nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2017‒03‒19
twenty-two papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Data Revisions and DSGE Models By Galvao, Ana Beatriz
  2. Explaining International Business Cycle Synchronization: Recursive Preferences and the Terms of Trade Channel By Kollmann, Robert
  3. Countercyclical Capital Regulation in a Small Open Economy DSGE Model By Lozej, Matija; Onorante, Luca; Rannenberg, Ansgar
  4. Fiscal Policy Shocks and Stock Prices in the United States By Haroon Mumtaz; Konstantinos Theodoridis
  5. Optimal Monetary Policy under Rigid Wages and Decreasing Returns By Kohlbrecher, Britta
  6. Targeted fiscal policy to increase employment and wages of unskilled workers By Konstantinos Angelopoulos; Wei Jiang; James Malley
  7. Money and Credit; Theory and Applications By Liang Wang; Randall Wright; Lucy Qian Liu
  8. The labor market effect of demographic change: Alleviation for financing social security By Friese, Max
  9. Business Cycle Asymmetries and the Labor Market By Merkl, Christian; Kohlbrecher, Britta
  10. Natural cycles and pollution By Stefano Bosi; David Desmarchelier
  11. Labor Market Effects of Pension Reform: An Overlapping Generations General Equilibrium Model Applied to Tunisia By Mouna Ben Othman; Mohamed Ali Marouani
  12. Pareto Weights in Practice: A Quantitative Analysis across 32 OECD Countries By Bo Hyun Chang; Youngsung Chang; Sun-Bin Kim
  13. Agency Costs and the Monetary Transmission Mechanism By Reiter, Michael; Sveen, Tommy; Weinke, Lutz
  14. Recovery is Never Easy - Dynamics and Multiple Equilibria with Financial Arbitrage, Production and Collateral Constraints By Ally Quan Zhang
  15. Managers and Productivity Differences By Nezih Guner; Andrii Parkhomenko; Gustavo Ventura
  16. Housing Wealth Reallocation Between Subprime and Prime Borrowers During Recessions By Sapci, Ayse; Vu, Nam
  17. Fiscal Multipliers in the 21st Century By Pedro Brinca; Hans A. Holter; Per Krusell; Laurence Malafry
  18. Fully Funded Social Security Pensions, Lifetime Risk and Income By Laps, Jochen
  19. Arbitrage with Production, Collateral Constraint and Heterogeneous Belief By Zhang, Ally Quan
  20. Collect More, Spend Better; Public Investment in Asian Frontier Markets By Manuk Ghazanchyan; Ricardo Marto; Jiri Jonas; Kaitlyn Douglass
  21. A comprehensive evaluation of macroeconomic forecasting methods By Andrea Carriero; Galvao, Ana Beatriz; Kapetanios, George
  22. Investment under Rational Inattention: Evidence from US Sectoral Data By Zorn, Peter

  1. By: Galvao, Ana Beatriz (Warwick Business School, University of Warwick)
    Abstract: The typical estimation of DSGE models requires data on a set of macroeconomic aggregates, such as output, consumption and investment, which are subject to data revisions. The conventional approach employs the time series that is currently available for these aggregates for estimation, implying that the last observations are still subject to many rounds of revisions. This paper proposes a release-based approach that uses revised data of all observations to estimate DSGE models, but the model is still helpful for real-time forecasting. This new approach accounts for data uncertainty when predicting future values of macroeconomic variables subject to revisions, thus providing policy-makers and professional forecasters with both backcasts and forecasts. Application of this new approach to a medium-sized DSGE model improves the accuracy of density forecasts, particularly the coverage of predictive intervals, of US real macrovariables. The application also shows that the estimated relative importance of business cycle sources varies with data maturity.
    Keywords: data revisions ; medium-sized DSGE models ; forecasting ; variance decomposition JEL Classification Numbers: C53
    Date: 2016
  2. By: Kollmann, Robert
    Abstract: The business cycles of advanced economies are synchronized. Standard macro models fail to explain that fact. This paper presents a simple model of a two-country, two-traded-good, complete-financial-markets world in which country-specific productivity shocks generate business cycles that are highly correlated internationally. The model assumes recursive intertemporal preferences (Epstein-Zin-Weil), and a muted response of labor hours to household wealth changes (due to Greenwood-Hercowitz-Huffman period utility and demand-determined employment under rigid wages). Recursive intertemporal preferences magnify the terms of trade response to country-specific shocks.Hence, a productivity (and GDP) increase in a given country triggers a strong improvement of the foreign country’s terms of trade, which raises foreign labor demand. With a muted labor wealth effect, foreign labor and GDP rise, i.e. domestic and foreign real activity comove positively.
