of test. Its aim is to test subsets of the structural equations of a DSGE model. The test draws on the statistical inference for limited information models and the use of indirect inference to test DSGE models. Using Monte Carlo experiments on two subsets of equations of the Smets-Wouters model we show that the model has accurate size and good power in small samples. In a test of the Smets-Wouters model on US Great Moderation data we reject the speci…cation of the wage-price but not the expenditure sector, pointing to the …first as the source of overall model rejection.
    Keywords: sub sectors of models, limited information, indirect inference, testing DSGE models equations, Monte Carlo, power, test size
    JEL: C12 C32 C52 E1
    Date: 2016–12
  10. By: Rarytska, Olena; Tsyrennikov, Viktor
    Abstract: Belief heterogeneity generates speculative cross-border capital flows that are much larger than flows generated by the hedging/insurance motives. We show theoretically that limiting financial trades may gen- erate welfare gains despite inhibiting insurance possibilities. Financial constraints tame speculation forces, limit movements of the net for- eign wealth positions, and thus reduce consumption volatility. This provides a novel justification for capital controls. Simulations indicate that welfare gains from imposing capital con- trols can be substantial, equivalent to a permanent consumption in- crease of up to 4%, or 80 times the cost of business cycles. Controls that activate only during substantial inflows or outflows are preferred to those constantly active, e.g. a transaction tax used by some emerg- ing market economies. Yet, despite improving macroeconomic stability capital controls may unintentionally lead to increased volatility in the domestic financial markets.
    Keywords: international portfolios, capital controls, foreign ex- change intervention, International Relations/Trade, F32,
    Date: 2016–04
  11. By: Harris Dellas (University of Bern); Fabrice Collard (University of Bern); George-Marios Angeletos (M.I.T.)
    Abstract: We develop a new method for dissecting the comovements of macroeconomic variables over the business cycle. We use this to show that the data is consistent with models in which the forces (i.e., shocks and propagation mechanisms) that drive the fluctuations in output, investment, hours, and unemployment are strongly connected with one another, while also being relatively disconnected from those that drive the fluctuations in productivity, inflation, and interest rates. We document a similar disconnect between inflation and the labor share. We explain why these findings are at odds with existing macroeconomic models of either the RBC or the NK variety, and discuss how they provide guidance for future theoretical research.
    Date: 2016
  12. By: Robert Lester (Colby College); Julio Garin (University of Georgia)
    Abstract: The flow utility of unemployment plays a crucial role in labor search and matching models. Recent evidence by Chodorow-Reich and Karabarbounis (Forthcoming) suggests that the flow utility is high on average, volatile, and strongly procyclical. Taken together, these facts imply that labor search and matching models perform worse than prevailing conventional wisdom. In contrast, we build a model where unemployed workers choose between home production and job search. Procyclical job search implies that the effective unemployment benefit is countercyclical. Our results suggest that omitting endogenous search will upwardly bias the measured correlation between effective unemployment benefits and productivity.
    Date: 2016
  13. By: Beaudry, Paul; Galizia, Dana; Portier, Franck
    Abstract: This paper begins by re-examining the spectral properties of several cyclically sensitive variables such as hours worked, unemployment and capacity utilization. For each of these series, we document the presence of an important peak in the spectral density at a periodicity of approximately 36-40 quarters. We take this pattern as suggestive of intriguing but little-studied cyclical phenomena at the long end of the business cycle, and we ask how best to explain it. In particular, we explore whether such patterns may reflect slow-moving limit cycle forces, wherein booms sow the seeds of the subsequent busts. To this end, we present a general class of models, featuring local complementarities, that can give rise to unique-equilibrium behavior characterized by stochastic limit cycles. We then use the framework to extend a New Keynesian-type model in a manner aimed at capturing the notion of an accumulation-liquidation cycle. We estimate the model by indirect inference and find that the cyclical properties identified in the data can be well explained by stochastic limit cycles forces, where the exogenous disturbances to the system are very short lived. This contrasts with results from most other macroeconomic models, which typically require very persistent shocks in order to explain macroeconomic fluctuations.
