nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2017‒02‒12
nineteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Jobless Recoveries: The Interaction between Financial and Search Frictions By Dennis Wesselbaum
  2. Government Commitment and Unemployment Insurance Over the Business Cycle By Pei, Yun; Xie, Zoe
  3. Business Cycles and the Propagation of Shocks in the Input-Output Network By Molnarova, Zuzana; Molnárová, Zuzana; Reiter, Michael
  4. Sectoral Composition of Government Spending, Distortionary Income Taxation, and Macroeconomic (In)stabilit By Jang-Ting Guo; Juin-Jen Chang; Jhy-Yuan Shieh; Wei-Neng Wang
  5. Human Capital Acquisition and Occupational Choice: Implications for Economic Development By Mestieri, Martí; Schauer, Johanna; Townsend, Robert M
  6. On the Effects of Private Capital Falling into the Public Domain. By DAVILA, Julio
  7. A dynamic economic equilibrium model for the economic assessment of the fishery stock-rebuilding policies By José-María Da-Rocha; Raul Prellezo; Jaume Sempere; Luis Taboada Antelo
  8. Monetary Policy and Inequality when Aggregate Demand depends on Liquidity By Bilbiie, Florin Ovidiu; Ragot, Xavier
  9. The Effect of the Affordable Care Act on the Labor Supply, Savings, and Social Security of Older Americans By Eric French; Hans-Martin von Gaudecker; John Bailey Jones
  10. Public-Sector Employment in an Equilibrium Search and Matching Model By Albrecht, James; Robayo-Abril, Monica; Vroman, Susan
  11. Neoclassical Growth Model with Overlapping Generations By Vasilev, Aleksandar
  12. Optimal Fiscal and Monetary Policy, Debt Crisis and Management By Cristiano Cantore; Paul Levine; Giovanni Melina; Joseph Pearlman
  13. Delays in Public Goods By Santanu Chatterjee; Olaf Posch; Dennis Wesselbaum
  14. A Model of Secular Stagnation: Theory and Quantitative Evaluation By Gauti B. Eggertsson; Neil R. Mehrotra; Jacob A. Robbins
  15. Liquidity Traps and Monetary Policy: Managing a Credit Crunch By Buera, Francisco J.; Nicolini, Juan Pablo
  16. Post Keynesian Dynamic Stochastic General Equilibrium Theory By Farmer, Roger E A
  17. Intergenerational risk trading and the innovative role of equity-wage swaps By Jiajia, C.; Ponds, Eduard
  18. Did the FED REact to Asset Price Bubbles? By Dennis Wesselbaum; Marc-Andre Luik
  19. Cheap Talk in a New Keynesian Model By Dennis Wesselbaum

  1. By: Dennis Wesselbaum (Department of Economics, University of Otago, New Zealand)
    Abstract: This paper establishes a link between labor market frictions and financial market frictions. We present empirical evidence about the relation between search and financial frictions. Then, we build a stylized DSGE model that features this channel. Simulation excercises show that the model with this channel generates a strong internal propagation mechanism, replicates stylized labor market effects of the Great Recession, and, most importantly, creates a jobless recovery.
    Keywords: DSGE, Jobless Recovery, Labor Market and Financial Frictions
    JEL: C32 E24 E32 J63
    Date: 2016–02
  2. By: Pei, Yun; Xie, Zoe
    Abstract: We investigate the role of government commitment to future policies in shaping unemployment insurance (UI) policy in a stochastic general equilibrium model of labor search and matching. Compared with the optimal(Ramsey)policy of a government with commitment, the policy under no commitment characterized by a Markov-perfect equilibrium has higher benefits and leads to higher unemployment rates in the steady state. We also find starkly different policy responses to a productivity shock or changes in unemployment. The differences arise because the Ramsey government can use an ex-ante committed policy to stimulate job search.
    Keywords: Unemployment insurance, Commitment, Markov-perfect equilibrium, Business cycle
    JEL: E61 H21 J64 J65
    Date: 2016–11–03
  3. By: Molnarova, Zuzana; Molnárová, Zuzana; Reiter, Michael
    Abstract: This paper studies the relative importance of aggregate and industry-specific shocks in generating business cycle fluctuations. We assess the role of demand and supply side shocks at the aggregate and the industry level. We build a highly disaggregated multi-industry DSGE model with an input-output network structure. In the model, fluctuations in measured total factor productivity can arise as an endogenous response to demand shocks. The model is estimated by the simulated method of moments using U.S. industry data from 1960 to 2005. We show that aggregate technology shocks play a small role in explaining business cycles. Instead, aggregate demand shocks together with industry-specific technology shocks are important drivers of fluctuations of output and productivity. Demand shocks explain 60% of the variance of GDP and more than 10% of measured aggregate productivity. Industry-specific technology shocks are transmitted via input-output linkages and affect output and measured productivity in connected industries. They alone explain 50% of the variance of aggregate productivity and more than 20% of the variance in GDP. The presence of the input-output network is crucial for the results. The linkages between industries decrease the share of aggregate fluctuations explained by aggregate technology shock by 40 percentage points.
