nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2017‒12‒03
thirty-one papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. What Prevents a Real Business Cycle Model from Matching the U.S. Data? Decomposing the Labor Wedge By Dmitry Plotnikov
  2. Customer Capital, Markup Cyclicality, and Amplification By Hong, Sungki
  3. Optimal Fiscal Policy in Overlapping Generations Models By Garriga, Carlos
  4. Fiscal Consolidation Programs and Income Inequality By Pedro Brinca; Miguel H. Ferreira; Francesco Franco; Hans A. Holter; Laurence Malafry
  5. Uncertainty shocks and firm dynamics : Search and monitoring in the credit market By Brand, Thomas; Isoré, Marlène; Tripier, Fabien
  6. Market Reforms at the Zero Lower Bound By Matteo Cacciatore; Romain A Duval; Giuseppe Fiori; Fabio Ghironi
  7. FX Intervention in the New Keynesian Model By Zineddine Alla; Raphael A Espinoza; Atish R. Ghosh
  8. Uncertainty, Financial Frictions and Nominal Rigidities: A Quantitative Investigation By Ambrogio Cesa-Bianchi; Emilio Fernández Corugedo
  9. Does Household Finance Matter? Small Financial Errors with Large Social Costs By Bhamra, Harjoat Singh; Uppal, Raman
  10. Financial Fragility and the Keynesian Multiplier By van der Kwaak, Christiaan; van Wijnbergen, Sweder
  11. Financial Shocks, Intangible Capital and the Cyclical Behavior of Unemployment By Lopez, Jose Ignacio; Olivella, Virginia
  12. Innovation, Productivity, and Monetary Policy By Albert Queralto; Patrick Donnelly Moran
  13. Escaping unemployment traps By Acharya, Sushant; Bengui, Julien; Dogra, Keshav; Wee, Shu Lin
  14. Mortgage Debt, Consumption, and Illiquid Housing Markets in the Great Recession By Garriga, Carlos; Hedlund, Aaron
  15. Aggregate recruiting intensity By Gavazza, Alessandro; Mongey, Simon; Violante, Giovanni L
  16. The Lifetime Costs of Bad Health By Mariacristina De Nardi; Svetlana Pashchenko; Ponpoje Porapakkarm
  17. Income Distribution by Age Group and Productive Bubbles By Xavier Raurich; Thomas Seegmuller
  18. Marriage-Related Policies in an Estimated Life-Cycle Model of Households' Labor Supply and Savings for Two Cohorts By Margherita Borella; Mariacristina De Nardi; Fang Yang
  19. Debt Hangover in the Aftermath of the Great Recession By Stephane Auray; Aurelien Eyquem; Paul Gomme
  20. Do Individual Behavioral Biases Affect Financial Markets and the Macroeconomy? By Bhamra, Harjoat Singh; Uppal, Raman
  21. A Model of Collateral By Yu Awaya; Hiroki Fukai; Makoto Watanabe
  22. On fiscal and monetary integration in Europe By Verstegen, Loes
  23. Financial Crises and Lending of Last Resort in Open Economies By Luigi Bocola; Guido Lorenzoni
  24. Banking Panics and Liquidity in a Monetary Economy By Tarishi Matsuoka; Makoto Watanabe
  25. Markup Cyclicality: A Tale of Two Models By Hong, Sungki
  26. The Persistence of Financial Distress By Athreya, Kartik B.; Mustre-del-Rio, Jose; Sanchez, Juan M.
  27. Bankruptcy Technology, Finance, and Entrepreneurship By Nelson Sobrinho
  28. Revisiting Hopenhayn and Nicolini 's optimal unemployment insurance with job search monitoring and sanctions By Sebastien Menard; Solenne Tanguy
