nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2017‒09‒03
forty-two papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. An estimated Dynamic Stochastic Disequilibrium model of Euro-Area unemployment By Christian Schoder
  2. Optimal Progressivity with Age-Dependent Taxation By Heathcote, Jonathan; Storesletten, Kjetil; Violante, Giovanni L.
  3. Tuning in RBC Growth Spectra By Tamas Csabafi; Michal Kejak; Max Gillman; Jing Dang; Szilard Benk
  4. Leverage and Deepening Business Cycle Skewness By Henrik Jensen; Ivan Petrella; Søren Hove Ravn; Emiliano Santoro
  5. Searching for Wages in an Estimated Labor Matching Model By Tristan Potter; Sanjay Chugh; Ryan Chahrour
  6. Aggregate Recruiting Intensity By Gavazza, Alessandro; Mongey, Simon; Violante, Giovanni L.
  7. Asset prices and climate policy By Karp, Larry; Rezai, Armon
  8. Optimal Ramsey Capital Income Taxation —A Reappraisal By Chien, YiLi; Wen, Yi
  9. Confounding Dynamics By Todd Walker; Giacomo Rondina
  10. Flight to What? ---Dissecting Liquidity Shortage in Financial Crisis By Dong, Feng; Wen, Yi
  11. Changing Business Cycle Dynamics in the US: The Role of Women's Employment By Stefania Albanesi
  12. Growth and Bubbles: The Interplay between Productive Investment and the Cost of Rearing Children By Xavier Raurich; Thomas Seegmuller
  13. Goods-Market Frictions and International Trade By Andrew McCallum; Pawel Krolikowski
  14. Intergenerational Transfers and China’s Social Security Reform By Ayşe İmrohoroğlu; Kai Zhao
  15. Financial Heterogeneity and the Investment Channel of Monetary Policy By Thomas Winberry; Pablo Ottonello
  16. Liquidity Policies and Systemic Risk By Adrian, Tobias; Boyarchenko, Nina
  17. Das House-Kapital: A Long Term Housing & Macro Model By Thomas Steger; Volker Grossmann
  18. Should Unconventional Monetary Policies Become Conventional? By Pau Rabanal; Dominic Quint
  19. Dynamic Impacts on Growth and Intergenerational Effects of Energy Transition in a Time of Fiscal Consolidation By Frédéric Gonand
  20. Political Distribution Risk and Aggregate Fluctuations By Drautzburg, Thorsten; Fernandez-Villaverde, Jesus; Guerron-Quintana, Pablo
  21. The Lifetime Costs of Bad Health By Svetlana Pashchenko; Ponpoje (Poe) Porapakkarm; Mariacristina De Nardi
  22. Are consistent expectations better than rational expectations ? By Elliot Aurissergues
  23. Money, Banking and Financial Markets By Andolfatto, David; Berentsen, Aleksander; Martin, Fernando M.
  24. The Effect of Partial Retirement on Labor Supply, Public Balances and the Income Distribution: Evidence from a Structural Analysis By Songül Tolan
  25. Job Search Behavior among the Employed and Non-Employed By Faberman, R. Jason; Mueller, Andreas I.; Sahin, Aysegül; Topa, Giorgio
  26. The Chinese Saving Rate: Long-Term Care Risks, Family Insurance, and Demographics By Ayşe İmrohoroğlu; Kai Zhao
  27. Hopf Bifurcation from new-Keynesian Taylor rule to Ramsey Optimal Policy By Jean-Bernard Chatelain; Kirsten Ralf
  28. The Optimal Inflation Rate with Discount Factor Heterogeneity By Antoine Lepetit
  29. Income and Wealth Distribution in Macroeconomics: A Continuous-Time Approach By Yves Achdou; Jiequn Han; Jean-Michel Lasry; Pierre-Louis Lions; Benjamin Moll
  30. Optimal Taxation to Correct Job Mismatching By Guillaume Wilemme
  31. Multidimensional Sorting under Random Search By Fabien Postel-Vinay; Ilse Lindenlaub
  32. Household Finance in China By Russell Cooper; Guozhong Zhu
  33. Pension Reforms and Adverse Demographics: The Case of the Czech Republic By Martin Stepanek
  34. Fostering Renewables and Recycling a Carbon Tax: Joint Aggregate and Intergenerational Redistributive Effects By Frédéric Gonand
  36. Estimating Macroeconomic Models of Financial Crises: An Endogenous Regime Switching Approach By Christopher Otrok; Andrew Foerster; Alessandro Rebucci; Gianluca Benigno
  37. Banks Interconnectivity and Leverage By Vincenzo Quadrini; Laura Moretti; Alessandro Barattieri
  38. Non-Neutrality of Open Market Operations By Salvatore Nistico; Pierpaolo Benigno
  39. Optimal Contracts with Reflection By Yuzhe Zhang; Borys Grochulski
  40. Engines of Leisure By Benjamin Bridgman
  41. Ambiguity, Monetary Policy and Trend Inflation By Francesca Monti; Riccardo Maria Masolo
  42. Accounting for Automation and Offshoring in International Macroeconomic and Employment Dynamics By Federico Mandelman

  1. By: Christian Schoder (Department of Economics, New School for Social Research)
    Abstract: An empirical variant of the Dynamic Stochastic Disequilibrium (DSDE) model proposed by Schoder (2017a) is estimated for the Euro Area using Bayesian inference. Unemployment arises from job rationing due to insucient aggregate spending. The nominal wage is taken as a policy variable subject to a collective Nash bargaining process between workers and rms with the state of the labor market a ecting the relative bargaining power. A consumption function is implied by a precautionary saving motive arising from an uninsurable risk of permanent income loss. Comparing the estimated DSDE model to the corresponding estimated Dynamic Stochastic General Equilibrium (DSGE) model with frictional unemployment yields the following results: (i ) the DSDE model outperforms the corresponding DSGE model empirically according to the Bayes factor. (ii ) The scal multiplier is considerably higher in the DSDE model than in the DSGE model. (iii ) As observed empirically, the DSDE model predicts the real wage to move pro-cyclically with a lag whereas the DSGE model predicts a counter-cyclical movement. (iv ) In the DSDE model, a productivity shock is contractionary in the short run and expansionary in the medium run. (v) Strengthening the worker's bargaining power is expansionary in the short run and contractionary in the medium run. (vi ) Output variation is mainly driven by demand shocks in the DSDE model. Productivity shocks are important only in the DSGE model. (vii ) Unemployment variation is primarily caused by demand and productivity shocks in the DSDE model. Labor supply shocks are essential only in the DSGE model.