    JEL: E32 E37 D24
    Date: 2016
  4. By: Jang-Ting Guo (Department of Economics, University of California Riverside); Juin-Jen Chang (Academia Sinica); Jhy-Yuan Shieh (Soochow University); Wei-Neng Wang (Academia Sinica)
    Abstract: This paper quantitatively examines the interrelations between sectoral composition of government spending and macroeconomic (in)stability in a two-sector real business cycle model with positive productive externalities in investment and distortionary income taxation through a stylized balanced-budget fiscal policy rule. We find that under endogenous public expenditures, the benchmark model always exhibits indeterminacy and sunspots provided the constant tax rate does not exceed a critical value. When the tax rate is raised to a higher level, a sufficiently high public-consumption share can destabilize the macroeconomy by generating belief-driven cyclical fluctuations. We also find that under the baseline parameterization with fixed government spending, the low-tax steady state is an indeterminate sink and the high-tax steady state is a saddle point, regardless of how public expenditures are divided between consumption and investment goods.
    Keywords: Government Spending; Distortionary Income Taxation; Equilibrium (In)determinacy.
    JEL: E32 E62 O41
    Date: 2017–02
  5. By: Mestieri, Martí; Schauer, Johanna; Townsend, Robert M
    Abstract: Using household-level data from Mexico we document patterns among schooling, entrepreneurial decisions and household characteristics such as assets, talent of household members and age of the household head. Motivated by our findings, we develop a heterogeneous-agent, incomplete- markets, overlapping-generations dynasty model. Households jointly decide over their life cycle on (i) kids' human capital investments (schooling) and (ii) parents' entry, exit and investment into alternative entrepreneurial modes (subsistence and modern). With financial constraints all of these are co-determined. A calibrated version of our model can account for the broad correlation patterns uncovered in the data within and across generations, e.g., a non-monotonic relationship between educational choices and assets across occupations, growth in profits and employment for modern firms only, and dynastic persistence across generations in education and wealth. Endogenous human capital acquisition is a key driver of inequality and intergenerational persistence. Eliminating this channel would decrease the top 10% income share by 47%. Eliminating within-period borrowing constraints would increase average household expenditure by 7.1% and benefit the middle class, reducing top and bottom expenditure shares. It would also reduce by 28% the correlation between household assets and kids' schooling levels.
    Keywords: entrepreneurship; Human Capital; inequality; Mexico; Occupational choice
    JEL: I24 I25 O15 O54
    Date: 2017–02
  6. By: DAVILA, Julio (Université catholique de Louvain, CORE, Belgium)
    Abstract: The fact that some private capital eventually slides into the public domain (e.g. taxes on household savings and income channeled to public infrastructures, or R+D investments as patents expire) inefficiently distorts downwards the capital accumulation. This is established for both infinitely-lived agents and overlapping generations setups. I provide next a tax and transfers balanced policy able to decentralize the planner’s steady state without resorting to the (impracticable) extension of property rights otherwise needed to address the problem. It consists of (i) subsidizing the rental rate of capital by an amount equal to the depreciation/obsolescence rate of the capital sliding into the public domain, and (ii) taxing households debt issued against future dividends.
    Date: 2016–11–26
  7. By: José-María Da-Rocha (ITAM and Universidad de Vigo); Raul Prellezo (AZTI); Jaume Sempere (El Colegio de México); Luis Taboada Antelo ((IIM) CSIC)
    Abstract: The paper develops and analyses a dynamic general equilibrium model with heterogeneous agents that can be used for assessment of the economic consequences of fish stock-rebuilding policies within the EU. In the model, entry and exit processes for individual firms are endogenous, as well as output, employment and wages. This model is applied to a fishery of the Mediterranean Sea. The results provide both individual and aggregate data that can help managers in understanding the economic consequences of rebuilding strategies. In particular, this study shows that, for the application presented, all aggregate results improve if the stock rebuilding strategy is followed, while individual results depend on the indicator selected.