  29. The Importance of Hiring Frictions in Business Cycles By Renato Faccini; Eran Yashiv
  30. Financing Ventures By Greenwood, Jeremy; Han, Pengfei; Sanchez, Juan M.
  31. The Exchange Rate as an Instrument of Monetary Policy By Heipertz, Jonas; Mihov, Ilian; Santacreu, Ana Maria

  1. By: Dmitry Plotnikov
    Abstract: I carry out a business cycle accounting exercise (Chari, Kehoe and McGrattan, 2007) on the U.S. data measured in wage units (Farmer (2010)) for the entire postwar period. In contrast to a conventional approach, this approach preserves common medium-term business cycle fluctuations in GDP, its components and the unemployment rate. Additionally, it facilitates decomposition of the labor wedge into the labor supply and the labor demand wedges. Using this business cycle accounting methodology, I find that in the transformed data, most movements in GDP are accounted for by the labor supply wedge. Therefore, I reverse a key finding of the real business cycle literature which asserts that 70% or more of economic fluctuations can be explained by TFP shocks. In other words, the real business cycle model fits the data badly because the assumption that households are on their labor supply equation is flawed. This failure is masked by data that has been filtered with a conventional approach that removes fluctuations at medium frequencies. My findings are consistent with the literature on incomplete labor markets.
    Keywords: Unemployment;United States;Western Hemisphere;Business cycles;labor wedge, Forecasting and Simulation, Demand and Supply, Energy and the Macroeconomy
    Date: 2017–09–08
  2. By: Hong, Sungki (Federal Reserve Bank of St. Louis)
    Abstract: This paper studies the importance of firm-level price markup dynamics for business cycle fluctuations. The first part of the paper uses state-of-the-art IO techniques to measure the behavior of markups over the business cycle at the firm level. I find that markups are countercyclical with an average elasticity of -0.9 with respect to real GDP, in line with the earlier industry-level evidence. Importantly, I find substantial heterogeneity in markup cyclicality across firms, with small firms having significantly more countercyclical markups than large firms. In the second part of the paper, I develop a general equilibrium model that matches these empirical findings and explore its implications for business cycle dynamics. In particular, I embed customer capital (due to deep habits as in Ravn, Schmitt-Grohe, and Uribe 2006) into a standard Hopenhayn (1992) model of firm dynamics with entry and exit. A key feature of the model is that a firm's decision about markups becomes dynamic {firms accumulate customer capital in the periods of fast growth by charging low markups, and choose to exploit it by charging high markups in the downturns. In particular, during recessions, the endogenous higher exit probability for smaller firms implies that they place lower weight on future profits, leading them to charge higher markups. This mechanism serves to endogenously increase the dispersion of firm sales and employment in recessions, a property that is consistent with the data. I further show that the resulting input misallocation amplifies both the volatility and persistence of the exogenous productivity shocks driving the business cycle.
    Date: 2017–04–30
  3. By: Garriga, Carlos (Federal Reserve Bank of St. Louis)
    Abstract: In this paper, we explore the proposition that the optimal capital income tax is zero using an overlapping generations model. We prove that for a large class of preferences, the optimal capital income tax along the transition path and in steady state is non-zero. For a version of the model calibrated to the US economy, we find that the model could justify the observed rates of capital income taxation for an empirically reasonable intertemporal utility function and a robust demographic structure.
    Keywords: Optimal taxation; uniform commodity taxation
    JEL: E62 H21
    Date: 2017–05–22
  4. By: Pedro Brinca; Miguel H. Ferreira; Francesco Franco; Hans A. Holter; Laurence Malafry
    Abstract: Following the Great Recession, many European countries implemented fiscal con- solidation policies aimed at reducing government debt. Using three independent data sources and three different empirical approaches, we document a strong positive re- lationship between higher income inequality and stronger recessive impacts of fiscal consolidation programs across time and place. To explain this finding, we develop a life-cycle, overlapping generations economy with uninsurable labor market risk. We calibrate our model to match key characteristics of a number of European economies, in- cluding the distribution of wages and wealth, social security, taxes and debt, and study the effects of fiscal consolidation programs. We find that higher income risk induces precautionary savings behavior, which decreases the proportion of credit-constrained agents in the economy. Credit-constrained agents have less elastic labor supply re- sponses to fiscal consolidation achieved through either tax hikes or public spending cuts, and this explains the relationship between income inequality and the impact of fiscal consolidation programs. Our model produces a cross-country correlation between inequality and the fiscal consolidation multipliers, which is quite similar to that in the data. JEL codes: E21, E62, H31, H50
    Keywords: fiscal consolidation, income inequality, fiscal multipliers, public debt, income risk
    Date: 2017
  5. By: Brand, Thomas; Isoré, Marlène; Tripier, Fabien
    Abstract: We develop a business cycle model with gross flows of firm creation and destruction.The credit market is characterized by two frictions. First,entrepreneurs undergo a costly search for intermediate funding to create a firm. Second, upon a match, a costlystate-verification contract is set up. When defaults occurs, banks monitor firms, seize their assets, and a fraction of financial relationships are severed. The model is estimated using Bayesian methods for the U.S. economy. Among other shocks, uncertainty in productivity turns out to be a major contributor to both macro-financial aggregates and firm dynamics.
