nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2017‒11‒05
23 papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Uncertainty-driven Business Cycles: Assessing the Markup Channel By Benjamin Born; Johannes Pfeifer
  2. House Prices and Macroprudential Policy in an Estimated DSGE Model of New Zealand By Michael Funke; Robert Kirkby; Petar Mihaylovski
  3. Misallocation and Financial Frictions: the Role of Long-Term Financing By Patrick Macnamara; Marios Karabarbounis
  4. Financial Frictions in the Small Open Economy By Shim, Jae-Hun
  5. The Lifetime Costs of Bad Health By Mariacristina De Nardi; Svetlana Pashchenko; Ponpoje Porapakkarm
  6. The Labor Market Impact of Undocumented Immigrants: Job Creation vs. Job Competition By Christoph Albert
  7. Dynamic Scoring of Tax Reforms in the EU By Dolls, Mathias; Wittneben, Christian
  8. Stock Prices, Regional Housing Prices, and Aggregate Technology Shocks By Yoshida, Jiro
  9. Global Demographic Change and Climate Policies By Reyer Gerlagh; Richard Jaimes; Ali Motavasseli
  10. Imperfect Monitoring of Job Search: Structural Estimation and Policy Design By Bart Cockx; Muriel Dejemeppe; Andrey Launov; Bruno Van der Linden
  11. The Optimum Quantity of Debt for Japan By Tomoyuki Nakajima; Shuhei Takahashi
  12. Pension reform disabled By Sigurd Mølster Galaasen
  13. Liquidity Constraints in the U.S. Housing Market By Virgiliu Midrigan; Denis Gorea
  14. Global Dynamics in a Search and Matching Model of the Labor Market By Lazaryan, Nika; Lubik, Thomas A.
  15. Redistributive Tax Policy at the Zero Bound By Lancastre, Manuel
  16. Growth and Welfare under Endogenous Lifetime By Maik T. Schneider; Ralph Winkler
  17. Financial Repression in General Equilibrium By Scheer, Alexander; Müller, Gernot; Kriwoluzky, Alexander
  18. Safety, Liquidity, and the Natural Rate of Interest By Marc Giannoni; Domenico Giannone; Andrea Tambalotti; Marco Del Negro
  19. Heterogeneous consumers, segmented asset markets, and the real effects of monetary policy By Enders, Zeno
  20. Why Does U.S Public Debt Flow to China? By Xin Tang; Marina Azzimonti
  21. Replacing Income Taxation with Consumption Taxation in Japan By Selahattin Imrohoroglu
  22. When is there more employment, with individual or collective wage bargaining? By García Martínez, José Ramón; Sorolla i Amat, Valeri
  23. The Elephant in the Room: the Impact of Labor Obligations on Credit Markets By Xiaoji Lin; Xiaofei Zhao; Jack Favilukis

  1. By: Benjamin Born; Johannes Pfeifer
    Abstract: A growing recent literature relies on a precautionary pricing motive embedded in representative agent DSGE models with sticky prices and wages to generate negative output effects of uncertainty shocks. We assess whether this theoretical model channel is consistent with the data. Building a New Keynesian model, we show that indeed with sufficient nominal rigidities markups increase and output falls after uncertainty shocks. The model is also used as a business cycle accounting device to construct aggregate markups from the data. Time-series techniques are employed to study the conditional comovement between markups and output in the data. Consistent with the model’s precautionary wage setting, we find that wage markups increase after uncertainty shocks. Price markups in contrast fall. This finding - inconsistent with the model - is corroborated by industry-level data. Overall, these results point to a prominent role for sticky wages in the transmission of uncertainty shocks.
    Keywords: uncertainty shocks, price markup, wage markup
    JEL: E32 E01 E24
    Date: 2017
  2. By: Michael Funke; Robert Kirkby; Petar Mihaylovski
    Abstract: We analyse the effects of macroprudential and monetary policies and their interactions using an estimated dynamic stochastic general equilibrium (DSGE) model tailored to New Zealand. We find that the main historical drivers of house prices are shocks specific to the housing sector. While our estimates show that monetary policy has large spillover effects on house prices, it does not appear to have been a major driver of house prices in New Zealand. We consider macroprudential policies, including the loan-to-value restrictions that have been implemented in New Zealand. We find that loan-to-value restrictions reduce house prices with negligible effects on consumer prices, suggesting that they can be used without derailing monetary policy. We estimate that the loan-to-value restrictions imposed in New Zealand in 2013 reduced house prices by 3.8 per cent and that greater forward guidance on their duration would have made them more effective.