    Keywords: international business cycle synchronization, recursive preferences, terms of trade, real exchange rate, wealth effect on labor supply
    JEL: E32 F31 F32 F36 F41 F43 F44 F47
    Date: 2017–03–15
  3. By: Lozej, Matija (Central Bank of Ireland); Onorante, Luca; Rannenberg, Ansgar (Central Bank of Ireland)
    Abstract: We assess the macroeconomic performance of different countercyclical capital buffer rules, where regulatory capital responds to deviation from a long-run trend in the credit-to-GDP ratio (the credit gap), in a medium scale DSGE model of the Irish economy. We find that rules based on the credit gap create a trade-off between the stabilisation of fluctuations originating in the housing market (which are attenuated) and stabilisation of fluctuations caused by foreign demand shocks (which are amplified) because the credit gap is not always procyclical. The trade-off disappears if the regulator follows a rule based on house prices instead of the credit gap.
    Keywords: Bank capital, Countercyclical capital regulation, Housing bubbles, boom-and-bust.
    JEL: F41 G21 G28 E32 E44
    Date: 2017–01
  4. By: Haroon Mumtaz (Queen Mary University of London); Konstantinos Theodoridis (Bank of England and Lancaster University)
    Abstract: This paper uses a range of structural VARs to show that the response of US stock prices to fiscal shocks changed in 1980. Over the period 1955-1980 an expansionary spending or revenue shock was associated with modestly higher stock prices. After 1980, along with a decline in the fiscal multiplier, the response of stock prices to the same shock became negative and larger in magnitude. We use an estimated DSGE model to show that this change is consistent with a switch from an economy characterised by active fiscal policy and passive monetary policy to one where fiscal policy was passive and the central bank acted aggressively in response to inflationary shocks.
    Keywords: Fiscal policy shocks, Stock prices, VAR, DSGE
    JEL: C5 E1 E5 E6
    Date: 2017–02
  5. By: Kohlbrecher, Britta
    Abstract: This paper is the first to study optimal Ramsey monetary policy in a search and matching model that combines real wage rigidity and decreasing returns to scale in production. Adding decreasing returns to scale significantly reduces the trade-off between employment and inflation stabilization usually associated with real wage rigidity. As firms adjust employment in response to an aggregate productivity shock, the resulting change in the marginal product of labor partly offsets the effect of a rigid real wage on marginal costs. The effect is quantitatively important. Optimal inflation volatility is reduced by a factor of four compared to a model with constant returns.
    JEL: E24 E52 J64
    Date: 2016
  6. By: Konstantinos Angelopoulos; Wei Jiang; James Malley
    Abstract: We extend the canonical model of search and matching frictions by including capital-skill complementarity in production, labour markets with skilled and unskilled workers and on-the-job-learning (OJL) within and across skill types. These extensions capture key characteristics of skilled and unskilled labour markets in the data. We find that increases in public spending to enhance unskilled productivity via OJL are beneficial to employed unskilled workers and reduce earnings inequality between employed skilled and unskilled labour. However, unskilled unemployment and labour income inequality within the group of unskilled labour rises. We next find that vacancy subsidies work to increase employment and returns to unskilled workers. However, unemployment for skilled workers rises and skilled wages and labour income fall in the short-run. We finally show that it is possible to increase skilled vacancy subsidies to nullify the negative effects on skilled employment following an increase in unskilled vacancy subsidies.
    Keywords: fiscal policy; sectoral labour productivity; earnings inequality; search and matching
    JEL: E24 E32 J63 J64 J68
    Date: 2017–01
  7. By: Liang Wang; Randall Wright; Lucy Qian Liu
    Abstract: We develop a theory of money and credit as competing payment instruments, then put it to work in applications. Buyers can use cash or credit, with the former (latter) subject to the inflation tax (transaction costs). Frictions that make the choice of payment method interesting also imply equilibrium price dispersion. We deliver closed-form solutions for money demand. We then show the model can simultaneously account for the price-change facts, cash-credit shares in micro payment data, and money-interest correlations in macro data. We analyze the effects of inflation on welfare, price dispersion and markups. We also describe nonstationary equilibria as self-fulfilling prophecies, which is standard, except here it entails dynamics in the price distribution.