    JEL: D8 E3 E4 E5
    Date: 2017–11–23
  6. By: Matteo Cacciatore; Romain A Duval; Giuseppe Fiori; Fabio Ghironi
    Abstract: This paper studies the impact of product and labor market reforms when the economy faces major slack and a binding constraint on monetary policy easing. such as the zero lower bound. To this end, we build a two-country model with endogenous producer entry, labor market frictions, and nominal rigidities. We find that while the effect of market reforms depends on the cyclical conditions under which they are implemented, the zero lower bound itself does not appear to matter. In fact, when carried out in a recession, the impact of reforms is typically stronger when the zero lower bound is binding. The reason is that reforms are inflationary in our structural model (or they have no noticeable deflationary effects). Thus, contrary to the implications of reduced-form modeling of product and labor market reforms as exogenous reductions in price and wage markups, our analysis shows that there is no simple across-the-board relationship between market reforms and the behavior of real marginal costs. This significantly alters the consequences of the zero (or any effective) lower bound on policy rates.
    Date: 2017–10–03
  7. By: Zineddine Alla; Raphael A Espinoza; Atish R. Ghosh
    Abstract: We develop an open economy New Keynesian Model with foreign exchange intervention in the presence of a financial accelerator mechanism. We obtain closed-form solutions for the optimal interest rate policy and FX intervention under discretionary policy, in the face of shocks to risk appetite in international capital markets. The solution shows that FX intervention can help reduce the volatility of the economy and mitigate the welfare losses associated with such shocks. We also show that, when the financial accelerator is strong, the risk of multiple equilibria (self-fulfilling currency and inflation movements) is high. We determine the conditions under which indeterminacy can occur and highlight how the use of FX intervention reinforces the central bank’s credibility and limits the risk of multiple equilibria.
    Keywords: Foreign exchange;Central banks and their policies;Central bank reserves; Speculative attack; Portfolio balance model; Equilibrium determinacy; Capital flows; Capital controls; Open Economy New Keynesian Model, Central bank reserves, Speculative attack, Portfolio balance model, Equilibrium determinacy, Capital flows, Capital controls, Open Economy New Keynesian Model, Monetary Policy (Targets, Instruments, and Effects)
    Date: 2017–09–29
  8. By: Ambrogio Cesa-Bianchi; Emilio Fernández Corugedo
    Abstract: Are uncertainty shocks a major source of business cycle fluctuations? This paper studies the effect of a mean preserving shock to the variance of aggregate total factor productivity (macro uncertainty) and to the dispersion of entrepreneurs' idiosyncratic productivity (micro uncertainty) in a financial accelerator DSGE model with sticky prices. It explores the different mechanisms through which uncertainty shocks are propagated and amplified. The time series properties of macro and micro uncertainty are estimated using U.S. aggregate and firm-level data, respectively. While surprise increases in micro uncertainty have a larger impact on output than macro uncertainty, these account for a small (non-trivial) share of output volatility.
