nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2017‒04‒30
twenty-two papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Commodity price risk management and fiscal policy in a sovereign default model By Bernabe Lopez-Martin; Julio Leal; Andre Martinez Fritscher
  2. The Macro-Dynamics of Sorting between Workers and Firms By Jeremy Lise; Jean-Marc Robin
  3. Matching, Sorting, and Wages By Jeremy Lise; Costas Meghir; Jean-Marc Robin
  4. The Effectiveness of a Fiscal Transfer Mechanism in a Monetary Union: A DSGE Model for the Euro Area By Loes Verstegen; Lex Meijdam
  5. Capital injection to banks versus debt relief to households By Yoo, Jinhyuk
  6. Input vs. output taxation - a DSGE approach to modelling resource decoupling By Marek Antosiewicz; Piotr Lewandowski; Jan Witajewski-Baltvilks
  7. Frictional Unemployment and Stochastic Bubbles By Guillaume Vuillemey; Etienne Wasmer
  8. Population Aging, Health Care, and Fiscal Policy Reform: The challenges for Japan By HSU Minchung; YAMADA Tomoaki
  9. Disentangling Goods, Labor, and Credit Market Frictions in Three European Economies By Thomas Brzustowski; Nicolas Petrovsky-Nadeau; Etienne Wasmer
  10. Fiscal Policy Uncertainty and Economic Activity in South Africa By Kevin Kotze
  11. Life Insurance and Life Settlement Markets with Overconfident Policyholders By Hanming Fang; Zenan Wu
  12. Labor Market Reforms and Unemployment Dynamics By Fabrice Murtin; Jean-Marc Robin
  13. The Welfare Cost of Inflation Risk Under Imperfect Insurance By Yann Algan; Olivier Allais; Edouard Challe; Xavier Ragot
  14. The Cyclical Behavior of Unemployment and Wages under Information Frictions By Camilo Morales-Jimenez
  15. International shocks and macroeconomics: a new multi-country DSGE platform for policy analysis in OECD countries. By Edgar Mata Flores
  16. Interest Rate Volatility And Macroeconomic Dynamics: A Cross-Country Analysis By Michael Curran; Adnan Velic
  17. Assets with possibly negative dividends By Pham, Ngoc-Sang
  18. Can Fiscal Budget-Neutral Reforms Stimulate Growth? Model-Based Results By M. Bussière; L. Ferrara; M. Juillard; D. Siena
  19. THEORETICAL FRAMEWORK OF THE GREAT RECESSION in US (2008-2015Q2) (Comparison With Great Depression) By Leyla Baştav
  20. Information Frictions and Real Exchange Rate Dynamics By Giacomo Candian
  21. Labor Market Effects of Pension Reform :an overlapping genenrations general equilibrium model applied to Tunisia By MOUNA BEN OTHMAN; Mohamed Ali MAROUANI
  22. The German labor market in the Great Recession: Shocks and institutions By Gehrke, Britta; Lechthaler, Wolfgang; Merkl, Christian

  1. By: Bernabe Lopez-Martin; Julio Leal; Andre Martinez Fritscher
    Abstract: Commodity prices are an important driver of fiscal policy and the business cycle in many developing and emerging market economies. We analyze a dynamic stochastic small-open-economy model of sovereign default, featuring endogenous fiscal policy and stochastic commodity revenues. The model accounts for a positive correlation of commodity revenues with government expenditures and a negative correlation with tax rates. We quantitatively document the extent to which the utilization of different financial hedging instruments by the government contributes to lowering the volatility of different macroeconomic variables and their correlation with commodity revenues. An event analysis illustrates how financial hedging instruments moderate fiscal adjustment in response to significant falls in the price of commodities. We evaluate the conditional and unconditional welfare gains for the representative household, generated by financial derivatives and commodity-indexed bonds.
    Keywords: commodity revenues, hedging, indexed bonds, fiscal policy, sovereign default
    Date: 2017–03
  2. By: Jeremy Lise (University College of London); Jean-Marc Robin (Département d'économie)
    Abstract: We develop an equilibrium model of on-the-job search with ex ante heterogeneous workers and firms, aggregate uncertainty, and vacancy creation. The model produces rich dynamics in which the distributions of unemployed workers, vacancies, and worker-firm matches evolve stochastically over time. We prove that the surplus function, which fully characterizes the match value and the mobility decision of workers, does not depend on these distributions. This result means the model is tractable and can be estimated. We illustrate the quantitative implications of the model by fitting to US aggregate labor market data from 1951–2012. The model has rich implications for the cyclical dynamics of the distribution of skills of the unemployed, the distribution of types of vacancies posted, and sorting between heterogeneous workers and firms.
