nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2017‒07‒09
thirteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. When Inequality Matters for Macro and Macro Matters for Inequality By Ahn, SeHyoun; Kaplan, Greg; Moll, Benjamin; Winberry, Thomas; Wolf, Christian
  2. Rational Inattention and the Dynamics of Consumption and Wealth in General Equilibrium By Luo, Yulei; Nie, Jun; Wang, Gaowang; Young, Eric
  3. Robustness, Low Risk-Free Rates, and Consumption Volatility in General Equilibrium By Luo, Yulei; Nie, Jun; Young, Eric
  4. Striking a balance: optimal tax policy with labor market duality By Gilbert Mbara; Joanna Tyrowicz; Ryszard Kokoszczynski
  5. International business cycles: quantifying the effects of a world market for oil By Gars, Johan; Olovsson, Conny
  6. Offshore Production and Business Cycle Dynamics with Heterogeneous Firms By Zlate, Andrei
  7. Offshoring, Low-skilled Immigration, and Labor Market Polarization By Mandelman, Federico S.; Zlate, Andrei
  8. On Welfare Effects of Increasing Retirement Age By Krzysztof Makarski; Joanna Tyrowicz
  9. Fiscal Forward Guidance: A Case for Selective Transparency By Fujiwara, Ippei; Waki, Yuichiro
  10. Aggregate Reallocation Shocks, Occupational Employment and Distance By Jacob Wong
  11. Nominal GDP Targeting With Heterogeneous Labor Supply By Bullard, James B.; Singh, Aarti
  12. Job mobility and creative destruction: flexicurity in the land of Schumpeter By Andreas Kettemann; Francis Kramarz; Josef Zweimüller
  13. Welfare effects of fiscal policy in reforming the pension system By Oliwia Komada; Krzysztof Makarski; Joanna Tyrowicz

  1. By: Ahn, SeHyoun; Kaplan, Greg; Moll, Benjamin; Winberry, Thomas; Wolf, Christian
    Abstract: We develop an efficient and easy-to-use computational method for solving a wide class of general equilibrium heterogeneous agent models with aggregate shocks, together with an open source suite of codes that implement our algorithms in an easy-to-use toolbox. Our method extends standard linearization techniques and is designed to work in cases when inequality matters for the dynamics of macroeconomic aggregates. We present two applications that analyze a two-asset incomplete markets model parameterized to match the distribution of income, wealth, and marginal propensities to consume. First, we show that our model is consistent with two key features of aggregate consumption dynamics that are difficult to match with representative agent models: (i) the sensitivity of aggregate consumption to predictable changes in aggregate income and (ii) the relative smoothness of aggregate consumption. Second, we extend the model to feature capital-skill complementarity and show how factor-specific productivity shocks shape dynamics of income and consumption inequality.
    Date: 2017–06
  2. By: Luo, Yulei; Nie, Jun; Wang, Gaowang; Young, Eric
    Abstract: We use a recursive utility version of a basic Huggett (1993) model to study the cross-sectional dispersion of consumption and wealth (relative to income). The basic model implies too little dispersion compared to the data, whereas a one-parameter extension to include rational inattention (limited information processing) delivers a better fit to both facts in general equilibrium. In particular, intertemporal substitution plays an important role in determining the two key dispersion moments via affecting the degree of optimal attention in equilibrium. Alternative models that rely on habit formation, incomplete information about current income, or borrowing constraints are not consistent with the facts we document.
    Keywords: Rational Inattention; General Equilibrium; Consumption and Wealth Volatility
    JEL: E2 E21
    Date: 2017–04–18
  3. By: Luo, Yulei; Nie, Jun; Young, Eric
    Abstract: This paper develops a tractable continuous-time recursive utility (RU) version of the Huggett (1993) model to explore how the preference for robustness (RB) interacts with intertemporal substitution and risk aversion and then affects the interest rate, the dynamics of consumption and income, and the welfare costs of model uncertainty in general equilibrium. We show that RB reduces the equilibrium interest rate and the relative volatility of consumption growth to income growth when the income process is stationary, but our benchmark model cannot match the observed relative volatility. An extension to an RU-RB model with a risky asset is successful at matching this ratio. The model implies that the welfare costs of uncertainty are very large.