    Date: 2017–08
  2. By: Heathcote, Jonathan (Federal Reserve Bank of Minneapolis); Storesletten, Kjetil (University of Oslo); Violante, Giovanni L. (Princeton University)
    Abstract: This paper studies optimal taxation of labor earnings when the degree of tax progressivity is allowed to vary with age. We analyze this question in a tractable equilibrium overlapping-generations model that incorporates a number of salient trade-offs in tax design. Tax progressivity provides insurance against ex-ante heterogeneity and earnings uncertainty that missing markets fail to deliver. However, taxes distort labor supply and human capital investments. Uninsurable risk cumulates over the life cycle, and thus the welfare gains from income compression via progressive taxation increase with age. On the other hand, average labor productivity rises with age, and thus the welfare losses from progressive taxation's distortionary impact on labor supply also increase with age. The optimal age-varying system balances these distortions. In a calibrated version of the economy, we quantify the welfare gains of moving from the optimal age-invariant to the optimal age-dependent system and find that they are negligible.
    Keywords: Tax progressivity; Tagging; Income distribution; Skill investment; Labor supply; Partial insurance; Government expenditures; Welfare
    JEL: D30 E20 H20 H40 J22 J24
    Date: 2017–08–04
  3. By: Tamas Csabafi (University of Missouri, St Louis); Michal Kejak (CERGE-EI); Max Gillman (University of Missouri at St Louis); Jing Dang (SGCC, China); Szilard Benk (Magyar Nemzeti Bank)
    Abstract: For US postwar data, the paper explains an array of RBC puzzles by adding to the standard RBC model external margins for both physical capital and human capital, and examining model fit with data across business cycle (BC) and low frequency (LF) as well as Medium Cycle (MC) windows. The model results in a goods sector productivity shock with a 7500 times smaller variance than the standard RBC model, implying greatly improved amplification of the shock. In addition, output growth persistence autocorrelation profiles are modeled as in data, thus improving upon the propagation puzzle. The model produces a consumption-output ratio as in the business cycle data, a labor share of output that is countercyclic as in data, and human capital investment time that is countercyclic as in data. Also the capacity utilization rate is procyclic within BC, LF and MC windows as in data; including labor moments, a wide array of moments are explained for correlations, volatilities and growth persistence across these business cycle and lower frequency windows. Using a metric of fit, along with a uniform grid search, measures of fit are presented by window and category. In the BC window, key correlations have only an average 15% deviation from the data moments; the LF growth persistence has only an average 8% deviation from the data moments.
    Date: 2017
  4. By: Henrik Jensen (Department of Economics, University of Copenhagen); Ivan Petrella (Warwick Business School, University of Warwick); Søren Hove Ravn (Department of Economics, University of Copenhagen); Emiliano Santoro (Department of Economics, University of Copenhagen)
    Abstract: We document that the U.S. economy has been characterized by an increasingly negative business cycle asymmetry over the last three decades. This fi?nding can be explained by the concurrent increase in the fi?nancial leverage of households and fi?rms. To support this view, we devise and estimate a dynamic general equilibrium model with collateralized borrowing and occasionally binding credit constraints. Higher leverage increases the likelihood that constraints become slack in the face of expansionary shocks, while contractionary shocks are further ampli?ed due to binding constraints. As a result, booms become progressively smoother and more prolonged than busts. We are therefore able to reconcile a more negatively skewed business cycle with the Great Moderation in cyclical volatility. Finally, in line with recent empirical evidence, fi?nancially-driven expansions lead to deeper contractions, as compared with equally-sized non-?financial expansions.
    Keywords: Credit constraints, business cycles, skewness, deleveraging
    JEL: E32 E44
    Date: 2017–08–24
  5. By: Tristan Potter (Drexel University); Sanjay Chugh (The Ohio State University); Ryan Chahrour (Boston College)
    Abstract: We estimate a real business cycle economy with search frictions in the labor market in which the latent wage follows a non-structural ARMA process. The estimated model does an excellent job matching a broad set of quantity data and wage indicators. Under the estimated process, wages respond immediately to shocks but converge slowly to their long-run levels, inducing substantial variation in labor’s share of surplus. These results are not consistent with either a rigid real wage or flexible Nash bargaining. Despite inducing a strong endogenous response of wages, neutral shocks to productivity account for the vast majority of aggregate fluctuations in the economy, including labor market variables.
    Date: 2017
  6. By: Gavazza, Alessandro (London School of Economics); Mongey, Simon (Federal Reserve Bank of Minneapolis); Violante, Giovanni L. (Princeton University)
    Abstract: We develop an equilibrium model of firm dynamics with random search in the labor market where hiring firms exert recruiting effort by spending resources to fill vacancies faster. Consistent with microevidence, fast-growing firms invest more in recruiting activities and achieve higher job-filling rates. These hiring decisions of firms aggregate into an index of economy-wide recruiting intensity. We study how aggregate shocks transmit to recruiting intensity, and whether this channel can account for the dynamics of aggregate matching efficiency during the Great Recession. Productivity and financial shocks lead to sizable pro-cyclical fluctuations in matching efficiency through recruiting effort. Quantitatively, the main mechanism is that firms attain their employment targets by adjusting their recruiting effort in response to movements in labor market slackness.