    Keywords: On-the-job search; Heterogeneity; Aggregate fluctuations; Mismatch
    JEL: E24 E32 J63 J64
    Date: 2016
  3. By: Jeremy Lise (University College of London); Costas Meghir (Economics department); Jean-Marc Robin (Département d'économie)
    Abstract: We develop an empirical search-matching model which is suitable for analyzing the wage, employment and welfare impact of regulation in a labor market with heterogeneous workers and jobs. To achieve this we develop an equilibrium model of wage determination and employment which extends the current literature on equilibrium wage determination with matching and provides a bridge between some of the most prominent macro models and microeconometric research. The model incorporates productivity shocks, long-term contracts, on-the-job search and counter-offers. Importantly, the model allows for the possibility of assortative matching between workers and jobs due to complementarities between worker and job characteristics. We use the model to estimate the potential gain from optimal regulation and we consider the potential gains and redistributive impacts from optimal unemployment benefit policy. Here optimal policy is defined as that which maximizes total output and home production, accounting for the various constraints that arise from search frictions. The model is estimated on the NLSY using the method of moments.
    Keywords: Sorting; Mismatch; Search-matching; Wage dynamics
    JEL: J3 J64 J65
    Date: 2016–01
  4. By: Loes Verstegen; Lex Meijdam
    Abstract: In this paper, we incorporate a transfer mechanism into a DSGE model with a rich fiscal sector to assess the effectiveness of fiscal transfers for a monetary union, in particular for the Economic and Monetary Union. Using a heterogeneous setup, the model is estimated for the North and the South of Europe using Bayesian methods. The results show that the transfer mechanism is effective in stabilizing the economy of the southern block of countries during the financial crisis, although the total welfare effect for the EMU is negative, though small. Ex ante, a transfer mechanism would be beneficial for both the North and the South in terms of welfare and stabilization purposes.
    Keywords: Economic and Monetary Union of Europe, General equilibrium modeling, Public finance
    Date: 2016–07–04
  5. By: Yoo, Jinhyuk
    Abstract: House financing has played a prominent role in advanced economies. In addition, most of the banking crises in advanced economies were associated with boom-bust cycles in house prices. Prominent researchers suggest that more grants for household debt reduction would have provided a significant boost to the economy lacking aggregate demand after the Great Recession of 2007. In contrast, leading policy makers at that time, such as Geithner and Summers, argue differently. In his paper, Yoo comes up with a dynamic stochastic equilibrium (DSGE) model to evaluate the relative effectiveness of a policy to inject capital into banks versus a policy to relieve households of mortgage debt. He concludes that in the middle of a housing debt crisis, when households are highly leveraged, the short-run effects of the debt relief policy are more substantial. When the zero lower bound is additionally considered, the debt relief pölicy can be much more powerful in boosting the economy both in the short-run and in the long-run.
    Keywords: capital injection to banks,debt relief to households,housing debt crisis,macro-financial linkages,leverage,zero lower bound
    JEL: E17 E44 E52 E62 G1 G21 H12
    Date: 2017
  6. By: Marek Antosiewicz; Piotr Lewandowski; Jan Witajewski-Baltvilks
    Abstract: Explore two forms of taxation (input and output tax) and their ability to induce resource efficiency. Details in paper. Large scale Multisector DSGE model containing endogenous technological change mechanism calibrated for EU and Kalman filter simulations. Details in paper. Input taxation more efficient in inducing resource efficiency at lower macroeconomic cost. Details in paper.
    Keywords: EU27, General equilibrium modeling, Tax policy
    Date: 2016–07–04
  7. By: Guillaume Vuillemey (Département d'économie); Etienne Wasmer (Département d'économie)
    Abstract: Bubbles are recurrent events, which contribute to both macroeconomic and employment volatility. We introduce stochastic bubbles in the standard search-and matching model of the labor market. The economy alternates between latent and bubbly states, each being associated with a distinct solution for the market value of firms (respectively, stable or explosive). Bubbles in firm value induce distortions in hiring decisions and wages, which we explicitly characterize. Faced with bubbles, the social planner optimally deviates from the standard Hosios efficiency condition. The optimal share of workers in total surplus must be above the elasticity of hiring rates, by a small but increasing amount as the bubble expands. Finally, our specification for bubbles significantly improves the quantitative ability of the model to match U.S. data, along both real and financial dimensions.
