nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2017‒05‒28
fifteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Labor Market Institutions and the Cost of Recessions By Tom Krebs; Martin Scheffel
  2. Policy, Risk and Spillover Analysis in the World Economy; A Panel Dynamic Stochastic General Equilibrium Approach By Francis Vitek
  3. Job Displacement Risk and Severance Pay By Marco Cozzi
  4. Capital Taxation with Heterogeneous Discounting and Collateralized Borrowing By Nina Biljanovska; Alexandros Vardoulakis
  5. Optimal Fiscal and Monetary Policy, Debt Crisis and Management By Cristiano Cantore; Paul L Levine; Giovanni Melina; Joseph G Pearlman
  6. Should Unconventional Monetary Policies Become Conventional? By Dominic Quint; Pau Rabanal
  7. Hopf Bifurcation from new-Keynesian Taylor rule to Ramsey Optimal Policy By Chatelain, Jean-Bernard; Ralf, Kirsten
  8. Macroprudential Policy Coordination with International Capital Flows By William Chen; Gregory Phelan
  9. Macroeconomic Effects of Medicare By Juan Carlos Conesa; Daniela Costa; Parisa Kamali; Timothy J. Kehoe; Vegard M. Nygard; Gajendran Raveendranathan; Akshar Saxena
  10. Monetary Policy, Fisal Federalism, and Capital Intensity By Nadav Ben Zeev; Ohad Raveh
  11. "Demographics, Immigration, and Market Size" By Koichi Fukumura; Kohei Nagamachi; Yasuhiro Sato; Kazuhiro Yamamoto
  12. The Optimum Quantity of Debt for Japan By Tomoyuki Nakajima; Shuhei Takahashi
  13. Resolving International Macro Puzzles with Imperfect Risk Sharing and Global Solution Methods By Jonathan J Adams; Philip Barrett
  14. Safe Assets By Barro, Robert J.; Fernández-Villaverde, Jesús; Levintal, Oren; Mollerus, Andrew
  15. Macroprudential Policy, Incomplete Information and Inequality; The case of Low-Income and Developing Countries By Margarita Rubio; Filiz D Unsal

  1. By: Tom Krebs; Martin Scheffel
    Abstract: This paper studies the effect of two labor market institutions, unemployment insurance (UI) and job search assistance (JSA), on the output cost and welfare cost of recessions. The paper develops a tractable incomplete-market model with search unemployment, skill depreciation during unemployment, and idiosyncratic as well as aggregate labor market risk. The theoretical analysis shows that an increase in JSA and a reduction in UI reduce the output cost of recessions by making the labor market more fluid along the job finding margin and thus making the economy more resilient to macroeconomic shocks. In contarst, the effect of JSA and UI on the welfare cost of recessions is in general ambiguous. The paper also provides a quantitative appliation to the German labor market reforms of 2003-2005, the so-called Hartz reforms, which improved JSA (Hartz III reform) and reduced UI (Hartz IV reform). According to the baseline calibration, the two labor market reforms led to a substantial reduction in the output cost of recessions and a moderate reduction in the welfare cost of recessions in Germany.
    Keywords: Incomplete markets;Europe;Germany;Labor market institutions;cost of Recessions, German Labor Market Reform
    Date: 2017–04–03
  2. By: Francis Vitek
    Abstract: This paper develops a structural macroeconometric model of the world economy, disaggregated into forty national economies, to facilitate multilaterally consistent macrofinancial policy, risk and spillover analysis. This panel dynamic stochastic general equilibrium model features a range of nominal and real rigidities, extensive macrofinancial linkages, and diverse spillover transmission channels. These macrofinancial linkages encompass bank and capital market based financial intermediation, with financial accelerator mechanisms linked to the values of the housing and physical capital stocks. A variety of monetary policy analysis, fiscal policy analysis, macroprudential policy analysis, spillover analysis, and forecasting applications of the estimated model are demonstrated. These include quantifying the monetary, fiscal and macroprudential transmission mechanisms, accounting for business cycle fluctuations, and generating relatively accurate forecasts of inflation and output growth.
    Date: 2017–04–04
  3. By: Marco Cozzi (Department of Economics, University of Victoria)
    Abstract: This paper is a quantitative, equilibrium study of the insurance role of severance pay when workers face displacement risk and markets are incomplete. A key feature of our model is that,in line with an established empirical literature, job displacement entails a persistent fall in earnings upon re-employment due to the loss of tenure. The model is solved umerically and calibrated to the US economy.In contrast to previous studies that have analyzed severance payments in the absence of persistent earning losses, we find that the welfare gains from the insurance against job displacement afforded by severance pay are sizable.
