nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2017‒06‒25
twenty papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Financial Disruptions and the Cyclical Upgrading of Labor By Brendan Epstein; Alan Finkelstein Shapiro; Andrés González Gómez
  2. Monetary Policy, Financial Frictions and Structural Changes: A Markov-Switching DSGE Approach By Francis Leni Anguyo; Rangan Gupta; Kevin Kotzé
  4. Impulse on the Aggregate Demand in Bolivia through the coordination of the Monetary and Fiscal Policy in crisis time By Valdivia Coria, Joab Dan; Valdivia Coria, Daney
  5. Macroeconomic Fluctuations Under Natural Disaster Shocks in Central America and the Caribbean By Allan Wright; Patrice Borda
  6. Bargaining with renegotiation in models with on-the-job search By Gottfries, A.
  7. Pension Reform in Taiwan: the Path to Long-Run Sustainability By Yu-Hsiang Cheng; Hsuan-Chih (Luke) Lin; Atsuko Tanaka
  8. Financial Frictions and Export Dynamics in Large Devaluations By Kohn, David; Leibovici, Fernando; Szkup, Michal
  9. Do Term Premiums Matter? Transmission via Exchange Rate Dynamics By Mitsuru Katagiri; Koji Takahashi
  10. Optimal Taxes Under Private Information: The Role of the Inflation Tax By Gomis-Porqueras, Pedro; Waller, Christopher J.
  11. Aging, Informality and Public Policies in a Small Open Economy By Daniel Baksa; Mihnea Constantinescu; Zsuzsa Munkacsi
  12. Investment-Specific Shocks, Business Cycles, and Asset Prices By Giuliano Curatola; Michael Donadelli; Patrick Grüning; Christoph Meinerding
  13. Fiscal Forward Guidance: A case for selective transparency By FUJIWARA Ippei; WAKI Yuichiro
  14. A Generalized Approach to Indeterminacy in Linear Rational Expectations Models By Francesco Bianchi; Giovanni Nicolò
  15. Monetary Policy under Behavioral Expectations: Theory and Experiment By Cars Hommes; Domenico Massaro; Matthias Weber
  16. Personal Bankruptcy, Bank Portfolio Choice and the Macroeconomy By Eglë Jakuèionytë
  17. Unemployment and Income-Distribution Effects of Economic Growth: A Minimum-Wage Analysis with Optimal Saving By Richard A. Brecher; Till Gross
  18. Innovation Dynamics and Fiscal Policy: Implications for Growth, Asset Prices, and Welfare By Michael Donadelli; Patrick Grüning
  19. Equilibrium Search and the Impact of Equal Opportunities for Women By Coles, Melvyn; Francesconi, Marco
  20. Bond Finance, Bank Credit, and Aggregate Fluctuations in an Open Economy By Roberto Chang; Andres Fernandez; Adam Gulan

  1. By: Brendan Epstein; Alan Finkelstein Shapiro; Andrés González Gómez
    Abstract: Amid total factor productivity (TFP) shocks job-to-job flows amplify the volatility of unemployment, but the aggregate implications of job-to-job flows amid financial shocks are less understood. To develop such understanding we model a general equilibrium labor-search framework that incorporates on-the-job (OTJ) search and distinctly accounts for the differential impact of TFP and financial shocks. Surprisingly, we find that the interaction of OTJ search with financial shocks is sufficiently different from its interaction with TFP shocks so that, under standard calibrations, our model generates aggregate dynamics exceedingly in line with the behavior of key U.S. macro data across several decades and in the wake of the Global Financial Crisis as well. Importantly, as in the data, the model yields relatively high volatilities of consumption, labor income, and unemployment. As such, our work contributes to resolving two limitations of current general equilibrium labor-search theory: under standard calibrations models without OTJ search generate implausibly low unemployment volatility, while models with OTJ search generate unemployment volatility closer to the data but at the expense of implausibly low consumption and labor-income volatility.