    Keywords: Unemployemnt volatility; Labor frictions; Bubbles
    JEL: E32 J60
    Date: 2016–10
  8. By: HSU Minchung; YAMADA Tomoaki
    Abstract: This paper quantitatively studies the influence of a rapidly aging population on the financing of a public universal health insurance system and the corresponding fiscal policies. We construct a general equilibrium life-cycle model to investigate the effects of aging and evaluate various policy alternatives designed to lessen the negative influence of aging. In particular, we analyze the reforms of insurance benefits and tax financing tools that were the recent focus of a great amount of attention and debate in Japan because of the tense financial situation. We show that although the potential reforms significantly improve the welfare of future generations, political implementation of such reforms is difficult because of the large welfare costs for the current population. Our analysis suggests that a gradual reform with an intergenerational redistribution will be more implementable politically than a sudden reform.
    Date: 2017–03
  9. By: Thomas Brzustowski (London School of Economics and Political Science (LSE)); Nicolas Petrovsky-Nadeau (Tepper School of Business); Etienne Wasmer (Département d'économie)
    Abstract: We build a flexible model with search frictions in three markets: credit, labor, and goods markets. We then apply this model (called CLG) to three different economies: a flexible, finance-driven economy (the UK), an economy with wage moderation (Germany), and an economy with structural rigidities (Spain). In these three countries, goods and credit market frictions play a dominant role in entry costs and account for 75% to 85% of the total entry costs. In the goods market, adverse supply shocks are amplified through their propagation to the demand side, as they also imply income losses for consumers. This adds up to, at most, an additional 15% to 25% to the impact of the shocks. Finally, the speed of matching in the goods market and the credit market accounts for a small fraction of unemployment: most variation in unemployment comes from the speed of matching in the labor market.
    Keywords: Search; Matching; Financial frictions; Goods frictions
    Date: 2016
  10. By: Kevin Kotze (School of Economics, University of Cape Town)
    Abstract: This paper considers the effect of fiscal volatility shocks on key macroeconomic variables. The identification of these shocks is derived from a stochastic volatility model that is applied to policy rules for each fiscal instrument. Thereafter, a vector autoregressive model makes use of these measures in a reduced-form setting to consider the effect of an aggregate fiscal volatility shock on economic output, consumption, investment, prices and interest rates. The final part of the analysis involves the construction of a dynamic stochastic general equilibrium model that may be used to investigate the effects of an unexpected increase in the volatility of each fiscal instrument. The results suggest that fiscal volatility shocks produce prolonged contractions in economic output, consumption and investment. In addition, the labour market is also negatively affected, while gross markups and inflation increase. Hence, it is suggested that fiscal volatility shocks have had an important adverse effect on economic activity in South Africa.
    Date: 2017
  11. By: Hanming Fang; Zenan Wu
    Abstract: We analyze how the life settlement market – the secondary market for life insurance – may affect consumer welfare in a dynamic equilibrium model of life insurance with one-sided commitment and overconfident policyholders. As in Daily et al. (2008) and Fang and Kung (2010), policyholders may lapse their life insurance policies when they lose their bequest motives; but in our model the policyholders may underestimate their probability of losing their bequest motive, or be overconfident about their future mortality risks. For the case of overconfidence with respect to bequest motives, we show that in the absence of life settlement overconfident consumers may buy “too much” reclassification risk insurance for later periods in the competitive equilibrium. In contrast, when consumers are overconfident about their future mortality rates in the sense that they put too high a subjective probability on the low-mortality state, the competitive equilibrium contract in the absence of life settlement exploits the consumer bias by offering them very high face amounts only in the low-mortality state. In both cases, life settlement market can impose a discipline on the extent to which overconfident consumers can be exploited by the primary insurers. We show that life settlement may increase the equilibrium consumer welfare of overconfident consumers when they are sufficiently vulnerable in the sense that they have a sufficiently large intertemporal elasticity of substitution of consumption.
