nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2017‒05‒07
nineteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Information heterogeneity, housing dynamics and the business cycle By Guo, Zi-Yi
  2. Model Uncertainty in Macroeconomics: On the Implications of Financial Frictions By Binder, Michael; Lieberknecht, Philipp; Quintana, Jorge; Wieland, Volker
  3. Commodity Price Risk Management and Fiscal Policy in a Sovereign Default Model By López-Martín Bernabé; Leal-Ordoñez Julio C.; Martínez André
  4. Fiscal foundations of inflation: Imperfect knowledge By Stefano Eusepi; Bruce Preston
  5. Constrained Efficiency with Adverse Selection and Directed Search By Mohammad Davoodalhosseini
  6. MEDSEA : a small open economy DSGE model for Malta By Noel Rapa
  7. Macroeconomic Effects of Medicare By Conesa, Juan Carlos; Costa, Daniela; Kamali, Parisa; Kehoe, Timothy J.; Nygard, Vegard; Raveendranathan, Gajen; Saxena, Akshar
  8. A Tractable Model of Monetary Exchange with Ex-Post Heterogeneity By Rocheteau, Guillaume; Weill, Pierre-Olivier; Wong, Russell
  9. Policy Distortions and Aggregate Productivity with Endogenous Establishment-Level Productivity By José-María Da-Rocha; Marina Mendes Tavares; Diego Restuccia
  10. Output gap, monetary policy trade-offs and financial frictions By Francesco Furlanetto; Paolo Gelain; Marzie Taheri Sanjani
  11. Monetary Policy, Bounded Rationality, and Incomplete Markets By Emmanuel Farhi; Iván Werning
  12. The German labor market during the Great Recession: Shocks and institutions By Gehrke, Britta; Lechthaler, Wolfgang; Merkl, Christian
  13. The Good and the Bad Fiscal Theory of the Price Level By Buiter, Willem H.
  14. Energy Price Uncertainty and Decreasing Pass-through to Core Inflation By Ahmed Jamal Pirzada
  15. “Acelerador financiero, impacto del precio del gas” By Valdivia Coria, Joab Dan
  16. The New Keynesian Cross: Understanding Monetary Policy with Hand-to-Mouth Households By Bilbiie, Florin Ovidiu
  17. A model-based analysis of the macroeconomic impact of the refugee migration to Germany By Stähler, Nikolai
  18. Evaluación de la Política Fiscal de Bolivia By Valdivia Coria, Joab Dan
  19. Buffer-stock saving and households' response to income shocks By Fella, Giulio; Frache, Serafin; Koeniger, Winfried

  1. By: Guo, Zi-Yi
    Abstract: Empirical evidence shows that house prices are highly volatile and closely correlated with the business cycle, and the fact is at odds with the evidence that rental prices are relatively stable and almost uncorrelated with the business cycle. To explain the fact, we introduce information heterogeneity into a standard dynamic stochastic general equilibrium (DSGE) model with financial frictions. Agents are endowed with heterogeneous shocks, and rationally extract information from market activities. Since agents are confused by changes in average private signals about future fundamentals, the model generates an amplified effect of technology shocks on house prices, which accounts for the disconnect between house prices and the discounted sum of future rents. In addition, the model provides insights for the lead-lag relationship between residential and nonresidential investment over the business cycle. The solution method developed in this paper can be applied in other DSGE models with heterogeneous information.
