nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2017‒03‒05
twenty papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Uncertainty-driven business cycles: assessing the markup channel By Born, Benjamin; Pfeifer, Johannes
  2. Financial frictions and robust monetary policy in the models of New Keynesian framework By Ekaterina Pirozhkova
  3. Asymmetric Macro-Financial Spillovers By Bluwstein, Kristina
  4. A Quantitative Model of Bubble-Driven Business Cycles By Larin, Benjamin
  5. Child-Related Transfers, Household Labor Supply and Welfare By Nezih Guner; Remzi Kaygusuz; Gustavo Ventura
  6. Optimal Unemployment Insurance and International Risk Sharing By Stähler, Nikolai; Moyen, Stephane; Winkler, Fabian
  7. Borrower heterogeneity within a risky mortgage-lending market By Maria Teresa Punzi; Katrin Rabitsch
  8. Budget-neutral fiscal rules targeting inflation differentials By Brede, Maren
  9. Employment and Welfare Effects of Short-Time Work in Germany By Niedermayer, Kilian; Tilly, Jan
  10. Homeownership and entrepreneurship By Gaetano Lisi
  11. Capital Accumulation and Dynamic Gains from Trade By Ravikumar, B.; Santacreu, Ana Maria; Sposi, Michael J.
  12. On the Cyclicality of R&D Activities By Mand, Matthias
  13. The impact of constrained monetary policy on fiscal multipliers on output and inflation By Bletzinger, Tilman; Lalik, Magdalena
  14. "Do Consumption Externalities Correspond to the Indivisible Tax Rates on Consumpiton?" By Yoichi Gokan
  15. The Burden of Unanticipated Fiscal Policy By Scharrer, Christian; Heer, Burkhard
  16. International Trade and Intertemporal Substitution By Leibovici, Fernando; Waugh, Michael E.
  17. Gradualism and Liquidity Traps By Schmidt, Sebastian; Nakata, Taisuke
  18. Optimal Fiscal Substitutes For The Exchange Rate In A Monetary Union By Kaufmann, Christoph
  19. Firm Entry and Exit and Aggregate Growth By Asturias, Jose; Hur, Sewon; Kehoe, Timothy J.; Ruhl, Kim J.
  20. Competition, Patent Protection, and Innovation in an Endogenous Market Structure By Suzuki, Keishun

  1. By: Born, Benjamin; Pfeifer, Johannes
    Abstract: A growing recent literature relies on a precautionary pricing motive embedded in representative agent DSGE models with sticky prices and wages to generate negative output effects of uncertainty shocks. We assess whether this model channel is consistent with the data. We build a New Keynesian DSGE model with time-varying wage and price markups and document the predicted conditional comovement of output and markups following demand and supply uncertainty shocks. Using the model as a business cycle accounting device, we also construct aggregate markup series from the data. Time-series techniques are used to identify uncertainty shocks in the data and to study whether the conditional comovement between markups and output is consistent with the one implied by the model. The response to uncertainty shocks is found to be consistent with precautionary wage setting, but not price setting, putting the role of sticky wages into the focus.
    JEL: E32 E01 E24
    Date: 2016
  2. By: Ekaterina Pirozhkova (Birkbeck, University of London)
    Abstract: In this paper I study how financial frictions affect robustness of monetary policy in DSGE models in the case of model uncertainty. The types of frictions I consider are financial accelerator and collateral constraints. Modeling monetary policy in terms of optimal interest rate rules, I find that welfare-maximizing policies for the models with financial frictions are robust to model uncertainty. Policy rule optimal for the basic New Keynesian model is not robust. Thereby I show that when there is uncertainty about what type of frictions is at work, a policymaker exposes economy to risks of significant welfare losses by using a reference model without frictions as economy representation. Using fault tolerance approach I find that modified policy rule optimal for the basic New Keynesian model is robust when it allows to respond to fluctuations in output.
    Keywords: optimal monetary policy rules, financial frictions, DSGE models, robustness.