    Keywords: macroeconomics, general equilibrium model, multiannual management plans
    JEL: Q22
    Date: 2017–01
  8. By: Bilbiie, Florin Ovidiu; Ragot, Xavier
    Abstract: Monetary policy design changes a great deal when inequality matters. In our New Keynesian model, aggregate demand depends on liquidity as heterogeneous consumers hold money in face of uninsurable risk and participate infrequently in financial markets. Endogenous fluctuations in precautionary liquidity challenge central bank's aggregate demand management: the Taylor coefficients required for determinacy are in the double digits, for moderate market incompleteness. Responding to inequality or liquidity can restore conventional wisdom. A novel tradeoff for Ramsey-optimal monetary policy arises between inequality and standard---inflation and output---stabilization objectives. Price stability has significant welfare costs that are inequality-related: inflation volatility hinders volatility of constrained agents' consumption.
    Keywords: determinacy; heterogenous agents; incomplete markets; inequality; interest rate rules; limited participation; liquidity constraints; money; optimal (Ramsey) monetary policy; Taylor principle
    JEL: D14 D31 E21 E3 E4 E5
    Date: 2017–01
  9. By: Eric French (University College London); Hans-Martin von Gaudecker (Universität Bonn); John Bailey Jones (Federal Reserve Bank of Richmond and University at Albany, SUNY)
    Abstract: This paper assesses the effect of the Affordable Care Act (ACA) on the labor supply of Americans ages 50 and older. Using data from the Health and Retirement Study and the Medical Expenditure Panel Survey, we estimate a dynamic programming model of retirement that accounts for both saving and uncertain medical expenses. Importantly, we model the two key channels by which health insurance rates are predicted to change: the Medicaid expansion and the subsidized private exchanges.
    Date: 2016–10
  10. By: Albrecht, James (Georgetown University); Robayo-Abril, Monica (World Bank); Vroman, Susan (Georgetown University)
    Abstract: We extend the Diamond-Mortensen-Pissarides model of equilibrium unemployment to incorporate public-sector employment. We calibrate our model to Colombian data and analyze the effects of public-sector wage and employment policy on the unemployment rate, on the division of employment between the private and public sectors, and on the distributions of wages in the two sectors.
    Keywords: public sector, search and matching, wages, unemployment
    JEL: J45 J64 D83
    Date: 2017–01
  11. By: Vasilev, Aleksandar
    Abstract: notes on growth models with overlapping generations (OLG) structure
    Keywords: growth models,OLG
    JEL: A1
    Date: 2017
  12. By: Cristiano Cantore (University of Surrey); Paul Levine (University of Surrey); Giovanni Melina (City Univeristy and IMF); Joseph Pearlman (City University)
    Abstract: The initial government debt-to-GDP ratio and the government’s commitment play a pivotal role in determining the welfare-optimal speed of fiscal consolidation in the management of a debt crisis. Under commitment, for low or moderate initial government debt-to-GPD ratios, the optimal consolidation is very slow. A faster pace is optimal when the economy starts from a high level of public debt implying high sovereign risk premia, unless these are suppressed via a bailout by official creditors. Under discretion, the cost of not being able to commit is reflected into a quick consolidation of government debt. Simple monetary-fiscal rules with passive fiscal policy, designed for an environment with “normal shocks”, perform reasonably well in mimicking the Ramsey-optimal response to one-off government debt shocks. When the government can issue also long-term bonds – under commitment – the optimal debt consolidation pace is slower than in the case of short-term bonds only, and entails an increase in the ratio between long and short-term bonds.
    JEL: E52 E62 H12 H63
    Date: 2017–02
  13. By: Santanu Chatterjee (Department of Economics, University of Georgia, USA); Olaf Posch (Department of Economics, Universitat Hamburg, Germany); Dennis Wesselbaum (Department of Economics, University of Otago, New Zealand)
    Abstract: In this paper, we analyze the consequences of delays and cost overruns typically associated with the provision of public infrastructure in the context of a growing economy. Our results indicate that uncertainty about the arrival of public capital can more than offset its positive spillovers for private-sector productivity. In a decentralized economy, unanticipated delays in the provision of public capital generate too much consumption and too little private investment relative to the first-best optimum. The characterization of the first-best optimum is also affected: facing delays in the arrival of public goods, a social planner allocates more resources to private investment and less to consumption relative to the first-best outcome in the canonical model (without delays). The presence of delays also lowers equilibrium growth, and leads to a diverging growth path relative to that implied by the canonical model. This suggests that delays in public capital provision may be a potential determinant of cross-country differences in income and economic growth.
