nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2017‒01‒01
twenty-one papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Financial Variables in a Policy Rule: Does It Bring Macroeconomic Benefits? By Jan Zacek
  2. International Business Cycle and Financial Intermediation By Tamas Csabafi; Max Gillman; Ruthira Naraidoo
  3. Unemployment and Gross Credit Flows in a New Keynesian Framework By David Florian Hoyle; Johanna L. Francis
  4. Business Cycles, Investment Shocks, and the "Barro-King Curse" By Guido Ascari; Louis Phaneuf
  5. What is the truth about DSGE models? Testing by indirect inference By Meenagh, David; Minford, Patrick; Wickens, Michael; Xu, Yongdeng
  6. Comparing budget repair measures for a small open economy with growing debt By George Kudrna; Chung Tran
  7. Welfare Costs of Inflation and Imperfect Competition in a Monetary Search Model By Benjamín García
  8. Family Job Search and Wealth: The Added Worker Effect Revisited By Garcia-Perez, J. Ignacio; Rendon, Sílvio
  9. The macroeconomic forecasting model of the MNB By László Békési; Csaba Köber; Henrik Kucsera; Tímea Várnai; Balázs Világi
  10. Habits and Leverage By Tano Santos; Pietro Veronesi
  11. A Real-Business-Cycle model with efficiency wages and fiscal policy: the case of Bulgaria By Vasilev, Aleksandar
  12. Dynamic Properties and Pareto Efficiency of Equilibria in OLG Models By Alfredo Medio
  13. Trend inflation and exchange rate dynamics: A New Keynesian approach By Takashi Kano
  14. Online Appendix to "Life in shakles? The quantitative implications of reforming the educational financing system" By Ben Heijdra; Fabian Kindermann; Laurie Reijnders
  15. Efficiency in Search and Matching Models: A Generalized Hosios Condition By Benoît Julien; Sephorah Mangin
  16. Fewer but Better : Sudden Stops, Firm Entry, and Financial Selection By Sina T. Ates; Felipe Saffie
  17. Online Appendix to "Productivity Growth and Labor Reallocation: Latin America versus East Asia" By Murat Ungor
  18. Can Public Spending Boost Private Consumption? By Stylianos Asimakopoulos; Marco Lorusso; Luca Pieroni
  19. Hysteresis and Fiscal Policy By Philipp Engler; Juha Tervala
  20. Fiscal Multipliers, Oil Revenues and Balance Sheet Effects By Martha López
  21. Firing Costs, Misallocation, and Aggregate Productivity By Jose-Maria Da-Rocha; Marina Mendes Tavares; Diego Restuccia

  1. By: Jan Zacek (Institute of Economic Studies, Faculty of Social Sciences, Charles University in Prague, Smetanovo nabrezi 6, 111 01 Prague 1, Czech Republic)
    Abstract: After the recent financial crisis of 2007, a connection between monetary policy and financial stability has started to be thoroughly investigated. One of the particular areas of this research field deals with the role of various financial variables in the monetary policy rules. The main purpose of this research is to find whether direct incorporation of the financial variables in the monetary policy rule can bring macroeconomic benefits in terms of lower volatility of inflation and output. So far, the main emphasis of the research has been placed on the investigation of the augmented Taylor rules in the context of a closed economy. This paper sheds light on the performance of the augmented Taylor rules in a small open economy. For this purpose, a New Keynesian DSGE model with two types of financial frictions is constructed. The model is calibrated for the Czech Republic. This work provides four conclusions. First, incorporation of the financial variables (asset prices and the volume of credit) in the monetary policy rule is beneficial for macroeconomic stabilization in terms of lower implied volatilities of inflation and output. Second, the usefulness of the augmented monetary policy rule is the most apparent in case of the shock originating abroad. Third, there is a strong link between the financial and the real side of an economy. Fourth, if the banking sector experiences a sharp drop in bank capital that brings this sector into decline, activity in the whole economy deteriorates and monetary policy is not able to achieve macroeconomic stability using its conventional tools.