    Keywords: Aggregate matching efficiency; Firm dynamics; Macroeconomic shocks; Recruiting intensity; Unemployment; Vacancies
    JEL: E24 E32 E44 G01 J23 J63 J64
    Date: 2017–08–25
  7. By: Karp, Larry; Rezai, Armon
    Abstract: Currently living people might reduce carbon emissions to protect themselves, their wealth, or future generations from climate damage. An overlapping generations climate model with endogenous asset priceand investment levels disentangles these incentives. Asset markets capitalize the future e¤ects of policy, regardless of people’s concern for future generations. These markets can lead self-interested agents to undertake signi…cant abatement. A small climate policy that raises the price of capital increases welfare of old agents and also increases welfare of young agents with a high intertemporal elasticity of sub-stitution. Climate policy can also have subtle distributional e¤ects across the currently living generations.
    Keywords: Social and Behavioral Sciences, Climate externality, overlapping generations, climate pol- icy, generational con‡ict, dynamic bargaining, Markov perfection, ad- justment costs.
    Date: 2017–08–31
  8. By: Chien, YiLi (Federal Reserve Bank of St. Louis); Wen, Yi (Federal Reserve Bank of St. Louis)
    Abstract: This paper addresses a long-standing problem in the optimal Ramsey capital taxation literature. The tractability of our model enables us to solve the Ramsey problem analytically along the entire transitional path. We show that the conventional wisdom on Ramsey tax policy and its underlying intuition and rationales do not hold in our model and may thus be misrepresented in the literature. We uncover a critical trade off for the Ramsey planner between aggregate allocative efficiency in terms of the modified golden rule and individual allocative efficiency in terms of self-insurance. Facing the trade off, the Ramsey planner prefers issuing debt rather than taxing capital if possible. In particular, the planner always intends to supply enough bonds to relax individuals' borrowing constraints and through which to achieve the modified golden rule by crowding out capital. Capital tax is not the vital tool to achieve aggregate allocative efficiency despite possible over-accumulation of capital. Thus the optimal capital tax can be zero, positive, or even negative, depending on the Ramsey planner's ability to issue debt. The modified golden rule can fail to hold whenever the government encounters a debt limit. Finally, the desire to relax individuals' borrowing constraints by the planner may lead to unlimited debt accumulation, resulting in a dynamic path featuring no steady state.
    Keywords: Optimal Capital Taxation; Ramsey Problem; Incomplete Market
    JEL: E13 E62 H21 H30
    Date: 2017–08–18
  9. By: Todd Walker (Indiana University); Giacomo Rondina (University of Colorado, Boulder)
    Abstract: In the context of a dynamic model with incomplete information, we isolate a novel mechanism of shock propagation that results in waves of optimism and pessimism along a Rational Expectations equilibrium. We term the mechanism confounding dynamics because it arises from agents’ optimal signal extraction efforts on variables whose dynamics—as opposed to superimposed noise—prevents full revelation of information. Employing methods in the space of analytic functions, we are able to obtain analytical characterizations of the equilibria that generalize the celebrated Hansen-Sargent optimal prediction formula. We apply our results to a canonical real business cycle model and derive the analytic solution for output, consumption and capital. We show that, in response to a permanent positive productivity shock, confounding dynamics generate expansions and recessions that would not be present under complete information.
    Date: 2017
  10. By: Dong, Feng (Shanghai Jiao Tong University, Shanghai, China.); Wen, Yi (Federal Reserve Bank of St. Louis)
    Abstract: We endogenize the liquidity and the quality of private assets in a tractable incomplete-market model with heterogeneous agents. The model decomposes the convenience yield of government bond into a "liquidity premium" (flight to liquidity) and a "safety premium" (flight to quality) over the business cycle. When calibrated to match the U.S. aggregate output fluctuations and bond premiums, the model reveals that a sharp reduction in the quality, instead of the liquidity, of private assets was the culprit of the recent financial crisis, consistent with the perception that it was the subprime mortgage problem that triggered the Great Recession. Since the provision of public liquidity endogenously affects the provision of private liquidity, our model indicates that excessive injection of public liquidity during financial crisis can be welfare reducing under either conventional or unconventional policies. In particular, too much intervention for too long can depress capital investment.
    Keywords: Liquidity Shortage; Resaleability Constraint; Information Asymmetry; Flight to Liquidity; Flight to Quality; Financial Crisis; Unconventional Policy.
    JEL: E44 E58 G01 G10
    Date: 2017–08–01
  11. By: Stefania Albanesi (University of Pittsburgh)
    Abstract: I examine the effects of female labor market behavior on the dynamics of aggregate employment and hours in the trend and over the business cycle in the US. I argue that the steep increase in women's labor force participation throughout the 1970s and 1980s, and its flattening out since the 1990s can contribute to explain three puzzling phenomena experienced by the US: the non-stationarity of aggregate hours, the decrease business cycle volatility of labor market variables before the great recession, and the recent jobless recoveries. To develop the analysis, I first construct an aggregate time series for hours by gender similar to the series used in in aggregate business cycle analysis, and provide descriptive empirical evidence supporting the hypothesis proposed in this paper. I then develop and estimate a dynamic stochastic general equilibrium model that allows for gender differences in hours and wages to assess the implications of the changing trend in female participation on the behavior of aggregate variables. I find that female specific shocks explain a substantial fraction of the volatility of aggregate outcomes, both at the business cycle frequency and in the longer run. Using a number of counterfactuals, I show that the trend in female participation and its variation over time can rationalize the three phenomena of interest. These findings have implications for the behavior of aggregate labor market variables in other advanced economies where female labor force participation is experiencing secular changes.