    Keywords: Severance Payments, Incomplete Markets, Welfare
    JEL: E24 D52 D58 J65
    Date: 2016–03–29
  4. By: Nina Biljanovska; Alexandros Vardoulakis
    Abstract: We study optimal long-run capital taxation in a closed economy with heterogeneity in agents' time-discount factors where borrowing is allowed but restricted by a collateral constraint. Financial frictions distort intertemporal optimization margins and the tax system serves a dual role: first, it is used to finance government consumption; second, it serves to alleviate the distortions arising from the binding collateral constraint. The discrepancy between the private and the social discount factors pushes for a subsidy on capital, while the discrepancy introduced by the collateral constraint pushes for a tax in the long-run. When consumption smoothing motives are muted, the two effects counter-balance each other and the tax is zero. With finite elasticity of intertemporal substitution, the second discrepancy dominates and the tax on capital income is positive in the long-run.
    Keywords: Ramsey taxation ; Collateral constraint ; Heterogeneous discount factors ; Tax on capital
    JEL: E60 E61 E62 H21
    Date: 2017–05–05
  5. By: Cristiano Cantore; Paul L Levine; Giovanni Melina; Joseph G Pearlman
    Abstract: The initial government debt-to-GDP ratio and the government’s commitment play a pivotal role in determining the welfare-optimal speed of fiscal consolidation in the management of a debt crisis. Under commitment, for low or moderate initial government debt-to-GPD ratios, the optimal consolidation is very slow. A faster pace is optimal when the economy starts from a high level of public debt implying high sovereign risk premia, unless these are suppressed via a bailout by official creditors. Under discretion, the cost of not being able to commit is reflected into a quick consolidation of government debt. Simple monetary-fiscal rules with passive fiscal policy, designed for an environment with “normal shocks†, perform reasonably well in mimicking the Ramsey-optimal response to one-off government debt shocks. When the government can issue also long-term bonds–under commitment–the optimal debt consolidation pace is slower than in the case of short-term bonds only, and entails an increase in the ratio between long and short-term bonds.
    Keywords: Crisis management;Debt consolidation;Optimal fiscal-monetary policy, long-term debt, fiscal limits, Monetary Policy (Targets, Instruments, and Effects)
    Date: 2017–03–30
  6. By: Dominic Quint; Pau Rabanal
    Abstract: The large recession that followed the Global Financial Crisis of 2008-09 triggered unprecedented monetary policy easing around the world. Most central banks in advanced economies deployed new instruments to affect credit conditions and to provide liquidity at a large scale after shortterm policy rates reached their effective lower bound. In this paper, we study if this new set of tools, commonly labeled as unconventional monetary policies (UMP), should still be used when economic conditions and interest rates normalize. In particular, we study the optimality of asset purchase programs by using an estimated non-linear DSGE model with a banking sector and long-term private and public debt for the United States. We find that the benefits of using such UMP in normal times are substantial, equivalent to 1.45 percent of consumption. However, the benefits from using UMP are shock-dependent and mostly arise when the economy is hit by financial shocks. When more traditional business cycle shocks (such as supply and demand shocks) hit the economy, the benefits of using UMP are negligible or zero.
    Keywords: United States;Banking;Western Hemisphere;Unconventional Monetary Policy, Optimal Rules, Time-Series Models, Monetary Policy (Targets, Instruments, and Effects)
    Date: 2017–03–31
  7. By: Chatelain, Jean-Bernard; Ralf, Kirsten
    Abstract: This paper shows that a shift from Ramsey optimal policy under short term commitment (based on a negative-feedback mechanism) to a Taylor rule (based on positive-feedback mechanism) in the new-Keynesian model is in fact a Hopf bifurcation, with opposite policy advice. The number of stable eigenvalues corresponds to the number of predetermined variables including the interest rate and its lag as policy instruments for Ramsey optimal policy. With a new-Keynesian Taylor rule, however, these policy instruments are arbitrarily assumed to be forward-looking variables when policy targets (inflation and output gap) are forward-looking variables. For new-Keynesian Taylor rule, this Hopf bifurcation implies a lack of robustness and multiple equilibria if public debt is not set to zero for all observation.