    JEL: D03 D86 G22 L11
    Date: 2017–03
  12. By: Fabrice Murtin (Département d'économie); Jean-Marc Robin (Département d'économie)
    Abstract: We quantify the contribution of labor market reforms to unemployment dynamics in nine OECD countries (Australia, France, Germany, Japan, Portugal, Spain, Sweden, UK, US). We estimate a dynamic stochastic search-matching model with heterogeneous workers and aggregate productivity shocks. The heterogeneous-worker mechanism proposed by Robin (2011) explains unemployment volatility by productivity shocks well in all countries. Placement and employment services, UI benefit reduction and product market deregulation are found to be the most prominent policy levers for unemployment reduction. Business cycle shocks and LMPs explain about the same share of unemployment volatility (except for Japan, Portugal and the US).
    Keywords: Unemployment dynamics; Turnover; Labor market institutions; Job search; Matching function
    JEL: E24 E32 J21
    Date: 2016
  13. By: Yann Algan (Département d'économie); Olivier Allais (Laboratoire de Recherche sur la Consommation); Edouard Challe (Department of Economics); Xavier Ragot (Observatoire français des conjonctures économiques)
    Abstract: What are the costs of inflation fluctuations and who bears those costs? In this paper, we investigate this question by means of a quantitative incomplete-market, heterogenous-agent model wherein households hold real and nominal assets and are subject to both idiosyncratic labor income shocks and aggregate inflation risk. Inflation risk is found to generate significant welfare losses for most households, i.e., between 1 and 1.5 percent of permanent consumption. The loss is small or even negative for households at the very top of the productivity and/or wealth distribution. A key feature of our analysis is a nonhomothetic specification for households’ preferences towards money and consumption goods. Unlike traditional specifications, ours allows the model to reproduce the broad features of the distribution of monetary assets (in addition to being consistent with the joint distribution of nonmonetary assets and consumption).
    Keywords: Money-in-the-utility; Incomplete markets; Inflation risk; Welfare
    JEL: E21 E32 E41
    Date: 2016–02
  14. By: Camilo Morales-Jimenez
    Abstract: I propose a new mechanism for sluggish wages based on workers' noisy information about the state of the economy. Wages do not respond immediately to a positive aggregate shock because workers do not (yet) have enough information to demand higher wages. This increases firms' incentives to post more vacancies, which makes unemployment volatile and sensitive to aggregate shocks. The model is robust to two major criticisms of existing theories of sluggish wages and volatile unemployment: flexibility of wages for new hires and pro-cyclicality of the opportunity cost of employment. Calibrated to U.S. data, the model explains 70% of unemployment volatility.
    Keywords: Information Frictions ; Unemployment ; Wages and compensation
    JEL: E24 E32 J31 J63
    Date: 2017–03–01
  15. By: Edgar Mata Flores
    Abstract: To disclose the impact and features of international macroeconomic shocks between heterogeneous economies linked within networks of commercial and financial exchange. Multi-country DSGE modelling, regional networks, Bayesian estimations, partial information solution, stochastic simulation. Distinctive features of the impacts of macroeconomic, risk and policy shocks on representative variables as output, general and consumer prices, interest rates and employment.
    Keywords: Australia, Canada, France, Germany, Japan, Korea, Mexico, Spain, United States., General equilibrium modeling, Macroeconometric modeling
    Date: 2016–07–04
  16. By: Michael Curran (Department of Economics, Villanova School of Business, Villanova University); Adnan Velic (Dublin Institute of Technology)
    Abstract: Employing relatively novel computational techniques, this paper examines the relation between real interest rate volatility and macroeconomic dynamics for a diverse panel of countries. Empirically, we find that interest rate volatility is quite high and persistent overall, with estimates exhibiting non-negligible heterogeneity across countries. Moreover, we highlight that volatility increases at higher interest rate levels, while it is negatively correlated with measures of macroeconomic performance such as output, consumption and investment. Our analysis demonstrates that the empirical facts can be generated by a DSGE model augmented with stochastic volatility shocks.
    Keywords: interest rates; stochastic volatility; persistence; macroeconomic dynamics; general equilibrium models
    JEL: C11 E13 E32 E43 E44 F41
    Date: 2017–04
  17. By: Pham, Ngoc-Sang
    Abstract: The paper introduces assets whose dividends can take any value (positive, negative or zero) in a dynamic general equilibrium model with financial market imperfections. We investigate the interplay between the asset markets and the production sector. The behavior of asset price and value is also studied.
