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on Dynamic General Equilibrium |
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Issue of 2017‒02‒05
nineteen papers chosen by Christian Zimmermann Federal Reserve Bank of St. Louis |
| By: | Michael Assous; Pedro Garcia Duarte |
| Abstract: | The canonical history of macroeconomics, one of the rival schools of thought and the great economists, gives Robert Lucas a prominent role in shaping the recent developments in the area. According to it, his followers were initially split into two camps, the “real business cycle” theorists with models of efficient fluctuations, and the “new-Keynesians” with models in which fluctuations are costly, and the government has a role to play, due to departures from the competitive equilibrium (such as nominal rigidities and imperfect competition). Later on, a consensus view emerged (the so-called new neoclassical synthesis), based on the dynamic stochastic general equilibrium (DSGE) model, which combines elements of the models developed by economists of those two groups. However, this account misses critical developments, as already pointed out by Cherrier and Saïdi (2015). As a reaction to Lucas’s 1972 policy ineffectiveness results, based on an overlapping generations (OLG) model, a group of macroeconomists realized that a competitive OLG model may have a continuum of equilibria and that this indeterminacy justified government intervention for competitive cycles that emerged even in deterministic models. We can identify here two distinct, but related, groups: one of the deterministic cycles of David Gale, David Cass, and Jean-Michel Grandmont, and another of the stochastic models and sunspots of Karl Shell, Roger Guesnerie, Roger Farmer and Costas Azariadis (Lucas’s PhD student). Here, the OLG was the workhorse model. Following from these works, a number of authors, including Michael Woodford, argued that similar results could occur in models with infinitely lived agents when there are various kinds of market imperfections. With such generalization, some of these macroeconomists saw that once these imperfections are introduced, nothing important for business cycle modeling was lost and they could therefore leave the OLG model aside as a model of business fluctuations, to the dismay of authors such as Grandmont, Robert Solow and Frank Hahn. In this paper, we scrutinize the differences between the deterministic cycles and sunspot groups and explore the many efforts of building a dynamic competitive business cycle model that implies a role for the government to play. We then assess the transformation process that took place in the late 1980s when several macroeconomists switched from OLG to infinite-lived agents models with imperfections that eventually became central to the DSGE literature. With this we hope to shed more light on the origins of new neoclassical synthesis. |
| Keywords: | overlapping generations model; Robert Lucas; Michael Woodford; DSGE model; new neoclassical synthesis |
| JEL: | B22 B23 E32 |
| Date: | 2017–01–26 |
| URL: | http://d.repec.org/n?u=RePEc:spa:wpaper:2017wpecon03&r=dge |
| By: | Alessandro Gavazza; Simon Mongey; Giovanni L Violante |
| Abstract: | We develop a model of firm dynamics with random search in the labor market where hiring firms exert recruiting effort by spending resources to fill vacancies faster. Consistent with micro evidence, in the model fast-growing firms invest more in recruiting activities and achieve higher job-filling rates. In equilibrium, individual decisions of hiring firms aggregate into an index of economy-wide recruiting intensity. We use the model to study how aggregate shocks transmit to recruiting intensity, and whether this channel can account for the dynamics of aggregate matching efficiency around the Great Recession. Productivity and financial shocks lead to sizable pro-cyclical fluctuations in matching efficiency through recruiting effort. Quantitatively, the main mechanism is that firms attain their employment targets by adjusting their recruiting effort as labor market tightness varies. Shifts in sectoral composition can have a sizable impact on aggregate recruiting intensity. Fluctuations in new-firm entry, instead, have a negligible effect despite their contribution to aggregate job and vacancy creations. |
| Keywords: | Aggregate Matching Efficiency; Firm Dynamics; Macroeconomic Shocks; Recruiting Intensity; Unemployment; Vacancies |
| JEL: | R14 J01 |
| Date: | 2016–10 |
| URL: | http://d.repec.org/n?u=RePEc:ehl:lserod:69017&r=dge |
| By: | Lorenza Rossi (Department of Economics and Management, University of Pavia); Chiara Punzo (Università Cattolica Sacro Cuore, Milano) |