    Keywords: Bifurcation,Taylor rule,new-Keynesian model,Ramsey optimal policy,Finite horizon commitment
    JEL: C61 C62 E43 E47 E52 E58
    Date: 2017
  8. By: William Chen (Williams College); Gregory Phelan (Williams College)
    Abstract: We theoretically illustrate how macroprudential policy spillovers through international cap- ital flows can lead to uncoordinated policy choices that are tighter than would occur with coor- dination. We consider a symmetric two-country macro model in which countries have limited ability to issue state-contingent contracts in international markets. Accordingly, output en- dogenously depends on the relative share of wealth held by each country. Because markets are incomplete, welfare can be improved by regulating countries’ borrowing positions. Tighter macroprudential policy in country A (limiting leverage or capital inflows) stabilizes country A and endogenously increases the frequency with which A is relatively more wealthy than coun- try B. Thus, tight policy in A provides incentives for B to choose tight policy as well so that B is not poor on average relative to A. We numerically solve for the coordinated and uncoordinated equilibria when countries choose among countercyclical macroprudential policies.
    Keywords: International Capital Flows, Capital Controls, Macroeconomic Instability, Macroprudential Regulation, Policy Coordination, Spillovers, Financial Crises
    JEL: E44 F36 F38 F42 G15
    Date: 2017–05
  9. By: Juan Carlos Conesa; Daniela Costa; Parisa Kamali; Timothy J. Kehoe; Vegard M. Nygard; Gajendran Raveendranathan; Akshar Saxena
    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.
    JEL: E21 E62 H51 I13
    Date: 2017–05
  10. By: Nadav Ben Zeev; Ohad Raveh
    Abstract: Does monetary policy play a role in scal federalism? This paper presents a novel implication of monetary policy shocks by studying their heterogeneous e ects across federal-states and their consequent connection to scal equalization. A two-region monetary union DSGE model with a federal equalization mechanism shows that capital intensive states experience a relatively larger contraction following a positive monetary policy shock, due to the greater share that capital takes in their production process. This, in turn, brings them greater in ows of federal grants. We show that state-heterogeneity in capital intensity is explained by levels of natural resource abundance over large periods, and hence by pre-determined geographical characteristics. Based on this identi cation strategy, we test the model's predictions using a panel of U.S. states over the period 1969-2007 and nd that following a one standard deviation monetary policy shock, output growth (output share of federal transfers) in capital intensive states contemporaneously decreases (increases) by 1% relative to their counterparts, on average. In addition, we nd no di erential e ects on other state-level economic indicators, consistent with the model.
    Keywords: natural monetary policy, fiscal federalism, capital intensity
    JEL: E52 H77
    Date: 2017
  11. By: Koichi Fukumura (JSPS Research Fellow, Graduate School of Economics, Osaka University); Kohei Nagamachi (  Graduate School of Management, Kagawa University); Yasuhiro Sato (Faculty of Economics, The University of Tokyo); Kazuhiro Yamamoto (  Graduate School of Economics, Osaka University)
    Abstract: This paper constructs an overlapping generations model wherein people decide their number of children and levels of consumption for differentiated goods. We further assume that immigration takes place according to the utility difference between inside and outside a country. We show that an improvement in longevity has three effects on the market size and welfare: First, it decreases the number of children. Second, it increases the per capita expenditure on consumption. Finally, it increases immigration. The first effect has negative impacts on the market size and welfare whereas the latter two effects have positive impacts. We then calibrate our model to match Japanese and U.S. data from 1955 to 2014 and find that the negative effects dominate the positive ones. Moreover, our counterfactual analyses show that accepting immigration in Japan can be useful in overcoming population and market shrinkage caused by an aging population.
    Date: 2017–05
  12. By: Tomoyuki Nakajima (Institute of Economic Research, Kyoto University); Shuhei Takahashi (Institute of Economic Research, Kyoto University)
    Abstract: Japan's net government debt reached 130% of GDP in 2013. The present paper analyzes the welfare implications of the large debt for Japan. We use an Aiyagari (1994)-style heterogeneous-agent, incomplete-market model with idiosyncratic wage risk and endogenous labor supply. We find that under the utilitarian welfare measure, the optimal government debt for Japan is -50% of GDP and the current level of debt incurs the welfare cost that is 0.22% of consumption. Decomposing the welfare cost by the Floden (2001) method reveals substantial welfare effects arising from changes in the level, inequality, and uncertainty. The level and inequality costs are 0.38% and 0.52% respectively, whereas the uncertainty benefit is 0.68%. Adjusting consumption taxes instead of the factor income taxes to balance the government budget substantially reduces the overall welfare cost.