    Keywords: DSGE models, financial imperfections, inflation targeting, monetary policy
    JEL: E31 E43 E52 E58
    Date: 2016–12
  2. By: Tamas Csabafi (Office No. C58, Cardiff Business School, Colum Drive, Cardiff, CF10 3EU, UK); Max Gillman (Office N. 408 SSB, 1 University Boulevard, St. Louis, Missouri 63121, USA); Ruthira Naraidoo (Faculty of Economics and Management Sciences, Department of Economics, University of Pretoria, South Africa)
    Abstract: The world-wide financial crisis of 2007 to 2009 caused bankruptcy and bank failures in the US and many other parts such as Europe. Recent empirical evidence suggests that this simultaneous drop in output was strongest in countries with greater financial ties to the US economy with important cross border deposit and lending. This paper develops a two-country framework to allow for banking structures within an international real business cycle model. The banking structure across countries is modelled using the production approach to financial intermediation. We allow both countries. banks to be able to take deposits both locally and internationally. We analyze the transmission mechanism of both goods and banking sector productivity shocks. We show that goods total factor productivity (TFP) and bank TFP have different effects on the finance premium. Most countries have shown procyclic equity premium over their histories but with evidence that these are countercyclic during the Great Recession especially. The model has the ability to explain the countercyclical movements of credit spreads during major recession and financial crisis when goods TFP also affects banking productivity. This we model as a cross correlation of shocks to replicate the recent events during the crisis period. Importantly, the model can also explain business cycles facts and the countercyclical behaviour of the trade balance.
    Keywords: : International Business Cycles, Financial Intermediation, Credit Spread
    JEL: E13 E32 E44 F41
    Date: 2016–12
  3. By: David Florian Hoyle (Central Reserve Bank of Peru); Johanna L. Francis (Fordham University)
    Abstract: The Great Recession of 2008-09 was characterized by high and prolonged unemployment and a lack of bank lending. In this paper, we account for the depth and persistence of unemployment during and after the crisis by considering the relationship between credit and firm hiring explicitly. We develop a New Keynesian model with nominal rigidities in wages and prices augmented by a banking sector characterized by search and matching frictions with endogenous credit destruction. In response to a financial shock, the model economy produces large and persistent increases in credit destruction, declines in credit creation, and an overall decline in reallocation of credit among banks and firms; total factor productivity declines and unemployment increases. Credit frictions not only amplify the effect of a financial shock by creating variation in the number of firms able to produce but they also increase the persistence of the shocks effects. These findings suggest that credit frictions combined with nominal rigidities are a plausible amplification mechanism for the impact of financial shocks and provide a mechanism for such shocks to have strong and persistent effects on the labor market.
    Keywords: Unemployment, financial crises, gross credit flows, productivity
    JEL: J64 E32 E44 E52
    Date: 2016–12
  4. By: Guido Ascari; Louis Phaneuf
    Abstract: Recent empirical evidence identfi es investment shocks as key driving forces behind business cycle fluctuations. However, existing New Keynesian models emphasizing these shocks counterfactually imply a negative unconditional correlation between consumption growth and investment growth, a weak positive unconditional correlation between consumption growth and output growth and anomalous profi les of cross-correlations involving consumption growth. These anomalies arise because of a short-run contractionary eff ect a positive investment shock on consumption. Such counterfactual co-movements are typical of the "Barro-King curse" (Barro and King 1984), wherein models with a real business cycle core must rely on technology shocks to account for the observed co-movement among output, consumption, investment, and hours. We show that two realistic additions to an otherwise standard medium scale New Keynesian model - namely, roundabout production and real per capita output growth stemming from trend growth in neutral and investment-specifi c technologies - can break the Barro-King curse and provide a more accurate account of unconditional business cycle comovements more generally. These two features substantially magnify the eff ects of neutral technology and investment shocks on aggregate fluctuations and generate a rise of consumption on impact of a positive investment shock.
    Keywords: Investment shocks, Business cycle comovements, Standard household preferences, Monopolistic competition, Wage and price contracting, Intermediate inputs, Trend output growth, Trend inflation
    JEL: E31 E32
    Date: 2016–12–14
  5. By: Meenagh, David (Cardiff Business School); Minford, Patrick (Cardiff Business School); Wickens, Michael (Cardiff Business School); Xu, Yongdeng (Cardiff Business School)
    Abstract: This paper addresses the growing gulf between traditional macroeconometrics and the increasingly dominant preference among macroeconomists to use DSGE models and to estimate them using Bayesian estimation with strong priors but not to test them as they are likely to fail conventional statistical tests. This is in con‡ict with the high scienti…c ideals with which DSGE models were fi…rst invested in their aim of …nding true models of the macroeconomy. As macro models are in reality only approximate representations of the economy, we argue that a pseudo-true inferential framework should be used to provide a measure of the robustness of DSGE models.