    Keywords: Business Cycle, Limit Cycle
    JEL: E24 E3 E32
    Date: 2016–11
  14. By: Le, Vo Phuong Mai (Cardiff Business School); Meenagh, David (Cardiff Business School); Minford, Patrick (Cardiff Business School)
    Abstract: In this paper we investigate the role of news shocks in aggregate fluctuations by comparing the empirical performance of models with and without the feature of the news shocks. We found a trivial difference between the two models. That is, the model with news shocks explains the variation as well as the alternative. The reason is that the news shocks can only advance the date at which agents know about the changes, but they do not change the stochastic structure of the model.
    Keywords: News shocks; DSGE; VAR; Indirect Inference
    JEL: E2 E3
    Date: 2016–11
  15. By: Xavier Ragot (Paris School of Economics); Florin O. Bilbiie (Paris School of Economics)
    Abstract: We put together a model where heterogenous households hold money because they particpate infrequently in financial markets, while firms face nominal frictions, as in the New Keynesian literature. We build a tractable framework whereby we characterize analytically the effect of money injections on inflation, economic activity, and inequality. Our framework gives rise, inter alia, to endogenous persistence in response to transitory shocks. Monetary policy is intimately linked to inequality as the nominal interest rate is a relevant price for holding money for self-insurance reasons.
    Date: 2016
  16. By: Illenin Kondo (Federal Reserve Board); Fabrizio Perri (Federal Reserve Bank of Minneapolis); Sewon Hur (University of Pittsburgh)
    Abstract: We show that the co-movement of inflation and domestic consumption growth affects both the pricing and the dynamics of nominal domestic debt. In particular a positive co-movement of inflation and consumption makes returns on government bonds negatively correlated with domestic consumption: this lowers risk premia on nominal domestic debt as seen in the data. However, as this co-movement increases, the debt becomes more risky for the government and reduces its incentives to accumulate debt. We find that debt accumulation is overall stronger the higher the co-movement of inflation and consumption. To assess these joint equilibrium properties of debt and interest rates, we calibrate a simple model of domestic default and nominal debt in the presence of exogenous inflation risk and domestic risk averse agents. Consistent with the data, the model also reveals that increased co-movement of inflation and consumption leads to more volatile interest rates.
    Date: 2016
  17. By: Marcin Kolasa; Michal Rubaszek
    Abstract: This paper evaluates the forecasting performance of several small open economy DSGE models relative to a closed economy benchmark using a long span of data for Australia, Canada and the United Kingdom. We find that opening the economy does not improve, and even deteriorates the quality of point and density forecasts for key domestic variables. We show that this result can be to a large extent attributed to an increase in forecast error due to a more sophisticated structure of the extended setup. This claim is based on a Monte Carlo experiment, in which an open economy model fails to consistently beat its closed economy benchmark even if it is the true data generating process.
    Keywords: Forecasting, DSGE models, New Open Economy Macroeconomics, Bayesian estimation
    JEL: D58 E17 F41 F47
    Date: 2016–11
  18. By: Giacomo Pasini (Department of Economics, University Of Venice Cà Foscari); Rob Alessie (University of Groningen Faculty of Economics and Business); Adriaan Kalwij (; School of Economics Universiteit Utrecht)
    Abstract: This paper investigates the timing of wealth transfers between generations. We develop an overlapping generations model in which each generation can borrow against its future income but not against expected bequest. As a result, generations relatively poorer than their parents may end up not smoothing consumption. We prove that if wealth transfers can take place earlier in life, then each generation smooths consumption despite the constraint on borrowing and the first best solution is restored. The model implies that parents transfer resources when the children are credit constrained. This implication is tested using Dutch survey data on households' intentions to make intervivos transfers matched with administrative data that allow to construct a measure of the probability of being in need of a transfer. All in all, the paper highlights the importance of intervivos transfers as a device that households can resort to in order to mitigate inter-generational wealth inequalities.
    Keywords: intervivos transfers, credit constraints, overlapping generations
    JEL: D12 D13 D91
    Date: 2016
  19. By: Aleksandar Vasilev (Department of Economics, American University in Bulgaria)
    Abstract: This paper focuses on explaining the economic uctuations in Bulgaria after the introduction of the currency board arrangement in 1997, the period of macroeconomic stability that ensued, the EU accession, and the episode of the recent global financial crisis. This paper follows Chari et al. (2002) and performs business cycle accounting (BCA) for Bulgaria during the period 1999-2014. As in Cavalcanti (2007), who studies the Portuguese business cycles, most of the volatility in output per capita in Bulgaria over the period is due to variations in the eciency and labor wedges.