    Keywords: Money;Credit;Demand for money;Sticky prices;Welfare;Econometric models;Money, Credit, Inflation, Price Dispersion, Sticky Prices
    Date: 2017–01–27
  8. By: Friese, Max
    Abstract: The paper shows the effect of demographic change on per capita burden of financing a PAYG social security system in the standard OLG model with a frictional labor market. Rising longevity and decreasing fertility both induce a rise in the employment level via increased capital accumulation and job openings. Simulations of the theoretical model show that this labor market effect indirectly crowds out part of the initial demographic shock's direct impact on per capita financing burden. This holds true for the generation at the period of impact as well as for the following generations.
    JEL: H55 J11 E24
    Date: 2016
  9. By: Merkl, Christian; Kohlbrecher, Britta
    Abstract: This paper shows that the matching function and the Beveridge curve in the United States exhibit strong nonlinearities over the business cycle. These patterns can be replicated by enhancing a search and matching model with idiosyncratic productivity shocks for new contacts. Large negative aggregate shocks move the hiring cutoff point into a part of the idiosyncratic density function with higher density and thereby generate large, asymmetric job-finding rate and unemployment reactions. Our proposed mechanism is of high relevance as it leads to time varying effects of certain policy interventions.
    JEL: E24 E32 E00
    Date: 2016
  10. By: Stefano Bosi (EPEE, University of Evry); David Desmarchelier (BETA, University of Lorraine)
    Abstract: In this paper, we study a competitive Ramsey model where a pollution externality, coming from production, impairs a renewable resource which affects the consumption demand. A proportional tax, levied on the production level, is introduced to finance public depollution expenditures. In the long run, two steady states may coexist, the one with a low resource level, the other with a high level. Interestingly, a higher green tax rate lowers the resource level of the low steady state, giving rise to a Green Paradox (Sinn, 2008). Moreover, the green tax may be welfare-improving at the high steady state but never at the low one. Therefore, at the latter, it is optimal to reduce the green tax rate as much as possible. Conversely, the optimal tax rate is positive when the economy experiences the high steady state. This rate is unique. In the short run, the two steady states may collide and disappear through a saddle-node bifurcation. Since consumption and natural resources are substitutable goods, a limit cycle may arise around the high stationary state. To the contrary, this kind of cycles never occur around the low steady state whatever the resource effect on consumption demand. Finally, focusing on the class of bifurcations of codimension two, we find a Bogdanov-Takens bifurcation.
    Keywords: Logistic dynamics, Ramsey model, Saddle-node bifurcation, Hopf bifurcation, Bogdanov-Takens bifurcation
    JEL: E32 O44
    Date: 2017–02
  11. By: Mouna Ben Othman; Mohamed Ali Marouani (Paris 1 Pantheon-Sorbonne University)
    Abstract: This paper develops an overlapping general equilibrium framework to capture the interactions among pension reform, labor market and inter-generational distribution issues in Tunisia. The impact on the labor market is addressed at the aggregate level but also by distinguishing different age categories. The three reform scenarios implemented to reduce the social security deficit consist in increasing social security contributions, reducing the replacement rate and postponing the retirement age. The main result obtained is that increasing contribution rates is the worst solution in terms of welfare and unemployment, particularly for the youth. The best option is postponing the retirement age. Contrary to the traditional wisdom, it does not entail an increase of youth unemployment. For the two scenarios where aggregate welfare increases, the middle-aged are those that benefit the most from the reforms.
    Date: 2016–06
  12. By: Bo Hyun Chang; Youngsung Chang; Sun-Bin Kim
    Abstract: We develop a quantitative heterogeneous-agents general equilibrium model that reproduces the income inequalities of 32 countries in the Organization for Economic Co-operation and Development. Using this model, we compute the optimal income tax rate for each country under the equal-weight utilitarian social welfare function. We simulate the voting outcome for the utilitarian optimal tax reform for each country. Finally, we uncover the Pareto weights in the social welfare functions of each country that justify the current redistribution policy.