    Keywords: Pseudo-true inference, DSGE models, Indirect Inference; Wald tests, Likelihood Ratio tests; robustness
    JEL: C12 C32 C52 E1
    Date: 2016
  6. By: George Kudrna; Chung Tran
    Abstract: In this study, we quantify the macroeconomic and welfare effects of alternative fiscal consolidation plans in the context of a small open economy. Using a computable overlapping generations model tailored to the Australian economy, we examine immediate and gradual eliminations of the existing fiscal deficit with (i) temporary income tax hikes, (ii) temporary consumption tax hikes and (iii) temporary transfer payment cuts. The simulation results indicate that all three examined fiscal measures result in favourable long-run macroeconomic and welfare outcomes, but have adverse consequences in the short run that are particularly severe under the immediate fiscal consolidation plan. Moreover, our results show that cutting transfer payments leads to the worst welfare outcome for all generations currently alive, and especially the poor. Increasing the consumption tax rate results in smaller welfare losses, but compared to raising income taxes, the current poor households pay much larger welfare costs. Overall, the welfare trade-offs between current and future generations, as well as between the rich and poor, highlight key political constraints and point to challenging policy choices for the wellbeing of future generations.
    Keywords: Fiscal Deficit, Public Debt, Fiscal Consolidation, Welfare, Dynamic General Equilibrium, Small Open Economy
    JEL: C68 E21 E63 H31 H60 J26
    Date: 2016–12
  7. By: Benjamín García
    Abstract: In this paper, I quantitatively measure the welfare costs of inflation. I build into standard moneysearch models, such as Rocheteau and Wright(2005) and Lagos and Wright(2005), by introducing endogenous imperfect competition based on free entry decisions that allow for the share of the transaction surplus going to firms to be determined endogenously. Under this framework, the welfare cost of inflation is amplified through a feedback loop, in which restricted money demand reduces the number of firms that the market can support. In turn, this reduction increases market concentration, reduces the consumer surplus, and further decreases the incentives to hold money. I find that, depending on the calibration, between 63 to 90 percent of the estimated welfare costs of inflation can be attributed to the interaction between money holdings and market concentration.
    Date: 2016–11
  8. By: Garcia-Perez, J. Ignacio (Universidad Pablo de Olavide and FEDEA); Rendon, Sílvio (Federal Reserve Bank of Philadelphia)
    Abstract: We develop and estimate a model of family job search and wealth accumulation. Individuals' job finding and job separations depend on their partners' job turnover and wages as well as common wealth. We fit this model to data from the Survey of Income and Program Participation (SIPP). This dataset reveals a very asymmetric labor market for household members, who share that their job finding is stimulated by their partners' job separation, particularly during economic downturns. We uncover a job search-theoretic basis for this added worker effect and find that this effect is stronger with more children in the household. We also show that excluding wealth and savings from the analysis and estimation leads to underestimating the interdependency between household members. Our analysis shows that the policy goal of supporting job search by increasing unemployment transfers is partially offset by a partner's lower unemployment and wages.
    Keywords: job search; asset accumulation; household economics; consumption; unemployment; estimation of dynamic structural models
    JEL: C33 E21 E24 J64
    Date: 2016–12–13
  9. By: László Békési (Magyar Nemzeti Bank, Central Bank of Hungary); Csaba Köber (OG Research); Henrik Kucsera; Tímea Várnai (Magyar Nemzeti Bank, Central Bank of Hungary); Balázs Világi (Magyar Nemzeti Bank, Central Bank of Hungary)
    Abstract: The lessons of the financial and macroeconomic crisis of 2007-2008 made the development of a new macroeconomic forecas ting model necessary in the MNB. The model represents a small open economy. It is based on the DSGE philosophy but it deviates from it at several points. The new features of the model, compared to previous forecasting models of the MNB, are that the debt constraint and the heterogeneity of households and financial accelerator mechanism through the financing constraints of the firms appear. From methodological point of view, it is important that the model deviates from ra??onal expectation hypothesis at several points and treats expectations pragmatically and flexibly. The model parameters are calibrated according to experts’ experience and SVAR estimations. The properties of the calibrated model are studied by impulse responses analysis, and the model fits into the MNB’s forecasting framework successfully.