    Keywords: Business Cycle accounting; Bulgarian economy; eciency and labor wedges
    JEL: E32 E37 O47
    Date: 2016–11
  20. By: Barsky, Robert (Federal Reserve Bank of Chicago); Boehm, Christoph E. (University of Michigan); House, Christopher L. (University of Michigan); Kimball, Miles (University of Michigan)
    Abstract: We analyze monetary policy in a New Keynesian model with durable and nondurable goods each with a separate degree of price rigidity. The model behavior is governed by two New Keynesian Phillips Curves. If durable goods are sufficiently long-lived we obtain an intriguing variant of the well-known “divine coincidence.” In our model, the output gap depends only on inflation in the durable goods sector. We then analyze the optimal Taylor rule for this economy. If the monetary authority wants to stabilize the aggregate output gap, it places much more emphasis on stabilizing durable goods inflation (relative to its share of value-added in the economy). In contrast, if the monetary authority values stabilizing aggregate inflation, then it is optimal to respond to sectoral inflation in direct proportion to their shares of economic activity. Our results flow from the inherently high interest elasticity of demand for durable goods. We use numerical methods to verify the robustness of our analytical results for a broader class of model parameterizations.
    Keywords: Taylor rule; inflation targeting; economic stabilization
    JEL: E31 E32 E52
    Date: 2016–11–06
  21. By: Yicheng Wang (University of Oslo)
    Abstract: Online appendix for the Review of Economic Dynamics article
    Date: 2016
  22. By: Di Pace, Frederico (Bank of England); Mitra, Kaushik (University of Birmingham); Zhang, Shoujian (Addiko Bank)
    Abstract: The standard search and matching model with rational expectations is well known to be unable to generate amplification in unemployment and vacancies. We document a new feature it is unable to replicate: properties of survey forecasts of unemployment in the near term. We present a parsimonious model with adaptive learning and simple autoregressive forecasting rules which provide a solution to both of these problems. Firms choose vacancies by forecasting wages using simple autoregressive models; they have greater incentive to post vacancies at the time of a positive productivity shock because of overoptimism about the discounted value of expected profits.
    Keywords: Adaptive learning; bounded-rationality; search and matching frictions
    JEL: E24 E32 J64
    Date: 2016–12–09
  23. By: Jaroslav Borovicka (New York University)
    Abstract: We develop a macroeconomic framework with agents facing time-varying concerns for model misspecification. These concerns lead agents to interpret the economy through the lens of a pessimistically biased `worst-case' model. We use survey data to identify exogenous fluctuations in the worst-case model. In an estimated New-Keynesian business cycle model with frictional labor markets, these ambiguity shocks explain a substantial portion of the variation in labor market quantities.
    Date: 2016
  24. By: Anastasia Zervou (Texas A&M University)
    Abstract: We study the effect of monetary policy on the equity premium using a segmented stock market model. Optimal monetary policy in our model involves risk-sharing and is countercyclical with respect to dividend shocks; thus, it implies low equity return compared to other policies, including inflation targeting. The optimal policy, however, does not guarantee inflation stability and produces higher nominal bond return compared to inflation targeting. Our calibration exercise finds equity premium of 7% under the inflation targeting policy and 1.5% under the optimal policy. We suggest that suboptimal policies focusing on inflation stability might result in high equity premia.
    Date: 2016
  25. By: Fernando Martin (Federal Reserve Bank of St. Louis); Aleksander Berentsen (University of Basel); David Andolfatto (Federal Reserve Bank of St. Louis)
    Abstract: We integrate the Diamond and Dybvig (1983) theory of financial fragility with the Lagos and Wright (2005) model of monetary exchange. Non-bank monetary economies with well-functioning secondary markets for capital can allocate risk reasonably well, but are never efficient. When secondary markets are subject to ``market freeze'' events, risk-sharing deteriorates accordingly. A fractional-reserve bank can dominate a monetary economy because: (i) it provides superior risk-sharing even when market freeze events are absent; and (ii) it bypasses the need for a secondary capital market to begin with. Indeed, fractional reserve banks can implement the optimal allocation when monetary policy follows the Friedman rule. However, the desirability of fractional reserve banking is diminished if the structure is subject to ``bank runs''. In the event of a run, an open secondary market allows banks to liquidate capital at a price that permits honoring all deposit obligations. If bank runs are expected to occur with a sufficiently high probability, then a narrow banking structure may be preferred. Narrow banks are more stable, but offer less risk-sharing. We find that high inflation economies penalize narrow banking systems relatively more than fractional reserve systems. Special interests are not generally aligned over the choice of bank regime.