    Date: 2017
  12. By: Xavier Raurich (Departament de Teoria Econòmica and CREB, Universitat de Barcelona.); Thomas Seegmuller (GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - EHESS - École des hautes études en sciences sociales - AMU - Aix Marseille Université - CNRS - Centre National de la Recherche Scientifique - ECM - Ecole Centrale de Marseille)
    Abstract: As it is documented, investment of households in human capital is negatively related to the number of children individuals will have and requires some loans to be financed. We show that this negative relationship contributes to explain episodes of bubbles that are associated to higher growth rates. This conclusion is obtained in an overlapping generations model where agents choose to invest in a productive asset, that can be interpreted as human capital, and decide their number of children. A bubble allows to smooth consumption and expenses over the life-cycle, and can therefore be used to finance either productive investment or the cost of rearing children. The time cost of rearing children plays a key role in the analysis. If the time cost per child is sufficiently large, households have only a small number of children. The bubble then has a crowding-in effect because it is used to finance productive investment. On the contrary, if the time cost per child is low enough, households have a large number of children. Then, the bubble is mainly used to finance the total cost of rearing children and has a crowding-out effect on investment. Therefore, the new mechanism we highlight shows that a bubble enhances growth only if the economy is characterized by a high rearing time cost per child.
    Keywords: bubble,sustained growth,fertility
    Date: 2017–07
  13. By: Andrew McCallum (Federal Reserve Board); Pawel Krolikowski (Federal Reserve Bank of Cleveland)
    Abstract: We present a tractable framework that embeds goods-market frictions in a general equilibrium dynamic model with heterogeneous exporters and identical importers. These frictions arise because it takes time and expense for exporters and importers to meet. We show that search frictions lead to an endogenous fraction of unmatched exporters, alter the gains from trade, endogenize entry costs, and imply that the competitive equilibrium does not generally result in the socially optimal number of searching firms. Finally, ignoring search frictions results in biased estimates of the effect of tariffs on trade flows.
    Date: 2017
  14. By: Ayşe İmrohoroğlu (University of Southern California); Kai Zhao (University of Connecticut)
    Abstract: Most of the studies examining the implications of social security reforms in China use overlapping generations models and abstract from the role of family support. How-ever, in China, family support plays a prominent role in the well-being of the elderly and often substitutes for the lack of government-provided old-age support systems. In this paper, we investigate the impact of social security reform in China in a model with two-sided altruism as well as a pure life-cycle model. We show that the quantitative implications of social security reform are very different across the two models.
    Date: 2017–08
  15. By: Thomas Winberry (University of Chicago); Pablo Ottonello (University of Michigan)
    Abstract: We study the heterogeneous effects of monetary policy on firm-level investment and their implications for the aggregate transmission mechanism. Empirically, we find that firms with low levels of liquid assets and/or high levels of debt are substantially less responsive to identified monetary shocks in terms of their capital investment, inventory investment, and stock returns. We build a heterogeneous firm new Keynesian model featuring financial frictions consistent with this fact. In the model, firms with low net worth find it costlier to finance investment and are therefore less willing to respond to monetary shocks. The aggregate effect of monetary policy therefore depends on the distribution of net worth; it is weak when balance sheets are week, but becomes stronger as they recover.
    Date: 2017
  16. By: Adrian, Tobias; Boyarchenko, Nina
    Abstract: Bank liquidity shortages associated with the growth of wholesale-funded credit intermediation has motivated the implementation of liquidity regulations. We analyze a dynamic stochastic general equilibrium model in which liquidity and capital regulations interact with the supply of risk-free assets. In the model, the endogenously time varying tightness of liquidity and capital constraints generates intermediaries' leverage cycle, influencing the pricing of risk and the level of risk in the economy. Our analysis focuses on liquidity policies' implications for households' welfare. Within the context of our model, liquidity requirements are preferable to capital requirements, as tightening liquidity requirements lowers the likelihood of systemic distress without impairing consumption growth. In addition, we find that intermediate ranges of risk-free asset supply achieve higher welfare.
    Keywords: DSGE; Financial Intermediation; liquidity regulation; systemic risk
    JEL: E02 E32 G00 G28
    Date: 2017–08
  17. By: Thomas Steger (University of Leipzig); Volker Grossmann (University of Fribourg)
    Abstract: There are, by now, several long term, time series data sets on important housing & macro variables, such as land prices, house prices, and the housing wealth-to-income ratio. However, an appropriate theory that can be employed to think about such data and associated research questions has been lacking. We present a new housing & macro model that is designed specifically to analyze the long term. As an illustrative application, we demonstrate that the calibrated model replicates, with remarkable accuracy, the historical evolution of housing wealth (relative to income) after World War II and suggests a further considerable increase in the future. The model also accounts for the close connection of house prices to land prices in the data. We also compare our framework to the canonical housing & macro model, typically employed to analyze business cycles, and highlight the main differences.
    Date: 2017
  18. By: Pau Rabanal (IMF); Dominic Quint (Deutsche Bundesbank)
    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 short-term 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. We study the optimality of UMP 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 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.