    Keywords: Business cycles;Uncertainty shocks, Credit frictions, uncertainty, General, Financial Markets and the Macroeconomy
    Date: 2017–09–29
  9. By: Bhamra, Harjoat Singh; Uppal, Raman
    Abstract: Households with familiarity biases tilt their portfolios toward a few risky assets. Consequently, household portfolios are underdiversified and excessively volatile. To understand the implications of underdiversification for social welfare, we solve in closed form a model of a stochastic, dynamic, general-equilibrium economy with a large number of heterogeneous firms and households that bias their investments toward a few familiar assets. We find that the direct mean-variance loss from holding an underdiversified portfolio that is excessively risky is equivalent to a reduction of 1.66% per annum in a household's portfolio return, consistent with the estimate in Calvet, Campbell, and Sodini(2007). However, we show that in a more general model with intertemporal consumption, underdiversified portfolios increase consumption-growth volatility, amplifying the mean-variance losses by a factor of four. Moreover, in general equilibrium where growth is endogenous, underdiversified portfolios distort also aggregate investment and growth even when familiarity biases in portfolios cancel out across households. We find that the overall social welfare loss is about six times as large as the direct mean-variance loss. Our results illustrate that financial markets are not a mere sideshow to the real economy and that financial literacy, regulation, and innovation that improve the financial decisions of households can have a significant positive impact on social welfare.
    Keywords: familiarity bias; growth; Portfolio choice; social welfare; underdiversification
    JEL: E44 G02 G11
    Date: 2017–11
  10. By: van der Kwaak, Christiaan; van Wijnbergen, Sweder
    Abstract: Abstract We investigate the effectiveness of fiscal stimuli when banks are undercapitalized and have large holdings of government bonds subject to sovereign default risk. Deficit-financed government purchases then crowd out private expenditure and fiscal multipliers can turn negative. Crowding out increases for longer maturity bonds and higher sovereign default risk. We estimate a DSGE model with financial frictions for Spain and find that investment crowding out indeed leads to a negative cumulative fiscal multiplier. When monetary policy is exogenous, like at the ZLB or in a currency union, fiscal stimuli become more effective but multipliers are reduced when banks are undercapitalized.
    Keywords: Financial Intermediation; Macrofinancial Fragility; Fiscal Policy; Sovereign Default Risk
    JEL: E44 E62 H30
    Date: 2017–10
  11. By: Lopez, Jose Ignacio; Olivella, Virginia
    Abstract: We study the effects of financial shocks on labor markets in a model with both labor and financial frictions, two types of productive capital, physical and intangible, and in which only the former serves as collateral. A tighter borrowing constraint in this environment leads to a fall in credit and investment, skewed in detriment of intangibles, which in its turn lowers the marginal product of labor and reduces the incentives to hire workers. When feeding into the model financial shocks estimated from the data, we find that they explain labor outcomes during the last three downturns in the US, including the sharp increase in unemployment during the great recession.
    Keywords: Financial Shocks; Intangible Assets; Business Cycles; Employment Volatility
    JEL: E24 E32 E44
    Date: 2016–03–08
  12. By: Albert Queralto; Patrick Donnelly Moran
    Abstract: To what extent can monetary policy impact business innovation and productivity growth? We use a New Keynesian model with endogenous total factor productivity (TFP) to quantify the TFP losses due to the constraints on monetary policy imposed by the zero lower bound (ZLB) and the TFP benefits of tightening monetary policy more slowly than currently anticipated. In the model, monetary policy influences firms incentives to develop and implement innovations. We use evidence on the dynamic effects of R&D and monetary shocks to estimate key parameters and assess model performance. The model suggests significant TFP losses due to the ZLB.