    Date: 2016
  26. By: Pierre-Richard Agénor; Alessandro Flamini
    Abstract: The performance of alternative institutional policy mandates for achieving macroeconomic and financial stability is studied in a model with financial frictions. These mandates involve goal-integrated, goal-distinct, and common-goal mandates for the monetary authority and the financial regulator. In the first case both monetary and macroprudential policies are set optimally, but in the last two cases monetary policy only is set optimally whereas macroprudential policy is implemented through a simple, credit-based reserve requirement rule. The model is parameterized and used to simulate responses to a financial shock. The analysis shows that it is optimal to use both the policy rate and the required reserve ratio only under the goal-integrated mandate. In addition, it is optimal to delegate the financial stability goal solely to the monetary authority when the financial regulator is only equipped with a credit-based reserve rule. The key reason is that only the integrated mandate can fully internalize the policy spillovers which adversely affect economic stability..
    Date: 2016
  27. By: Gauti Eggertsson (Brown University); Neil Mehrotra (Brown University); Sanjay Singh (Brown University); Lawrence Summers (Harvard University)
    Abstract: We propose an open economy model of secular stagnation and show how it can be transmitted from one country to another via current account imbalances. While current account surpluses normally lower interest rates in the recipient country, in a secular stagnation, surpluses transmit recessions due to the zero lower bound on nominal interest rates. In general monetary policies and those directed at competitiveness have negative externalities on trading partners in these circumstances, while fiscal policies and those directed at stimulating domestic demand have positive externalities. This, in a positive sense, explains why the world has relied so much on monetary policies relative to fiscal policies in the wake of the financial crisis and in a normative sense points towards the desirability of fiscal policies. Fiscal policies in response to a secular stagnation are self-financing as in De Long and Summers (2012) in our numerical experiments and a one shot increase in debt will raise demand and is fiscally sustainable. While expansionary monetary policy only provides for a possibility of a better outcome without ex- cluding the possibility of continuing secular stagnation appropriate fiscal policy eliminates secular stagnation by directly raising the natural rate of interest as in Eggertsson-Mehrotra (2014).
    Date: 2016
  28. By: Mindy X. Zhang (University of Texas at Austin); Hanno Lustig (Stanford GSB); Barney Hartman-Glaser (University of California at Los Angeles)
    Abstract: We analyze national income accounting in an equilibrium model of industry dynamics with long-term contracts between risk-averse workers and heterogeneous firms. In our model, firms insure workers against firm-specific productivity shocks. We use this model as a laboratory for analyzing the impact of firm-level risk on the stationary distribution of rents. An increase in firm-level risk always increases the aggregate capital share in the economy, but may lower the average firm's capital share. Because of selection, the aggregate capital share reported in national income accounts produces a biased estimate of ex ante profitability of firms which determines compensation. Workers effectively pay a larger insurance premium to the owners of capital.
    Date: 2016
  29. By: Patrick Bolton (Columbia University); Neng Wang (Columbia Business School); Jinqiang Yang (School of Finance, Shanghai University of Finance and Economics)
    Abstract: We formulate a dynamic financial contracting problem with risky inalienable human capital. We show that the inalienability of the entrepreneur’s risky human capital not only gives rise to endogenous liquidity limits but also calls for dynamic liquidity and risk management policies via standard securities that firms routinely pursue in practice, such as retained earnings, possible line of credit draw-downs, and hedging via futures and insurance contracts.
    Date: 2016
  30. By: Yuliy Sannikov (Princeton University); Saki Bigio (UCLA)
    Abstract: We develop a monetary theory where monetary policy operates exclusively through the bank-lending channel. Credit demand and deposit creation are dynamically linked. Policy tools affect lending through the provision of reserves and their influence on interbank market rates. A credit crunch causes debt-deflation episode that sends agents to their borrowing constraints. Unemployment increases because firms reduce utilization to avoid the risk of violating borrowing limits. Standard monetary policy has power only if credit is extended. We study the cross-section and aggregate dynamics of credit, monetary aggregates, nominal interest, and prices after several policy experiments.