    Date: 2017
  19. By: Frédéric Gonand (LEDa - Laboratoire d'Economie de Dauphine - Université Paris-Dauphine, Chaire économie du climat - Chaire économie du climat)
    Abstract: Social planners in most western countries will be facing two long-lasting challenges in the next years: energy transition and fiscal consolidation. One problem is that governments might consider that implementing an energy transition could get in the way of achieving a fiscal consolidation. If so, interrupting the energy transition in a time of fiscal consolidation would involve significant aggregate impacts on activity and intergenerational redistributive effects. This article tries to assess them empirically. It relies on an overlapping-generations framework in a general equilibrium setting, with a detailed energy module. The model is parameterized on data provided by OECD/IEA for France. Different results emerge. Renouncing to the energy transition would slightly foster the level of GDP during the next 10 to 15 years - depending on the dynamics of the prices of fossil fuels on world markets - but weigh on it more significantly afterwards (up to -1% in 2050). If the prices of fossil fuels keep increasing in the future, implementing an energy transition could have broadly the same favourable effects on the GDP level in the long run as those of a fiscal consolidation diminishing significantly public spending instead of raising taxes. In the long-run, the GDP would be maximized by implementing an energy transition and simultaneously lessening the public deficit by lowering some public expenditure, a policy that would entail an overall gain of around 1,6% of GDP in 2050. Stopping the energy transition would also bring about intergenerational issues. It would be detrimental to the intertemporal wellbeing of almost all cohorts alive in 2010. A fiscal policy with lower public expenditures and frozen tax rates may be still more favourable to young and future generations than implementing an energy transition. However, renouncing to an energy transition would annihilate most of these proyouth effects.
    Keywords: fiscal consolidation,general equilibrium,Energy transition,intergenerational redistribution,overlapping generations
    Date: 2017–05–12
  20. By: Drautzburg, Thorsten (Federal Reserve Bank of Philadelphia); Fernandez-Villaverde, Jesus (Federal Reserve Bank of Philadelphia); Guerron-Quintana, Pablo (Federal Reserve Bank of Philadelphia)
    Abstract: We argue that political distribution risk is an important driver of aggregate fluctuations. To that end, we document significant changes in the capital share after large political events, such as political realignments, modifications in collective bargaining rules, or the end of dictatorships, in a sample of developed and emerging economies. These policy changes are associated with significant fluctuations in output and asset prices. Using a Bayesian proxy-VAR estimated with U.S. data, we show how distribution shocks cause movements in output, unemployment, and sectoral asset prices. To quantify the importance of these political shocks for the U.S. as a whole, we extend an otherwise standard neoclassical growth model. We model political shocks as exogenous changes in the bargaining power of workers in a labor market with search and matching. We calibrate the model to the U.S. corporate non-financial business sector and we back up the evolution of the bargaining power of workers over time using a new methodological approach, the partial filter. We show how the estimated shocks agree with the historical narrative evidence. We document that bargaining shocks account for 34% of aggregate fluctuations.
    Keywords: Political redistribution risk; bargaining shocks; aggregate fluctuations; partial filter; historical narrative
    JEL: E32 E37 E44 J20
    Date: 2017–08–21
  21. By: Svetlana Pashchenko (University of Georgia); Ponpoje (Poe) Porapakkarm (National Graduate Institute for Policy Studies (GRIPS,Tokyo)); Mariacristina De Nardi (Federal Reserve Bank of Chicago)
    Abstract: How costly is bad health and what makes good health valuable over the life cycle? Answering these questions requires carefully modeling health dynamics, including in the longer run, and a rich model of how health can affect households. We estimate a health shock process that allows for both history-dependence and ex-ante heterogeneity, and we introduce it in a rich life-cycle model that we estimate and that matches three sets of important facts: (i) The dynamics of health; (ii) The quantitative impact of bad health on labor earnings, medical spending, and life expectancy; (iii) The large disparity in accumulated wealth between the healthy and the unhealthy at retirement. We find that the costs of bad health among the working age population are steeply increasing in the number of years spent unhealthy and that the largest component of these costs is the loss in labor earnings. In contrast, the effect of out-of-pocket medical spending is relatively small. To also evaluate the non-pecuniary effects of health, we evaluate the willingness to pay to be healthy and we find that the most valuable aspect of being healthy is a longer life expectancy
    Date: 2017
  22. By: Elliot Aurissergues (PSE - Paris School of Economics)
    Abstract: In this paper, I argue that agents may prefer learning a misspecified model instead of learning the rational expectation model. I consider an economy with two types of agent. Fundamentalists learn a model where endogenous variables depend on relevant exogenous variables whereas followers learn a model where endogenous variables are function of their lagged values. A Fundamentalist is like a DSGE econometrician and a follower is like a VAR econometrician. If followers (resp. fundamentalists) give more accurate forecasts, a fraction of fundamentalists (resp. followers) switch to the follower model. I apply this algorithm in a linear model. Results are mixed for rational expectations. Followers may dominate in the long run when there are strategic complementarities and high persistence of exogenous variables. When ad-ditionnal issues are introduced, like structural breaks or unobservable exogenous variable, followers can have a significant edge on fundamentalists. I apply the algo-rtihm in three economic models a cobweb model, an asset price model and a simple macroeconomic model. JEL Classification: D83,D84
    Keywords: cobweb model,consistent expectations,Adaptive learning
    Date: 2017–05
  23. By: Andolfatto, David (Federal Reserve Bank of St. Louis); Berentsen, Aleksander (University of Basel); Martin, Fernando M. (Federal Reserve Bank of St. Louis)
    Abstract: The fact that money, banking, and financial markets interact in important ways seems self-evident. The theoretical nature of this interaction, however, has not been fully explored. To this end, we integrate the Diamond (1997) model of banking and financial markets with the Lagos and Wright (2005) dynamic model of monetary exchange--a union that bears a framework in which fractional reserve banks emerge in equilibrium, where bank assets are funded with liabilities made demandable for government money, where the terms of bank deposit contracts are constrained by the liquidity insurance available in financial markets, where banks are subject to runs, and where a central bank has a meaningful role to play, both in terms of inflation policy and as a lender of last resort. The model provides a rationale for nominal deposit contracts combined with a central bank lender-of-last-resort facility to promote efficient liquidity insurance and a panic-free banking system.