    Keywords: Endogenous Technology ; Business Cycles ; Monetary Policy
    JEL: E32 F41 F44 G15
    Date: 2017–11–22
  13. By: Acharya, Sushant (Federal Reserve Bank of New York); Bengui, Julien (Université de Montréal); Dogra, Keshav (Federal Reserve Bank of New York); Wee, Shu Lin (Carnegie Mellon University)
    Abstract: We present a model in which temporary shocks can permanently scar the economy's productive capacity. Unemployed workers lose skill and are expensive to retrain, generating multiple steady state unemployment rates. Large temporary shocks push the economy into a liquidity trap, generating deflation. With nominal wages unable to adjust freely, real wages rise, reducing hiring and catapulting the economy toward the high-unemployment steady state. Even after a short-lived liquidity trap, the economy recovers slowly at best; at worst, it falls into a permanent unemployment trap. Because monetary policy may be powerless to escape such a trap ex post, it is especially important to avoid it ex ante: policy should be preventive rather than curative. The model can quantitatively account for the slow recovery in the United States following the Great Recession. The model also suggests that a lack of swift monetary accommodation by the ECB can help explain stagnation in the European periphery.
    Keywords: hysteresis; monetary policy; multiple steady states; skill depreciation
    JEL: E24 E3 E5 J23 J64
    Date: 2017–11–01
  14. By: Garriga, Carlos (Federal Reserve Bank of St. Louis); Hedlund, Aaron (University of Missouri,)
    Abstract: Using a model with housing search, endogenous credit constraints, and mortgage default, this paper accounts for the housing crash from 2006 to 2011 and its implications for aggregate and cross-sectional consumption during the Great Recession. Left tail shocks to labor market uncertainty and tighter down payment requirements emerge as the key drivers. An endogenous decline in housing liquidity amplifies the recession by increasing foreclosures, contracting credit, and depressing consumption. Balance sheets act as a transmission mechanism from housing to consumption that depends on gross portfolio positions and the leverage distribution. Low interest rate policies accelerate the recovery in housing and consumption.
    Keywords: Housing; Consumption; Liquidity; Debt; Great Recession
    JEL: D31 D83 E21 E22 G11 G12 G21
    Date: 2017–10–01
  15. By: Gavazza, Alessandro; Mongey, Simon; Violante, Giovanni L
    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 economywide 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
    JEL: J1 R14 J01
    Date: 2017–11–11
  16. By: Mariacristina De Nardi; Svetlana Pashchenko; Ponpoje Porapakkarm
    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.
    JEL: E21 H31 I14
    Date: 2017–10
  17. By: Xavier Raurich (University of Barcelona, CREB and BEAT); Thomas Seegmuller (Aix-Marseille Univ. (Aix-Marseille School of Economics), CNRS, EHESS and Centrale Marseille)
    Abstract: The aim of this paper is to study the role of the distribution of income by age group on the existence of speculative bubbles. A crucial question is whether this distribution may promote a bubble associated to a larger level of capital, i.e. a productive bubble. We address these issues in a three period overlapping generations (OC) model, where productive investment done in the first period of life is a long term investment whose return occurs in the following two periods. A bubble is a short term speculative investment that facilitates intertemporal consumption smoothing. We show that the distribution of income by age group determines both the existence and the effect of bubbles on aggregate production. We also show that fiscal policy, by changing the distribution of income, may facilitate or prevent the existence of bubbles and may also modify the effect that bubbles have on aggregate production.
    Keywords: bubble, efficiency, income distribution, overlapping generations
    JEL: E22 E44
    Date: 2017–10
  18. By: Margherita Borella; Mariacristina De Nardi; Fang Yang
    Abstract: In the U.S., both taxes and old age Social Security benefits explicitly depend on one's marital status. We study the effects of eliminating these marriage-related provisions on the labor supply and savings of two different cohorts. To do so, we estimate a rich life-cycle model of couples and singles using the Method of Simulated Moments (MSM) on the 1945 and 1955 birth-year cohorts. Our model matches well the life cycle profiles of labor market participation, hours, and savings for married and single people and generates plausible elasticities of labor supply. We find that these marriage-related provisions reduce the participation of married women over their life cycle, the participation of married men after age 55, and the savings of couples. These effects are large for both the 1945 and 1955 cohorts, even though the latter had much higher labor market participation of married women to start with.