    Date: 2016
  31. By: Kvamsdal, Sturla F. (SNF – Centre for Applied Research); Maroto, José M. (Dept. of Statistics and Operations Research II, Complutense University of Madrid); Morán, Manuel (Dept. of Foundation of Economic Analysis I, Complutense University of Madrid); Sandal, Leif K. (Dept. of Business and Management Science, Norwegian School of Economics)
    Abstract: We consider an infinite horizon optimization problem with arbitrary but finite periodicity in discrete time. The problem can be formulated as a fix-point problem for a contraction operator, and we provide a solution scheme for this class of problems. Our approach is an extension of the classical Bellman problem to the special case of non-autonomy that periodicity represents. Solving such problems paves the way for consistent and rigorous treatment of, for example, seasonality in discrete dynamic optimization. In an illustrative example, we consider the decision problem in a fishery with seasonal fluctuations. The example demonstrates that rigorous treatment of periodicity has profound influence on the optimal policy dynamics compared to the case where seasonality is abstracted from by considering average effects only.
    Keywords: Bellman; optimization; periodicity; contraction operator; solution scheme
    JEL: C61 Q22 Q57
    Date: 2016–11–30
  32. By: Huseyin Murat Ozbilgin
    Abstract: This paper studies the welfare impact of a reform that reduces the completion duration of public capital. For a sample of emerging economies, I inspect the welfare gains from shortening the completion time from 10 to 3 years by tailoring a parsimonious general equilibrium model. My analysis reveals sizable gains from the reform. For the mean emerging country in the sample, the reform brings about 1.53 percent benefits in terms of compensating variation in consumption. Rising social demand for public investment under a shorter implementation duration moves the economy towards a higher public capital to output ratio, which leads to higher levels of private investment and consumption, bringing notable welfare gains. Most of the gains accrue within 15 years after the reform. For certain countries, such as Thailand, Romania, Russia, and India, the gains emerge as remarkably large, whereas for another group that includes Serbia, Bulgaria, Phillippines, and Argentina, the gains turn out to be modest.
    Keywords: Public investment, Time-to-Build, Externalities, Welfare
    JEL: E22 E62 H30 H54
    Date: 2016
  33. By: Chao Gu; Han Han (School of Economics, Peking University); Randall Wright (FRB Chicago, FRB Minneapolis, University of Wisconsin and NBER)
    Abstract: We analyze the impact of news (information shocks) in economies where liquidity plays a role. While we also consider news about real factors, like productivity, one motivation is that central bank announcements evidently affect markets, as taken for granted by advocates of forward guidance policy. The dynamic effects can be complicated, with information about monetary policy or real factors affecting markets for goods, equity, housing, credit and foreign exchange. Even news about neutral policy can induce cyclic or boom-bust responses. More generally, we show that central bank announcements can induce rather than reduce volatility, and might increase or decrease welfare.
    Keywords: Announcements, Monetary Policy, News, Dynamics
    JEL: E30 E44 E52 G14 D53 D83
  34. By: Gonzalo F. de-Córdoba (Departamento de Teoría e Historia Económica, Universidad de Málaga); Pau S. Pujolas (Department of Economics, McMaster University); José L. Torres (Department of Economics, University of Málaga)
    Abstract: We develop a general equilibrium model with a detailed structure of government expenditures and revenues, calibrate it to the Greek and German economies, and use it study the link between scal discipline and defaults. We show that even if the Greek government had entered the Great Recession with the same structure of government expenditures and revenues as Germany, but with the Greek level of debt, it would still have chosen to default when facing a high interest rate. Alternatively, if the Greek government had kept its structure of government expenditures and revenues, but managed to decrease its debt to the level of Germany, it would not have defaulted. The primacy of debt over the structure of government expenditures and revenues in default decisions is further emphasized by our ndings that even if Germany, with a low level of debt, faced the same high interest rate as Greece did, it would still not have defaulted.
    Keywords: Dynamic General Equilibrium Model, Fiscal Policy, Government Expenditure, Government Default
    JEL: H5 H6
    Date: 2016–11
  35. By: Peter Spahn
    Abstract: Post Keynesian stagnation theory argues that slower population growth dampens consumption and investment. A New Keynesian OLG model derives an unemployment equilibrium due to a negative natural rate in a three-generations credit contract framework. Besides deleveraging or rising inequality, also a shrinking population is a triggering factor. In all cases, a saving surplus drives real interest rates down. In other OLG settings however, with bonds as stores of value, slower population growth, on the contrary, causes a lack of saving and thus rising rates. Moreover, the recent fall in market interest rates was brought about by monetary factors.