    Date: 2017–06–08
  2. By: Francis Leni Anguyo (School of Economics, University of Cape Town, Rondebosch, South Africa); Rangan Gupta (Department of Economics, University of Pretoria, Pretoria, South Africa and IPAG Business School, Paris, France); Kevin Kotzé (School of Economics, University of Cape Town, Rondebosch, South Africa)
    Abstract: This paper considers the use of regime-switching dynamic stochastic general equilibrium models for monetary policy analysis and forecasting purposes. The model incorporates financial frictions that are introduced through the activities of heterogeneous agents in the household and several other features that are incorporated in most small open-economy models. Two variants of regime-switching models are considered: one includes switching in the monetary policy rule (only) and the other employs switching in both the monetary policy rule and the volatility of the shocks. The models are applied to the quarterly macroeconomic data for Uganda and most of the parameters are estimated with the aid of Bayesian techniques. The results of the extensive in- and out-of-sample evaluation suggest that the model parameters do not remain constant over the two regimes. In addition, the transition probabilities suggest that the nature of the regime-switching is consistent with the existence of isolated pulse effects that relate to significant shocks which affected the Ugandan economy, rather than level shifts in the central bank policy rule. It is also noted that the forecasting performance of the regime-switching models is possibly superior to the model that excludes these features.
    Keywords: Monetary policy, inflation-targeting, financial frictions, small open-economy, low income country, dynamic stochastic general equilibrium model, Bayesian estimation.
    JEL: E32 E52 F41
    Date: 2017–06
  3. By: Corbae, Dean (University of Wisconsin - Madison); D'Erasmo, Pablo (Federal Reserve Bank of Philadelphia)
    Abstract: In this paper, we ask how bankruptcy law affects the financial decisions of corporations and its implications for firm dynamics. According to current U.S. law, firms have two bankruptcy options: Chapter 7 liquidation and Chapter 11 reorganization. Using Compustat data, we first document capital structure and investment decisions of non-bankrupt, Chapter 11, and Chapter 7 firms. Using those data moments, we then estimate parameters of a firm dynamics model with endogenous entry and exit to include both bankruptcy options in a general equilibrium environment. Finally, we evaluate a bankruptcy policy change recommended by the American Bankruptcy Institute that amounts to a \fresh start" for bankrupt _rms. We find that changes to the law can have sizable consequences for borrowing costs and capital structure, which via selection affects productivity (allocative effciency rises by 2:58%) and welfare (rises by 0:54%).
    Keywords: bankruptcy law; corporations; United States
    Date: 2017–06–13
  4. By: Valdivia Coria, Joab Dan; Valdivia Coria, Daney
    Abstract: At the end of 2014, the Bolivian economy, despite facing negative external shocks (falling oil prices), registered a high economic growth in the region of Latin America. Monetary policy was aimed at keeping the government bond rate close to zero and raising liquidity levels in the economy (monetary policy expansive). On the part of the government, the two main sources of income of the nonfinancial public sector (SPNF) are: i) tax revenues and ii) the sale of hydrocarbons (gas), at that time Bolivia's fiscal policy was countercyclical To the behavior of the Latin American Product (increases in fiscal expenditure in infrastructure). These antecedents, aid to the interest of the study of the coordination of the economic policy in Bolivia. The structure of a Dynamic Stochastic General Equilibrium Model (DSGE) helps us to understand the transmission channels of shocks (in Taylor rule, Phillips curve and public investment) and how the monetary and fiscal policy reacts to these shocks.
    Keywords: Bayesian Estimation, Monetary Policy, Fiscal Policy, Dynamic Stochastic General Equilibrium Model (DSGE).
    JEL: E52 E58 E59 E62
    Date: 2017–05
  5. By: Allan Wright; Patrice Borda
    Abstract: This paper examines the role of disaster shock in a one-sector, representative agent dynamic stochastic general equilibrium model (DSGE). First, it estimates a panel vector autoregresive (VAR) model for output, investment, trade balance, consumption, and country spread to capture the economic effects of output, country risk, and exogenous natural disaster shocks. The study determines the empirical dynamic responses of ten Caribbean countries and seven countries in Central America. Second, by taking into account rare events and trend shocks, this paper also provides a baseline framework of the dynamic interactions between the macroeconomic effects of rare events and financial friction for two specific countries: Barbados and Belize. Similar findings between empirical and general frameworks show that disaster shocks in Central America and the Caribbean have only a significative impact in the short-run regional business cycle. The findings show that Caribbean countries are better prepared for natural disaster shocks.
    Keywords: Natural disasters, Productivity Shock, Macroeconomics, investment level, Financial Frictions, Economic Impact Analysis, Trade Balance, natural disaster shocks, trade balance, productivity shock, macroeconomic fluctuations
    JEL: F41 E32
    Date: 2016–12
  6. By: Gottfries, A.
    Abstract: This paper analyzes a model of wage bargaining with on-the-job search. The model in Shimer (2006) is extended to include an opportunity of within-match wage renegotiation. This opportunity arrives at a Poisson rate. I show that once an opportunity for wage renegotiation is introduced there is a unique equilibrium wage distribution, in contrast to the indeterminacy found by Shimer. Furthermore, the model provides a natural bridge between the results of Shimer (2006) and Pissarides (1994). When the arrival rate of renegotiation opportunities tends to infinity, the equilibrium of the model converges to the equilibrium pay-offs found by Pissarides, and when the arrival rate converges to zero, the equilibrium in the model converges to one of the equilibria found by Shimer.