    Keywords: Income Inequality, Optimal Tax, Pareto Weights, Political Economy, Redistribution
    Date: 2016–02
  13. By: Reiter, Michael (Institute for Advanced Studies, Vienna); Sveen, Tommy (BI Norwegian Business School); Weinke, Lutz (Humboldt Universitaet zu Berlin)
    Abstract: Once New Keynesian (NK) theory (see, e.g., Woodford 2003) is combined with a standard model of investment (see, e.g., Thomas 2002), the resulting framework loses its ability to generate a realistic monetary transmission mechanism. This is the puzzle uncovered in Reiter et al. (2013). The simple economic reason behind it is the unrealistically large interest rate elasticity of investment, as implied by standard investment theory. In order to address this puzzle we develop a NK model featuring fully flexible investment combined with a financial friction in the spirit of Carlstrom and Fuerst (1997). This model is used to isolate the quantitative importance of the financial friction for the monetary transmission mechanism.
    Keywords: Financial Frictions, Sticky Prices
    JEL: E22 E31 E32
    Date: 2017–03
  14. By: Ally Quan Zhang (University of Zurich and Swiss Finance Institute)
    Abstract: We develop a simple general equilibrium model to study the interactions between financial arbitrage and the real economy under collateral constraints. In good times, arbitrage activities help boost the production sectors by providing external funds to capital investment. However, when exposed to adverse shocks and panic market reactions, arbitrage also amplifies the financial distress and makes it easier for the economy to fall into self-fulfilling crises. Moreover, the possibility of regime switches triggered by exogenous shocks also complicates the path to recovery. The combination of financial distress and pessimistic market anticipation not only slows down the recovery process, but also can trap the economy in a less healthy steady state.
    Keywords: limit of arbitrage, financial intermediary, segmented markets, financial crises, market liquidity, multiple equilibria, collateral constraints
    JEL: D52 D58 E44 G01 G12
    Date: 2017–01
  15. By: Nezih Guner; Andrii Parkhomenko; Gustavo Ventura
    Abstract: We document that for a group of high-income countries (i) mean earnings of managers tend to grow faster than for non managers over the life cycle; (ii) the earnings growth of managers relative to non managers over the life cycle is positively correlated with output per worker. We interpret this evidence through the lens of an equilibrium life-cycle, span-of-control model where managers invest in their skills. We parameterize this model with U.S. observations on managerial earnings, the size-distribution of plants and macroeconomic aggregates. We then quantify the relative importance of exogenous productivity differences, and the size-dependent distortions emphasized in the misallocation literature. Our findings indicate that such distortions are critical to generate the observed differences in the growth of relative managerial earnings across countries. Thus, observations on the relative earnings growth of managers become natural targets to discipline the level of distortions. Distortions that halve the growth of relative managerial earnings (a move from the U.S. to Italy in our data), lead to a reduction in managerial quality of 27% and to a reduction in output of about 7% – more than half of the observed gap between the U.S. and Italy. We find that crosscountry variation in distortions accounts for about 42% of the cross-country variation in output per worker gap with the U.S.
    Keywords: Managers, Management, Practices, Distortions, Size, Skill Investments, Productivity Differences
    JEL: E23 E24 J24 M11 O43 O47
    Date: 2015–12
  16. By: Sapci, Ayse (Department of Economics, Colgate University); Vu, Nam (Department of Economics, Colgate University)
    Abstract: We study a general equilibrium model with a housing market to understand the role of credit access among borrowers and show that an adverse financial shock can increase the asymmetry in the housing wealth distribution of subprime and prime borrowers. Households with better credit access can take advantage of the low housing prices during recessions, especially when the subprimers are previously subjected to lax credit conditions. Our model is consistent with the data since the late 1980s, showing that the homeownership rates of the two groups move in opposite directions during turmoils as prime borrowers are more likely to invest in the housingmarket during recessions.
    Date: 2017–03–01
  17. By: Pedro Brinca; Hans A. Holter; Per Krusell; Laurence Malafry
    Abstract: The recent experience of a Great Recession has brought the effectiveness of fiscal policy back into focus. Fiscal multipliers do, however, vary greatly over time and place. Running VARs for a large number of countries, we document a strong correlation between wealth inequality and the magnitude of fiscal multipliers. To explain this finding, we develop a life-cycle, overlapping generations economy with uninsurable labor market risk. We calibrate our model to match key characteristics of a number of OECD economies, including the distribution of wages and wealth, social security, taxes and debt and study the effects of changing policies and various forms of inequality on the fiscal multiplier. We find that the fiscal multiplier is highly sensitive to the fraction of the population who face binding credit constraints and also negatively related to the average wealth level in the economy. This explains the correlation between wealth inequality and fiscal multipliers.