    Keywords: heterogeneous information,DSGE model,housing market
    JEL: C63 E22 E32
    Date: 2017
  2. By: Binder, Michael; Lieberknecht, Philipp; Quintana, Jorge; Wieland, Volker
    Abstract: For some time now, structural macroeconomic models used at central banks have been predominantly New Keynesian DSGE models featuring nominal rigidities and forward-looking decision-making. While these features are widely deemed crucial for policy evaluation exercises, most central banks have added more detailed characterizations of the financial sector to these models following the Great Recession in order to improve their fit to the data and their forecasting performance. We employ a comparative approach to investigate the characteristics of this new generation of New Keynesian DSGE models and document an elevated degree of model uncertainty relative to earlier model generations. Policy transmission is highly heterogeneous across types of financial frictions and monetary policy causes larger effects, on average. The New Keynesian DSGE models we analyze suggest that a simple policy rule robust to model uncertainty involves a weaker response to inflation and the output gap in the presence of financial frictions as compared to earlier generations of such models. Leaning-against-the-wind policies in models of this class estimated for the Euro Area do not lead to substantial gains. With regard to forecasting performance, the inclusion of financial frictions can generate improvements, if conditioned on appropriate data. Looking forward, we argue that model-averaging and embracing alternative modelling paradigms is likely to yield a more robust framework for the conduct of monetary policy.
    Keywords: Financial Frictions; fiscal policy transmission; Forecasting; macroprudential policy transmission; model comparison; Model uncertainty; monetary policy transmission; New Keynesian DSGE; robust monetary policy
    JEL: E17 E44 E47 E52
    Date: 2017–04
  3. By: López-Martín Bernabé; Leal-Ordoñez Julio C.; Martínez André
    Abstract: Commodity prices are an important driver of fiscal policy and the business cycle in many developing 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.
    Keywords: commodity revenues;hedging;indexed bonds;fiscal policy;sovereign default
    JEL: F34 F41 F44
    Date: 2017–04
  4. By: Stefano Eusepi; Bruce Preston
    Abstract: This paper proposes a theory of the fiscal foundations of inflation based on imperfect knowledge and learning. Because imperfect knowledge breaks Ricardian equivalence the scale and composition of the public debt matter for inflation. High moderate-duration debt generates wealth effects on consumption demand that impairs the intertemporal substitution channel of monetary policy: aggressive monetary policy is required to anchor inflation expectations. Counterfactual experiments, in an estimated medium-scale DSGE model, reveal the US economy would have been substantially more volatile over the Great Inflation and Great Moderation periods, had average debt been consistent with levels currently observed in Italy or Japan.
    Keywords: Monetary and Fiscal Interactions, Learning Dynamics, Expectations Stabilization, Great Moderation, Great Inflation
    JEL: E32 D83 D84
    Date: 2017–05
  5. By: Mohammad Davoodalhosseini
    Abstract: Constrained efficient allocation (CE) is characterized in a model of adverse selection and directed search (Guerrieri, Shimer, and Wright (2010)). CE is defined to be the allocation that maximizes welfare, the ex-ante utility of all agents, subject to the frictions of the environment. When equilibrium does not achieve the first best (the allocation that maximizes welfare under complete information), then welfare in the CE is strictly higher than welfare in the equilibrium allocation. That is, equilibrium is not constrained efficient. Under some conditions, welfare in the CE even attains welfare in the first best. Finally, sufficient conditions are provided under which equilibrium is not constrained Pareto efficient, either. Cross-subsidization is the key to all these results. In an asset market application, the first best is shown to be implementable through tax schedules that are monotone in the asset prices.
    Keywords: Economic models, Financial markets, Financial system regulation and policies, Market structure and pricing
    JEL: D82 D83 E24 G1 J31 J64
    Date: 2017
  6. By: Noel Rapa (Central Bank of Malta)
    Abstract: This paper describes MEDSEA, a compact small open economy DSGE model of the Maltese economy. The model is similar in nature to other small open economy models, thus containing a number of nominal and real frictions allowing the model to replicate the sluggish reaction of economic variables documented in empirical research. Moreover, MEDSEA contains key modifications designed to account for Malta’s specific characteristics. The model distinguishes between a tradable and non-tradable sector reflecting the different nature of exports when compared to other production meant for domestic use. Furthermore, the model features distribution costs in the export sector allowing for a wedge to exist between wholesale and retail export prices.