    JEL: E32 E37 E44 E52
    Date: 2017–02
  3. By: Bluwstein, Kristina (European University Institute)
    Abstract: The 2008 financial crisis has shown that financial busts can influence the real economy. However, there is less evidence to suggest that the same holds for financial booms. Using a Markov-Switching vector autoregressive model and euro area data, I show that financial booms tend to be less procyclical than financial busts. To identify the sources of asymmetry, I estimate a non-linear DSGE model with a heterogeneous banking sector and an occasionally binding borrowing constraint. The model matches the key features of the data and shows that the borrowers’ balance sheet channel accounts for the asymmetry in the macro-financial linkages. The muted macro-financial transmission during financial booms can be exploited for macroprudential policies. By comparing capital buffer rules with monetary policy ‘leaningagainst- the-wind’ rules, I find that countercyclical capital buffers improve welfare.
    Keywords: Macro-financial linkages; non-linearities; Markov-Switching VAR; credit channel; occasionally binding constraints; DSGE; macroprudential policy; leaning-against-the-wind policy
    JEL: E44 E52 E58
    Date: 2017–02–01
  4. By: Larin, Benjamin
    Abstract: The 2007-2008 financial crisis highlighted that a turmoil in the financial sector including bursting asset price bubbles can cause pronounced and persistent fluctuations in real economic activity. This justifies the consideration of evolving and bursting asset price bubbles as another source of fluctuations in business cycle models. Business cycle models should therefore include asset price bubble as another source for fluctuations. In this paper rational asset price bubbles are incorporated into a life-cycle RBC model as first developed by Ríos (1996). The calibration of the model to the post-war US economy and the numerical solution show that the model is able to depict plausible bubble-driven business cycles. In particular, the model generates i) a higher and empirically more plausible volatility of consumption at the cost of ii) a lower and empirically less plausible contemporaneous correlation of consumption with output than the life-cycle RBC model without bubbles.
    JEL: D58 E32 E44
    Date: 2016
  5. By: Nezih Guner (CEMFI, Centro de Estudios Monetarios y Financieros); Remzi Kaygusuz (Tilburg University); Gustavo Ventura (Arizona State University)
    Abstract: What are the macroeconomic and welfare effects of expanding transfers to households with children in the United States? How do childcare subsidies compare to alternative policies? We answer these questions in a life-cycle equilibrium model with household labor-supply decisions, skill losses of females associated to non participation, and heterogeneity in terms of fertility, childcare expenditures and access to informal care. We consider the expansion of transfers that are contingent on market work - childcare subsidies and Child and Dependent Care Tax Credits (CDCTC) - versus those that are not - Child Tax Credits (CTC). We find that expansions of transfers of the first group have substantial positive effects on female labor supply, that are largest at the bottom of the skill distribution. Universal childcare subsidies at a 75% rate lead to long-run increases in the participation of married females of 8.8%, while an equivalent expansion of the CTC program leads to the opposite - a reduction of about 2.4%. We find that welfare gains of newborn households are substantial and up to 2.3% under the CDCTC expansion. The expansion of none of the existing programs, however, receives majority support at the time of its implementation. Our findings show substantial heterogeneity in welfare effects, with a small fraction of households - young and poorer households with children - who gain significantly while many others lose.
    Keywords: Household labor supply, child-related transfers, childcare.
    JEL: E62 H24 H31
    Date: 2016–12
  6. By: Stähler, Nikolai; Moyen, Stephane; Winkler, Fabian
    Abstract: In this paper, we discuss how cross-country unemployment insurance can be used to improve international risk sharing. We use a two-country business cycle model ugmented by a search labour market and incomplete financial markets and let the unemployment insurance scheme operate across both countries. We find that cross-country insurance through the unemployment insurance system can in principle be achieved without distorting national labour markets, and that international risk-sharing introduces a countercyclical element to the unemployment insurance tradeoff. When we calibrate our model to the Euro area, the optimal supranational policy makes replacement rates countercyclical, while they would be procyclical in the absence of cross-country transfers. Recent Eurozone policy proposals, by contrast, seem to have only limited effects.