    Keywords: Government debt; welfare; incomplete markets; Japanese economy.
    JEL: E62 H63
    Date: 2017–03
  13. By: Jonathan J Adams (Department of Economics, University of Florida); Philip Barrett (International Monetary Fund)
    Abstract: Do gross international asset positions matter for macroeconomic outcomes? In this paper, we argue that they do. In particular, we demonstrate that asset market incompleteness which features a meaningful portfolio choice can resolve the Backus-Smith puzzle: that relative consumptions and real exchange rates are negatively correlated. Because income and nominal exchange rates are positively correlated, countries choose a portfolio that features home bias in bond holdings, which is common in the data. We compare our findings to the predictions of alternative asset market structures frequently used in the literature - such as complete markets or restricting assets to a single bond - and show that they cannot solve the Backus-Smith puzzle without further frictions. We also show that local perturbation methods that use endogenous discount factors to stabilize the model are inaccurate, even when they correctly characterize the average portfolio holdings. Instead, we use a novel global solution method to accurately solve the portfolio problem when asset markets are incomplete, using an approach that generalizes Maliar and Maliar (2015) to solve a wide class of models.
    JEL: F30 F41
  14. By: Barro, Robert J.; Fernández-Villaverde, Jesús; Levintal, Oren; Mollerus, Andrew
    Abstract: A safe asset's real value is insulated from shocks, including declines in GDP from rare macroeconomic disasters. However, in a Lucas-tree world, the aggregate risk is given by the process for GDP and cannot be altered by the creation of safe assets. Therefore, in the equilibrium of a representative-agent version of this economy, the quantity of safe assets will be nil. With heterogeneity in coefficients of relative risk aversion, safe assets can take the form of private bond issues from low-risk-aversion to high-risk-aversion agents. The model assumes Epstein-Zin/Weil preferences with common values of the intertemporal elasticity of substitution and the rate of time preference. The model achieves stationarity by allowing for random shifts in coefficients of relative risk aversion. We derive the equilibrium values of the ratio of safe to total assets, the shares of each agent in equity ownership and wealth, and the rates of return on safe and risky assets. In a baseline case, the steady-state risk-free rate is 1.0% per year, the unlevered equity premium is 4.2%, and the quantity of safe assets ranges up to 15% of economy-wide assets (comprising the capitalized value of GDP). A disaster shock leads to an extended period in which the share of wealth held by the low-risk-averse agent and the risk-free rate are low but rising, and the ratio of safe to total assets is high but falling. In the baseline model, Ricardian Equivalence holds in that added government bonds have no effect on rates of return and the net quantity of safe assets. Surprisingly, the crowding-out coefficient for private bonds with respect to public bonds is not 0 or -1 but around -0.5, a value found in some existing empirical studies.
    Date: 2017–05
  15. By: Margarita Rubio; Filiz D Unsal
    Abstract: In this paper, we use a DSGE model to study the passive and time-varying implementation of macroprudential policy when policymakers have noisy and lagged data, as commonly observed in lowincome and developing countries (LIDCs). The model features an economy with two agents; households and entrepreneurs. Entrepreneurs are the borrowers in this economy and need capital as collateral to obtain loans. The macroprudential regulator uses the collateral requirement as the policy instrument. In this set-up, we compare policy performances of permanently increasing the collateral requirement (passive policy) versus a time-varying (active) policy which responds to credit developments. Results show that with perfect and timely information, an active approach is welfare superior, since it is more effective in providing financial stability with no long-run output cost. If the policymaker is not able to observe the economic conditions perfectly or observe with a lag, a cautious (less aggressive) policy or even a passive approach may be preferred. However, the latter comes at the expense of increasing inequality and a long-run output cost. The results therefore point to the need for a more careful consideration toward the passive policy, which is usually advocated for LIDCs.
    Keywords: Credit;Low-income developing countries;Macroprudential Policy;incomplete information, collateral requirements, inequality, Financial Markets and the Macroeconomy, Government Policy and Regulation
    Date: 2017–03–22

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.
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