    Date: 2017–08–03
  24. By: Songül Tolan
    Abstract: This paper develops a structural dynamic retirement model to investigate effects and corresponding underlying mechanisms of a partial retirement program on labor supply, fiscal balances, and the pension income distribution. The structural approach allows for disentangling the two counteracting mechanisms that drive the employment effects of partial retirement: 1) the crowding-out from full-time employment, and 2) the movement from early retirement or unemployment to partial retirement. It also allows for investigating the role of financial compensations in a partial retirement program. Based on a unique German administrative dataset, I perform counterfactual policy simulations that analyze the role of partial retirement combined with financial subsidies and an increased normal retirement age. The results show that partial retirement extends working lives but reduces the overall employment volume. The fiscal consequences of partial retirement are negative but substantially less so when wages and pensions in partial retirement remain uncompensated. Partial retirement decreases inequality in pension income and provides a way to smooth consumption especially for retirees in lower income deciles in the context of an increased normal retirement age.
    Keywords: Retirement, Partial Retirement, Social Security and Public Pensions, Structural estimation, Dynamic Discrete Choice
    JEL: C61 J26 H55
    Date: 2017
  25. By: Faberman, R. Jason (Federal Reserve Bank of Chicago); Mueller, Andreas I. (Columbia University); Sahin, Aysegül (Federal Reserve Bank of New York); Topa, Giorgio (Federal Reserve Bank of New York)
    Abstract: Using a unique new survey, we study the relationship between search effort and outcomes for employed and non-employed workers. We find that the employed fare better than the non-employed in job search: they receive more offers per application and are offered higher pay even after controlling for observable characteristics. We use an on-the-job search model with endogenous search effort and find that unobserved heterogeneity explains less than a third of the residual wage offer differential. The model calibrated using various moments from our survey provides a good fit to the data and implies a reasonable flow value of unemployment.
    Keywords: job search, unemployment, on-the-job search, search effort, wage dispersion
    JEL: E24 J29 J60
    Date: 2017–08
  26. By: Ayşe İmrohoroğlu (University of Southern California); Kai Zhao (University of Connecticut)
    Abstract: In this paper, we show that a general equilibrium model that properly captures the risks in old age, the role of family insurance, changes in demographics, and the productivity growth rate is capable of generating changes in the national saving rate in China that mimic the data well. Our findings suggest that the combination of the risks faced by the elderly and the deterioration of family insurance due to the one-child policy may account for approximately half of the increase in the saving rate between 1980 and 2010. Changes in the productivity growth rate account for the fluctuations in the saving rate during this period.
    Date: 2017–08
  27. By: Jean-Bernard Chatelain (PSE - Paris School of Economics); Kirsten Ralf (Ecole Supérieure du Commerce Extérieur - ESCE - International business school)
    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: Bifurcations,Taylor rule,Taylor principle,new-Keynesian model,Ramsey optimal policy,Finite horizon commitment
    Date: 2017–05–19
  28. By: Antoine Lepetit (Banque de France - Banque de France - Banque de France)
    Abstract: This paper considers a standard New Keynesian model in which the relevant frictions faced by the monetary authority are price stickiness and the market power of firms, and shows that the optimal inflation rate is no longer zero in the presence of discount factor heterogeneity. I derive analytical solutions for the long-run optimal inflation rate under different assumptions about price setting, and find that it is positive when the social discount factor is greater than the discount factor used by firms when evaluating profit flows, zero when the two are equal, and negative when the planner is more impatient than firms.
    Keywords: Optimal inflation rate, sticky prices, discount factor heterogeneity
    Date: 2017–05–25
  29. By: Yves Achdou; Jiequn Han; Jean-Michel Lasry; Pierre-Louis Lions; Benjamin Moll
    Abstract: We recast the Aiyagari-Bewley-Huggett model of income and wealth distribution in continuous time. This workhorse model – as well as heterogeneous agent models more generally – then boils down to a system of partial differential equations, a fact we take advantage of to make two types of contributions. First, a number of new theoretical results: (i) an analytic characterization of the consumption and saving behavior of the poor, particularly their marginal propensities to consume; (ii) a closed-form solution for the wealth distribution in a special case with two income types; (iii) a proof that there is a unique stationary equilibrium if the intertemporal elasticity of substitution is weakly greater than one; (iv) characterization of “soft” borrowing constraints. Second, we develop a simple, efficient and portable algorithm for numerically solving for equilibria in a wide class of heterogeneous agent models, including – but not limited to – the Aiyagari-Bewley-Huggett model.
    JEL: D31 E00 E21
    Date: 2017–08
  30. By: Guillaume Wilemme (GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - EHESS - École des hautes études en sciences sociales - AMU - Aix Marseille Université - CNRS - Centre National de la Recherche Scientifique - ECM - Ecole Centrale de Marseille)
    Abstract: This paper presents a new efficiency argument for an accommodating taxation policy on high incomes. Job seekers, applying to different segments of a frictional labor market, do not internalize the consequences of mismatch on the entry decision of firms. Workers are not selective enough, resulting in a lower average job productivity and suboptimal job creation. The output-maximizing policy is anti-redistributive to improve the quality of the jobs prospected. As an income tax affects the sharing of the match surplus, a tax on production (or profits) is required to redress the slope of the wage curve. Neither a minimum wage nor unemployment benefits can fully decentralize optimal search behaviors.