    JEL: E12 E30 E50
    Date: 2016
  7. By: Conesa, Juan Carlos (Stony Brook University); Costa, Daniela (Federal Reserve Bank of Minneapolis); Kamali, Parisa (Federal Reserve Bank of Minneapolis); Kehoe, Timothy J. (Federal Reserve Bank of Minneapolis); Nygard, Vegard (Federal Reserve Bank of Minneapolis); Raveendranathan, Gajen (Federal Reserve Bank of Minneapolis); Saxena, Akshar (Harvard University)
    Abstract: This paper develops an overlapping generations model to study the macroeconomic effects of an unexpected elimination of Medicare. We find that a large share of the elderly respond by substituting Medicaid for Medicare. Consequently, the government saves only 46 cents for every dollar cut in Medicare spending. We argue that a comparison of steady states is insufficient to evaluate the welfare effects of the reform. In particular, we find lower ex-ante welfare gains from eliminating Medicare when we account for the costs of transition. Lastly, we find that a majority of the current population benefits from the reform but that aggregate welfare, measured as the dollar value of the sum of wealth equivalent variations, is higher with Medicare.
    Keywords: Medicare; Medicaid; Overlapping generations; Steady state; Transition path
    JEL: E21 E62 H51 I13
    Date: 2017–04–27
  8. By: Rocheteau, Guillaume (University of California, Irvine); Weill, Pierre-Olivier (University of California, Los Angeles); Wong, Russell (Federal Reserve Bank of Richmond)
    Abstract: We construct a continuous-time, New-Monetarist economy with general preferences that displays an endogenous, non-degenerate distribution of money holdings. Properties of equilibria are obtained analytically and equilibria are solved in closed form in a variety of cases. We study policy as incentive-compatible transfers financed with money creation. Lump-sum transfers are welfare-enhancing when labor productivity is low, but regressive transfers achieve higher welfare when labor productivity is high. We introduce illiquid government bonds and draw implications for the existence of liquidity-trap equilibria and policy mix in terms of "helicopter drops" and open-market operations.
    Keywords: money; inflation; risk sharing; liquidity traps
    JEL: E40 E50
    Date: 2017–04–20
  9. By: José-María Da-Rocha; Marina Mendes Tavares; Diego Restuccia
    Abstract: What accounts for differences in output per capita and total factor productivity (TFP) across countries? Empirical evidence points to resource misallocation across heterogeneous production units as an important factor. We study resource misallocation in a model where establishment-level productivity is endogenous and responds to the same policy distortions that create misallocation. In this framework, policy distortions not only misallocate resources across a given set of productive units (static effect), but also create disincentives for productivity improvement (dynamic effect) thereby affecting the productivity distribution and further contributing to lower aggregate output and productivity. The dynamic effect is substantial quantitatively. Reducing the dispersion in revenue productivity in the model by 25 percentage points to the level of the U.S. benchmark implies an increase in aggregate output and TFP by a factor of 2.9-fold. Improved resource allocation accounts for 42 percent of the gain, whereas the change in the productivity distribution accounts for the remaining 58 percent.
    JEL: E0 E1 O1 O4
    Date: 2017–04
  10. By: Francesco Furlanetto (Norges Bank (Central Bank of Norway)); Paolo Gelain (Norges Bank (Central Bank of Norway)); Marzie Taheri Sanjani (International Monetary Fund)
    Abstract: This paper investigates how the presence of financial frictions and financial shocks changes the definition and the estimated dynamics of the output gap in a New Keynesian model. Financial shocks absorb explanatory power from efficient labor supply shocks, thus changing radically the dynamics of the economy's efficient frontier. Despite their large impact on the output gap, financial factors affect the monetary policy trade-offs only to some extent. Nominal stabilization can be achieved at the cost of limited (but non-negligible) fluctuations in real economic activity. Finally, we discuss an alternative measure of the output gap (in deviation from the optimal equilibrium) that is a better measure of imbalances in the economy than the conventional output gap.