    Keywords: macroprudential policies, housing, DSGE, Bayesian estimation, New Zealand
    JEL: E32 E44 E52 E58
    Date: 2017
  3. By: Patrick Macnamara (University of Manchester); Marios Karabarbounis (Federal Reserve Bank of Richmond)
    Abstract: This paper analyzes the effect of financial frictions on misallocation when firms can issue long-term bonds and can default on their obligations. Our model combines the endogenous investment, firm-financing structure of Hennessy and Whited (2007) with the long-term financing model of Hatchondo and Martinez (2009). We show that when investment is endogenous and firms issue long-term debt, productive firms can face as severe borrowing constraints as the low productivity firms. This occurs because good firms are more likely to refinance and hence "dilute" their existing debt obligations. A key step of our exercise is that we match the large cross-sectional dispersion in credit spreads we observe in the data. In our model productivity loss due to misallocation is about 10% which is 2.5 times higher compared to a model with short-term financing or exogenous collateral constraints.
    Date: 2017
  4. By: Shim, Jae-Hun
    Abstract: This paper introduces a global banking system in a small open economy DSGE model with financialfrictions. The model features global relative price adjustments with incomplete asset market. Three mainfindings stand out. Firstly, foreign financial shocks capture negative spillovers from foreign country ina global financial crisis. We show that country differences in the severity of the shocks depend on thedegree of trade openness and banking system stability. Secondly, credit policy could be more powerfulthan monetary policy to alleviate foreign financial shocks since an expansionary monetary policy andalternative policy rules are not a sufficient tool in the global financial crisis. In particular, credit policybased on international credit spread outperforms credit policy based on domestic credit spread since thelatter leads to “excess smoothness” in the real exchange rate. Lastly, foreign credit policy has a negligibleinfluence on domestic welfare so that the small open economy can effectively reduce welfare losses onlyif the central bank in the economy injects credit.
    Date: 2016–06
  5. By: Mariacristina De Nardi (University College London / Federal Reserve Bank of Chicago / IFS / NBER); Svetlana Pashchenko (University of Georgia); Ponpoje Porapakkarm (National Graduate Institute for Policy Studies)
    Abstract: Health shocks are an important source of risk. People in bad health work less, earn less, face higher medical expenses, die earlier, and accumulate much less wealth compared to those in good health. Importantly, the dynamics of health are much richer than those implied by a low-order Markov process. We first show that these dynamics can be parsimoniously captured by a combination of some lag-dependence and ex-ante heterogeneity, or health types. We then study the effects of health shocks in a structural life-cycle model with incomplete markets. Our estimated model reproduces the observed inequality in economic outcomes by health status, including the income-health and wealth-health gradients. Our model has several implications concerning the pecuniary and non-pecuniary effects of health shocks over the life-cycle. The (monetary) lifetime costs of bad health are very concentrated and highly unequally distributed across health types, with the largest component of these costs being the loss in labor earnings. The non-pecuniary effects of health are very important along two dimensions. First, individuals value good health mostly because it extends life expectancy. Second, health uncertainty substantially increases lifetime inequality by affecting the variation in lifespans.
    Keywords: Health, health insurance, medical spending, wealth-health gradient, life-cycle model
    JEL: D52 D91 E21 H53 I13 I18
    Date: 2017–10
  6. By: Christoph Albert
    Abstract: This paper explores the labor market impact of both documented and undocumented immigration in a model featuring search frictions and non-random hiring that generates predictions consistent with novel patterns documented in data. Due to their lower earnings, a rise in the share of immigrant workers in the economy leads to the creation of additional jobs, but also more job competition for natives. As undocumented immigrants earn the lowest wages of all workers, their job creation effect is large, whereas it is small and potentially negative for documented immigrants. Model simulations show that the job creation effect of undocumented immigration dominates the competition effect, leading to gains in terms of both employment and wages for natives, which does not hold in case of documented immigration. Stricter immigration enforcement in form of a higher deportation risk for undocumented immigrants mutes job creation and raises the unemployment rate of all workers, having an even larger detrimental effect if it targets employed immigrants because this leads to a risk premium in their wages. I present empirical evidence that gives support to the qualitative predictions of the model.