    Keywords: Public goods, delays, time overrun, cost overrun, implementation lags, fiscal policy, economic growth
    JEL: C61 E62 H41 O41
    Date: 2017–02
  14. By: Gauti B. Eggertsson; Neil R. Mehrotra; Jacob A. Robbins
    Abstract: This paper formalizes and quantifies the secular stagnation hypothesis, defined as a persistently low or negative natural rate of interest leading to a chronically binding zero lower bound (ZLB). Output-inflation dynamics and policy prescriptions are fundamentally different than in the standard New Keynesian framework. Using a 56-period quantitative lifecycle model, a standard calibration to US data delivers a natural rate ranging from -1% to -2%, implying an elevated risk of ZLB episodes for the foreseeable future. We decompose the contribution of demographic and technological factors to the decline in interest rates since 1970 and quantify changes required to restore higher rates.
    JEL: E31 E32 E5 E52 E58 E6 E62
    Date: 2017–01
  15. By: Buera, Francisco J. (Federal Reserve Bank of Chicago); Nicolini, Juan Pablo (Federal Reserve Bank of Minneapolis)
    Abstract: We study a model with heterogeneous producers that face collateral and cash-in-advance constraints. A tightening of the collateral constraint results in a credit-crunch-generated recession that reproduces several features of the financial crisis that unraveled in 2007 in the United States. The model can be used to study the effects of the credit-crunch on the main macroeconomic variables and the impact of alternative policies. The policy implications regarding forward guidance are in contrast with the prevalent view in most central banks, based on the New Keynesian explanation of the liquidity trap.
    Keywords: Liquidity trap; Credit crunch; Collateral constraints; Monetary policy; Ricardian equivalence
    JEL: E44 E52 E58 E63
    Date: 2017–02–02
  16. By: Farmer, Roger E A
    Abstract: This paper explains the connection between ideas developed in my recent books and papers and those of economists who self-identify as Post Keynesians. My own work is both neoclassical and "old Keynesian". Much of my published work assumes that people have rational expectations and that "animal spirits" should be modeled as a new fundamental. I adopt a general equilibrium framework to model the macroeconomy. But although I write from a neo-classical tradition the themes I explore in my published writing have much in common with heterodox economics. This paper explains the common elements between these seemingly disparate traditions. I make the case for unity between Post-Keynesian and General Equilibrium Theory under the banner of Post-Keynesian Dynamic Stochastic General Equilibrium Theory.
    Keywords: Dynamic Stochastic General Equilibrium Theory; Post Keynesian Economics
    JEL: E12 E20
    Date: 2017–01
  17. By: Jiajia, C.; Ponds, Eduard (Tilburg University, School of Economics and Management)
    Abstract: From a life cycle theory perspective, both young and old individuals may gain from a reallocation of equity and wage risk exposure between each other. However, current financial markets do not offer wage growth-linked securities and borrowing against labor income without collateral is difficult. To improve intergenerational risk reallocation, we propose a market-based voluntary risk trading arrangement between coexisting generations via an innovative swap market where participants trade equity-related returns for wage-linked returns, and vice versa. The maturity of the swap contract is restricted to one year to address the collateral issue. We find there is always a market for equity–wage swaps and the market-clearing premium will vary depending on multiple state variables (economy, demographics, and human and financial capital). This innovative swap market is effective at improving the welfare of all generations because the trading of wagelinked returns leads to a more complete market, enabling individuals to realize a more preferred risk exposure over their life cycles.
    Date: 2016
  18. By: Dennis Wesselbaum (Department of Economics, University of Otago, New Zealand); Marc-Andre Luik (Helmut-Schmidt University)
    Abstract: This paper investigates whether the U. S. Federal Reserve responds to asset price bubbles or not. We estimate a DSGE model featuring a financial accelerator and a process for asset price bubbles. We find evidence for a fairly strong reaction to bubbles. However, a counterfactual analysis shows that output is lower if the central banks reacts to the asset price bubble. Finally, we estimate an asymmetric version in which the central bank only reacts to positive price deviations. This version generates the best statistical fit. Including the bubble reduces the negative effects of the recent financial crisis but the symmetric response would have generated an earlier and stronger recovery.
    Keywords: Bayesian Methods, Bubbles, Monetary Policy.
    JEL: C11 E32 E44 E62
    Date: 2016–02
  19. By: Dennis Wesselbaum (Department of Economics, University of Otago, New Zealand)
    Abstract: This paper shows that the stance of fiscal policy does have significant impact on the conduct of monetary policy in the United States. Further, we document that the implied fiscal-monetary policy interactions are subject to regime instability, using a Markov-switching model. Then, we develop a microfoundation of regime switches using a cheap talk game between central bank and government. As a case study, we simulate the effects of regime switches within an otherwise standard New Keynesian model using the cheap talk game in the state-space of our model.
    Keywords: Markov-switching, Monetary and Fiscal Policy Interactions, Policy Coordination Games, Sequential Games
    JEL: C32 C7 E5 E6
    Date: 2016–02

This nep-dge issue is ©2017 by Christian Zimmermann. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.