    Keywords: On-the-job search, Bargaining, Renegotiation, Wage contracts
    JEL: C78 J31 J41 J64
    Date: 2017–05–31
  7. By: Yu-Hsiang Cheng (Public Utilities Section, Department of Public Works, Keelung City Government); Hsuan-Chih (Luke) Lin (Institute of Economics, Academia Sinica, Taipei, Taiwan); Atsuko Tanaka (Department of Economics, University of Calgary)
    Abstract: This paper quantifies the fiscal costs of different pension reforms in Taiwan that achieve long-run sustainability. We build a general equilibrium life-cycle model with endogenous labor supply in both intensive and extensive margins, consumption, saving, and benefit claiming. Several options to make pensions sustainable under current demographic changes are presented; increase income tax by 5.4 percent, increase the consumption tax by 6.2 percent, increase the pension tax by 9 percent, or reduce the pension benefits by 23.5 percent. Furthermore, we evaluate the changes in macroeconomic indicators as well as labor market outcomes under different reforms. Last, we highlight the importance of the general equilibrium effects that can account for endogenously saving and labor supply, as partial equilibrium analysis usually underestimates negative effects.
    Keywords: Pension Reform, Long-Run Sustainability, Intensive and Extensive Margins JEL Classification: E2, E6, H5, J2
    Date: 2017–06
  8. By: Kohn, David (Universidad Cat´olica de Chile); Leibovici, Fernando (Federal Reserve Bank of St. Louis); Szkup, Michal (University of British Columbia)
    Abstract: We study the role of financial frictions and balance-sheet effects in accounting for the dynamics of aggregate exports in large devaluations. We investigate a small open economy with heterogeneous firms, where firms face financing constraints and debt can be denominated in foreign units. We find that these channels can explain only a small fraction of the dynamics of exports observed in the data. While these frictions distort production and investment decisions, they affect exports significantly less since firms reallocate sales across markets in response to real exchange rate changes. We document the importance of this mechanism using plant-level data.
    Keywords: Financial frictions; large devaluations; export dynamics; balance-sheet effects.
    JEL: F1 F4 G32
    Date: 2017–05–01
  9. By: Mitsuru Katagiri (Bank of Japan); Koji Takahashi (Bank of Japan)
    Abstract: The macroeconomic effect of term premiums is a controversial issue both theoretically and quantitatively. In this paper, we explore the possibility that term premiums affect inflation and the real economy via exchange rate dynamics. For this purpose, we construct a small open economy model with limited asset market participation, focusing particularly on the empirical fact that uncovered interest parity (UIP) tends to hold for longer-term interest rate differentials. In a quantitative exercise, we estimate parameters using Japanese and U.S. data and show that changes in the term premiums of both Japanese and U.S. long-term yields have sizable effects on Japanese inflation rates via the yen-U.S. dollar exchange rate. This result implies that although decreasing domestic term premiums increased Japan's inflation rates via the exchange rate channel to some extent, it is almost equally influenced by foreign factors such as a rise in U.S. term premium.
    Keywords: Exchange Rate; Term Premium; Uncovered Interest Rate Parity
    JEL: E31 E52 E58
    Date: 2017–06–09
  10. By: Gomis-Porqueras, Pedro (Deakin University); Waller, Christopher J. (Federal Reserve Bank of St. Louis)
    Abstract: We consider an overlapping generation framework with search and private information to study optimal taxation. Agents sequentially trade in markets that are characterized by different frictions and trading protocols. In frictional decentralized markets, agents receive shocks that determine if they are going to be consumers or producers. Shocks are private information. Mechanism design is used to solve for the constrained optimal allocation. We then study whether a government can replicate the constrained optimal allocation with an array of policy instruments including fiat money. We show that if the government has a full set of non-linear taxes, then lump-sum taxes and inflation are irrelevant for the allocation. However, if the government is constrained to use linear taxes, then using the inflation tax is optimal even if lump-sum taxes are available.