    Keywords: wage gap, migrant workers, hiring, employment
    JEL: J31 J61 J63 J64
    Date: 2017
  7. By: Dolls, Mathias; Wittneben, Christian
    Abstract: In this paper, we present a dynamic scoring analysis of tax reforms for EU countries, accounting for the feedback effects resulting from the adjustment in labour supply and economy-wide reaction to tax policy changes. We combine the microsimulation model EUROMOD incorporating an estimated labour supply model, with the new Keynesian DSGE model QUEST used by the European Commission. We illustrate the results obtained when scoring specific reforms in three EU Member States.
    Date: 2017
  8. By: Yoshida, Jiro
    Abstract: The correlation between stock and housing prices, which is critical for household asset allocations, varies widely by metropolitan area and country. A general equilibrium model demonstrates that an aggregate positive technology shock increases stock prices and housing demand but can decrease housing prices where land supply is elastic because stable future rents are discounted at higher interest rates. Using panel data of U.S. metropolitan areas and OECD countries, I find that the housing price response to TFP shocks as well as the stock-housing correlation are smaller and even negative where the housing supply is elastic. I also find that household equity investment is positively related to housing supply elasticity.
    Keywords: macroeconomic shocks, total factor productivity, general equilibrium, regional heterogeneity, house price, housing supply elasticity, asset allocation
    JEL: E32 R21 R31 G11
    Date: 2017–10
  9. By: Reyer Gerlagh; Richard Jaimes; Ali Motavasseli
    Abstract: Between 1950 and 2017, world average life expectancy increased from below-50 to above-70, while the fertility rate dropped from 5 to about 2.5. We develop and calibrate an analytic climate-economy model with overlapping generations to study the effect of such demographic change on capital markets and optimal climate policies. Our model replicates findings from the OLG-demography literature, such as a rise in households’ savings, and a declining rate of return to capital. We also find that demographic change raises the social cost of carbon, at 2020, from 28 euro/tCO2 in a model that abstracts from demography, to 94 euro/tCO2 in our calibrated model.
    Keywords: climate change, social cost of carbon, environmental policy, demographic trends
    JEL: H23 J11 Q54 Q58
    Date: 2017
  10. By: Bart Cockx; Muriel Dejemeppe; Andrey Launov; Bruno Van der Linden
    Abstract: We build and estimate a non-stationary structural job search model that incorporates the main stylized features of a typical job search monitoring scheme in unemployment insurance (UI) and acknowledges that search effort and requirements are measured imperfectly. Based on Belgian data, monitoring is found to affect search behavior only weakly, because (i) assessments were scheduled late and infrequently; (ii) the monitoring technology was not sufficiently precise, (iii) lenient Belgian UI results in caseloads that are less responsive to incentives than elsewhere. Simulations show how changing the aforementioned design features can enhance effectiveness and that precise monitoring is key in this.
    Keywords: monitoring, sanctions, non-stationary job search, unemployment benefits, structural estimation
    JEL: J64 J68 C41
    Date: 2017
  11. By: Tomoyuki Nakajima; Shuhei Takahashi
    Abstract: Japan's net government debt is 130% of GDP in 2013. The present paper analyzes the effect of the large government debt on welfare. We use a heterogeneous-agent, incomplete-market model with idiosyncratic wage risk, a borrowing constraint, and endogenous labor supply. We calibrate the model to the Japanese economy using evidence based on macro-level and micro-level data. We find that the optimal level of government debt is -50% of GDP for Japan. The welfare cost of keeping government debt to 130% of GDP rather than the optimal level is 0.19% of consumption.