    JEL: H20 J64 E62
    Date: 2016
  7. By: Maria Teresa Punzi (Department of Economics, Vienna University of Economics and Business); Katrin Rabitsch (Department of Economics, Vienna University of Economics and Business)
    Abstract: We propose a model of a risky mortgage-lending market in which we take explicit account of heterogeneity in household borrowing conditions, by introducing two borrower types: one with a low loan-to-value (LTV) ratio, one with a high LTV ratio, calibrated to U.S. data. We use such framework to study a deleveraging shock, modeled as an increase in housing investment risk, that falls more strongly on, and produces a larger contraction in credit for high-LTV type borrowers, as in the data. We find that this deleveraging experience produces significant aggregate effects on output and consumption, and that the contractionary effects are orders of magnitudes higher in a model version that takes account of borrower heterogeneity, compared to a more standard model version with a representative borrower.
    Keywords: Borrowing Constraints, Loan-to-Value ratio, Heterogeneity, Financial Amplification
    JEL: E23 E32 E44
    Date: 2017–02
  8. By: Brede, Maren
    Abstract: In light of persistent inflation dispersion and high debt levels in the EMU, this paper investigates the desirability of budget-neutral fiscal policy rules that respond to the domestic inflation differential. The paper employs a two-country DSGE model of a monetary union with traded and non-traded goods. When consumption or labour income taxes respond to the domestic inflation differential while lump-sum taxes balance the budget, a national fiscal authority is able to reduce welfare costs of business cycle fluctuations by 1-4%. When lump-sum taxes are absent, hybrid rules using only distortionary taxes can reduce welfare costs by 6-10% under demand and supply disturbances. Gains in welfare stem from higher mean consumption due to lower price dispersion when the fiscal authority actively compresses the domestic inflation differential and thus domestic inflation.
    JEL: E62 F41 F45
    Date: 2016
  9. By: Niedermayer, Kilian; Tilly, Jan
    Abstract: We study the employment and welfare effects of short-time work in Germany during the recession between 2008 and 2010. Using a unique matched employer-employee data set that contains the universe of workers and employers for the metropolitan area of Nuremberg, we document the intensive and extensive margin of short-time work. We then develop and estimate an equilibrium search model in which worker-firm matches are subject to productivity shocks that differ in expected duration. After observing the realization of productivity, a worker-firm match decides whether to work full-time, lay off the worker, or use short-time work. Employed workers accumulate human capital whereas unemployed workers’ human capital depreciates. Laid off workers can be recalled by their previous employers. We find that for every four workers on short-time work, one job was saved during the recession.
    JEL: J64 J08 J38
    Date: 2016
  10. By: Gaetano Lisi (Centro di Analisi Economica CREAtività e Motivazioni)
    Abstract: Housing costs can damage labour market outcomes and increase unemployment. Also, an important and related research stream claims that higher homeownership rates are associated with fewer new businesses. Using a search-matching model, this paper investigates the relation between homeownership and entrepreneurship by distinguishing two channels through which homeownership affects the creation of enterprises and jobs. The first channel looks at the job search intensity of homeowners, while the second considers the link between the benefit of being a homeowner and the productivity of a new enterprise. The key result of this paper is that the intrinsic preference for homeownership plays a key role in the establishment of new small businesses, while in general homeownership does not encourage the development of existing enterprises.
    Keywords: entrepreneurship; homeownership; job creation; new firms; small businesses.