    Keywords: overlapping generations, zero lower bound, deflation equilibrium, natural versus market interest rates
    JEL: E12 E21 E43 J11
    Date: 2016–03
  36. By: KANO, Takashi
    Abstract: The paper studies exchange rate implications of trend inflation within a two-country New Keynesian (NK) model under incomplete international financial markets. A NK Phillips curve generalized by trend inflation with a positive long-run mean implies an expectational difference equation of inflation with higher-order leads of expected inflation. The resulting two-country inflation differential is smoother, more persistent, and more insensitive to a real exchange rate. General equilibrium then yields (i) a persistent real exchange rate with an autoregressive root close to one, (ii) a hump-shaped impulse response of a real exchange rate with a half-life longer than four years, (iii) a volatile real exchange rate relative to cross-country inflation differential, (iv) an almost perfect co-movement between real and nominal exchange rates. and (v) a sharp rise in the volatility of a real exchange rate from a managed nominal exchange rate regime to a flexible one within an otherwise standard two-country NK model. Trend inflation, therefore, approaches empirical puzzles of exchange rates dynamics.
    Keywords: Real and Nominal Exchange Rates, Trend Inflation, New Keynesian Models
    JEL: E31 E52 F31 F41
    Date: 2016–12
  37. By: Mi Luo (New York University); Matthew Shapiro (University of Michigan); Joseph Briggs (New York University); Chris Tonetti (Stanford GSB); Andrew Caplin (NYU); John Ameriks (The Vanguard Group, Inc.)
    Abstract: This paper examines the effects of inter-generational altruism on late-in-life wealth accumulation. We designed and fielded a new survey to better measure transfers from parents to descendants as part of the Vanguard Research Initiative. New survey features include a carefully designed family inventory, a break-down of transfers into four categories, and a path of past and future expected transfers three years before and after. We also asked Strategic Survey Questions (SSQs) to identify preference parameters related to the desire to insure family risks via transfers. We use these new transfer measurements and SSQs to study the dynamics of parent-to-child giving by estimating a life-cycle consumption-savings model. Agents in our model save for consumption smoothing, uncertain medical and long-term care needs, inter-vivos transfers to cover uncertain family needs, and bequests. We find that there is a large and uncertain family need risk, and parents save in order to help when their descendants most need it, rather than at the end of life. Precautionary saving induced by family risks is quantitatively important in determining elderly wealth levels and inter-generational wealth transmission patterns.
    Date: 2016
  38. By: Jan Werner (University of Minnesota)
    Abstract: Ambiguous beliefs may lead to speculative trade and speculative bubbles. We demonstrate this by showing that the classical Harrison and Kreps (1978) example of speculative trade among agents with heterogeneous beliefs can be replicated with agents having common but ambiguous beliefs. More precisely, we show that the same asset prices and pattern of trade can be obtained in equilibrium with agents' having recursive multiple-prior expected utilities with common set of probabilities. While learning about the true distribution of asset dividends makes speculative bubbles vanish in the long run under heterogeneous beliefs, it may not do so under common ambiguous beliefs. Ambiguity need not disappear with learning over time, and speculative bubbles may persist forever.
    Date: 2016
  39. By: Alessandra Fogli (Minneapolis Federal Reserve Bank)
    Abstract: In this paper we develop a theory for the twilight of the American dream and explore its economic and social consequences. We model the American dream and its evolution over time as the outcome of a learning model in which individuals form beliefs about the return to human capital investment from the experience of their neighbors. Increasing inequality drives up segregation across communities in the U.S. and reduces interactions among different socioeconomic groups. In turn, less interaction translates into fewer shared success stories. As lower income Americans are increasingly surrounded by poverty and failure, they shy away from the American dream and invest less in their children than higher income parents. This gap widens over time reducing inter-generational mobility and feeding higher levels of inequality in the following generations. To investigate the empirical relevance of our theory, we use a new county-level data set to compare our calibrated model to the time-series and geographic patterns of education.
    Date: 2016

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