    Date: 2017–10
  12. By: Sigurd Mølster Galaasen (Norges Bank (Central Bank of Norway))
    Abstract: Old-age pension reform is on the agenda across the OECD, and a key target is to delay retirement. Most of these countries also have a disability insurance (DI) program accounting for a large share of labor force exits. This paper builds a quantitative life-cycle model with endogenous retirement to study how DI and old-age pension (OA-pension) systems interact with health and wages to determine retirement age, with particular focus on the macroeconomic effects of OA-pension reforms. Individuals face uncertain future health status and wages, and if in bad health they are eligible for DI if they choose to retire before reaching the statutory retirement age. I calibrate the model to the Norwegian economy and explore the effects of raising the statutory retirement age and cutting OA-pension on labor supply and public finances. The main contribution of the paper is that I, in contrast to standard macro pension models, include DI as another endogenous margin of retirement. I show that failure to account for this margin might severely bias the analysis of OA-pension reforms.
    Keywords: Retirement, disability insurance, life-cycle, pension reform
    JEL: E2 E6 H31 H55 J26
    Date: 2017–10–23
  13. By: Virgiliu Midrigan (New York University); Denis Gorea (Bank of Canada)
    Abstract: We study the severity of liquidity constraints in the U.S. housing market using a lifecycle model with uninsurable idiosyncratic risks in which houses are illiquid, but agents have the option to refinance their long-term mortgages or extract home equity. The model reproduces well the distribution of individual-level balance sheets – the fraction of housing, mortgage debt and liquid assets in a household’s wealth, the fraction of hand-to-mouth homeowners (Kaplan and Violante, 2014), as the well as the frequency of housing turnover and home equity extraction in the 2001 data. The model implies that 75% of homeowners are liquidity constrained and willing to pay an average of 9 cents to extract an additional dollar of liquidity from their home. Liquidity constraints imply sizable welfare losses that amount to a 1.2% permanent drop in consumption, despite the relatively high frequency of home equity extraction observed in the data.
    Date: 2017
  14. By: Lazaryan, Nika (Federal Reserve Bank of Richmond); Lubik, Thomas A. (Federal Reserve Bank of Richmond)
    Abstract: We study global and local dynamics of a simple search and matching model of the labor market. We show that the model can be locally indeterminate or have no equilibrium at all, but only for parameterizations that are empirically implausible. In contrast to the local results, we show that the model exhibits chaotic and periodic dynamics for reasonable parameter values both in backward and forward time. In contrast to earlier work, we establish these results analytically without placing numerical restrictions on the parameters.
    Keywords: Indeterminacy; Bifurcation; Chaos; Backward Map; Forward Map
    JEL: C62 C65 E24 J64
    Date: 2017–10–20
  15. By: Lancastre, Manuel
    Abstract: Emulating consumer price inflation with an increasing path of consumption taxes when the nominal interest rate binds and monetary policy becomes ineffective, as proposed by Correia et al. [1] in the Standard New Keynesian model, may not neutralize a liquidity trap of very long duration. Instead this paper presents a wealth redistributive tax policy, in an OLG model with credit constraints, able to prevent or counteract a liquidity trap caused by a credit shock. The tax prescription is opposite to the one proposed by Correia et al.[1]
    Keywords: Zero Bound; Fiscal policy; Credit constraints; Sticky prices; Heterogeneous agents; Redistribution
    JEL: E21 E24 E31 E40 E43 E52 E62
    Date: 2017–08–31
  16. By: Maik T. Schneider; Ralph Winkler
    Abstract: We study the role of endogenous healthcare choices by households to extend their expected lifetimes on economic growth and welfare in a decentralized overlapping generations economy with the realistic feature that households’ savings are held in annuities. We characterize healthcare spending in the decentralized market equilibrium and its effects on economic growth. We identify the moral-hazard effect in healthcare investments when annuity rates are conditioned on average mortality and explain the conditions under which this leads to over-investment in healthcare. Moreover, we specify the general equilibrium effects and macroeconomic repercussions associated with this moral-hazard effect. In a numerical simulation of our model with OECD data, we find that the moral-hazard effect may be substantial and implies sizeable welfare losses of approximately 1.5%. At a more general level, our study suggests that welfare improvements from longevity increases may be lower than suggested when considered in planner economies.