    Keywords: anti-redistributive taxation,composition externality,job quality,mismatch,search strategy
    Date: 2017–06
  31. By: Fabien Postel-Vinay (University College London); Ilse Lindenlaub (Yale University)
    Abstract: We analyze sorting in a standard market environment characterized by search frictions and random search, but where both workers and jobs have multi-dimensional characteristics. We first offer a definition of multi-dimensional positive (and negative) assortative matching in this frictional environment. According to this notion, matching is positive assortative if a more skilled worker in a certain dimension is matched to a distribution of jobs that first-order stochastically dominates that of a less skilled worker. We then provide conditions on the primitives of this economy (technology and distributions) under which positive sorting obtains in equilibrium. We show that in several environments of interest, the main restriction on the primitives is a single-crossing condition of the technology, although in general further restrictions on type distributions are needed. Guided by our theoretical framework, we conduct simulation exercises to quantify the errors in assessing sorting, mismatch and policy by wrongly assuming that heterogeneity is one-dimensional when it is really multi-dimensional.
    Date: 2017
  32. By: Russell Cooper; Guozhong Zhu
    Abstract: This paper studies household finance in China, focusing on the high savings rate, the low participation rate in the stock market, and the low stock share in household portfolios. These salient features are studied in a lifecycle model in which households receive both income and medical expense shocks and decide on stock market participation and portfolio adjustment. The structural estimation explicitly takes into account important regime changes in China, such as the re-opening of the stock market, the privatization of the housing market and the labor market reforms that changed household income processes. The paper also compares household finance patterns in China to those in the US, and shows that between-country differences in financial choices are driven by both institutional factors (e.g. higher costs associated with stock market participation and a lower consumption floor in China) and preferences (e.g. higher discount factors of Chinese households).
    JEL: E21 G11 P2
    Date: 2017–08
  33. By: Martin Stepanek (Institute of Economic Studies, Faculty of Social Sciences, Charles University in Prague, Smetanovo nabrezi 6, 111 01 Prague 1, Czech Republic)
    Abstract: Unsustainability of pension systems particularly in developed economies looms large on the horizon due to increasing life expectancy and continuous drop in fertility. In spite of a broad awareness of the issues, there is no consensus on appropriate remedy and little action. In this paper, I present a comprehensive OLG model tailored for simulation of pension reforms and calibrated on real-world data that accounts not only for optimising agents but also for productivity shocks and financial market frictions. The model is used for assessment of alternative pension reforms in the Czech Republic, yet many of the conclusions apply to other countries as well. The estimates show that retirement age will need to increase constantly in the next decades in order to maintain the current levels of replacement rates in the existing PAY-GO scheme and that this result is virtually independent of the level of economic growth. On the other hand, a transition towards a fully funded scheme would be extremely costly and while it would improve system's resistance to demographic changes, it would also substantially redistribute wealth in the society and expose pensions to financial markets risks. The best option overall may then be a well designed multipillar pension scheme, which can provide an optimal balance of performance indicators without leading to excessive costs of transition.
    Keywords: pension, OLG, simulation, ageing
    JEL: H55 H68 I38 J32
    Date: 2017–08
  34. By: Frédéric Gonand (Chaire économie du climat - Chaire économie du climat, LEDa - Laboratoire d'Economie de Dauphine - Université Paris-Dauphine)
    Abstract: A rising share of renewables in the energy mix push es up the average price of energy - and so does a carbon tax. However the former bolsters the accumulation of capital whereas the latter, if fully recycled, does not. Thus, in general equilibrium, the effects on growth and intertemporal welfare of these two environmental po licies differ. The present article assesses and compares these effects. It relies on a computable general equilibrium model with overlapping generations, an energy module and a pub lic finance module. The main result is that an increasing share of renewables in the energy mix and a fully recycled carbon tax have opposite (though limited) impacts on activity and i ndividuals’ intertemporal welfare in the long run. The recycling of a carbon tax fosters consumption and labour supply, and thus growth and welfare, whereas an increasing share of renewables does not. Results also suggest that a higher share of renewables and a recycled carbon tax trigger intergenerational redistributive effects, with the former being relat ively detrimental for young generations and the latter being pro-youth. The policy implication is that a social planner seeking to modify the structure of the energy mix while achieving some ne utrality as concerns the GDP and triggering some proyouth intergenerational equity, could usefully contemplate the joint implementation of higher quantitative targets for the future development of renewables and a carbon tax fully recycled through lower proportional taxes.
    Keywords: Energy transition,intergenerational redistribution,overlapping generations,carbon tax,general equilibrium
    Date: 2017–05–12
  35. By: Brecht Boone; Ewoud Quaghebeur (-)
    Abstract: n this paper, we explore the effects of government spending in the real business cycle model where agents use a learning mechanism to form expectations. In contrast to most of the learning literature, we study learning behaviour in the original non-linear model. Following the learning interpretation of the parameterized expect- ations method, agents’ forecast rules are approximations of the conditional expectations appearing in the Euler equation. We show that variation in agents’ beliefs about the coefficients of these rules, generates time variation in the transmission of government spending shocks to the economy. Hence, our modelling approach provides an endogenous mechanism for time-varying government spending multipliers in the standard real business cycle model.