    Keywords: Robustness, Precautionary Savings, the Permanent Income Hypothesis, Low Interest Rates, Consumption and Income Inequality, General Equilibrium
    JEL: E2 E21
    Date: 2017–07–05
  4. By: Gilbert Mbara (University of Warsaw); Joanna Tyrowicz (Faculty of Economic Sciences, University of Warsaw; National Bank of Poland); Ryszard Kokoszczynski (Faculty of Economic Sciences, University of Warsaw; National Bank of Poland)
    Abstract: We develop a dynamic general equilibrium model in which firms may evade the employer contribution component of social security taxes by offering some workers secondary contracts. We calibrate the model to data from the United States and EU-14 countries and obtain estimates of the secondary labor market participation consistent with empirical evidence. We then investigate the optimal mix of the avoidable and unavoidable components of labor taxes and analyze the fiscal and macroeconomic effects of bringing the composition to the welfare optimum. We find that partial labor tax evasion makes tax revenues more elastic, but full tax compliance need not be a welfare enhancing policy mix. Relating to the highly cited work of Trabandt and Uhlig (2011), we extend their framework to analyze the phenomenon of non-standard employment. We distinguish between avoidable and unavoidable labor taxation -- the former may be evaded by firms if they formulate a contract with a worker as a non-standard employment contract and may be associated with employers' share in labor taxation. The latter is paid by worker--households. Our results enrich the intuition about the optimal mix of the two types of labor taxation. We show that in countries where the share of avoidable labor taxes is relatively low, substantial welfare gains can be achieved by changing the mix of the two types of labor taxes. The gains emanate from higher labor supply and consumption which accompanies modest increases in secondary employment. These gains are obtained without loss to aggregate fiscal revenue. In addition to these main results, we also show that plausible estimates of the levels of tax evasion, the efficiency of tax auditing and the shares of secondary employment can be obtained from aggregate tax revenue data.
    Keywords: Laffer curve, tax evasion, labor market duality
    JEL: H26 H3 E13 E26 J81
    Date: 2017
  5. By: Gars, Johan (GEDB, Royal Swedish Academy of Sciences); Olovsson, Conny (Research Department, Central Bank of Sweden)
    Abstract: To what extent is the international business cycle affected by the fact that an essential input (oil) is traded on the world market? We quantify the contribution of oil by setting up a model with separate shocks to efficiencies of capital/labor and oil, as well as global shocks to the oil supply. We find that the shocks to the supply and the efficiency of oil both contribute to positive comovements. These two shocks are also relatively transitory, which induces high responses in output and low responses in consumption. As a consequence, the model resolves both the consumption correlation puzzle and the international comovement puzzle.
    Keywords: International comovements; business cycles; oil; productivity
    JEL: E32 F32 F41 Q43
    Date: 2017–05–01
  6. By: Zlate, Andrei (Federal Reserve Bank of Boston)
    Abstract: To examine the effect of offshoring through vertical FDI on the international transmission of business cycles, I propose a two-country model in which firms endogenously choose the location of their production plants over the business cycle. Firms face a sunk cost to enter the domestic market and an additional fixed cost to produce offshore. As such, the offshoring decision depends on the firm-specific productivity and on fluctuations in the relative cost of effective labor. The model generates a procyclical pattern of offshoring and dynamics along its extensive margin that are consistent with data from Mexico's maquiladora sector. The extensive margin enhances the procyclical response of the value added offshore to expansions in the home economy, as the number of offshoring firms mirrors the dynamics of firm entry at home. As a result, offshoring increases the comovement of output across economies, in line with the empirical evidence.
    Keywords: Offshore production; extensive margin; heterogeneous firms; firm entry; business cycle dynamics; terms of labor.
    JEL: F23 F41
    Date: 2016–02–17
  7. By: Mandelman, Federico S. (Federal Reserve Bank of Atlanta); Zlate, Andrei (Federal Reserve Bank of Boston)
    Abstract: During the last three decades, the U.S. labor market has been characterized by its employment polarization. As jobs in the middle of the skill distribution have shrunk, employment has expanded in high- and low-skill occupations. Real wages have not followed the same pattern. While earnings for high-skill occupations have risen robustly, wages for both low- and middle-skill workers have remained subdued. We attribute this outcome to the rise in offshoring and low-skilled immigration, and develop a three-country stochastic growth model to rationalize their asymmetric effect on employment and wages, as well as their implications for U.S. welfare. In the model, the increase in offshoring negatively affects middle-skill occupations but benefits the high-skill ones, which in turn boosts aggregate productivity. As the income of high-skill occupations rises, so does the demand for complementary services provided by low-skill workers. However, low-skill wages remain depressed due to the rise in low-skilled immigration. Native workers react to immigration by investing in training. Offshoring and low-skilled immigration improve aggregate welfare in the U.S. economy, notwithstanding their asymmetric impact on native workers of different skill levels. The model is estimated using data on real GDP, U.S. employment by skill group, and enforcement at the U.S.-Mexico border.
    Keywords: International labor migration; offshoring; labor market polarization; task upgrading; heterogeneous workers
    JEL: F16 F22 F41
    Date: 2016–09–30
  8. By: Krzysztof Makarski (Group for Research in Applied Economics (GRAPE); Warsaw School of Economics; Narodowy Bank Polski); Joanna Tyrowicz (Group for Research in Applied Economics (GRAPE); University of Warsaw)
    Abstract: We develop an OLG model with realistic assumptions about longevity to analyze the welfare effects of raising the retirement age. We look at a scenario where an economy has a pay-as-you-go defined benefit scheme and compare it to a scenario with defined contribution schemes (funded or notional). We show that initially in both types of pension system schemes majority of the welfare effects come from adjustment in taxes and/or prices. After the transition period, welfare effects are predominantly generated by the preference for smoothing inherent in many widely used models. We also show that although incentives differ between defined benefit and defined contribution systems, the welfare effects are of comparable magnitude under both schemes. We provide an explanation for this counter-intuitive result.