    Keywords: annuities, economic growth, endogenous longevity, healthcare expenditures, healthcare technology, moral hazard, pension systems, welfare analysis
    JEL: O40 I10 J10
    Date: 2017
  17. By: Scheer, Alexander; Müller, Gernot; Kriwoluzky, Alexander
    Abstract: Financial repression allows governments to borrow at artificially low interest rates. Quantifying financial repression is challenging, because it relies on an estimate of the interest rate which would prevail in the absence of repression. In this paper, we put forward a quantitative business cycle model which features financial repression. We estimate the model on US times series for the period 1948-1979 in order to quantify the extent of financial repression and its impact on the economy.
    Date: 2017
  18. By: Marc Giannoni (Federal Reserve Bank of New York); Domenico Giannone (Federal Reserve Bank of New York); Andrea Tambalotti (Federal Reserve Bank of New York); Marco Del Negro (Federal Reserve Bank of New York)
    Abstract: Why are interest rates so low in the Unites States? We nd that they are low mostly because the premium for safety and liquidity has increased since the late 1990s. We reach this conclusion using two complementary perspectives: a exible time series model of trends in nominal rates, Treasury and corporate yields, in ation, and long term expectations, and a medium-scale DSGE model. We discuss the implications of this nding for the natural rate of interest.
    Date: 2017
  19. By: Enders, Zeno
    Abstract: This paper proposes a novel mechanism by which changes in the distribution of money holdings have real effects. Specifically, I develop a flexible-price model of segmented asset markets that generates real aggregate effects of monetary policy through the dependence of optimal markups on the heterogeneity of money holdings. Because varieties of consumption bundles are purchased sequentially, newly injected money disseminates slowly throughout the economy via second-round effects.
    JEL: E31
    Date: 2017
  20. By: Xin Tang (International Monetary Fund); Marina Azzimonti (Stony Brook University)
    Abstract: We show that the massive flows of U.S public debt to China can arise as an equilibrium outcome of a model where governments issue debt to help domestic entrepreneurs insure against idiosyncratic investment risks. Precautionary motive of entrepreneurs pushes down equilibrium interest rate. Hence in autarky, the country with lower investment risks (the U.S) has higher interest rate and lower stock of debt. When it integrates with a country with higher investment risks (China), the extra precautionary demand drives the interest rate down further, lowering the borrowing cost. As a result, the U.S issues more debt, and much of these debt flows to China.
    Date: 2017
  21. By: Selahattin Imrohoroglu
    Abstract: Over the past two decades, Japan has suffered from low economic growth and a large and growing debt to output ratio. Furthermore, Japan anticipates significant increases in future government expenditures due to an aging population. These problems have led Japan to introduce a consumption tax rate in an attempt to raise revenues, and, more recently, to reduce the statutory corporate income tax rate to raise investment and output growth. In this paper we study the growth and welfare consequences of a reduction in income taxation in Japan along with increases in consumption taxation to stabilize the debt to output ratio. In particular, we consider various unanticipated tax reforms using the model described in Hansen and Imrohoroglu (2016). We find that while output per working age population is projected to be roughly constant between 2015 and 2021 in the benchmark equilibrium representing the status quo, under alternative policies considered, output could be as much as 15% higher by 2021.
    Date: 2017–10
  22. By: García Martínez, José Ramón; Sorolla i Amat, Valeri
    Abstract: In a standard Diamond-Mortensen-Pissarides labour market with frictions, the authors seek to determine when there is more employment with individual wage bargaining than with collective wage bargaining, using a wage equation generated by the standard total surplus sharing rule. Using a Cobb-Douglas production function (AL,
    Keywords: Matching Frictions,Unemployment,Individual and Collective Wage Setting
    JEL: E24 O41
    Date: 2017
  23. By: Xiaoji Lin (Ohio State University); Xiaofei Zhao (University of Texas-Dallas); Jack Favilukis (University of British Columbia)
    Abstract: We show that labor market frictions are first-order for understanding credit markets. Wage growth and labor share forecast aggregate credit spreads and debt growth as well as or better than alternative predictors. They also predict credit risk and debt growth in a cross-section of international firms. Finally, high labor share firms choose lower financial leverage. A model with labor market frictions and risky long-term debt can explain these findings, and produce large credit spreads despite realistically low default probabilities. This is because pre-committed payments to labor make other committed payments (i.e. interest) riskier.
    Date: 2017

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