    JEL: E21 H3 H31
    Date: 2017–10
  19. By: Stephane Auray (CREST-Ensai and Universite du Littoral Cote d'Opale); Aurelien Eyquem (CREST-Ensai, GATE, UMR 5824, Universite de Lyon, and Universite Lumiere Lyon 2); Paul Gomme (Concordia University and CIREQ)
    Abstract: Following the Great Recession, U.S. government debt levels exceeded 100% of output. We develop a macroeconomic model to evaluate the role of various shocks during and after the Great Recession; labor market shocks have the greatest impact on macroeconomic activity. We then evaluate the consequences of using alternative fiscal policy instruments to implement a fiscal austerity program to return the debt-output ratio to its pre-Great Recession level. Our welfare analysis reveals that there is not much difference between applying fiscal austerity through government spending, the labor income tax, or the consumption tax; using the capital income tax is welfare-reducing.
    Keywords: fiscal policy; fiscal austerity; Great Recession
    JEL: E62 H63 E24
    Date: 2017–11
  20. By: Bhamra, Harjoat Singh; Uppal, Raman
    Abstract: A common criticism of behavioral economics is that it has not shown that the psychological biases of individual investors lead to aggregate long-run effects on both asset prices and macroeconomic quantities. Our objective is to address this criticism by providing a simple example of a production economy where individual portfolio biases cancel when summed across investors, but still have an effect on aggregate quantities that does not vanish in the long-run. Specifically, we solve in closed form a model of a stochastic general-equilibrium production economy with a large number of heterogeneous firms and investors. Investors in our model are averse to ambiguity and so hold portfolios biased toward familiar assets. We specify this bias to be unsystematic so it cancels out when aggregated across investors. However, because of holding underdiversified portfolios, investors bear more risk than necessary, which distorts the consumption of all investors in the same direction. Hence, distortions in consumption do not cancel out in the aggregate and therefore increase the price of risk and distort aggregate investment and growth. The increased risk from holding biased portfolios, which increases the demand for the risk-free asset, leading to a higher equity risk premium and a lower risk-free rate that match the values observed empirically. Furthermore, all investors survive in the long-run, and so the effects of their biases never vanish. Our analysis illustrates that idiosyncratic behavioral biases can have long-run distortionary effects on both financial markets and the macroeconomy.
    Keywords: aggregate growth; ambiguity aversion; behavioral finance; investment; underdiversification
    JEL: E44 G02 G11
    Date: 2017–11
  21. By: Yu Awaya; Hiroki Fukai; Makoto Watanabe
    Abstract: This paper presents a simple equilibrium model in which collateralized credit emerges endogenously. Just like in repos, individuals cannot commit to the use of collateral as a guarantee of repayment, and both lenders and borrowers have incentives to renege. Our theory provides a micro-foundation to justify the borrowing constraints that are widely used in the existing macroeconomic models. We provide an explanation to the question of why assets are often used as collateral, rather than simply as a means of payment, why there is a tradeoff in assets between return and liquidity, and what kinds of assets are useful as collateral.
    Keywords: collateral, search, medium of exchange, voluntary separable repeated game
    JEL: E30 E50 C73
    Date: 2017
  22. By: Verstegen, Loes (Tilburg University, School of Economics and Management)
    Abstract: This dissertation consists of three chapters on fiscal and monetary integration in Europe. The first chapter investigates quantitatively the benefits from participation in the Economic and Monetary Union for individual Euro area countries. The synthetic control method is used to estimate how real GDP per capita would have developed for the EMU member states, if those countries had not joined the EMU. The estimates show that most countries have profited from having the euro, though the crisis leads to negative effects of EMU membership. The PIGS countries in particular would have been better off if they had not been an EMU member during the crisis. The second chapter examines the effectiveness of an automatic fiscal transfer mechanism for the Economic and Monetary Union. A transfer scheme is incorporated into a DSGE model for a monetary union with an extensive fiscal sector. Using a heterogeneous setup, the model is estimated for the North and the South of Europe using Bayesian methods. The transfer mechanism is shown to be effective in stabilizing the economy of the southern block of countries during the financial crisis, although the total welfare effect for the EMU is negative, though small. Ex ante, a transfer mechanism would be beneficial for both the North and the South in terms of welfare and stabilization purposes. In the third chapter, an EMU-wide unemployment insurance is incorporated into an estimated DSGE model for the Euro area. The European unemployment benefit scheme, if introduced in 2013 replacing the regional systems, would have had positive risk sharing effects on the North and the South. If this introduction would have led to a higher level of the unemployment benefit in a region, unemployment would have increased. Ex ante, the European unemployment benefit scheme would be beneficial for both the northern and southern block of countries in terms of welfare and stabilization of employment. Labor market harmonization would lead to higher gains from European unemployment insurance.