    Keywords: Fiscal Multipliers, Wealth Inequality, Government Spending, Taxation
    JEL: E21 E62 H50
    Date: 2015–09
  18. By: Laps, Jochen
    Abstract: The paper analyzes the welfare consequences of insuring mortality risk by means of standard, fully funded Social Security pensions when individuals wish to make transfers to their heirs. In the presence of uninsured mortality risk, within-family transfers depend on realized lifespan. While Social Security crowds out private transfers, it provides transfer insurance and insurance of the ex ante risk of future generations inheriting a particular amount of transfer wealth. We find that, once ex ante insurance is taken into account, Social Security is welfare improving over the long-run as long as capital is not too productive and the transfer motive is not too strong. Altruists gain far less from Social Security than egoists.
    JEL: D91 E61 H55
    Date: 2016
  19. By: Zhang, Ally Quan
    Abstract: We construct a dynamic model economy in which households from segmented markets have varying financial asset demand. Intermediaries make profit by exploiting the price difference in segmented financial markets. However, intermediaries have to separately post their physical investment as collateral to trade. We show that the heterogeneous belief will disturb the intermediaries’ self-recovery process in both financial and real sectors through endogenously determined collateral constraints. The dynamic interaction between belief determined collateral constraint and liquidity supply turns out to be a powerful transmission mechanism by which the effects of shocks persist, amplify and spill over to other sectors.
    JEL: E44 G01 P43
    Date: 2016
  20. By: Manuk Ghazanchyan; Ricardo Marto; Jiri Jonas; Kaitlyn Douglass
    Abstract: We use a dynamic small open economy model to explore the macroeconomic impact of alternative public investment scaling-up scenarios, analyzing how improving the efficiency of capital spending and of tax revenue collection affect growth and debt sustainability for three fast-growing Southeast Asian economies: Cambodia, Sri Lanka, and Vietnam. We show that a gradual public investment profile is more favorable than front-loading capital spending because we assume governments are able to gradually learn how to invest more efficiently, accelerating public capital accumulation and therefore growth. We discuss the pros and cons of alternative financing options and identify the financing mix that generates the best macroeconomic outcome. Sometimes overlooked, improving the efficiency of revenue collection over time may ease the burden of fiscal adjustment, achieving higher GDP growth with substantially lower debt-to-GDP ratios, and will help policymakers efficiently meet the challenge of addressing large infrastructure gaps while maintaining debt sustainability.
    Keywords: Public investment;Cambodia;Sri Lanka;Vietnam;Southeast Asia;Emerging markets;Tax collection;Capital expenditure;Fiscal policy;Public Investment, Growth, Debt Sustainability, Fiscal Policy, Revenue Collection, Cambodia, Sri Lanka, Vietnam.
    Date: 2017–01–24
  21. By: Andrea Carriero (Queen Mary University of London); Galvao, Ana Beatriz (University of Warwick); Kapetanios, George (Kings College London)
    Abstract: This paper contributes to the academic literature and the practice of macroeconomic forecasting. Our evaluation compares the performance of four classes of state-of-art forecasting models : Factor-Augmented Distributed Lag (FADL) Models, Mixed Data Sampling (MIDAS) Models, Bayesian Vector Autoregressive (BVAR) Models and a medium-sized Dynamic Stochastic General Equilibrium Model (DSGE). We look at these models to predict output growth and ination with datasets from the US, UK, Euro Area, Germany, France, Italy and Japan. We evaluate the accuracy of point and density forecasts, and compare models with a large set of predictors with models that employ a medium-sized dataset. Our empirical results shed light on how the predictive ability of economic indicators for output growth and ination changes with horizon, on the impact of dataset size on the calibration of density forecasts, and how the choice of the multivariate forecasting model depends on the forecasting horizon.
    Keywords: factor models ; BVAR models ; MIDAS models ; DSGE models ; density forecasts JEL Classification Numbers: C53
    Date: 2016
  22. By: Zorn, Peter
    Abstract: I document the effects of macroeconomic and sector-specific shocks on investment in disaggregate sectoral capital expenditure data. The response of sectoral investment to macroeconomics shocks is protracted and hump-shaped, just as in aggregate data. By contrast, the effects of sector-specific innovations are short-lived and monotonically decreasing. I build a model of investment with rational inattention to explain these facts. The model predicts protracted effects of aggregate shocks and short-lived effects of sector-specific shocks on sectoral investment.
    JEL: E22 E32 D83
    Date: 2016

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