    Keywords: Financial frictions; output gap; monetary policyClassification-JEL: E32, C51, C52Note:
    Date: 2017–04–27
  11. By: Emmanuel Farhi; Iván Werning
    Abstract: This paper extends the benchmark New-Keynesian model with a representative agent and rational expectations by introducing two key frictions: (1) agent heterogeneity with incomplete markets, uninsurable idiosyncratic risk, and occasionally-binding borrowing constraints; and (2) bounded rationality in the form of level-k thinking. Compared to the benchmark model, we show that the interaction of these two frictions leads to a powerful mitigation of the effects of monetary policy, which is much more pronounced at long horizons, and offers a potential rationalization of the “forward guidance puzzle”. Each of these frictions, in isolation, would lead to no or much smaller departures from the benchmark model. We conclude that the interaction of bounded rationality and market frictions improves the ability of the model to account for the effects of monetary policy.
    JEL: E03 E1 E4 E52
    Date: 2017–03
  12. By: Gehrke, Britta; 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 post-unification 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.
    Keywords: Great Recession,search and matching,DSGE,short-time work,fiscal policy,business cycles,Germany
    JEL: E24 E32 E62 J08 J63
    Date: 2017
  13. By: Buiter, Willem H.
    Abstract: Necessary conditions for valid dynamic general equilibrium analysis include: (1) the number of equations equals the number of unknowns; (2) the number of state variables equals the number of boundary conditions; (3), if (1) and (2) hold, the model has one or more solutions and these solutions make economic sense. The fiscal theory of the price level – in any of its variants - fails these conditions, both away from and at the effective lower bound. The fundamental fallacy at the root of the FTPL is not requiring the intertemporal budget constraint (IBC) of the State to hold identically but only in equilibrium, and treating the IBC of the State (holding with equality and with sovereign debt priced at its contractual value) as a (misspecified) government bond pricing equilibrium condition. Arbitrary (non-Ricardian) policies governing public spending, taxation, interest rates and monetary issuance are asserted to satisfy the intertemporal budget constraint of the State in equilibrium because either the price level (in the original FTPL) or the level of real economic activity (in the Keynesian version of the FTPL developed by Sims) will adjust to make the real contractual value of the outstanding stock of nominal public debt equal to the present discounted value of current and future primary surpluses plus seigniorage. In reality this means overdetermined or inconsistent systems unless (a) the price level is flexible, (b) the interest rate is the monetary policy instrument and (c) there is a non-zero stock of nominal government bonds. Thus, a sticky price level implies overdeterminacy or another inconsistency, and a nominal money stock rule implies overdeterminacy. When all three conditions are satisfied, unacceptable anomalies occur: the possibility of negative price levels; the FTPL can price money when money does not exist; the logic of the FTPL applies equally to the intertemporal budget constraint of an individual household; when the bond pricing equation is specified correctly, there is no FTPL. The FTPL has nothing to do with monetary vs. fiscal dominance or active v. passive fiscal policy. The FTPL implies government debt is never a problem; the price level or the level of real economic activity take care of it, and not through unanticipated inflation or financial repression. If acted upon by fiscal authorities, the consequences could be severe. There is a correct fiscal theory of seigniorage. The issuance of return-dominated and/or irredeemable central bank money creates fiscal space and ensures that a combined monetary-fiscal stimulus always boosts nominal aggregate demand.
    Keywords: Fiscal theory of the price level; intertemporal budget constraint; equilibrium bond pricing equation; monetary and fiscal policy coordination
    JEL: E31 E40 E50 E58 E62 H62 H63
    Date: 2017–04
  14. By: Ahmed Jamal Pirzada
    Abstract: This paper uses an extended version of the New Keynesian model to provide an alternate explanation for the decrease in energy price pass-through to core inflation. The results show that in a model in which energy goods are consumed by households, uncertain energy prices decrease firms’ responsiveness to an increase in the energy price. This is because uncertain energy prices increase the precautionary savings motive of households. Since firms expect demand for finished consumption goods to contract more, they increase their prices by less. When energy prices are highly uncertain, instead of increasing prices, firms decrease their prices following a positive energy price shock.
    Keywords: Energy Prices, Uncertainty, Inflation, Monetary Policy, DSGE.