    Date: 2017
  23. By: Luigi Bocola; Guido Lorenzoni
    Abstract: We study financial panics in a small open economy with floating exchange rates. In our model, bank runs trigger a decline in domestic wealth and a currency depreciation. Runs are more likely when banks have dollar debt. Dollar debt emerges endogenously in response to the precautionary motive of domestic savers: dollar savings provide insurance against crises; so when crises are possible it becomes relatively more expensive for banks to borrow in local currency, which gives them an incentive to issue dollar debt. This feedback between aggregate risk and savers' behavior can generate multiple equilibria, with the bad equilibrium characterized by financial dollarization and the possibility of bank runs. A domestic lender of last resort can eliminate the bad equilibrium, but interventions need to be fiscally credible. Holding foreign currency reserves hedges the fiscal position of the government and enhances its credibility, thus improving financial stability.
    JEL: E44 F34 F41 G11 G15
    Date: 2017–11
  24. By: Tarishi Matsuoka; Makoto Watanabe
    Abstract: This paper studies banks’ liquidity provision in the Lagos and Wright model of monetary exchanges. With aggregate uncertainty we show that banks sometimes exhaust their cash reserves and fail to satisfy their depositors’ need of consumption smoothing. The banking panics can be eliminated by the zero-interest policy for the perfect risk sharing, but the first best can be achieved only at the Friedman rule. In our monetary equilibrium, the probability of banking panics is endogenous and increases with inflation, as is consistent with empirical evidence. The model derives a rich array of non-trivial effects of inflation on the equilibrium deposit and the bank’s portfolio.
    Keywords: money search, monetary equilibrium, banking panic, liquidity
    JEL: E40
    Date: 2017
  25. By: Hong, Sungki (Federal Reserve Bank of St. Louis)
    Abstract: Many models in the business cycle literature generate counter-cyclical price markups. This paper examines if the prominent models in the literature are consistent with the empirical findings of micro-level markup behavior in Hong (2016). In particular, I test the markup behavior of the following two models: (i) an oligopolistic competition model, and (ii) a New Keynesian model with heterogeneous price stickiness. First, I explore the Atkeson and Burstein (2008) model of oligopolistic competition, in which markups are an increasing function of firm market shares. Coupled with an exogenous uncertainty shock as in Bloom (2009), i.e. a second-moment shock to firm productivities in recessions, this model results in a countercyclical average markup, as in the data. However, in contrast with the data, this model predicts that smaller firms reduce their markups. Second, I calibrate both Calvo and menu cost models of price stickiness to match the empirical heterogeneity in price durations across small and large firms, as in Goldberg and Hellerstein (2011). I find that both models can match the average counter-cyclicality of markups in response to monetary shocks. Furthermore, since small firms adjust prices less frequently, they exhibit greater markup counter-cyclicality, consistent with the empirical patterns. Quantitatively, however, only the menu cost model, through its selection effect, can match the extent of the empirical heterogeneity in markup cyclicality. In addition, both sticky price models imply pro-cyclical markup behavior in response to productivity shocks.
    Date: 2017–09–21
  26. By: Athreya, Kartik B. (Federal Reserve Bank of Richmond); Mustre-del-Rio, Jose (Federal Reserve Bank of Kansas City); Sanchez, Juan M. (Federal Reserve Bank of St. Louis)
    Abstract: Using recently available proprietary panel data, we show that while many (35%) US consumers experience financial distress at some point in the life cycle, most of the events of financial distress are primarily concentrated in a much smaller proportion of consumers in persistent trouble. Roughly 10% of consumers are distressed for more than a quarter of the life cycle, and less than 10% of borrowers account for half of all distress events. These facts can be largely accounted for in a straightforward extension of a workhorse model of defaultable debt that accommodates a simple form of heterogeneity in time preference but not otherwise.