    Keywords: Inflation; Monetary Policy; Fiscal Policy
    JEL: E52 E62 H21
    Date: 2017–05–31
  11. By: Daniel Baksa (Department of Economics, Central European University; Institute of Economics, Hungarian Academy of Sciences); Mihnea Constantinescu (Bank of Lithuania); Zsuzsa Munkacsi (Bank of Lithuania)
    Abstract: We extend OGRE, the overlapping generation model developed by Baksa and Munkacsi (2016) by adding openness. We then employ the model to explore how the macroeconomic effects of aging, assumed to manifest itself as a decrease in the mortality rate, can be counteracted through public policies. The extended version inherits the previous modelling features of OGRE allowing us to also account for the impact openness has on the effectiveness of the considered policies.
    Keywords: population aging, public pension reforms, pay-as-you-go, fully funded, shadow economy, informal employment, small open-economy, overlapping generations
    JEL: E24 E26 F41 H55 J11 J46
    Date: 2016–09–23
  12. By: Giuliano Curatola (Goethe University Frankfurt); Michael Donadelli (Goethe University Frankfurt); Patrick Grüning (Bank of Lithuania & Faculty of Economics, Vilnius University); Christoph Meinerding (Goethe University Frankfurt)
    Abstract: This paper proposes and tests a new source of time variation in real investment opportunities, namely long-run shocks to the productivity of the investment sector, to explain the joint behavior of macroeconomic quantities and asset prices. A two-sector general equilibrium model with long-run investment shocks and wage rigidities produces both positive co-movement among key macroeconomic variables and a sizable return volatility differential between the investment and consumption sector. Moreover, positive long-run investment shocks are associated with low marginal utility and thus command a positive risk premium. We test our model using data on sectoral TFP and find evidence in support of our theoretical predictions.
    Keywords: General Equilibrium Asset Pricing, Production Economy, Long-Run Risk, Investment-Specific Shocks, Wage Rigidities.
    JEL: E32 G12
    Date: 2016–11–30
  13. By: FUJIWARA Ippei; WAKI Yuichiro
    Abstract: Should the fiscal authority use forward guidance to reduce future policy uncertainty perceived by private agents? Using dynamic stochastic general equilibrium models, we examine the welfare effects of announcing future fiscal policy shocks. Analytical as well as numerical experiments show that selective transparency is desirable—announcing future fiscal policy shocks that are distortionary can be detrimental to ex ante social welfare, whereas announcing non-distortionary shocks generally improves welfare. Sizable welfare gains are found with constructive ambiguity regarding the timing of a consumption tax increase in the fiscal consolidation scenario in Japan recommended by Hansen and Imrohoroglu (2016). However, being secretive about distortionary tax shocks is time inconsistent, and welfare loss from communication may be unavoidable without commitment.
    Date: 2017–06
  14. By: Francesco Bianchi; Giovanni Nicolò
    Abstract: We propose a novel approach to deal with the problem of indeterminacy in Linear Rational Expectations models. The method consists of augmenting the original model with a set of auxiliary exogenous equations that are used to provide the adequate number of explosive roots in presence of indeterminacy. The solution in this expanded state space, if it exists, is always determinate, and is identical to the indeterminate solution of the original model. The proposed approach accommodates determinacy and any degree of indeterminacy, and it can be implemented even when the boundaries of the determinacy region are unknown. As a result, the researcher can estimate the model by using standard packages without restricting the estimates to a certain area of the parameter space. We apply our method to simulated and actual data from a prototypical New-Keynesian model for both regions of the parameter space. We show that our method successfully recovers the true parameter values independent of the initial values.
    JEL: C19 C51 C62 C63
    Date: 2017–06
  15. By: Cars Hommes (Amsterdam School of Economics (University of Amsterdam) & Tinbergen Institute); Domenico Massaro (Universit? Cattolica del Sacro Cuore & Complexity Lab in Economics); Matthias Weber (Bank of Lithuania & Faculty of Economics, Vilnius University)
    Abstract: Expectations play a crucial role in modern macroeconomic models. We consider a New Keynesian framework under rational expectations and under a behavioral model of expectation formation. We show how the economy behaves in the alternative scenarios with a focus on inflation volatility. Contrary to the rational model, the behavioral model predicts that inflation volatility can be lowered if the central bank reacts to the output gap in addition to inflation. We test the opposing theoretical predictions in a learning-to-forecast experiment. The results support the behavioral model and the claim that output stabilization can lead to less volatile inflation.