    JEL: J63 J64 R21 M13 L26
    Date: 2017–02
  11. 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, multicountry model with capital accumulation. We examine transition paths for 93 countries following a permanent, uniform, unanticipated trade liberalization. Both the relative price of investment and the investment rate respond to changes in trade frictions. Relative to a static model, the dynamic welfare gains in a model with balanced trade are three times as large. The gains including transition are 60 percent of those computed by comparing only steady states. Trade imbalances have negligible effects on the cross-country distribution of dynamic gains. However, relative to the balanced-trade model, small, less-developed countries accrue the gains faster in a model with trade imbalances by running trade deficits in the short run but have lower consumption in the long-run. In both models, most of the dynamic gains are driven by capital accumulation.
    Keywords: Welfare gains from trade; Dynamic gains; Capital accumulation; Trade imbalances
    JEL: E22 F11 O11
    Date: 2017–02–27
  12. By: Mand, Matthias
    Abstract: While an opportunity cost argument suggests that recessions are ideal times to undergo R&D aimed at enhancing productivity, empirical measures of U.S. R&Dactivity are procyclical. To resolve this discrepancy, I propose a calibrated real business cycle model featuring R&D-based growth through horizontal innovations. The model is used to quantitatively analyze the impact of business cycle shocks under various specifications of the R&D process. I find that the specification of R&D inputs is essential for the cyclicality of R&D activities. First, the popular knowledge-driven specification of R&D has a hard time to generate both procyclical R&D investment and procyclical R&D labor at the same time. Second, the calibrated multi-input specification generates procyclical R&D investment as well as procyclical employment of scientists. In addition, the endogenous growth mechanism gives rise to amplification of business cycle shocks.
    JEL: E32 O31 O33
    Date: 2016
  13. By: Bletzinger, Tilman; Lalik, Magdalena
    Abstract: This paper uses two established DSGE models (QUEST III and Smets-Wouters) to assess the impact of fiscal spending cuts on output and, in particular, also on inflation in the euro area under alternative settings for monetary policy. We compare four different settings of constrained monetary policy, taking into account alternative agents’ expectations about future monetary policy. We illustrate that those expectations are even more important for the size of the fiscal multipliers than the difference between exogenously versus endogenously modelled constraints. We confirm the well-known finding that fiscal multipliers exhibit an over-proportional reaction when monetary policy is constrained. The novelty of our results is that this over-proportionality is stronger for the fiscal multiplier on inflation than on output. We relate this finding to the structural parameters of the models by means of a Global Sensitivity Analysis. JEL Classification: E31, E43, E52, E62, E63
    Keywords: constrained monetary policy, fiscal multipliers, zero lower bound
    Date: 2017–02
  14. By: Yoichi Gokan (Faculty of Economics, Ritsumeikan University)
    Abstract: This paper puts the apperantly di¤erent distortions of consumption externalities and endogenous consumption taxes to work in the one-sector Ramsey model without any distortions. We will prove that the two distortions can have similar or possibly exact same dynamic impacts on the aggregate economy, only if we use very familiar preferences in macro-dynamic literature. These two distortions ana- lytically have a very close similarity as the obstacle distorting a market equilibrium path and consumption externalities seem the invisible tax rates (transefer rates) on consumption for positive (negative) external e¤ects.
    Date: 2017–03
  15. By: Scharrer, Christian; Heer, Burkhard
    Abstract: We study the impact of a government spending shock on the distribution of wealth and income between cohorts in a dynamic stochastic overlapping generations model with two types of households, a Ricardian household and a rule-of-thumb consumer. We demonstrate that an unexpected increase in government spending increases income inequality and decreases wealth inequality. In contrast to conventional wisdom that the financing of the additional expenditures by debt rather than taxes especially burdens young on behalf of the old generations, we find that a bond-financed increase in government spending rather harms the Ricardian households during both working age and retirement, while the rule-of-thumb consumers benefit at working age. The crucial element in our analysis is a wealth effect that results from the decline in the price of capital due to higher government debt.