| Abstract: | We consider a NK-DSGE model with distortive taxation and heterogeneous agents, modeled using a modified version of the mechanism pro- posed by Bilbiie, Monacelli and Perotti (2012). Following Galì (2014), we study the effects of a shock to government purchases under two alternative financing regimes: (i) monetary financing; (ii) debt financing. Particularly, we focus on the redistributive effects of the two regimes and we find the following. Both regimes imply a redistributive effect from savers to borrowers, measured in terms of the ratio between the consumption of borrowers and that of savers. The redistribution is much greater in the money-financed fiscal stimulus, where the consumption ratio is more than three times higher than the implied one in the debt-financed fiscal stimulus. Borrowers are better o¤ also in terms of their relative labor supply and money demand. Finally, with respect to the representative agent model, the presence of borrowers enhances the impact of the fiscal intervention on aggregate output, when spending is debt financed. Remarkably, with respect to Galì (2014) the same regime implies a reduction of the debt burden instead of an increase. |
| Date: | 2016–12 |
| URL: | http://d.repec.org/n?u=RePEc:pav:demwpp:demwp0131&r=dge |
| By: | Charles Ka Yui Leung; Chung-Yi Tse |
| Abstract: | We add arbitraging middlemen -- investors who attempt to profit from buying low and selling high -- to a canonical housing market search model. Flipping tends to take place in sluggish and tight, but not in moderate, markets. To follow is the possibility of multiple equilibria. In one equilibrium, most, if not all, transactions are intermediated, resulting in rapid turnover, a high vacancy rate, and high housing prices. In another equilibrium, few houses are bought and sold by middlemen. Turnover is slow, few houses are vacant, and prices are moderate. Moreover, flippers can enter and exit en masse in response to the smallest interest rate shock. The housing market can then be intrinsically unstable even when all flippers are akin to the arbitraging middlemen in classical finance theory. In speeding up turnover, the flipping that takes place in a sluggish and illiquid market tends to be socially beneficial. The flipping that takes place in a tight and liquid market can be wasteful as the efficiency gain from any faster turnover is unlikely to be large enough to offset the loss from more houses being left vacant in the hands of flippers. Based on our calibrated model, which matches several stylized facts of the U.S. housing market, we show that the housing price response to interest rate change is very non-linear, suggesting cautions to policy attempt to “stabilize” the housing market through monetary policy. |
| Date: | 2017–01 |
| URL: | http://d.repec.org/n?u=RePEc:dpr:wpaper:0989&r=dge |
| By: | Chen, Kan (BBVA Research); Crucini, Mario J. (Vanderbilt University and NBER) |
| Abstract: | Economic research into the causes of business cycles in small open economies is almost always undertaken using a partial equilibrium model. This approach is characterized by two key assumptions. The first is that the world interest rate is unaffected by economic developments in the small open economy, an exogeneity assumption. The second assumption is that this exogenous interest rate combined with domestic productivity is sufficient to describe equilibrium choices. We demonstrate the failure of the second assumption by contrasting general and partial equilibrium approaches to the study of a cross-section of small open economies. In doing so, we provide a method for modeling small open economies in general equilibrium that is no more technically demanding than the small open economy approach while preserving much of the value of the general equilibrium approach. |
| JEL: | C55 C68 F41 F44 |
| Date: | 2016–08–12 |
| URL: | http://d.repec.org/n?u=RePEc:fip:feddgw:279&r=dge |
| By: | Yannis Mesquida (University of Lausanne); Pascal St-Amour (University of Lausanne and Swiss Finance Institute) |
| Abstract: | Lifetime financial-, work- and health-related decisions made by agents are intertwined with one another. Understanding how these decisions are made is essential to gauge if saving in financial, retirement and human assets is adequate or not. This paper numerically solves, simulates, and structurally estimates a dynamic life cycle model of allocations (consumption/savings, leisure/work and health expenditures), statuses (health, financial and pension wealth) and welfare, allowing for (partially) adjustable exposure to morbidity and mortality risks. Using the simulated life cycle variables as benchmark, our results show that observed choices are not fully consistent with an optimal, forward-looking strategy. Whereas financial savings and pension claims are both adequate, individuals in the data are not healthy enough, and consequently face a shorter life horizon than expected. Moreover, full insurance, and age-increasing wages would optimally point to more spending and less leisure to maintain health than currently observed. As a consequence, observed post-retirement income is too low, and explains a sharp drop in consumption after 65 that is inconsistent with optimizing behavior. Relaxing assumptions on full insurance and pension regimes only partially alleviates these discrepancies. |