    Keywords: DSGE models, forecasting, precautionary motive, buffer stock model, heterogeneous households, financial accelerator, non-rational expectations.
    JEL: E21 E27 E31 E37 E44 E52
    Date: 2016
  10. By: Tano Santos; Pietro Veronesi
    Abstract: Many stylized facts of leverage, trading, and asset prices follow from a frictionless general equilibrium model that features agents’ heterogeneity in endowments and habit preferences. Our model predicts that aggregate debt increases in good times when stock prices are high, return volatility is low, and levered agents enjoy a “consumption boom.” Our model is consistent with poorer agents borrowing more and with recent evidence on intermediaries’ leverage being a priced factor of asset returns. In crisis times, levered agents strongly deleverage by “fire selling” their risky assets as asset prices drop. Yet, consistently with the data, their debt-to-wealth ratios increase because their wealth decline faster due to higher discount rates.
    JEL: E21 E44 G12
    Date: 2016–12
  11. By: Vasilev, Aleksandar
    Abstract: In this paper we investigate the quantitative importance of efficiency wages in explaining fluctuations in Bulgarian labor markets. This is done by augmenting an otherwise standard real business cycle model a la Long and Plosser (1983) with unobservable workers effort by employers and wage contracts as in Shapiro and Stiglitz (1984). This imperfection in labor markets introduces a strong propagation mechanism that allows the model to capture the business cycles in Bulgaria better than earlier models. The model performs well vis-a-vis data, especially along the labor market dimension, and in addition dominates the market-clearing labor market framework featured in the standard RBC model, e.g Vasilev (2009).
    Keywords: general equilibrium,shirking,efficiciency wages,unemployment
    JEL: E24 E32
    Date: 2016
  12. By: Alfredo Medio (Université Côte d'Azur, France; GREDEG CNRS)
    Abstract: In this paper, we discuss the problem of Pareto efficiency/inefficiency in a family of two-period, pure exchange model of overlapping generations models (OLG). Making use of a known necessary and sucient condition for efficiency of an intertemporal OLG equilibrium, the so-called "Cass Criterion", we establish a systematic relation between efficiency/inefficiency of equilibria and the dynamical properties of the forward-in-time dynamics characterizing the different types of OLG models belonging to the generalclass considered in the paper. In so doing, we discuss two generally neglected questions, namely: (i) the "backward dynamics" problem arising in OLG models of the Samuelson type; and (ii) for OLG models yielding multiple intertemporal equilibria of different types, the problem of determining which of them are typical or exceptional.
    Keywords: Overlapping Generations, Pareto-Efficiency, Dynamic Properties
    JEL: D50 C61
    Date: 2016–12
  13. By: Takashi Kano
    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
  14. By: Ben Heijdra (University of Groningen); Fabian Kindermann (University of Bonn); Laurie Reijnders (University of Groningen)
    Abstract: Online appendix for the Review of Economic Dynamics article
    Date: 2016
  15. By: Benoît Julien; Sephorah Mangin
    Abstract: This paper generalizes the well-known Hosios (1990) efficiency condition to dynamic search and matching environments where the expected match output depends on the market tightness. Such environments give rise to a novel externality – the output externality – which may be either positive or negative. The generalized Hosios condition is simple: entry is constrained efficient when buyers’ surplus share equals the matching elasticity plus the surplus elasticity (i.e. the elasticity of the expected joint match surplus with respect to buyers). This intuitive condition captures both the standard externalities generated by the frictional matching process and the output externality.
    Keywords: constrained efficiency, search and matching, directed search, competitive search, Nash bargaining, Hosios condition
    JEL: C78 D83 E24 J64
    Date: 2016–11
  16. By: Sina T. Ates; Felipe Saffie
    Abstract: We incorporate endogenous technical change into a real business cycle small open economy framework to study the productivity costs of sudden stops. In this economy, productivity growth is determined by the entry of new firms and the expansion decisions of incumbent firms. New firms are created after the implementation of business ideas, yet the quality of ideas is heterogeneous and good ideas are scarce. Selection of the most promising ideas gives rise to a trade-off between mass (quantity) and composition (quality) in the entrant cohort. Chilean plant-level data from the sudden stop triggered by the Russian sovereign default in 1998 confirm the main mechanism of the model, as firms born during the credit shortage are fewer, but better. The quantitative analysis shows that four years after the crisis, 12.5% of the output deviation from trend is due to permanent productivity losses. Distortions in the entry margin account for 40% of the loss, and the remainder is due to distortion in the expansion decisions of incumbents.