    Keywords: Infinite-horizon, general equilibrium, productivity, asset price, negative dividend
    JEL: D5 D90 E44 G12
    Date: 2017–04–07
  18. By: M. Bussière; L. Ferrara; M. Juillard; D. Siena
    Abstract: This paper focuses on growth enhancing budget-neutral fiscal reforms, i.e. changes in the composition of government revenues and spending that stimulate GDP growth while keeping the ratio of the fiscal budget to GDP constant. To this aim, we present simulation results using a multi-country DSGE model with three large economic regions, the US, the euro area and the rest of the world. The model features constrained and unconstrained non-Ricardian households and a detailed government sector; its multi-country nature allows investigating cross-country spillovers. The paper focuses on the most growth-friendly budget-neutral fiscal measures: (i) an incomplete fiscal devaluation (ii) a rise in government investment compensated by a fall in government consumption and (iii) a rise in government investment compensated by a rise in consumption and labor taxes. Dampening or amplifying effects due to coordination across policies (monetary and fiscal) and across economic regions are also considered. Three main results stand out. First, an increase in government investment financed by rising less distortionary taxes appears to be an effective growth-friendly budget-neutral reform in the sense that it generates both short- and long-run GDP growth and improves fiscal sustainability. Second, benefits and costs of budget-neutral reforms are not equally distributed across agents, giving rise to a policy trade-off between growth and distributional consequences. Third, budget-neutral reforms do not have large cross-border trade spillovers; however, reforms coordinated across all countries in periods of accommodative monetary policy do have amplified domestic effects.
    Keywords: Fiscal composition, budget-neutral reforms, taxes, government spending, multi-country DSGE model, international spillovers.
    JEL: E62 E63 F42
    Date: 2017
  19. By: Leyla Baştav
    Abstract: The paper analyses the dynamics of the major macroeconomic aggregates of the US economy through the recession following 2008 financial crises up until 2015 theoretically in an IS-LM and AS-AD framework.The paper also compares and contrasts the Great Recession with the Great Depression of 1929 within the theoretical framework. DSGE modelling framework explained with the Keynesian framework of IS-LM. Role of expectations on demand side spending, nominal and real wage rigidities thus leading to sticky inflation, (typical price stickiness), also role of monetary policy (demand management) pushing the economy out of recession and stagflation are discussed. The economy has been pulled out of recession and broken the vicious cycle of stagflation and thus depression with expansionary monetary policies. Still the economy needs fine tuning since the growth performance may be fragile in the coming terms.
    Keywords: USA, General equilibrium modeling, Business cycles
    Date: 2016–07–04
  20. By: Giacomo Candian
    Abstract: The paper provides a novel explanation for the observed large and persistent fluctuations in real exchange rate dynamics using a flexible-price model with dispersed information among firms. The paper extend the imperfect common knowledge model developed by Woodford (2002) and Melosi (2014) to a two-country environment. The model is estimated on US and European data using Bayesian methods. The model successfully explain the volatility and persistence of the US/Euro Area real exchange rate, as well as its high correlation with the nominal exchange rate. In line with the empirical evidence, the estimated model delivers hump-shaped dynamics for real exchange rate and highly persistent effect of monetary disturbances. A battery of results shows that the model with information frictions outperforms traditional sticky-price models of real exchange rates.
    Keywords: US and the Euro Area, Monetary issues, General equilibrium modeling
    Date: 2016–07–04
    Abstract: Capture the interactions among pension reform, labor market and inter-generational distribution issues We use an overlapping generation general equilibrium model. The impact on the labor market is addressed on the aggregate level but also y distinguishing different age categories. Results: Increasing the contribution rate is the worst solution in terms of welfare and unemployment, particularly of the youth.Postponing the retirement age is the best option and it does not entail an increase of youth unemployment contrary to the traditional wisdom. The middle-aged are those who benefit the most from the reforms in terms of welfare.
    Keywords: TUNISIA, Labor market issues, General equilibrium modeling
    Date: 2016–07–04
  22. By: Gehrke, Britta (Institut für Arbeitsmarkt- und Berufsforschung (IAB), Nürnberg [Institute for Employment Research, Nuremberg, Germany]); Lechthaler, Wolfgang; Merkl, Christian
    Abstract: This paper analyzes Germany's unusual labor market experience during the Great Recession. We estimate a general equilibrium model with a detailed labor market block for postunification Germany. This allows us to disentangle the role of institutions (short-time work, government spending rules) and shocks (aggregate, labor market, and policy shocks) and to perform counterfactual exercises. We identify positive labor market performance shocks (likely caused by labor market reforms) as the key driver for the "German labor market miracle" during the Great Recession.
    JEL: E24 E32 E62 J08 J63
    Date: 2017–04–14

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