| Keywords: | Defined Benefits and Contributions Plans, Consumption, Leisure, Health Expenditures, Mortality and Morbidity Risks, Optimal Savings |
| JEL: | D91 I12 J22 |
| URL: | http://d.repec.org/n?u=RePEc:chf:rpseri:rp1657&r=dge |
| By: | Cockx, Bart (Ghent University); Dejemeppe, Muriel (Université catholique de Louvain); Launov, Andrey (University of Kent); Van der Linden, Bruno (IRES, Université catholique de Louvain) |
| Abstract: | We build and estimate a non-stationary structural job search model that incorporates the main stylized features of a typical job search monitoring scheme in unemployment insurance (UI) and acknowledges that search effort and requirements are measured imperfectly. Based on Belgian data, monitoring is found to affect search behavior only weakly, because (i) assessments were scheduled late and infrequently; (ii) the monitoring technology was not sufficiently precise, (iii) lenient Belgian UI results in caseloads that are less responsive to incentives than elsewhere. Simulations show how changing the aforementioned design features can enhance effectiveness and that precise monitoring is key in this. |
| Keywords: | unemployment benefits, non-stationary job search, sanctions, monitoring, structural estimation |
| JEL: | J64 J68 C41 |
| Date: | 2017–01 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp10487&r=dge |
| By: | Iftikhar, Zainab (Center for Mathematical Economics, Bielefeld University); Zaharieva, Anna (Center for Mathematical Economics, Bielefeld University) |
| Abstract: | In this study we develop and calibrate a search and matching model of the German labour market and analyze the impact of recent immigration. Our model has two production sectors (manufacturing and services), two skill groups and two ethnic groups of workers (natives and immigrants). Moreover, we allow for the possibility of self-employment, endogenous price and wage setting and fiscal redistribution policy. We find that search frictions are less important for wages of the low skilled, especially in manufacturing, whereas wages of the high skilled are more sensitive to their outside opportunities. Furthermore, employment chances of immigrant workers are up to four times lower than employment chances of native workers, especially in the high skill segment. Our results show that recent immigration to Germany, including refugees, has a moderate negative effect on the welfare of low skill workers in manufacturing (-0.6%), but all other worker groups are gaining from immigration, with high skill service employees gaining the most (+4.3%). This is because the productivity of high (low) skill workers is increasing (decreasing) and there is a higher demand for services. The overall effect of recent immigration is estimated at +1.6%. Finally, we observe that productive capacities of immigrant workers are underutilized in Germany and a policy implementing equal employment opportunities can generate a welfare gain equal to +0.9% with all worker groups (weakly) gaining due to the redistribution. |
| Keywords: | search frictions, immigration, general equilibrium, redistribution, welfare |
| Date: | 2016–10–05 |
| URL: | http://d.repec.org/n?u=RePEc:bie:wpaper:568&r=dge |
| By: | Michalis Rousakis; Romanos Priftis |
| Abstract: | Abstract This paper presents an analytical narration of the later stages of the Greek crisis, focusing on two key events that unfolded during 2014-2015 and set Greece apart from other episodes of sovereign debt crises: the risk of Grexit and the imposition of capital controls on the banking sector. To account for them both, we extend the standard small open economy environment along three dimensions. First, we allow for an informal sector. Second, we allow for a richer menu of assets that include cash, which is needed for informal consumption and is costly to hold. Third, we introduce a banking sector that turns households' deposits into capital. We show that a risk of Grexit leads households to run down their deposits to the detriment of bank balance sheets, increase their demand for cash, and increase their consumption whilst reallocating it towards formal goods. As evidenced by the data capital controls mitigate the deposit ight and reinforce the switch of consumption to formality. |
| Keywords: | Capital controls, small open economy, exit from a currency union, cash, informal economy, financial intermediaries, Greece |
| JEL: | E2 E4 F41 G11 G28 |
| Date: | 2017–01–25 |
| URL: | http://d.repec.org/n?u=RePEc:oxf:wpaper:822&r=dge |
| By: | Richter, Alexander (Federal Reserve Bank of Dallas); Throckmorton, Nathaniel (College of William & Mary) |