    JEL: E62 E30 E12
    Date: 2016
  16. By: Leibovici, Fernando (Federal Reserve Bank of St. Louis); Waugh, Michael E. (New York University and NBER)
    Abstract: This paper studies the role of international trade delivery lags and variation in the intertemporal marginal rate of substitution in accounting for puzzling features of cyclical fluctuations of international trade volumes. Our insight is that, because international trade is time-intensive, variation in the rate at which agents are willing to substitute across time affects how trade volumes respond to changes in output and prices. We calibrate our model to match key features of U.S. data and discipline the variation in the intertemporal marginal rate of substitution using asset price data. We find that our model is quantitatively consistent with U.S. cyclical import fluctuations.
    JEL: E3 F1 F41
    Date: 2016–06–01
  17. By: Schmidt, Sebastian; Nakata, Taisuke
    Abstract: Modifying the mandate of a discretionary central bank to include an interest-rate smoothing objective increases the welfare of an economy where large contractionary shocks occasionally force the central bank to lower the policy rate to its effective lower bound. The central bank with an interest-rate smoothing objective credibly keeps the policy rate low for longer than the discretionary central bank with the standard mandate does, as in optimal commitment policy. Through expectations, the temporary overheating of the economy associated with such low-for-long interest rate policy mitigates the declines in inflation and output when the lower bound constraint is binding. In a calibrated model, we find that the introduction of an interest-rate smoothing objective can reduce the welfare costs associated with the lower bound constraint by more than half.
    JEL: E52 E61 E58
    Date: 2016
  18. By: Kaufmann, Christoph
    Abstract: This paper studies Ramsey-optimal monetary and fiscal policy in a New Keynesian 2-country open economy framework, which is used to assess how far fiscal policy can substitute for the role of nominal exchange rates within a monetary union. Giving up exchange rate flexibility can result in high welfare costs, which depend significantly on whether firms set prices in producer or in local currency. By using only one tax instrument per country and robust to changes in the calibration, the welfare costs can be reduced by 86% in case of producer currency pricing and by 68% in case of local currency pricing. Optimal policy in a monetary union can be described as a fiscal devaluation: if a nominal devaluation of the domestic currency is optimal under flexible exchange rates, optimal fiscal policy in a monetary union is a relative increase of the domestic VAT.
    JEL: F41 F45 E63
    Date: 2016
  19. By: Asturias, Jose (Georgetown University Qatar); Hur, Sewon (University of Pittsburgh); Kehoe, Timothy J. (Federal Reserve Bank of Minneapolis); Ruhl, Kim J. (Pennsylvania State University)
    Abstract: Using data from Chile and Korea, we find that a larger fraction of aggregate productivity growth is due to firm entry and exit during fast-growth episodes compared to slow-growth episodes. Studies of other countries confirm this empirical relationship. We develop a model of endogenous firm entry and exit based on Hopenhayn (1992). Firms enter with efficiencies drawn from a distribution whose mean grows over time. After entering, a firm’s efficiency grows with age. In the calibrated model, reducing entry costs or barriers to technology adoption generates the pattern we document in the data. Firm turnover is crucial for rapid productivity growth.
    Keywords: Entry; Exit; Productivity; Entry barriers; Barriers to technology adoption
    JEL: E22 O10 O38 O47
    Date: 2017–02–21
  20. By: Suzuki, Keishun
    Abstract: This study revisits the relationship between competition and innovation by incorporating an endogenous market structure (EMS) in a dynamic general equilibrium model. We consider that both innovative and non-innovative followers engage in Cournot competition with free entry. A competition-enhancing policy, which reduces entry cost, can stimulate the entry of innovative followers when the entry cost is high. However, when the entry cost is sufficiently low, the entry of non-innovative followers crowd-out innovative followers from the market. As a result, there is a non-monotonic relationship (inverted-V shape) between competition and innovation. Furthermore, we show that, while strengthening patent protection positively affects innovation when competition is sufficiently intense, the effect may be negative under milder competition. This suggests that a competition policy could complement a patent policy.
    Keywords: Competition, Patent Protection, Innovation, Endogenous Market Structure
    JEL: O30 O40
    Date: 2017–02–25

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.