    Keywords: longevity, PAYG, retirement age, pension system reform, welfare
    JEL: C68 E21 J11 H55
    Date: 2017
  9. By: Fujiwara, Ippei (Keio University); Waki, Yuichiro (University of Queensland)
    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 nondistortionary 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.
    JEL: D82 E30 E62 H20
    Date: 2017–06–01
  10. By: Jacob Wong (School of Economics, University of Adelaide)
    Abstract: A unique general equilibrium model featuring many occupations and aggregate shocks is created to study occupational employment dynamics by imposing a correlated TFP structure across occupations along with distance between occupations. Productivity processes across occupations are correlated with similar occupations experiencing similar fluctuations. Mobility frictions and the correlated-productivity structure produce a systematic relationship between occupational employment correlations and occupational distance that does not arise when productivity processes are independent. Using employment data and measures of task-distance between occupations from the U.S. economy, a negative relationship between the correlation of occupational employment and task-distance separating occupation-pairs is uncovered.
    Keywords: Labour reallocation, Occupation switching, Task-distance
    JEL: E24 J24 J31 J62
    Date: 2017–05
  11. By: Bullard, James B. (Federal Reserve Bank of St. Louis); Singh, Aarti (University of Sydney)
    Abstract: We study nominal GDP targeting as optimal monetary policy in a model with a credit market friction following Azariadis, Bullard, Singh and Suda (2016), henceforth ABSS. As in ABSS, the macroeconomy we study has considerable income inequality which gives rise to a large private sector credit market. Households participating in this market use non-state contingent nominal contracts (NSCNC). We extend the ABSS framework to allow for endogenous and heterogeneous household labor supply among credit market participant households. We show that nominal GDP targeting continues to characterize optimal monetary policy in this setting. Optimal monetary policy repairs the distortion caused by the credit market friction and so leaves heterogeneous households supplying their desired amount of labor, a type of “divine coincidence” result. We also analyze the case when there is an aging population. We interpret these findings in light of the recent debate in monetary policy concerning labor force participation.
    Keywords: Non-state contingent nominal contracting; optimal monetary policy; nominal GDP targeting; life cycle economies; heterogeneous households; credit market participation; labor supply
    JEL: E4 E5
    Date: 2017–02–17
  12. By: Andreas Kettemann; Francis Kramarz; Josef Zweimüller
    Abstract: This paper evaluates the 2003 Austrian severance-pay reform, often advocated as a role model for structural reforms in countries plagued by inflexible labor markets and high unemployment. The reform replaced a system with tenure-based severance payments after a layoff (but not after a quit) by payments into pension accounts that accrue to workers after a layoff as well as after a quit. We identify the reform effects using a regression discontinuity (RD) design and find a substantial increase in job mobility in response to the reform. A search-and-matching model with on-the- job search and tenure-dependent severance payments is structurally estimated using the RD-induced empirical moments. Counterfactual policy experiments suggest that flexicurity reforms spur job creation and can substantially reduce unemployment in countries where severance payments are initially high.
    Keywords: Severance pay, job mobility, flexicurity
    JEL: J63 J65
    Date: 2017–06
  13. By: Oliwia Komada (Group for Research in Applied Economics (GRAPE)); Krzysztof Makarski (Group for Research in Applied Economics (GRAPE); Warsaw School of Economics; Narodowy Bank Polski); Joanna Tyrowicz (Group for Research in Applied Economics (GRAPE); University of Warsaw)
    Abstract: Most reforms of the pension systems imply substantial redistributions between cohorts and within cohort. Fiscal policy, which accompanies these changes may counteract or reinforce this redistribution. Moreover, the literature has argued that the insurance motive implicit in some pension systems plays a major role in determining the welfare effects of the reform: reforms otherwise improving welfare become detrimental to welfare once insurance motive is internalized. We show that this result is not universal, i.e. there exists a variety of fiscal closures which yield welfare gains and political support for a pension system reform. In an OLG model with uncertainty we analyze two sets of fiscal adjustments: fiscally neutral adjustments in the pension system (via contribution rate or replacement rate) and balancing pension system by a combination of taxes and/or public debt. We find that fiscally neutral pension system reforms are more likely to yield welfare gains. Many adjustments obtain sufficient political support despite yielding aggregate welfare losses and vice versa. Furthermore, we point to fiscal closures which attenuate and reinforce the relevance of the insurance motive in determining the welfare effects.
    Keywords: pension system reform, fiscal policy, welfare effects
    JEL: C68 D72 E62 H55 J26
    Date: 2017

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