| Abstract: | This paper examines the importance of the zero lower bound (ZLB) constraint on the nominal interest rate by estimating three variants of a small-scale New Keynesian model: (1) a nonlinear model with an occassionally binding ZLB constraint; (2) a constrained linear model, which imposes the constraint in the filter but not the solution; and (3) an unconstrained linear model, which never imposes the constraint. The posterior distributions are similar, but important differences arise in their predictions at the ZLB. The nonlinear model fits the data better at the ZLB and primarily attributes the ZLB to a reduction in household demand due to discount factor shocks. In the linear models, the ZLB is due to large contractionary monetary policy shocks, which is at odds with the Fed’s expansionary policy during the Great Recession. Posterior predictive analysis shows the nonlinear model is partially able to account for the increase in output volatility and the negative skewness in output and inflation that occurred during the ZLB period, whereas the linear models predict almost no changes in those statistics. We also compare the results from our nonlinear model to the quasi-linear solution based on OccBin. The quasi-linear model fits the data better than the linear models, but it still generate too little volatility at the ZLB and predicts that a large policy shock caused the ZLB to bind in 2008Q4. |
| Keywords: | Bayesian estimation; model comparison; zero lower bound; particle filter |
| JEL: | C11 E43 E58 |
| Date: | 2016–08–02 |
| URL: | http://d.repec.org/n?u=RePEc:fip:feddwp:1606&r=dge |
| By: | Kengo Nutahara |
| Abstract: | Carlstrom and Fuerst (2007) ["Asset Prices, Nominal Rigidities, and Monetary Policy," Review of Economic Dynamics 10, 256-275] find that monetary policy response to share prices is a source of equilibrium indeterminacy in a stickyprice economy. We find that if housing price is a target of a central bank, monetary policy response to asset price is helpful for equilibrium determinacy. |
| Date: | 2017–01 |
| URL: | http://d.repec.org/n?u=RePEc:cnn:wpaper:17-001e&r=dge |
| By: | Martinez-Garcia, Enrique (Federal Reserve Bank of Dallas); Kabukcuoglu, Ayse (Koç University) |
| Abstract: | We introduce the market resources method (MRM) for solving dynamic optimization problems. MRM extends Carroll’s (2006) endogenous grid point method (EGM) for problems with more than one control variable using policy function iteration. The MRM algorithm is simple to implement and provides advantages in terms of speed and accuracy over Howard’s policy improvement algorithm. Codes are available. |
| JEL: | C6 C61 C63 C68 |
| Date: | 2016–06–01 |
| URL: | http://d.repec.org/n?u=RePEc:fip:feddgw:274&r=dge |
| By: | Ravikumar, B. (Federal Reserve Bank of St. Louis); Santacreu, Ana Maria (Federal Reserve Bank of St. Louis); Sposi, Michael J. (Federal Reserve Bank of Dallas) |
| Abstract: | We compute welfare gains from trade in a dynamic, multi-country Ricardian model where international trade affects capital accumulation. We calibrate the model for 93 countries and examine transition paths between steady-states after a permanent, uniform trade liberalization across countries. Our model allows for both the relative price of investment and the investment rate to depend on the world distribution of trade barriers. Accounting for transitional dynamics, welfare gains are about 60 percent of those measured by comparing only the steady-states, and three times larger than those with no capital accumulation. We extend the model to incorporate adjustment costs to capital accumulation and endogenous trade imbalances. Relative to the model with balanced trade, the gains from trade increase more for small countries because they accumulate capital at faster rates by running trade deficits in the short run. |
| Date: | 2017–01–01 |
| URL: | http://d.repec.org/n?u=RePEc:fip:feddgw:296&r=dge |
| By: | Friese, Max |
| Abstract: | The paper investigates the impacts of demographic change on the financial sustainability of a pay-as-you-go social security system in an economy with unemployment caused by trade unions. Using a simple two-period overlapping generations approach, it can be shown that the trade union behavior with respect to wage setting may have favorable effects on per capita contributions, if labor demand is sufficiently inelastic with respect to the wage rate. In contrast, if firm's labor demand reacts more sensitive to changes in the wage rate, the behavior of the trade union may amplify the imposed burden of demographic change on the social security system. |
| Keywords: | demographic change,PAYG public pensions,trade unions,unemployment,tax burden,output elasticity of capital,wage elasticity of labor demand |
| JEL: | E24 H55 J11 J51 |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:roswps:148&r=dge |
| By: | Guilloux-Nefussi, Sophie (Banque de France) |