    Keywords: Experimental macroeconomics; Heterogeneous expectations; LtFE; Tradeoff inflation and output gap
    JEL: C90 E03 E52 D84
    Date: 2017–03–30
  16. By: Eglë Jakuèionytë (Tinbergen Institute and the University of Amsterdam, the Netherlands)
    Abstract: This paper explores the spillover effects from increasing personal bankruptcy protection. Innovatively, the paper shows that the spillover effects can be influenced by the bank portfolio choice. Since a low level of personal bankruptcy protection keeps an insolvent individual liable until her debt is repaid in full, lender’s returns on mortgages are less uncertain than returns on other assets ceteris paribus. Risk-averse banks would prefer mortgages over other types of assets such as corporate loans. Corporate lending and thus equilibrium output would fall. In contrary to the popular view that creditor protection smooths credit provision and makes the allocation of resources more efficient, I show that in some cases a low level of personal bankruptcy protection can lead to aggregate consumption losses. Also I show that macroprudential policies (LTV ratios) can successfully complement higher personal bankruptcy protection in ensuring even higher welfare.
    Keywords: Personal bankruptcy, household debt, housing, general equilibrium, bank portfolio choice
    JEL: E44 G11 G21 K35 R21
    Date: 2017–04–24
  17. By: Richard A. Brecher (Department of Economics, Carleton University); Till Gross (Department of Economics, Carleton University)
    Abstract: Theoretically and numerically, we analyze the unemployment and income-distribution effects of economic growth, in a model with optimal saving (investment) and a minimum wage for unskilled labor. Within this three-factor model (including skilled labor), an exogenous rise in the growth rate increases unemployment if capital and unskilled labor are complements (versus substitutes), implying a trade-off between (faster) growth and (lower) unemployment. We also show how the growth rate affects the skill premium and factor shares of national income, providing little support for Piketty’s (2014) controversial thesis that capital’s share is higher when growth is slower.
    Keywords: Optimal growth, Minimum wage, Unskilled unemployment, Income distribution
    JEL: E24 O41
    Date: 2017–06–12
  18. By: Michael Donadelli (Faculty of Economics and Business Administration and Research Center SAFE, Goethe University Frankfurt); Patrick Grüning (Bank of Lithuania & Faculty of Economics, Vilnius University)
    Abstract: We study the general equilibrium implications of different fiscal policies on macroeconomic quantities, asset prices, and welfare by utilizing two endogenous growth models. The expanding variety model features only homogeneous innovations by entrants. The Schumpeterian growth model features heterogeneous innovations: “incremental” innovations by incumbents and “radical” innovations by entrants. The government levies taxes on labor income and corporate profits and supplies subsidies to consumption, capital investment, and investments in research and development by entrants and, if applicable, incumbents. With these models at hand, we provide new insights on the interplay of innovation dynamics and fiscal policy.
    Keywords: Endogenous growth, Asset pricing, Government, Fiscal policy, Heterogeneous innovation
    JEL: E22 G12 H20 I30 O30
    Date: 2017–04–03
  19. By: Coles, Melvyn (University of Essex); Francesconi, Marco (University of Essex)
    Abstract: This paper develops a new equilibrium model of two-sided search where ex-ante heterogenous individuals have general payoff functions and vectors of attributes. The analysis applies to a large class of models, from the non-transferable utility case to the collective household case with bargaining. The approach is powerful for it identifies a simple algorithm which, in the empirical application, is found to rapidly converge to equilibrium. Using indirect inference, we identify the differential effects of women's ability and charm on female match incentives. We use these results to assess the separate impacts of the arrival of equal opportunities for women in the labor market and the advent of the contraceptive pill on female economic activity and matching.
    Keywords: two-sided search, multiple attribute matching, marriage, female labor supply, contraceptive pill
    JEL: C6 J0 J1 N3
    Date: 2017–06
  20. By: Roberto Chang; Andres Fernandez; Adam Gulan
    Abstract: Corporate sectors in emerging markets have noticeably increased their reliance on foreign financing, presumably reflecting low global interest rates. The evidence also shows a rebalancing from bank loans towards bonds. To study these developments, this paper develops a dynamic open economy model where these modes of finance are determined endogenously. The model replicates the stylized facts following a drop in world interest rates; in particular, rebalancing towards bonds occurs because bank credit becomes relatively more expensive, reflecting the scarcity of bank equity. More generally, the model is suitable for studying interactions between modes of finance and the macroeconomy.
    Keywords: Bonds, Credit, Corporate Debt, Interest rates, Commodity Prices, Capital Goods, Financial Frictions, Emerging countries, bond finance, capital goods, interest rates
    JEL: G31 F41 E44 E32
    Date: 2016–08

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