    JEL: E31 E52 E58
    Date: 2017–04–13
  15. By: Valdivia Coria, Joab Dan
    Abstract: A general equilibrium model was developed for a small and open economy with financial frictions in order to analyze the effects of monetary policy and fiscal policy in Bolivia on certain variables such as: GDP, Consumption, Investment, interest rates Inflation The results were obtained from cyclical contraction effects of the Taylor rule on inflation. The estimation was made for the time periods 2000 - 2005 and 2006 - 2015 through Bayesian econometrics. A different response is evident in both periods of time, in fiscal spending and the price of natural gas.
    Keywords: Bayesian estimation, Fiscal Expenditure, Financial Frictions, Dynamic Stochastic General Equilibrium Model (DSGE).
    JEL: E42 E58 E62 E63
    Date: 2016–10
  16. By: Bilbiie, Florin Ovidiu
    Abstract: The "New Keynesian Cross" proposed here describes aggregate demand through a planned expenditure PE curve and captures analytically a key mechanism and decomposition in heterogeneous-agent New Keynesian (HANK) models à la Kaplan, Moll and Violante, 2015. In response to monetary policy, PE's shift is the direct effect (intertemporal substitution), while its slope (marginal propensity to consume) is the share of the indirect effect in total. The total and indirect effects are increasing with the share of hand-to-mouth agents when these are employed, but decreasing when unemployed; the same holds for forward guidance. Despite this, the optimal duration of forward guidance is not much affected, for when its power increases so does its welfare cost.
    Keywords: hand-to-mouth; heterogenous agents; aggregate demand; optimal monetary policy; liquidity trap; Keynesian cross; forward guidance.
    JEL: E21 E31 E40 E44 E50 E52 E58 E60 E62
    Date: 2017–04
  17. By: Stähler, Nikolai
    Abstract: By simulating various (labour market) integration scenarios with the aid of a New Keynesian DSGE model, this paper explores the potential economic consequences and transmission mechanisms resulting from the recent refugee migration to Germany. We find that the long-run costs and benefits for domestic agents depend critically on the skill levels migrants will obtain in the long run. A failure to integrate the about 800,000 migrants (equivalent to 1% of initial German population) could reduce per capita output and consumption by 0.43% and 0.48%, respectively, while integration measures that improve their qualification structure could even yield per capita output and consumption gains of 0.34% and 0.38%, respectively. Measures that cause the migrant qualification structure to closely match that of the native population over the long term do not lead to significant changes in GDP and consumption. Overall, our model simulations suggest that the macroeconomic impact of refugee migration is small.
    Keywords: Refugee Migration,Labour Market Integration,Macroeconomics
    JEL: F22 J61 J31 E24
    Date: 2017
  18. By: Valdivia Coria, Joab Dan
    Abstract: I built a general equilibrium model for a small open economy, in order to analyze the effects of fiscal spending in Bolivia, observing certain effects on variables like is constructed: GDP, consumption, investment, exports, imports, real exchange rate and interest rate. Shocks are transmitted to the economy in the presence of the relationship between fiscal spending and the international price of oil, which was analyzed. The results indicate that in the short-term commodity price shock and fiscal spending have positively impacts in the product and despise the way real change.
    Keywords: Key words: Bayesian Estimation, Open Economy, Fiscal Spending, Dynamic Stochastic General Equilibrium (DSGE), commodity Price.
    JEL: E42 E58 E63 H39
    Date: 2016–09
  19. By: Fella, Giulio; Frache, Serafin; Koeniger, Winfried
    Abstract: We use the Italian Survey of Household Income and Wealth, a rather unique dataset with a long time dimension of panel information on consumption, income and wealth, to structurally estimate a buffer-stock saving model. We exploit the information contained in the joint dynamics of income, consumption and wealth to quantify the degree of insurance against income risk. The estimated model implies that Italian households can insure between 89 and 95 percent of a transitory and between 7 and 9 percent of a permanent income shock. Compared to existing empirical estimates for the same dataset, our findings suggest that Italian households do not have access to significant insurance beyond self-insurance.
    Keywords: Consumption,Wealth,Incomplete markets,Insurance
    JEL: D91 E21
    Date: 2017

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