    Keywords: Non-linear learning, Parameterized expectations, Fiscal policy, Time-varying multipliers
    JEL: E62 D83 D84 E32
    Date: 2017–06
  36. By: Christopher Otrok (University of Missouri); Andrew Foerster (Federal Reserve Bank of Kansas City); Alessandro Rebucci (The Johns Hopkins Carey Business School); Gianluca Benigno
    Abstract: This paper develops an endogenous regime switching approach to modeling financial crises. In the model there are two regimes, one a crisis regime, the second a regime for normal economic times. The switch between regimes is based on a probability determined by economic variables in the economy. Agents in the economy know how economic fundamentals affect the probability of moving in or out of the crisis state. That is, it is a rational expectations solution of the model. The solution then ensures that decisions made in the normal state fully incorporate how those decision affect the probability of moving into the crisis state as well as how the economy will operate in a crisis. The model developed captures all of the salient features one would want in an empirical model of financial crises. First, it captures the non-linear nature of a crisis. Second, the regime switching model is solved using perturbation methods and a second order solution. This allows the solution to capture the impact of risk on decision rules due both in an out of the crisis. Third, since the solution method is perturbation based it can handle a number of state variables and many shocks. That is, we are less constrained than current non-linear methods in terms of the size of the model. Fourth, the speed of the solution method means that non-linear filters can be used to calculate the likelihood function of the model for a full Bayesian estimation of the relevant shocks and frictions that are fundamental to models of financial crises. Fifth, the fully rational expectations nature of the solution allows one to ask key counterfactual policy questions. We adopt this approach to study sudden stop episodes in Mexico.
    Date: 2017
  37. By: Vincenzo Quadrini (USC); Laura Moretti (Central Bank of Ireland); Alessandro Barattieri (Collegio Carlo Alberto and ESG UQAM)
    Abstract: In the period that preceded the 2008 crisis, US financial intermediaries have become more leveraged (measured as the ratio of assets over equity) and interconnected (measured as the share of liabilities held by other financial intermediaries). This upward trend in leverage and interconnectivity sharply reversed after the crisis. To understand this dynamic pattern we develop a model where banks make risky investments in the non-financial sector and sell part of their investments to other financial institutions (diversification). The model predicts a positive correlation between leverage and interconnectivity which we explore empirically using balance sheet data for over 14,000 financial intermediaries in 32 OECD countries. We enrich the theoretical model by allowing for Bayesian learning about the likelihood of a bank crisis (aggregate risk) and show that the model can capture the dynamics of leverage and interconnectivity observed in the data.
    Date: 2017
  38. By: Salvatore Nistico (Sapienza Università di Roma); Pierpaolo Benigno (LUISS Guido Carli)
    Abstract: We analyze the effects on inflation and output of unconventional open-market operations due to the possible income losses on the central bank's balance sheet. We first state a general Neutrality Property, and characterize the theoretical conditions supporting it. We then discuss three non-neutrality results. First, when treasury's support is absent, sizeable balance-sheet losses can undermine central bank's solvency and should be resolved through a substantial increase in inflation. Second, a financially independent central bank - i.e. averse to income losses - commits to a more inflationary stance and delayed exit strategy from a liquidity trap. Third, if the treasury is unable or unwilling to tax households to cover central bank's losses, the wealth transfer to the private sector also leads to higher inflation. Finally, we argue that non-neutral open-market operations can be used to escape suboptimal policies during a liquidity trap.
    Date: 2017
  39. By: Yuzhe Zhang (Texas A&M University); Borys Grochulski (Federal Reserve Bank of Richmond)
    Abstract: In this paper, we show that whenever the agent's outside option is nonzero, the optimal contract in the continuous-time principal-agent model of Sannikov (2008) is reflective at the lower bound. This means the agent is never terminated or retired after poor performance. Instead, the agent is asked to suspend effort temporarily, as in Zhu (2013), which brings the agent's continuation value up. The agent is then asked to resume effort, and the contract continues. We show that a nonzero agent's outside option arises endogenously if the agent is allowed to quit and find a new rm. In addition, we find new dynamics of the reflection at the lower bound. In the baseline model, the reflection is slow, as in Zhu (2013), i.e., effort is suspended often. However, if the agent's disutility from the first unit of effort is zero, which is a standard Inada condition, or if his utility of consumption is unbounded below, the reflection becomes fast, i.e., effort is suspended seldom.
    Date: 2017
  40. By: Benjamin Bridgman (U.S. Bureau of Economic Analysis)
    Abstract: U.S. time use patterns have changed over the last century in ways that appear inconsistent. Leisure has increased with income but has increased most for the poorest. I develop a unified model that treats leisure as an economic activity. Leisure services are produced using capital, like televisions, and non-market time. Doing so improves the labor supply predictions of macro models. The model's U.S. labor wedge more closely matches observable labor market distortions. It is also is consistent with the observed reversal in 20th Century leisure inequality, where high income workers went from working less to more than low income workers. Leisure capital reinforces inequality; poorer households have more leisure hours but less capital.
    Date: 2017
  41. By: Francesca Monti (Bank of England); Riccardo Maria Masolo (Bank of England)
    Abstract: Allowing for ambiguity, or Knightian uncertainty, about the behavior of the policymaker helps explain the evolution of trend inflation in the US in a simple new-Keynesian model, without resorting to exogenous changes in the inflation target. Using Blue Chip survey data to gauge the degree of private sector confidence, our model helps reconcile the difference between target inflation and the inflation trend measured in the data. We also show how, in the presence of ambiguity, it is optimal for policymakers to lean against the private sectors pessimistic expectations.
    Date: 2017
  42. By: Federico Mandelman (Federal Reserve Bank of Atlanta)
    Abstract: Employment in middle-skill occupations witnessed an outright decline in the US during the last three decades. Middle-skill workers specialize in routine labor tasks which are prone to be automated. In addition, these occupations do not usually require on-site interactions and thus may be offshored overseas. High-skill workers instead execute non-routine cognitive tasks while the low-skilled specialize in on-site service occupations that cannot be automated. Motivated by this evidence, I develop a stochastic growth model of international trade in tasks with the possibility of automation to account for the role of offshoring and computerization in the decline of middle-skill employment. A system based estimation approach which uses disaggregated employment data, trade-weighted international macroeconomic indicators, as well as, alternative proxies for automation and offshoring costs is implemented.
    Date: 2017

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.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.