    Keywords: Default; financial distress; consumer credit; credit card debt
    JEL: D60 E21 E44
    Date: 2017–11–09
  27. By: Nelson Sobrinho
    Abstract: Using an overlapping-generations growth model featuring financial intermediation, I find that inefficiencies in technology to deal with private debt distress (bankruptcy technology), and obstacles to entrepreneurship (high costs of doing business) have significant negative effects on the income per capita and welfare of developing countries. These inefficiencies may also interact in perverse ways, futher amplifying the negagtive effects in the long run. The results provide strong rationale for structural reforms that simultaneously speed up the resolution of private sector insolvency, improve creditor protection, and eliminate obstacles to entrepreneurship.
    Date: 2017–08–10
  28. By: Sebastien Menard; Solenne Tanguy
    Date: 2017
  29. By: Renato Faccini (Centre for Macroeconomics (CFM); London School of Economics and Political Science (LSE); Queen Mary, University of London); Eran Yashiv (Centre For Economic Policy Research (CEPR); Centre for Macroeconomics (CFM); London School of Economics and Political Science (LSE); Tel Aviv University)
    Abstract: The paper shows that there is an important direct role for hiring frictions in business cycles. This runs counter to key models in several strands of the macroeconomic literature, which imply that hiring frictions are not important per-se. In our model, conventional shocks yield non-standard and non-obvious macroeconomic outcomes in the presence of hiring frictions. Specifically, hiring frictions operate to offset, and possibly reverse, the effects of price frictions. This confluence of frictions has substantial effects. For a sub-set of the parameter space, model outcomes appear “frictionless,” though both hiring frictions and price frictions are at play. For a different sub-space, these interactions between the two frictions generate amplification in the responses of employment and unemployment to technology shocks, rather than friction-induced mitigation of responses. Despite the presence of price rigidity, positive technology shocks may still be expansionary in employment, and the effects of monetary policy shocks may still be negligible. We explain the underlying economic mechanisms and show their empirical implementation. In doing so, we argue in favor of the importance of explicitly using hiring frictions in business cycle modelling.
    Keywords: Hiring frictions, Business cycles, Interactions with price frictions, Endogenous wage rigidity
    JEL: E22 E24 E32 E52
    Date: 2017–11
  30. By: Greenwood, Jeremy (University of Pennsylvania); Han, Pengfei; Sanchez, Juan M. (Federal Reserve Bank of St. Louis)
    Abstract: The relationship between venture capital and growth is examined using an endogenous growth model incorporating dynamic contracts between entrepreneurs and venture capitalists. At each stage of financing, venture capitalists evaluate the viability of startups. If viable, VCs provide funding for the next stage. The success of a project depends on the amount of funding. The model is confronted with stylized facts about venture capital; viz., the average cash-on-cash multiple and statistics by funding round concerning the success rate, failure rate, investment rate, equity shares, and the value of an IPO. Raising capital gains taxation reduces growth and welfare.
    Date: 2017–08–01
  31. By: Heipertz, Jonas (Paris School of Economics); Mihov, Ilian (INSEAD); Santacreu, Ana Maria (Federal Reserve Bank of St. Louis)
    Abstract: Monetary policy research in small open economies has typically focused on “corner solutions”: either the currency rate is fixed by the central bank, or it is left to be determined by market forces. We build an open-economy model with external habits to study the properties of a new class of monetary policy rules in which the monetary authority uses the exchange rate as the instrument. Different from a Taylor rule, the monetary authority announces the rate of expected currency appreciation by taking into account inflation and output fluctuations. We find that the exchange rate rule outperforms a standard Taylor rule in terms of welfare, regardless of the policy parameter values. The differences are driven by: (i) the behavior of the nominal exchange rate and interest rates under each rule, and (ii) deviations from UIP due to a time-varying risk premium.
    Date: 2017–10–01

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