| Abstract: | The decline in the sensitivity of inflation to domestic slack observed in developed countries since the mid 1980’s has been often attributed to globalization. However, this intuition has so far not been formalized. I develop a general equilibrium setup in which the sensitivity of inflation to marginal cost decreases when international trade costs fall. In order to do so, I add three ingredients to an otherwise standard two-country new-Keynesian model. Strategic interactions generate a time varying desired markup; endogenous entry and heterogeneous productivity engender a self-selection of the most productive firms (also the largest ones) in international trade. Hence the weight of large firms in domestic production increases. These firms transmit less marginal cost fluctuations to price adjustments, rather absorbing them into their desired markup in order to protect their market share. At the aggregate level, domestic inflation reacts less to real activity fluctuations. |
| JEL: | E31 F41 F62 |
| Date: | 2016–11–03 |
| URL: | http://d.repec.org/n?u=RePEc:fip:feddgw:289&r=dge |
| By: | Caterina Mendicino (European Central Bank); Kalin Nikolov (European Central Bank); Javier Suarez (CEMFI); Dominik Supera (CEMFI, Centro de Estudios Monetarios y Financieros) |
| Abstract: | We characterize welfare maximizing capital requirement policies in a macroeconomic model with household, firm and bank defaults calibrated to Euro Area data. We optimize on the level of the capital requirements applied to each loan class and their sensitivity to changes in default risk. We find that getting the level right (so that bank failure risk remains small) is of foremost importance, while the optimal sensitivity to default risk is positive but typically smaller than under Basel IRB formulas. When starting from low levels, initially both savers and borrowers benefit from higher capital requirements. At higher levels, only savers are in favour of tighter and more time-varying capital charges. |
| Keywords: | Macroprudential policy, bank fragility, capital requirements, financial frictions, default risk. |
| JEL: | E3 E44 G01 G21 |
| Date: | 2016–12 |
| URL: | http://d.repec.org/n?u=RePEc:cmf:wpaper:wp2016_1614&r=dge |
| By: | Keen, Benjamin D. (University of Oklahoma); Richter, Alexander (Federal Reserve Bank of Dallas); Throckmorton, Nathaniel (College of William & Mary) |
| Abstract: | This paper examines forward guidance using a nonlinear New Keynesian model with a zero lower bound (ZLB) constraint on the nominal interest rate. Forward guidance is modeled with news shocks to the monetary policy rule. The effectiveness of forward guidance depends on the state of the economy, the speed of the recovery, the ZLB constraint, the degree of uncertainty, the monetary response to inflation, the size of the news shocks, and the forward guidance horizon. Specifically, the stimulus from forward guidance falls as the economy deteriorates or as households expect a slower recovery. When the ZLB binds, less uncertainty about the economy or an expectation of a stronger response to inflation reduces the benefit of forward guidance. Forward guidance via a news shock is less stimulative than an unanticipated monetary policy shock around the steady state, but a news shock is more stimulative near the ZLB and always has a larger cumulative effect on output. When the central bank extends the forward guidance horizon, the cumulative effect initially increases but then decreases. These results indicate that there are limits to the stimulus forward guidance can provide, but that stimulus is largest when the news is communicated early in a recession. |
| Keywords: | Forward guidance; zero lower bound; news shocks; global solution method |
| JEL: | E43 E58 E61 |
| Date: | 2016–11–08 |
| URL: | http://d.repec.org/n?u=RePEc:fip:feddwp:1612&r=dge |
| By: | Arellano, Cristina (Federal Reserve Bank of Minneapolis); Bai, Yan (University of Rochester); Kehoe, Patrick J. (Federal Reserve Bank of Minneapolis) |
| Abstract: | This appendix contains five sections. Section 1 provides details for the comparative statics exercise performed in the simple example. Section 2 discusses extending the model to allow firms to default on the wages for managers. Section 3 describes the firm-level and aggregate data. Section 4 contains the details of the computational algorithm. Finally, Section 5 reports the results for our model with a lower labor elasticity. |
| Keywords: | Uncertainty shocks; Great Recession; Labor wedge; Firm heterogeneity; Credit constraints; Credit crunch |
| JEL: | D52 D53 E23 E24 E32 E44 |
| Date: | 2017–01–24 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedmsr:538&r=dge |
| By: | Nikolay A Andreev (National Research University Higher School of Economics) |
| Abstract: | We study the boundedness properties of the value function for a general worst-case scenario stochastic dynamic programming problem. For the portfolio selection problem,we present sufficient economically reasonable conditions for the finitness and uniform boundedness of the value function. The results can be used to decide if the problem is ill-posed and to correctly solve the Bellman-Isaacs equation with an appropriate numeric scheme |
| Keywords: | portfolio selection, Bellman-Isaacs equation, stochastic dynamic programming, value function, worst-case optimization |
| JEL: | C61 C63 G11 |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:hig:wpaper:59/fe/2017&r=dge |