    Keywords: Selection ; Sudden Stop ; Endogenous Growth ; Firm Dynamics
    JEL: F40 F41 F43 O11 O16
    Date: 2016–11
  17. By: Murat Ungor (University of Otago)
    Abstract: Online appendix for the Review of Economic Dynamics article
    Date: 2016
  18. By: Stylianos Asimakopoulos (Stirling Management School, Economics Division, University of Stirling); Marco Lorusso (Centre for Energy Economics Research and Policy, Heriot-Watt University); Luca Pieroni (Department of Political Science, University of Perugia)
    Abstract: This paper analyses the effects on private consumption from an increase in productive and unproductive public spending. A new Keynesian model incorporating price and wage rigidities, monetary policy and various fiscal rules is developed and estimated, using Bayesian techniques, to capture the key cyclical characteristics of the US economy. We find that price and wage rigidities along with a positive shock to the part of public spending that is productive are sufficient to boost private consumption. Moreover, we show that this initial positive reaction of private consumption is adequate to create a positive present value consumption multiplier for more than five years. Finally, we show that our main results remain robust to changes in the monetary rule and the various methods of deficit financing.
    Keywords: fiscal rules, price rigidities, taylor rule, bayesian estimation
    JEL: C11 E27 E52 E62 H30
    Date: 2016–12
  19. By: Philipp Engler; Juha Tervala
    Abstract: Empirical studies support the hysteresis hypothesis that recessions have a permanent effect on the level of output. We analyze the implications of hysteresis for fiscal policy in a DSGE model. We assume a simple learning-by-doing mechanism where demand-driven changes in employment can affect the level of productivity permanently, leading to hysteresis in output. We show that the fiscal output multiplier is much larger in the presence of hysteresis and that the welfare multiplier of fiscal policy - the consumption equivalent change in welfare for one dollar change in public spending - is positive (negative) in the presence (absence) of hysteresis. The main bene.t of accommodative fiscal policy in the presence of hysteresis is to diminish the damage of a recession to the long-term level of productivity and, thus, output.
    Keywords: Fiscal policy, hysteresis, learning by doing, welfare
    JEL: E62 F41 F44
    Date: 2016
  20. By: Martha López (Banco de la República)
    Abstract: Fiscal multipliers are different across countries and under different economic circumstances. The studies of the effect of government spending shock on output have focus their attention on the behavior of consumption. However, the crowding out of investment is also an important matter of study. In this respect, balance sheet effects play an important role in all countries and in all circumstances. The aim of this paper is to study this important issue in a small open economy that is also characterized by an important proportion of non-Ricardian agents and commodity revenues. The results show that balance sheet effects might reduce the fiscal multiplier by half. Also, that this result might be mitigated if a subsidy, financed with the income taxes revenues from a higher fiscal multiplier, is put into action. Finally, the paper also shows that a structural fiscal rule delivers less welfare losses due to financial frictions than other rules. Classification JEL: D91, E21, E62.
    Keywords: Fiscal multipliers, fiscal policy rules, non-Ricardian households, DSGE model, Financial Frictions.
    Date: 2016–12
  21. By: Jose-Maria Da-Rocha; Marina Mendes Tavares; Diego Restuccia
    Abstract: We assess the quantitative impact of firing costs on aggregate total factor productivity (TFP) in a dynamic general-equilibrium framework where the distribution of establishment-level productivity is not invariant to the policy. Firing costs not only generate static factor misallocation, but also a worsening of the productivity distribution contributing to large aggregate TFP losses. Firing costs equivalent to 5 year's wages imply a drop in TFP of more than 20 percent. Factor misallocation accounts for 20 percent of the productivity loss, a relatively small drop in TFP, whereas the remaining 80 percent arises from the endogenous change in the productivity distribution.
    Keywords: firing costs, inaction, misallocation, establishments, productivity.
    JEL: O1 O4 E1 E6
    Date: 2016–12–23

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